Sex Sells, Bargain Basement Price

We are analyzing a special situation with American Apparel ($APP). As background, $APP secured rescue capital from Michael Serruya and Delavaco Capital on April 26 to help $APP avoid filing for bankruptcy. The company was able to re-negotiate the terms of their debt to avoid default provisions triggered when 2010 financial statements contained a “going concern” clause. At that time we initiated a very small long position in the stock, and we have been monitoring the situation ever since.

We think $APP offers a good risk/reward profile, with high risk but higher reward potential. It gets even better if the final deal goes through.

Today $APP announced plans to replace 2 of their directors. We think this is good news for the stock, and we added to our small position. Here are the main points:

● Serruya and Delavaco Capital bought 15.8mm shares at $0.90 per share. They have the option to buy another 27.4mm shares at $0.90 within 6 months of the initial investment [October 26]

● As part of the terms of the investment, the CEO of the company has an anti-dilution provision. If $APP reaches stock price performance goals of $3.25 by 2013, $4.25by 2014, and $5.25 by 2015, the CEO receives a total of 39.7mm additional shares. The likelihood of trading at these levels is elevated.

● The company’s 2010 sales were $533mm. Costs are high in both Cost of Goods and Selling / General & Administrative costs, but with some cost-cutting measures the company may be able to return to profitability.

● Total debt is well-collateralized:

Long-Term Debt as of Year End 2010: Total $139mm
Revolving Credit Facility at Bank of America, $75mm, $53.4mm is drawn, due July 2012
Term Loan at Lion, $81.2mm matures Dec 31, 2013

Assets as Collateral for Debt (as of Year End 2010): Total $287.3mm
Cash $7.6mm
Accounts Receivable $16.7mm
Inventory $178mm
Property and Equipment $85mm

● The company may now have enough time to return to profitability before cash runs out. The current rescue investment is for $15mm immediately plus an additional $25mm over the next 6 months at the discretion of the investor, for a total potential cash infusion of $40mm this year. Total cash usage for operating activities was $32mm in 2010, although it should be noted that in 2010 the company reduced inventory by $37mm (20%).

● The company is scheduled to announce earnings on August 1.

● All bets are off if the final tranche of the deal does not go through.

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.

Update on Thursday, July 7, 2011 at 12:32PM by Michael Bigger

Today APP announced sales numbers for the quarter ended June.  Sales were flat relative to last year’s June quarter, $132mm, despite a decrease in the number of stores.  We think this is very positive for the company.  Wholesale sales were down 4%, with the implication that retail / online sales made up the deficit.  We think this is a positive for operating margins.  We think of this company as a potential turnaround story, and today’s news represents confirmation that numbers are starting to turn around.  The earnings report is scheduled for August 1.

Apple and Salesforce.com Spread Temptation

In our statistically driven spread book we occasionally come across a spread that we had traded a few weeks before for a profit, which has returned to the price in which we originally entered the trade.  If the spread still meets all of our statistical criteria we will happily enter the trade.  But what do we do if all the criteria aren’t met.  It might be tempting to trade anyway, after all if the entry level is the same as it was two or three weeks ago, why not? But we believe the correct thing to do is to adhere strictly to our process. We started thinking about this earlier this week as a spread we had traded successfully in May, $AAPL - $CRM, approached the price at which we had entered the trade in late May.  But this time the stats said the spread was no longer cointegrated, and since cointegration is a major component of our trading rules we won’t trade this one again until it is cointegrated, even if it does hit the original level.

 

To be honest we haven’t always held fast to our processes, but we know we are better traders when we do.

      

Written by Norm Winer. Follow me on Twitter and StockTwits.

CockRoach Theory Applied to SuperValu

SuperValu ($SVU) is a company that we have been following since it’s most recent earnings release on April 14.  The stock has performed poorly in recent years.  On April 14 the company announced earnings of $0.44 compared to consensus estimate of $0.34.  The stock opened up 12%.  Since then, the stock continued to rally for a few weeks before declining back to below the post-earnings level.  It has rallied slightly from the lows of last week: 

 

Click to enlarge.

 

 

$SVU is scheduled to release earnings on July 25.  Consensus estimate is $0.33 per share, significantly below last quarter actual $0.44.  We think there is value in Supervalu ahead of this earnings release. Competitors, including $WINN and $KR, reported strong earnings recently, and the Cockroach Theory states that whenever you see a roach there are usually more hiding.  In this case the competitor earnings are the visible roaches, and we think SVU is hiding a roach (good earnings) as well.  

