Blessed by the Potato

John Hempton just put up a post about why he is short First Solar. I got out of FSLR just a month after getting in, in large part because it had a nice little rally that brought it closer to the upper end of my value range, and also in part because I realized that I have very little idea of their competitor’s economics, and could have been too optimistic in my initial estimates.

His preamble on why technology stocks can flounder in the long term is great. I’ve been looking on and off at RIM: on the one hand, even if they lose market share over time to Apple and Google for smartphones, more and more people are getting smartphones (I might even get one soon!), so it’s a declining share of a market that’s growing rapidly, so absolute growth should still be there. On the other hand, 4 years ago I got my Motorola Razr, and they seemed to be near the top of the cell phone game at the time, yet now are floundering (and similarly, their stock price is down ~50% in that time). Sentiment (especially consumer tastes) can change quickly. Right now people want to surf the net and level their pool tables with their phones, but if the next generation of voice devices is the size of a bluetooth earpiece now, the trend may revert to tiny and voice-only.

As for the specifics to First Solar, I’m kind of neutral on it now, but lean long, so I have some thinking to do on JH’s post. Questions that come to my mind though:

Silicon prices, are they temporarily low, or will First Solar’s edge in pricing disappear? If the low silicon prices are a temporary nadir due to the recession (and many raw material prices crashed last year), then their competitive edge may return. Unfortunately, a quick Google search suggests that the crash in prices was due to the supply-side expanding extremely rapidly and overshooting demand… so low prices will probably stay for a while.

Political risk has always hovered over this company — it (indeed, any solar company) depends pretty heavily on subsidies to make the economics work. However, on the short side, if the US gets serious about greening its grid and starts to introduce subsidies, that could delay declines for a while longer. I had hoped that would be the case when I was long, but still haven’t heard anything about that. Up here in the great white north, our federal rebates are over, and the provincial power purchase subsidies are due to expire shortly, and there hasn’t been word of renewing them.

However, his insight into the new technologies that allow less silicon to be used for wafers (further reducing the cost of the technically superior crystalline panels) may be the killer. The question then is what is the volume capacity in that world, and how long will it take for the crystalline competitors to catch up to take over First Solar’s market?

I just finished reading Michael Lewis’ The Big Short this weekend. It was a pretty quick read, and fairly informative on just what sort of shenanigans were going on in the CDO market of repackaged subprime loans. Even though I’ve been reading about these for something like two years now, I learned more scary facts about them. The book comes off as a really long newspaper article (albeit a rather good one), quoting the people who were there, and retelling the story of the guys who figured out early on what was going on, but there isn’t a central narrative (aside from subprime itself). Not too many of them seemed to grasp (or care about) the societal clusterfuck that would be unleashed if they were right until it was nearly upon them — they were just trying to make a buck on a mispricing of risk.

He has a few very interesting anecdotes about the generation of these financial instruments and the people behind it all, and it does contain a good explanation of what exactly a CDO is if you still haven’t picked that up.

I found it amazing that the raters (Moody’s, S&P) were so complicit in all of this. He makes a good point that our system is not set up to incentivize the “cops”: raters and regulators are paid far, far less well than the traders they’re trying to monitor. As a result, generally the “dumb” finance guys end up in those positions, and they get walked all over by the smart money (indeed, the big bucks in finance draw away some bright minds from physics, math, engineering, and even medicine who might do more societal good in those positions, rather than coming up with complicated computer models of how to redistribute capital). Some of these characters in the book who had figured out that these groups of subprime mortgages were doomed to fail asked the rating agency people to do a better job of rating the paper, since it obviously wasn’t AAA. Of course, they were doing that because they wanted the ratings lowered so they could make money on their shorts, and not out of some altruistic motive, but still. They pointed out things like how high default rates were in a period of rising house prices, and asked what their models said would happen to all this stuff if housing went down, even modestly — the ratings guys said they didn’t test negative numbers when rating the bonds.

