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Short Screen offers tools and ideas for short sellers, including a screener that pulls up companies predicted to go bankrupt by their Altman Z-scores. Here is a link to a third party review of the site, Screening Stocks for Short Selling. Here is a link to a post dealing with some common questions about short selling and risk.

Thanks for reading

And thanks especially to those of you who left intelligent comments here.

I'd been planning to shut this blog down when I started the new ones (which my crack design agency still hasn't finished yet), and link to the new blogs here, but now I think maybe it's better just to start fresh. I got that idea over the weekend, based on the reaction to a subsequently deleted post. I knew blogging was mostly pointless going into it, but that was just another reminder of that.

I'll still be blogging, for a while at least, at the new blogs, as I have a new subscription-based site to promote. Perhaps I'll see a few of you there. Goodbye and best of luck in the new year to the to the rest of you.

New short position: UAUA

With the Nasdaq near a 14-month high, and the VIX near a 14-month low, I have been building a basket of out-of-the-market puts on financially-distressed stocks drawn from Short Screen's screener¹. Today's addition to this basket are the $6 strike, JUN 10 puts on United Airlines parent UAL Corporation (Nasdaq: UAUA), UALRK.X. I bought a few of these today at $0.40.

Warren Buffett famously noted how awful airline stocks have long been as investments, quipping,

I like to think that if I'd been at Kitty Hawk in 1903 when Orville Wright took off, I would have been farsighted enough, and public-spirited enough--I owed this to future capitalists--to shoot him down. I mean, Karl Marx couldn't have done as much damage to capitalists as Orville did.

Despite Buffett's old admonition, investors have bid up shares of UAL to more than four times their low for the year in June. Like those of many risky companies, shares of UAL have been buoyed by the liquidity-fueled rally this year, despite having persistently weak fundamentals. In addition to having an Altman Z"-score of approximately -2.1, according to Short Screen's calculator (scores below 1.1 indicate distress, according to the model), UAL has lost money in three of its last four quarters, and has a current ratio of approximately .68, indicating that its debt burden is a near-term challenge as well as a longer-term one. Over the last year, according to Nasdaq, there have been 7 insider sales and no insider buys. I expect shares of UAL to decline when the euphoria of the current market rally fades and reality sets in again.


¹For those unfamiliar with it, Short Screen's screener uses the Altman Z-score model (for manufacturing companies) and the Altman Z"-score model (for non-manufacturing companies) to rank stocks according to their level of financial distress. In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event, with a Type II error of 6%. In a series of subsequent tests covering three different time periods over the next 31 years, the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event, with a Type II error of approximately 15-20%. For more detail on the models, and on how Short Screen's screener works, please see here.

VMED Update

Apparently, I'm not the only one who decided to bet against VMED recently. Short interest on VMED spiked 43% in the first two weeks of December.

What would have been spectacular timing

A day late. Damn. Details later.

Update: Here are the details I didn't have time to write about earlier. Sorry about not writing this out earlier, but it takes me a while to write these posts, and I just didn't have the time to do that earlier today, so I posted that as a placeholder.

As I mentioned in a previous post, the biggest risk I see with Alloy Steel International (OTC BB: AYSI.OB) is, "a nasty exogenous event (e.g., a big fall-off in Chinese demand for industrial commodities¹)". For companies that have options traded on them, you can of course buy puts on the company to hedge your position. How, exactly, to do that in an optimal way is what the next subscription-based site, Portfolio Armor, is about (Portfolio Armor isn't live just yet, but that's its logo above²). Portfolio Armor's proprietary algorithm tells you exactly how many of which put options to buy to give you the level of protection you specify at the lowest cost.