 

The chart below shows $SVU in blue compared to $WINN in red and $KR in green.  As you can see, $SVU has declined significantly compared to its peers since the weeks following its last earnings release.   It has started to tick higher, but we think it has more room to run ahead of July 25 earnings. This is the bias we have in trading $SVU at the moment. We are very active in trading spreads of $SVU against other instruments:

 

Click to enlarge.

 

 

$SVU has a new management team focused on cutting costs and branding. Consumers are still budget-conscious, to the benefit of low-cost grocery stores such as $SVU.  When investors start to focus on the next round of earnings, SVU could benefit.  That said, there are risks to our bullish view. Grocery retailing is a competitive business.  $SVU still struggles to draw customer loyalty to its brand, and big chains like $WMT and $TGT continue to expand grocery product offerings.  $SVU faces an uphill battle against these competitors and a headwind of high unemployment and fears about the economy.

 

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.

Beauty Contests

I want to thank Twitter user bluenextbear for bringing this article to my attention. I enjoyed it so much, I decided to share it with you. - Michael

 

Who's a pretty boy then? Or beauty contests, rationality and greater fools

Being Short Regeneron

We will probably jinx ourselves by writing this post, but here we go.  When trading spreads we often worry about one side gapping against us, especially the short side.  That said it seems more often than not we benefit from gaps or sharp stock moves in our spread book.  We began thinking about this Friday afternoon when a stock we were short, Regeneron Pharmaceuticals ($REGN), was halted pending news.  The news was positive, but the stock opened only about 4% higher and eventually traded below yesterday’s close.  I can think of a few examples over the past two months in which we benefitted from a plus or minus 10% move in a stock, including yesterday when Darling International ($DAR), a short of ours, was at one point down 15% on news that the Senate approved an amendment ending ethanol subsidies.

Assuming I don’t have selective memory and I have observed enough data, why is it that we seem to win more than lose from gaps?  I think it has to do with the nature of our methodology.  We are trading spreads based on statistics.  We enter a trade when the spread is a certain number of standard deviations from the mean.  So we are often buying stocks that are trading at historically low values, or selling stocks that are trading at historically high values, or some combination of the two.  So our longs don’t have a lot of room left to fall and our shorts don’t have a lot of room left to soar.  In a book of 50 plus spreads we occasionally take a hit, but so far the gaps have been in our favor.

Written by Norm Winer. Follow me on Twitter and StockTwits.

Trading Education: Techniques or Insight?

I read this passage from Howard Marks’s book titled The Most Important Thing: Uncommon Sense for the Thoughtful Investor:

In my view, that’s the definition of successful investing: doing better than the market and other investors. To accomplish that, you need either good luck or superior insight. Counting on luck isn’t much of a plan, so you’d better concentrate on insight. In basketball they say, “You can’t coach height,” meaning all the coaching in the world won’t make a player taller. It’s almost as hard to teach insight. As with any other art form, some people just understand investing better than others. They have—or manage to acquire—that necessary “trace of wisdom” that Ben Graham so eloquently calls for.

This comment got me thinking about trading education:

• Is trading education useless to a trader who lacks insight?
• How do you teach the art of being insightful?
• For an insightful trader, education is a way to add techniques to the trading toolkit. How much should he pay to acquire something that is widely available?
• If augmenting one's insightfulness is so important, where are all the schools of insight?
• Isn't it disappointing to rarely see the word “insight” in most education marketing material?
• Are we thinking about education in a Newtonian kind of way (Industrial Age-Euclidian-Time space) and missing what education could be in an insight-Internet-time-augmented human’s space?
• Is the cost of learning techniques fast approaching zero and the value of insight increasing to infinity?
• What is trading education’s adjacent possible?

Help me clarify my thoughts on the subject.

Written by Michael Bigger. Follow me on Twitter and StockTwits.

P.S. I want to thank Todd Sullivan for introducing me to Howard marks' book

Howard Marks, The Most Important Thing: Uncommon Sense for the Thoughtful Investor (New York: Columbia University Press, 2011), Kindle edition, 2.

Winning and Losing

I recently saw a tweet by @FledglingTrader that I thought was very interesting:

“I’ll forget about the Miami Heat loss, just like I forget when my stop-loss is hit.  It’s all part of the game”

The reason I found it so interesting is because it is so difficult (yet so important) to move past our losses in life and in trading so that we can focus on our wins.  It is so common to beat yourself up about a loss, revisiting it and focusing on it.  “How could I not see that I was wrong early on?  Why did I not close the position sooner?”  When we look back at the day, we tend to agonize about our losses rather than celebrate our wins.

Of course, there is something to be learned from our mistakes.  But we would learn so much more if we spent as much time learning from our successes as we do from our mistakes.

