About two years ago to the day, I wrote that Ambac Financial
Readers proceeded to mop the floors with me. "Do you have any understanding of insurance whatsoever?" asked one. "This is totally clueless drivel" said another. I got an email recommending I put myself out of my misery. And so on.
Shares fell 85% over the next eight months. That isn't a boast; I've made my share of awful calls. But today's situation is eerily similar to the last time I chimed in. Shareholders are clinging to hope -- blind Hail Mary hope -- when the odds are stacked so heavily against them, it hurts.
If you're a member of this camp, you may want to consider selling Ambac.
Running on empty
Management practically does, too. "Ambac has insufficient capital to finance its debt service and operating expense requirements beyond the second quarter of 2011 and may need to seek bankruptcy protection," its annual report says. In a more recent filing, the company warns that "as early as the second quarter of 2010, the Company may decide not to pay interest on its debt." That's serious stuff. Management rarely uses the "B" word in official filings until it's a foregone conclusion.
Bondholders have joined arm-in-arm to see this through, forming "an ad hoc committee [that] will try to push the company into a prepackaged bankruptcy," according to Reuters. Should they succeed, you can kiss your shares goodbye.
Gunning for hope
But life doesn't run in certainties. What if Ambac does manage to avoid failure? Hey, it could happen. A savior investor could emerge. Bondholders could donate their investments to shareholders out of charity. Who knows. For the polite sake of argument, let's assume Ambac skirts failure.
Even if it does, shares are still probably worthless.
When you purchase Ambac stock, you're really buying the Ambac holding company. Its main asset is an operating entity called Ambac Assurance. In normal times, Ambac Assurance pays dividends to the holding company, which uses the cash to service its debt, pay dividends to shareholders, and keep the lights on.
But these aren't normal times. In March, a Wisconsin insurance regulator seized $64 billion of Ambac Assurance's contracts linked to toxic mortgage assets. It did so to keep certain policyholders from getting burned. So much money was flying out the door to policyholders of toxic mortgages that municipal bond policyholders were in danger of getting the shaft. Some policyholders, like Citigroup
Here's what's important: As result of the seizure, the Wisconsin regulator now has a straitjacket on certain decisions Ambac Assurance can make. And as Ambac admits, "such decisions will be for the benefit of policyholders and will not take into account the interests of securityholders of Ambac." To boot, "it is highly unlikely that Ambac Assurance will be able to make dividend payments to Ambac for the foreseeable future."
Burn that last sentence into your brain. Even if Ambac manages to skirt bankruptcy, it would still rely on dividends from Ambac Assurance to warrant any value. Yet with the folks in Wisconsin pulling the levers, dividends to the holding company simply aren't feasible. Connect the dots.
Even if Ambac does somehow miraculously clear these hurdles, its ability to write new business will be shattered, given its abysmal credit rating. And even if it could write new businesses, this industry is a disheveled fragment of its former self. Thank the budgetary devastation at state and local governments for that. As Warren Buffett, whose Berkshire Hathaway
Fool me once …
So if I'm right, why does Ambac still trade at around a buck a share? Evidently, the market disagrees with me, you might say. Shares jumped more than 17% on Tuesday alone!
But that's routine for a company that may be mumbling its death rattle. It happened with General Motors. It happened with Lehman Brothers. It happened with Washington Mutual, Fannie Mae, and Freddie Mac. Wild volatility always accompanies stocks that are likely to become worthless. This can last for several months on end, turbocharged by short covering. It's a predictable trend: Investors get lured in by the fireworks of a surging penny stock, convinced it's an easy way to get rich quick. They pile on one after another, temporarily creating self-fulfilling glimmers of hope, only to be caught in eventual misery as shares become worthless. This happens over and over and over again. Don't get sucked into it.
Do yourself a favor. There are better stocks out there than Ambac.
