Asset Impairment

The original Pirate Investor highlights the greatest threat to your wealth today…paper assets.

Beginning around 100 AD, the cost of maintaining Rome’s armies could no longer be carried by the government. For the next 200 years, each successive Roman emperor had to pay the army more money to ensure its loyalty. The primary means to achieve these pay hikes was to lower the silver content of the coin, the antoniniani.

The same thing has happened in the United States, although it’s not the military that must be bought, it’s the voters. Over the last 100 years, the U.S. dollar has lost perhaps as much as 90% of its purchasing power through the government-led debasement of the currency. The winning political formula is to promise everything to everyone. Meanwhile, the first law of economics is scarcity.

Paper money is the bridge between politics and reality. And it’s not just the government’s money that’s regularly debased by the elite in order to maintain control…

Did you know that since 1999 almost every Dow Jones Industrial Average stock has recorded a major charge against equity?

These charges total over $125 billion in just the last three years. In 2001 alone, fully half of the Dow stocks took charges of at least $500 million. American Express wrote down over $1 billion lost to bad high-yield securities. AT&T wrote down $2.5 billion in worthless telecom assets. Proctor & Gamble wrote down $1.9 billion in "accelerated depreciation," which is another way of saying management made a big mistake.

Walt Disney wrote down $1.5 billion in equity because of "asset impairment." If you hold these big corporations in your portfolio, the assets behind the paper you own are disappearing.

But the Dow is only the beginning. Out in Silicon Valley – where I have spent a lot of time looking for quality high- tech investments – the shenanigans with your ‘wealth’ have been even worse.

In this space several months ago, I warned you about the abuse of stock options that has become a way of life in Silicon Valley. I recommended short selling a particularly aggressive issuer of options: Maxim Integrated Products. As I showed you during that essay, if you charged the company for the options it issued, Maxim wouldn’t have earned the $1.27 per share it reported in 2000. It would only have made $0.56. (Maxim’s shares fell more than 40% following that Daily Reckoning piece). And there are many more abuses.

According to the rules of GAAP accounting, Cypress Semiconductor earned $223 million from operations in the last five years. But, as I recently pointed out in an open letter to CEO T.J. Rodgers, that figure doesn’t account for ‘one-time’ charges that repeat every year. Nor does it factor in the consistently rising cash cost of capital expenditures in the semiconductor industry. And, most importantly, because investors pay the cost of stock options, not the company, it doesn’t factor in one of the company’s principle expenses: compensation.

These expenses, whether or not T.J. Rodgers desires to include them in his ‘pro forma’ earnings report that he gives to Wall Street (and defends in the media), have an impact on his company’s balance sheet…and an even bigger impact on yours. When you include all costs, rather than making $223 million over the last five years, the true value of Cypress’s contribution to our economy was a loss of $503 million.

If you doubt my figures, consider that in 1999 – at the height of the biggest boom of all time in the semiconductor industry – Cypress had to take out a $500 million loan. For the first time ever, the company would carry a significant amount of debt on its balance sheet. If the company was really earnings millions each year, why borrow money? And why that much?

Today the firm’s debt load stands at $517 million, and in the midst of an industry crash, this debt threatens to absorb the entire equity value of the company. Since I published my letter, shares have fallen from $12.00 to under $5.00, and Cypress has not rebounded strongly with the rest of the sector over the past two weeks. Frankly, its currency has been debased.

Why are these financial abuses tolerated in our society, by our culture? I don’t believe anyone can fully answer that question. Organized, systematic fraud has always been a part of large economic systems – since the Romans at least. Governments plunder taxpayers. Corporations plunder shareholders. Individuals return the favor with plaintiff lawsuits inspired by their own mistakes. We’re becoming a society of kleptomaniacs. Move over, Albania.

In the case of options accounting, many vested interests are at stake. The beneficiaries of options grand theft – certain CEOs and top officers – become major campaign donors and top clients of legal, accounting and investment firms. The accounting experts and many large institutional investors don’t want to make it easy for you, the individual investor, to figure out what a company is really earning (otherwise you wouldn’t need them). And, of course, almost every public company wants to look profitable, even more so than it seeks to be profitable.

So, when Bristol-Myers tries to write off $1.2 billion on an investment in ImClone (that everyone in the industry knew was a bad decision to start with) as a mistake that can’t be accounted for…or when MedImmune uses $1.6 billion of your stock to buy a drug from Aviron that has never worked (and still doesn’t)…or when CEOs with more ego than sense use your equity to legally enrich themselves and their top lieutenants…

The only real loser is you, the investor. Everyone else goes back to work on Monday.