Of course, Alloy Steel doesn't have any options traded on it, so there would be no way to use options to hedge against any purely idiosyncratic risk, but there are ways to hedge against the exogenous risk. I thought about this last night and figured that a way to do that would be to buy puts on a steel company with significant exposure to China. Then I figured, instead of using just any steel company with exposure to China, why not try to find a financially distressed one? I found just such a company using the screener on Short Screen. To give me a rough idea of how many of which of that company's puts to buy to hedge my AYSI position against the specific exogenous risk I mentioned above, I e-mailed my developers at around 8:30 am, asking them to run the algorithm on the steel company I found. When I got the answer from them later, I went to pull up the option and learned that the financially distressed steel company had announced a secondary offering at around 9am today, and on news of that dilution the stock dropped more than 20%, and the optimal put contract spiked more than 50%. Too bad I didn't think of this a day earlier.


¹That's the big question. We presented the positive view on China this post back in September, "China's new self-propelled economy", and the editors of the FT presented the scary view in this editorial last month, "The cost of China’s excess capacity". In a nutshell, the positive scenario: China's big stimulus this year has helped transition its economy to one fueled more by internal demand, in which case there should be continued growing demand for industrial commodities to build infrastructure in underdeveloped parts of China, manufacture first refrigerators for rural Chinese, etc. And the negative scenario: China's stimulus has been mainly hair of the dog, propping up an unsustainable status quo relying on massive trade surpluses that over-extended Western consumers can no longer support.

²Recall our discussion in this recent post of the initial challenges in coming up with this logo.

Alloy Steel's 10-K

Alloy Steel International (AYSI.OB) filed its 10-K today. I haven't had a chance to go over it in detail yet, but it looks like the big BHP deal that was announced during the AYSI's Q4 contributed less to earnings that quarter than expected. If my arithmetic is correct (the company didn't break out the Q4 numbers in its annual), Q4 earnings came in at 1.86 cents, which is well below my guess of record earnings that quarter, and well below the result of my small survey which found that earnings of about 5.6 cents would be needed to support the stock price above $2.20. I would expect the stock to drop below $2 today, but we'll see.

The 10-K does note that,

The gross profit and subsequent operating profit has been affected by the expensing as required under US GAAP of the materials consumed in the testing and tuning of the new mill. This would amount approximately to $900,000.

$900k = ~5.2 cents per share, so it could be we all underestimated how much the testing and tuning would eat into earnings in Q4. Then again, as the company doesn't break the numbers down by quarter, it's unclear how much of that cost was incurred in Q4. Something to consider going forward, considering that the company has announced plans for building additional mills next year: the ramp-up costs for the expansion related to the BHP deal and other business may eat into earnings more than previously anticipated in the next few quarters.

Update: Initially, I wasn't going to mention this, but its mention by a commenter on iHub made me think of something: the company also announced in its 10-K that it anticipated hiring 3 additional manufacturing workers in the next year. That's good news on its face, but it does make me wonder if they are still planning to build additional mills next year -- I'd think they'd need more than three additional manufacturing workers to run one new mill, let alone the two mentioned in September's press release. Just e-mailed the company, asking to confirm if they are still planning on building those two new mills in 2010.

Second Update: Alloy Steel's Malaga headquarters is shut down for its Christmas break, but I was able to get a hold of Alloy Steel's Brisbane-based International Manager Gregg Muller. Gregg says Alloy Steel's domestic sales reps report to him and he also handles international sales, freeing up Gene to focus more on R&D and manufacturing. Gregg was kind enough to spend an hour on the phone with me just now, and he answered a number of questions. Some notes from our conversation follow.

New mills:

- The third mill is currently about 3/4ths built. Gregg says these mills take about four months to build and another two months to test. They take that long to build because Alloy Steel builds the mills itself, partly to protect its proprietary technology, and partly because they have to build components that they can't get off the shelf. Greg estimates the third mill will be producing product by March or April. After that, he believes the company will start building the fourth mill. He says the third mill will be bigger than the second mill. Not sure, but he believes the intent is to finance the construction of mills three and four out of cash flow, as the previous one was.

Additional employees:

- Greg says it only takes 3 employees per shift to run a mill. The mills are computer controlled, and not labor intensive. At maximum capacity, they would run two 12 hour shifts. Prior to the Christmas break, the mills were running about 18-20 hours per day. He anticipates they might approach 24 hours per day by the end of January. Prior to the BHP deal, they were down to about 10 hours per day. Gregg agreed that it would seem the company would need to hire more than three additional workers to run two new mills.

