SAD SACHS ? / BARRON´S UP AND DOWN WALL STREET ( HIGHLY RECOMMENDED READING )

Up and Down Wall Street

MONDAY, APRIL 19, 2010

Sad Sachs?

By ALAN ABELSON

The SEC charges Goldman with defrauding investors. Fred Hickey plugs Microsoft.

"POLITICAL RISK" IS ONE OF THOSE SENTENTIOUS caveats that analysts dust off when trying to discourage foolhardy investors from investing in the likes of Nigeria, Venezuela or Zimbabwe. But now, it emerges, that familiar warning also describes, of all places, the good old U.S.A.

We were as shocked as you to learn that. For, as noted, it typically applies to countries run amok, in the throes of a bloody civil or guerrilla war, in the grip of a mad and dangerous dictator or trembling on the cusp of some terrible human carnage. But, it saddens us to report, the inclusion of our beloved nation in such repellent company is not the claim of some spiteful malcontent, but no less an authority than Sam Zell (and, offhand we can't think of any less an authority).

According to Mr. Zell, the present administration's polices are squarely to blame for being branded as a political risk (we have the dim feeling that Mr. Zell did not vote for Barack Obama). What's more, obviously a man who takes a long and measured view, Mr. Zell offers this elegantly phrased prophecy: "If the current situation is indicative of the next half-century, I think we're screwed."

Mr. Zell, in case the name doesn't ring a bell, is a billionaire real-estate mogul (he's often referred to in the press as a real-estate magnate, but somehow mogul fits him better) whose canny purchases of properties that seemed destined for oblivion earned him the name the Grave Dancer, and he knows a thing or two about risk. Back in 2007, he bought the Tribune Co., among other things publisher of the Chicago Tribune, the Los Angeles Times and the Baltimore Sun as well as owner of the Chicago Cubs, for $8.2 billion.

There is no evidence, if you happened to wonder, that Mr. Obama played any role in either the purchase or the subsequent troubles of Tribune Co. On the other hand, Mr. Obama indisputably was a U.S. senator representing Illinois at the time of the transaction and, politically speaking, is Chicago-bred, gruel enough for conspiracy aficionados, of which there's regrettably never a shortage.

To swing the deal, Mr. Zell contrived a rather ingenious device, creating an employee stock-ownership plan, which effectively made the Tribune Co.'s working stiffs its nominal owners, and had it borrow nearly $8 billion. He graciously chipped in $315 million of his own money and was duly anointed chairman and CEO.

His timing could have been better. Actually, it's hard to imagine how it could have been worse. Since the takeover, the newspaper business has been in a tailspin, the victim of a double whammy by the Great Recession, which visited terrible havoc on advertising linage, and the Internet, which sharply cut into circulation. The Chicago Cubs, alas, haven't set any worlds on fire, either.

Saddled with $13 billion in debt, swollen to that formidable level by the Zell-engineered leveraged buyout, and with interest payments alone taking a $1 billion annual bite, barely 12 months after the purchase, Tribune Co. scurried into Chapter 11 and the protection it provides against creditors, prominent among which are, as you doubtless guessed, JPMorgan Chase, Bank of America, Citigroup and Barclays.

Besides supplying the copious credit necessary to do the deal, most of these lending heavyweights happily rendered advice on carrying out the LBO, for which they garnered ample fees. Under a preliminary settlement they'd recover 62 cents on the dollar.

Tribune Co. has yet to emerge from Chapter 11. Mr. Zell is no longer CEO. The Cubs have been sold. Swirls of litigation still surround the company, brought by other creditors whose gripe is that the settlement leaves them short-changed or out in the cold. And the judge overseeing the bankruptcy indicated he would favor an independent examiner to prove the propriety of the 2007 purchase.

It's conceivable that Mr. Zell was so fixated on the political risk when he pursued Tribune Co. that he failed to perceive the financial risk, which, as he now has rueful reason to attest, can do quite serious damage in considerably less time than half a century. We fervently hope that this unfortunate episode won't prompt spiteful observers to start calling Mr. Zell the Grave Digger instead of the Grave Dancer.

THE GHOSTS OF BUBBLES PAST SUDDENLY returned to haunt the concrete canyons of Wall Street. It certainly seemed that way last week. No sooner had we finished off that little reprise on the misadventures of Sam Zell and the Tribune Co., out of the blue came the bombshell that rocked the stock market.