I was also surprised to hear of just how dodgy some of these CDOs were created. I knew that they took a pile of mortgages, say 1000 of them, and grouped them together, and then created tranches, or levels. Each level suffers defaults in a certain order: the lowest level takes the hits of defaults first, and if just ~8% of losses occur in the underlying mortgages, that level is wiped out, and it gets some low rating from the agencies (BBB-). The top level has a fair bit of protection, some high number of losses must occur before they’re wiped out, so that stuff gets rated AAA. Then what I found out is that first off, the characteristics of the whole group of loans was only ever described on average: so a group of 1000 loans to borrowers with a credit score of 610 was rated the same as one to 500 borrows with a credit score of 510 and 500 with a credit score of 710, yet the second pool was much more likely to suffer huge losses that would wipe out the bottom few rungs of the bond ladder since any small economic setback would lead someone with a score of 510 to default. Secondly, there was so much demand for these asset-backed securities that the firms started creating synthetic CDOs: they’d take all the lower-level paper (rated BBB) that they couldn’t sell because it was too risky for people to buy, then create a new tower of paper and tranche it out, and again the top level would get an AAA rating, even though it was entirely composed of the low-rated dreck they couldn’t sell individually. The theory was that not all the bad paper would go bad at once, so the top level would have protections similar to the group of 1000 mortgages. Except since this was all the paper that went to nothing with ~8% losses on the underlying pools of mortgages, anything that affected all those mortgages at once, even if just a little, would make this whole tower worthless… the risk models were in no way reflecting the reality of the situation. Then on top of that, when they started running out of mortgages to reshuffle, they made CDOs out of the credit default swaps these shorts were buying, just synthesizing securities out of whole cloth.

There was one anecdote in particular that really blew my mind though: The tale of Option One, which was creating subprime loans that were so bad, people were defaulting in the first month. I had some idea of how bad the subprime lending was in the US. I know that it’s better in Canada, but I’ve always held that it was merely a matter of degree and not of kind, and that as our market got away from fundamentals, a correction would be needed. For a brief instant when I was reading about how bad some of this stuff was, I started to wonder if the “it’s different up here” crowd might actually be right… then I remembered that in Toronto and Vancouver, you can’t buy a house/condo today and expect to make a profit renting it out in the long term (i.e., when rates return to something resembling normal).

I thought it was quite enjoyable. Wayfare managed to put her tongue on exactly what it was about this version — it’s not just that it’s a Tim Burton re-imagining of Alice in Wonderland/Through the Looking Glass, it’s that it’s a new version with at least the skeletal outline of a plot. Many of the previous versions (and, I’m lead to believe, the books themselves though I haven’t read them) consist simply of one dream-like sequence after another, with no overall connecting threads. That’s supposedly on purpose, since it’s supposed to be dream-like, but it’s not as rewarding for the audience to consume as a movie.

Aside from that, I thought that some of the CG was a over-done (the Hatter’s eyes), but otherwise enjoyed it all. I loved it when the Cheshire Cat started kneading the hat, that was so perfectly cat-like, and Anne Hathaway was full of awesome as the White Queen. In fact, she may be the source of all awesomeness within Wonderland.

We saw the movie in 2D, and at no point did I say to myself “You know, I really wish I had paid more for this so I could wear funny glasses and see that part appear to jump out at me and then leave with a headache.”

I just got a ticket for parking on campus at Western. I had the parking pass out and displayed on my dash, and they put the ticket on the windshield right overtop of the pass. I just finished filling out the online appeal form, and I have to wonder if this is some really un-funny April Fool’s joke.

I look to be in dead last:

HBU is up, but I had shorted it (-0.6%)
FRE-W is down a bit, but the more liquid -Z preferred issue is up (-11.6%)
IM is up to $6.64 (+25.3%)
AONE is down to $13.74 (-38.8%)

If my math is right, these picks are down 25.7% overall on the quarter (note that my real-life investments are not this risky and have not been as terrible!)

Note that this is a game with a set end-date so looking for value is not necessarily the way to go — often a shoot-the-moon approach works well in these kind of games. So bear that in mind, and don’t consider any of these as recommendations for you to actually buy!