Porter Stansberry
for The Daily Reckoning
October 29, 2002

Editor’s Note: Porter Stansberry is the founder of Pirate Investor, publishers of high-quality investment research.

Mall walkers, we read in yesterday’s news, are said to be bumping into fewer shoppers.

If this observation is confirmed, ‘it had to happen,’ we will say. For we couldn’t see how the consumer could continue to spend more than he earned forever.

The other big event that we thought ‘had to happen’ was the fall of the dollar. For what individual consumers did, the entire nation did too – spent more than it earned. America may have the best economy the world has ever seen. But it depends on the kindness of strangers to make up the difference between what it earns and what it wants.

Here at the Daily Reckoning headquarters in Paris, we know plenty of foreigners. We have lived among them and learned their ways. They are nice people, to be sure. And they’re usually willing to help a stranger in need. But they don’t like being taken for chumps any more than Americans do.

So, we figure, it can’t last: the foreigners will not be willing to finance Americans’ over-consumption forever. Sooner or later, they will look at their piles of paper dollars and think they have enough of them. Then, they will go into the market to try to unload them. But who will buy them, we wonder? Americans already have dollars…and are net exporters of them at the rate of $1.5 billion per day. They are less likely to take them back than the Japanese are to take back their Hondas, or the French their champagne. Champagne and Hondas are at least useful. What can you do with a used dollar no one wants?

When the foreigners decide to lighten up, they will have to try to sell them to each other. All of a sudden, the imperial currency might not merely slip, but crash.

In markets as in the rest of nature, nothing lasts forever. And things that ‘have to happen,’ do. The only problem is that the things ‘that can’t last much longer’ may last longer than you do.

Yesterday, the dollar astonished traders by dropping sharply. Eric has more details below.


Eric Fry, reporting from the Big Apple:

– Like a team of climbers scaling Mt. Everest, investors paused for a rest yesterday. They made camp at Dow 8,368, about 76 points below where they had trekked on Friday. Some of the more adventuresome investor-mountaineers harnessed themselves for the night to the sheer face of Nasdaq 1,315 – 15 points below Friday’s level. Assuming the weather remains fair, the climbers will resume their ascent this morning. The greatest danger, however, is not in ascending to the peak, but in returning safely to base camp with one’s capital intact.

– The dollar, meanwhile, suffered a little altitude sickness, as it fell from nearly one euro to 98.12 cents per euro. Gold capitalized on the dollar’s weakness by tacking on $1.70 to $315.60 an ounce.

– The dollar has been a conspicuously dour presence amidst the recent exuberance on Wall Street. Despite the stock market’s dramatic 20% rally over the last three weeks, the dollar has barely budged. It’s true that the overpriced US dollar doesn’t deserve to rally any more than the overpriced US stock market. Nevertheless, the dollar tends to rally when the stock market does. But that hasn’t happened this time. Maybe the dollar’s feeble price action is trying to tell us something.

– "The US dollar is to be admired, but not bought," advised Jim Grant at last Thursday’s Grant’s Interest Rate Observer Conference in New York. Grant refers sarcastically to the dollar as "America’s greatest success story." That’s because "each one costs less than a penny to produce and yet, is sold throughout the world for $1 apiece. What American export can match that?" Remarkably, the dollar’s strength endures despite our yawning current account deficit – equivalent to about 5% of US GDP. Global demand for greenbacks persists no matter how many we print.

– The strong dollar, says Grant, "is the monetary equivalent of the appearance of the Anaheim Angels in the World Series. The Angels shouldn’t be there – but there they are." Nevertheless, Grant believes investors should not underestimate the "capacity of sovereign governments to bring about the depreciation of the money they sponsor. Governments have few enough fields of competence…But a determined government can always find ways to depreciate the currency for which it holds the license to print."

– We consumers do not enjoy the luxury of printing money to satisfy our debts. We must earn it or inherit it. Unfortunately, jobs and old, rich relatives are both in short supply these days. And so, unpaid debts are soaring.

– "With millions of consumers burdened by mounting credit card debt, bank loans, unpaid medical bills and more, collectors are busier than ever," the Arizona Republic reports. "Nationally, more than 6,500 firms pursued $135 billion worth of delinquent consumer IOUs placed for collection in 2000, up from $73 billion a decade earlier." However, there is a bright side to America’s soaring tally of bad debts. "The collection business has become a growth industry," says the Republic, "with employment projected to swell by 35 percent over the next six years, according to the Bureau of Labor Statistics."