Current international business:

- Greg said the company has been active working with distributers in Chile and India, and he expects to close deal with a Brazilian distributer when he travels there in February. He started talking with this distributer six months ago. That distributer would be supplying Vale in Brazil, in addition to possibly other companies.

Indonesia:

- The outpost in Indonesia will start as a sales office, which is scheduled to open at the end of January. Greg says it only takes about 12 days to ship product there from Perth. If all goes well, Gregg says the company may build a mill in Indonesia toward the end of next year. If so, that would be the company's fifth mill.

Mongolia:

- Greg was last in Mongolia in October. The largest undeveloped copper mine in the world Oyu Tolgoi finally got the go-ahead from the Mongolian government a few months ago, after 7 years of delays. Gregg has heard that they are expecting to be moving dirt by 2011. Alloy Steel is looking to circle back with Geomandel in 2010 so they are ready for 2011. Also talking to OEMs that will be working on the project.

3-D cladding process:

- Not currently manufacturing or marketing it; currently focused on wear plates. Believes it could be a logical follow-up product sale to current clients down the road though. Might get more tweaking by Gene before then.

New developments with Super Arcoplate:

- Greg says they can now produce plate with a thickness of 1.25 inches, or 31 millimeters. He says they are trying to perfect producing a plate with 1.5 inch thickness, which will get them into casting, and open up new business possibilities. The 3rd mill is being set up so that it can produce plate an inch and a half thick once that level of thickness is perfected.

Math without end, amen

In the comments of a previous post, Commenter J.K. linked to this Discover interview with cosmologist Max Tegmark, "Is the Universe Actually Made of Math?". Worth reading in full, if you are interested in this sort of thing, but here are a few excerpts from the interview that start in media res.

That brings us to the last level: the level IV multiverse intimately tied up with your mathematical universe, the “crackpot idea” you were once warned against. Perhaps we should start there.

I begin with something more basic. You can call it the external reality hypothesis, which is the assumption that there is a reality out there that is independent of us. I think most physicists would agree with this idea.

The question then becomes, what is the nature of this external reality?

If a reality exists independently of us, it must be free from the language that we use to describe it. There should be no human baggage.


I see where you’re heading. Without these descriptors, we’re left with only math.

The physicist Eugene Wigner wrote a famous essay in the 1960s called “The Unreasonable Effectiveness of Mathematics in the Natural Sciences.” In that essay he asked why nature is so accurately described by mathematics. The question did not start with him. As far back as Pythagoras in the ancient Greek era, there was the idea that the universe was built on mathematics. In the 17th century Galileo eloquently wrote that nature is a “grand book” that is “written in the language of mathematics.” Then, of course, there was the great Greek philosopher Plato, who said the objects of mathematics really exist.

How does your mathematical universe hypothesis fit in?

Well, Galileo and Wigner and lots of other scientists would argue that abstract mathematics “describes” reality. Plato would say that mathematics exists somewhere out there as an ideal reality. I am working in between. I have this sort of crazy-sounding idea that the reason why mathematics is so effective at describing reality is that it is reality. That is the mathematical universe hypothesis: Mathematical things actually exist, and they are actually physical reality.

[...]

But why do some equations describe our universe so perfectly and others not so much?

Stephen Hawking once asked it this way: “What is it that breathes fire into the equations and makes a universe for them to describe?” If I am right and the cosmos is just mathematics, then no fire-breathing is required. A mathematical structure doesn’t describe a universe, it is a universe. The existence of the level IV multiverse also answers another question that has bothered people for a long time. John Wheeler put it this way: Even if we found equations that describe our universe perfectly, then why these particular equations and not others? The answer is that the other equations govern other, parallel universes, and that our universe has these particular equations because they are just statistically likely, given the distribution of mathematical structures that can support observers like us.