Would You Buy This Stock? Then Why Own The Bonds?
Keeping in mind Warren Buffett’s dictum to “buy, for a rational price, a piece of a business that you’re reasonably confident will have materially higher earnings 5, 10, 20 years from now, and never sell,” we hereby examine an incorporated entity which we believe represents a healthy slice of the American landscape.
The enterprise in question has been in existence for more than 200 years, and that alone is remarkable given the horrible mismanagement it has suffered over that time, particularly in the last few decades.
Looking at the income statement, we see that annual revenues approximate $15 million, which is unfortunate because expenses are running $18 million this year and are expected to rise to $20 million next year.
This upside-down “income” statement thus explains the balance sheet, which shows $17 million in general obligation debt.
Worse, the enterprise carries an eye-opening off-balance sheet liability in the form of a defined-benefits pension plan. (Our enterprise unfortunately never switched over to 401-K plans, and so it is stuck with an old-fashioned defined-benefits pension plan and its old-fashioned liabilities.)
The plan is somewhat underfunded. And by “somewhat” we mean “humongously.”
Specifically, the pension liabilities (accruing to a largely unionized workforce) stand at around $35 million.
Assets to support those liabilities, meanwhile, cruise in at a cool $4 million.
So on top of the $17 million in debt outstanding, add a $31 million unfunded pension obligation—and consider that we have no details on the assets themselves or the assumptions used to define the liabilities, so the net obligation could be worse.
All in all, our enterprise generates negative pre-tax income but carries close to $50 million in debt and long-term obligations.
So, to our question, “Would you buy this stock?” the answer, of course, is “No.”You’d pass on the opportunity to buy, and you might even sell it short.
And maybe—after the poor suckers who own the bonds really take the place over, clean house and install good management—you’d revisit the situation.
The “enterprise” in question is not, however, a company in the publicly-traded sense of the term.
It is a city—Central Falls, Rhode Island—whose tale of woe was only partly told in yesterday’s Wall Street Journal, and it is a stark sign of things to come for America’s municipalities.
For while Central Falls appears to have been run into the ground by its own unique blend of corruption and unsupportable promises to unionized employees—according to the Providence Journal, the mayor hired an old pal to board up 200 abandoned buildings at an average cost of $10,000 a piece, while nearby Providence pays $660 a house—it is by no means alone.
Indeed, our backyards teem with thousands of Greeces and Hungarys that, like Central Falls, are in far worse shape than those countries. They are already bankrupt in fact, if not in name.
Yet, oddly, for now, the world—and American fixed income players—seem to focus exclusively on the problems of Greece and Hungary, Spain and, perhaps even the United Kingdom, while using the American Dollar and our own long-term debt obligations as what the press likes to call “safe havens.”
But if you wouldn’t own them as an imagined stock, why would you own their very real bonds?
Jeff Matthews I Am Not Making This Up
© 2010 NotMakingThisUp, LLC Photo Courtesy of Providence Journal
The content contained in this blog represents only the opinions of Mr. Matthews, who also acts as an advisor: clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations. This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever. Also, this blog is not a solicitation of business: all inquiries will be ignored. The content herein is intended solely for the entertainment of the reader, and the author.