He Called Enron. Now?

The Man Who Called Enron: What He's Saying Now

By Dr. Steve Sjuggerud | 13 November 2007

Jim Chanos chose a ridiculous career...

In 1982, he started betting against stocks. His timing couldn't have been worse... 1982, after all, was the beginning of the greatest bull market in history. His first report came out the day the stock market bottomed in 1982. It was on Baldwin-United...

Baldwin soared from $24 when he wrote his report, all the way up to $50. Chanos was eventually proven right, as the stock crashed to $3 a share. Chanos says that's when the legends started calling... "Michael Steinhardt and George Soros were clients of the firm, and they called asking 'What else does the kid think we should short?'"

Jim started his own firm in 1985 to bet against stocks. Due to the great bull market, you'd think that he'd have been driven out of business quickly. Instead, today Jim now manages the world's largest hedge fund that bets against stocks. He's grown it to roughly $4 billion under management.

I have a huge amount of respect for Jim Chanos. We don't often get to hear from him. If I could talk with him, I'd have three questions for him:

1) How have you not blown up completely betting against stocks in a bull market?
2) What's your method for finding companies about to fall apart?
3) What do you... well... dislike now?

Thankfully, a new book called Hedge Hunters by Katherine Burton has a chapter on Chanos with an interview. And he granted an interview to the Financial Times over the summer. So putting these two things together, we can get my questions answered...

Let's answer them in order..

1. How has he not blown up?

In 2000, Chanos made a presentation about two companies likely to underperform in the next year. He named Enron and Williams Communications. Enron fell 99.9%, and Williams fell 96%. In short, Chanos does his homework and makes good calls.

He keeps from blowing up by limiting his risk, which we all can do, and making good calls, which isn't nearly as easy.

2. What's his method?

Jim's positions fall into a few different categories:

• Consumer fads. He's made money betting against companies associated with Martha Stewart, Cabbage Patch dolls, and George Foreman grills, for example.

• Accounting irregularities. Like Enron and WorldCom.

• Booms that go bust. He made money after the dot-com bubble in the late 1990s and real estate in the late 1980s.

• Technology obsolescence. "Look at Netflix," Chanos said. "Consider the concept of having little old ladies in warehouses stuffing envelopes with DVDs. That might be a business for two or three years, but then it won't work." Netflix faces the same pressures as Blockbuster, Chanos said. Just yesterday, Blockbuster announced a wide third-quarter loss.

3. What does he dislike now?

Chanos also sees a dismal future for certain cable companies. "I grew up sitting on the sofa watching television," he said. "The idea of watching The Simpsons at 8 p.m. is over now. In five years, it will be your programming, your network."

Chanos predicts in five years, our televisions will be hooked up to the Internet. If we want to watch an NFL football game, we watch it over the Internet, cutting out broadcast TV stations. "All these cable companies buying each other are just shuffling deck chairs on the Titanic," he says.

In his June interview with the Financial Times, Chanos predicted hard times for the credit-rating agency Moody's. "They're no longer a referee on the playing field. They are actually playing at this point," Chanos said. "Though they're wearing an umpire's outfit, they have a Yankees hat on, and I think this is the real problem. They're so entwined in the structured finance business."

Moody's was at $70 in June. It's around $40 as I write.

Finally, Jim dislikes companies specializing in creative "financial engineering"— like big banks and private-equity companies. One of his big ideas is shorting Australia's Macquarie Bank. The bank has built a huge business of buying up assets like roads and bridges, then packaging them up into investment funds... which somehow offer much higher dividend yields than they should.

He singles out Macquarie, saying its strategy "basically rests on purchasing infrastructure assets at ever increasing multiples of cash flow, selling them at a mark up into their trusts that they control, but which are funded by outside investors... For most of the trusts, the cash flow from the assets they hold do not cover the dividends. So they're borrowing against it and using this accounting artifice, in our opinion, to cover the costs. That is a business model I think that will be prone to a lot of stress..."

I like Jim Chanos. He's one of the few original thinkers on Wall Street. Whenever we can get a glimpse into what he's thinking, we should take it. It's not often that we hear from him. But fortunately we have lately. I thought I'd share his latest thoughts with you.



Normxxx    
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