– The message is clear: if you really want to help lower the national unemployment rate, stop paying your bills.

– From the "post-bubble economy department" comes the following anecdote: for the last three years, I’ve been sharing an office at 30 Wall Street with Jim Grant. But the lease is up, so I’ll be moving around the corner next month to 80 Broad Street. In preparation for the move, one of my colleagues put a phone call into the company that has been leasing furniture to us and asked them to come pick it all up. From the other end of the phone line came the surprising response, "Uhh…Do you mind hanging on to it for a while? We will stop charging you, of course," the company’s representative said. "We just have nowhere to store the furniture, once we pick it up. Our warehouses are overflowing with returning furniture, and so we’d have to pay to store it somewhere. Do you mind keeping it for a while longer?"

– "No problem," we said, regretting that we hadn’t made the call to cancel our furniture lease a few months earlier.

– During the dot-com bubble, Internet companies of all sorts sprouted from the financial landscape like so many weeds. The moment they received their VC funding, they hastily proceeded to build the country’s umpteenth nonessential Internet company. Each new start-up enterprise scurried about to lease office space, office furniture and computer equipment, while simultaneously rushing to hire 100 or so employees at double the salaries that any established, profitable firm would dare to pay…

– It was fun while it lasted. But eventually, the money ran out and the companies had to return all their toys. The problem is, so many toys are returning that they are of no use to anybody. Workstations, desk chairs, PCs, phone equipment and all the other accoutrement that outfitted a 2000-vintage enterprise are piling up in warehouses from coast to coast. What will the leasing companies do with all this stuff while waiting for the next once-in-a-lifetime stock market bubble?


Back in the French countryside…

*** "Alan Greenspan is the best chairman the Fed has ever had," says Allan Meltzer, a professor at Carnegie Mellon. Eric and Jim Grant believe the Fed’s finest will be able to do what the Fed does best – inflate the currency. Here in Paris, we have less confidence in bureaucrats. The Fed, Mr. Greenspan confessed, could not see the bubble forming on Wall Street…nor could it have done anything to stop it. Will it do any better against deflation? Will it do better than the Bank of Japan? Or better than the Fed of 1931? We’re not so sure.

*** It is another beautiful autumn day here in the heart of France. But that’s the problem. Writers need bad weather; otherwise they are tempted outdoors.

Yesterday, we went over to look at a pile of stones. You see, you need stones to build stone walls. Few people build stone walls anyone, so the market for stones has grown thin. You have to keep your eyes open for an old house that is being torn down…or an old wall that is being replaced.

Pierre and I drove over to a nearby village to admire a pile of rubble. Its owner, another Pierre, invited us in for a drink. Both Pierres were veterans of French parachute units. And both were old enough to recall WWII. Over shots of whiskey, they reminisced…

"It was unbelievable," explained the second Pierre, a retired colonel. "Hard to imagine now. I mean, during the war it was like Bosnia around here. After France capitulated, the regular officers were dismissed and sent back to their homes. They were supposed to lead the resistance. But the local resistance leaders were communists…or worse…they were afraid of the officers."

"Yes, I remember," replied the first Pierre. "Général Millet came home after the surrender and they arrested him. He and, who was it…yes, Capitain Delattre…they were imprisoned in a barn not far from where I live now.

"My father tried to get them out," he continued. He was the mayor of La Trimouille. Oh là là…one day, I remember it well, the Germans came for him. A German ambulance had disappeared on the road. It must have been taken by the local resistance, we didn’t know. But they held the mayors responsible. So, they took my father away. My mother said she didn’t think we would ever see him again. But they just questioned him and let him go…"

"That must have been near the end of the war," the second Pierre took up the conversation. "What was really shameful was not the way the Germans acted, but the way many French took advantage of the situation to settle old scores. You remember those fellows in Champs (a nearby village) who had their throats cut. They had nothing to do with the resistance. And some of these guys who claimed to be resistance fighters were just anarchists or thieves."

"Well," the first Pierre returned to the story of the French officers imprisoned nearby. "My father tried to get Millet and Delattre freed. Nobody really knows what happened. You know, after the war there were a lot of stories people didn’t want to remember. But the officers somehow escaped. And by then, no one seemed to want to try to find them."

"What is really amazing," the second Pierre again, "is that these things happened. Many of these people are still alive. But I guess that’s the important lesson. They were just like us. We humans seem to be capable of almost anything…"

The Daily Reckoning