No Brainer Trade: Short Companies With High Debt Ratios

Back in October 2002, the Nasdaq was down 75% from its highs just a year a half prior and there were hundreds of tech stocks trading down 90% plus from their highs.

See, in the late 1990s, any company with the word "communications" in their business plan could raise billions of dollars in debt and/or equity financing. But after the bubble popped in early 2000, nobody with the word "communications" could raise any capital at all. The virtuous cycle of booming growth turned to the vicious cycle of contraction (sound familiar? Did we have to bail out all the telecom companies to make sure the Internet kept working? No, of course. We let them recapitalize according to the contract laws that our Constitution used to guarantee until Hank Putin/Paulson changed that this week and last).

Indeed, one of the best moves I made in 2002 and 2003 was buying a basket of stocks that traded with negative enterprise values, which means the market was valuing the stock for less than the company had in their checking account. You could buy, say, Valueclick for example for, say, $80 million even as they had no debt and $100 million in net cash while the company was generating positive cash flow.

On the other hand, one of the worst moves I made in 2002 and 2003 was betting against any company that had excessive debt ratios. Companies like American Tower had billions of debt and were running out of cash and not generating any new cash. I figured they'd never be able to tap capital again without having to recapitalize the company...but I was wrong. The company was able to continue to finance their operations as capital started flowing fast and free again (in large part because 1% interest rates in a steady economy creates bubble dynamics) and AMT turned itself around. I think I was short from $5 to $7 before I covered it for a nasty loss...I should have covered and gone long, because the stock eventually climbed several hundred percent as the company bought enough time to really get earnings cranking.

The reason for this little flashback is because I don't expect history to repeat this time. That is, I'm not sure we can fix whatever is ailing these credit markets any time soon. Sorry, but despite Gross/Buffett/Paulson/Bush/Pelosi/Obama/McCain/Bernanke and the rest of you who would directly benefit from this extortion trying to convince me that taking a trillion dollars out of the private, profit-seeking economy and giving it to the in-over-their-head politicians to dole out to greedy Wall Streeters is somehow going to magically solve all our economy's problems...well, I think you're all either idiots or thieves and you're destroying private property rights and that's not a bullish thing. EVER.

So I'm thinking you can probably run a screen searching for stocks with the highest debt ratios you can find. And especially those companies that have a lot of debt coming due in 2009 -- you probably can get short and buy puts on those puppies. Because dilution -- a la, the Goldman Sachs/Warren Buffett deal -- is probably the best case scenario end game for most debt-laden companies in the next couple years. Bankruptcy would be another possibility (here's hoping we don't simply bail out any company that needs it in the next two years, a la the Ford/GM/Cerberus $25 billion bail out package that the Democrats and Republicans in power passed yesterday).

It's not as if Lehman and Bear are going to lead a junk bond issuing for Caterpillar next year, no matter what happens with this bail out package getting passed or not. Lehman and Bear don't exist anymore! And, btw, extorting a trillion dollars from my mom and dad won't bring them back and it won't bring back Main Street's ability to tap capital either.

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