November 30, 2007

ETFC Saved!

AH, SUCCESS. How I love it. As Loyal Rant Readers know, a few weeks back I bought a tiny number of shares in E*TRADE Financial Corp. (NASD:ETFC) at roughly $4.21 per share. Immediately after I did so, the stock skyrocketed and I have been completely insufferable ever since. For it was a completely speculative play but one that -- so far, anyway -- has actually paid off. Thursday, we got good news about ETFC -- at least for investors like me. Day traders, not so much. But we'll get back to that in a bit.

First, the good news. Citadel Investment Group agreed to inject some $2.5 billion in capital into E*Trade, which had been flailing about like a clothesline in a gale. The Wall Street Journal has a great story on how the deal came together -- it's really wonderful reporting. Anyway, the gist of the deal is this:


* Citadel bought E*Trade's crappy $3 billion portfolio of asset-backed securities for roughly $800 million, which works out to 27 cents on the dollar. The bad news is that E*Trade will take a $2.2 billion loss on the portfolio. The good news is that E*Trade doesn't have the damn thing hanging over its head any more, and now someone else can worry about the portfolio and its tranches (crap, super-crap, and uber-crap). And hey -- 27 cents on the dollar beats zero cents on the dollar.

* Citadel is pumping $1.75 billion into E*Trade. In return for this, Citadel will end up with roughly 20 pc of the company and get paid 12.5 pc per annum on ten-year notes. It's getting roughly 84 million shares of ETFC, which have a market value today of about $420 million. That's like the cherry on top the sundae of $1.75 billion in ten-year notes. Those notes should be very profitable in the meantime for Citadel, and could especially be so depending on how the notes are structured.

The good news is that E*Trade gets a bunch of cash it needs. The bad news is that E*Trade's managers have diluted the stock in agreeing to the deal, meaning less earnings in future for tiny shareholders like me. Also, the debt payments will reduce those earnings even further. But I don't have $1.75 billion, so I'm not complaining until my position goes under water.

* Citadel gets a seat on the board. This is good because it means the hedge fund will continually go after management to boost the company's valuation, which is good for speculators like me.


Now, the announcement of this deal also brought other things to light: perhaps most notably, it brought to light more proof that day traders are generally stupid. Particularly day traders who post messages on Internet bulletin boards. Consider: when the deal was announced, the stock shot up -- it opened at more than $6 per share. At the end of the day, the stock price actually went down and closed at $4.82 per share. Then, in after hours trading, it went back up to $5.06!

Quite frankly, I could care less because I bought in at $4.21. Furthermore, since my entire position is predicated on the assumption the whole thing could blow up tomorrow and I'll be out the whole thing, I can live with fluctuations -- and I'm happy as long as it stays above $4.22. (Well, above $5 would be nice). But my God! the caterwauling from the day traders who are getting blown out after having bought in the high $5 range!

Here are some of my favorite discussion threads on Google:


"What's moving this down ... shorts being covered?" *

(BJK: "And Ivan Ackerman -- always the wrong answer. Always.")

"Why is it falling?" **

(BJK: Key quote from discussion: "I bought this at 6.03 at opening. What do you suggest guys?Should I retain for next day trade or sell out?" Uh oh.)

"I am worried." ***

(BJK: The writer of this bought at $5.47 per share and lost $600 by COB. Now he's got a case of nerves?)


Aside from that, though, as details of the deal emerged, it became pretty clear that Citadel hit a home run in offering a deal that E*Trade felt it couldn't refuse. So I have to congratulate them on their cleverness, because it seems almost certain they'll make a boatload of profit off these transactions. Still, even with Citadel sinking its claws into E*Trade, I'm not yet convinced they have sunk deep enough to cause any lasting damage. Instead, they have probably rescued a company that was dangling from a cliff -- and now E*Trade can move forward, hopefully without too many nasty surprises in store.



* Sorry, I couldn't resist being snotty there, but it boggles the mind that an investor -- much less a speculator -- would have such a wrong impression about short-selling. I mean, there's a lot of money on the line here.

For those readers not investing-minded, a "short" seller is someone who essentially bets the price of a stock is going to go down. He borrows the shares from someone else to get the transaction started, and when he divests himself of the position he buys the shares back. Thus, if a speculator shorts 100 shares of a stock at $6 and the price drops to $4, he reaps $200 on the deal. But in buying the stock back, he contributes to its price going up, not down.

** Indeed, why does a stock fall? Truly there are as many reasons as there are grains of sand upon the beach, or as there are stars in the sky. And yet, sometimes, there is no reason at all. It just is. Become one with the ebb and flow of the market, and you will achieve enlightenment. Or you could just stop checking the price constantly, which also helps in that regard.

*** Scared money does not a good investment make. Particularly when it's, you know, an investment in the most volatile frickin' stock we've seen in years.


OBLIGATORY DISCLAIMER: I can't emphasize how great the risks are associated with speculating in ETFC right now, so don't buy anything just because I put in a tiny amount of cash into this. I mean, my God. It's probably one of the most volatile stocks on the market today, it's bouncing back and forth like a ping-pong ball at a table tennis tournament, and it's still conceivable the whole thing will blow up. In short, the risk of losing money is very high and you should discuss this with an actual financial professional before you make an investment decision. Better yet, take the money and buy some nice Christmas presents for the kids.

Posted by Benjamin Kepple at November 30, 2007 12:42 AM | TrackBack
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