If your system is advantaged, you can expect to have some wins and some losses as part of the head and tail equation (slightly skewed). Use both to improve your system

What was your biggest win today?

Written by Jennifer Galperin. Follow me on Twitter and StockTwits.

Licking Our Wounds

We decided to unwind our short $GLD-$GDX spread this week. We first went short on the spread in April and have averaged down a couple of times since as the spread continued to climb. The spread seemed to finally turn around at the end of May before turning sharply higher again the past week. What do you do in a situation like this? Add more? Unwind all or part? Buy more $GDX?

We’re not sure there is one right answer, but we can tell you why we chose to unwind. We felt that something has obviously changed in the market sentiment regarding the mining stocks since we put on the spread. Gold has held its own the past two months as other commodities sold off, but the gold mining stocks haven’t performed well. This doesn’t feel like a short-term liquidity gap. Also, overall stock market sentiment seems bearish, something that won’t help the mining stocks. Lastly, although $GLD-$GDX is trading at the highest level since the financial crisis, there is no reason why it won’t continue to grow higher to crisis levels. And that would mean additional losses. So we unwind now, lick our wounds, and perhaps return later in a stronger position.

Written by Norm Winer. Follow me on Twitter and StockTwits.

The Season Invariant Professional Trader

Mike Bellafiore wrote a great post about the unprofessional summer trader. You can read it here.

Every post that makes me think hard is a heck of a great post in my book. Mike’s post is awesome and obviously his recipes are working wonderfully for his firm.

At Bigger Capital, we are using a different approach to trading. We define our trading space not as humans operating in a 3 dimensional space in New York, facing their terminals all day long. We are after something else.

We are looking for the best brains we can find on a global basis. Our business is to empower these potential traders to create trading systems that scale; systems that do not require the creator to be present in front of a terminal all day long. We incorporate these traders’ insights into our global algorithmic trading system. Their brains become the algorithm and vice versa. Think of it as a virtual augmented brain. We define our trading space this way.

We have no patience for the common wisdoms permeating Wall Street firms. We are agnostic to the life style of our traders. Some of them have full time jobs, one of them is a very busy mother and she works from home.

Our requisite is that they be very smart, creative, and that they contribute in awesome ways to make our vision a reality.

One of our traders is somewhere in Europe on vacation. His algorithm, the output of his neurons, is hard at work without his presence. That is how we want things to operate around here.

If I go kiteboarding this afternoon, I will most likely experience coming down a big wave on a strapless surfboard, with the kite high in the sky. At that precise moment I will be experiencing ultimate flow; the balance between water, air, speed, me, transcendence, and so forth. I become one with nature and away from the markets I often stumble on some wonderful investing and trading insights. These activities also define who we are as traders.

Thoughts?

Written by Michael Bigger. Follow me on Twitter and StockTwits.

The Art of Becoming a Better Trader

I have told the following story in a few blog posts.

When I traded single stock derivatives at D.E. Shaw, my boss traded S&P options and he made money consistently though he took very little risk. He was a trading magician. He knew his options market, especially the S&P, and he knew how to trade spreads. He constantly traded in and out, squeezing juice out of the lemon. The lemon never ran out of juice! It was a wonderful thing—a winning trading method.

He started his career trading options for O’Connor & Associates, and then worked for Swiss Bank before joining D.E. Shaw. Both of these were great trading houses at the time.

Most of the best traders I have met, trade spreads. They spread different options, stocks versus stocks, indices, stocks against indices, etc. The number of combinations is endless. They are good at identifying pockets of value amongst the securities they trade and they rotate their inventory to take advantage of these discrepancies with no net increase in market exposure.

Gaining exposure to spread trading can help you become a much better trader. At a minimum asking: What else can we trade against this? Or; Can I get this exposure at a more advantaged level? The answers to these questions will augment your thinking about extracting more value out of the system.

When you start looking at the trading world from the point of view of trading a security against another one, you will:

• Analyze the economics of both legs.
• Hone your ability to identify value within the set.
• Remove some of the market noise from the equation.
• Establish a better basis for comparison and analysis.
• Investigate new areas for exploration.
• Understand the meaning of “hedge”, of “elastic forces”, “Brownian motion”, "half life", "Intersection of self influencing stochastic processes", and so forth.
• Think in terms of capital efficiency and velocity.
• Discover powerful trading patterns not visible using traditional charting methods.

Does this make sense to you? Did you learn anything? We are putting the final touches on our spread trading educational program. The program will introduce trading concepts you have never heard before. Stay tuned.

Written by Michael Bigger. Follow me on Twitter and StockTwits.