The SEC filed a civil complaint in Manhattan federal court against Goldman Sachs, charging the firm had defrauded investors.

Specifically, it alleged that Goldman failed to inform investors that one of those exotic and ultimately toxic numbers tied to residential-mortgage-backed securities (RMBS to the investment cognoscenti) it was peddling in early 2007, as housing was teetering on the edge, was in no small part the handiwork of a hedge fund that effectively was short the RMBS portfolio it had helped put together.

Charged along with Goldman was 31-year-old Fabrice Tourre, a vice president for the firm who labored in its structured-product correlation trading desk (our jaw aches from just muttering that titular mouthful), and acted as point man in creating and pushing ABACUS 2007-AC1, as the synthetic CDO, or collateralized debt obligation, was dubbed. The hedge fund was Paulson & Co., one of the biggest and most successful of the genre.

Needless to say -- but we'll say it anyway -- Goldman denies it is guilty of any misdeeds. Paulson wasn't charged because, as the SEC's head of enforcement told the AP, "It was Goldman who made the representations to investors. Paulson did not." That seems a rather a fine point, but then we're not a lawyer (and we say that thankfully).

The 20-page complaint is well worth a read not only for the occasional and inevitable indiscreet e-mail, but because it takes pains to make its case against a sophisticated and complex maneuver in admirably graspable form. We learn, moreover, that Paulson paid Goldman Sachs some $15 million for structuring and marketing ABACUS 2007-AC1. The deal closed April 26, 2007. By Oct. 24, 2007, 83% of the mortgage-backed securities in the ABACUS portfolio had been downgraded and 17% put on negative watch.

The result: Investors in ABACUS 2007-AC1 lost over $1 billion. But Paulson cleared $1 billion from essentially betting against the very portfolio it helped create.

It's hardly a coincidence, we suspect (and we're not joining the conspiratorial hordes, merely stating the obvious) that the SEC's move on Goldman comes as Congress is wrangling over fiscal reform. And the complaint, whatever its eventual disposition, strikes us as odds-on to yield a tougher bill than seemed in the making as recently as early last Friday.

At the same time, Paulson's involvement isn't likely to enhance the affection for hedge funds among lawmakers or the public at large. As for the market, stocks were looking for an excuse to take a breather or even, heaven forbid, prove they can still go down. Friday's action suggests, it may have found one.

LAST JULY, WE RAN A LITTLE FAVORABLE blurb on Microsoft and since then, the company and its shares have performed nicely. In that piece, we quoted Fred Hickey, one of our Roundtable gang and proprietor of the High-Tech Strategist, and he pretty much seconded our benign feelings.

What inspires this brief revisit is Fred's latest letter, in which he comes darn close to being exultant over Microsoft's prospects, even while he's a tad apprehensive about the exuberant market as a whole.

Not only has the company's Widows 7 proved a big winner (in contrast to its predecessor, Vista, which was a disappointment for sure and even a borderline bust), but Fred has high hopes for the new operating system that he confidently expects to enjoy a wave of demand from business buyers. He also believes the upgrade of what he calls Microsoft's other cash cow, Office, shipments of which are slated to start in June, will meet a warm reception.

Moreover, he is quite enthusiastic about relatively recent and promising new additions to the product line, like the SharePoint server, Bing search engine and Microsoft's "Project Natal" for the Xbox 360 game console, scheduled for unveiling June 13.

He contends that the stock (ticker: MSFT) is still something of a steal at 16 times depressed trailing earnings. Fiscal third-quarter profits, you might take note, are due to be released Thursday.

As Fred points out, Microsoft's software is firmly entrenched in most large business enterprises and its sundry software offerings are "complex and interoperable," while Google's comparable products just aren't in the same league.

"In this overpriced, dangerous stock market," he says, "I regard Microsoft as a great gift." Despite his usual aversion to hyperbole, he calls it "the most valuable tech stock in the universe." And, he waxes on, "Microsoft generates huge cash flows, pays a nearly 2% dividend, has a stock price upside of, say, 50% if the bull market continues to run, and limited downside if it does not."

Apple, he concedes, may be a great stock, but, at this point in his view, "Microsoft is better."

Oh, incidentally, we kind of like Microsoft, too.

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