Rule Breaker Portfolio

THE RULE BREAKER PORTFOLIO

Covering Trump
Plus, vacancy at Amazon U.K.

By Paul Larson (TMF Parlay)

CHICAGO, IL (Sept. 9, 1999) -- It was a fairly good day for the Rule Breaker portfolio since the portfolio was up 2.3%, soundly beating the market averages. About the most salient chunk of news to hit the companies in the portfolio was something that just barely registered on the radar. It seems the head of Amazon's U.K. business is stepping down to pursue other interests. This is not too surprising since the person that is leaving, Simon Murdoch, came to the company via an acquisition. The market seemed to blow the news off since Amazon was up over two bucks today.

Of course, this week is a big week for the Rule Breaker thanks to other reasons. For the first time in over six months, the Rule Breaker portfolio is making a transaction. (Imagine Tattoo from the old show Fantasy Island screaming, "A Trade! A Trade! A Trade!") In case you missed the announcement yesterday, one of the riskier and smaller positions in the portfolio, the Trump (NYSE: DJT) short, is in the process of being closed. No trades were made today, but there are four more trading days to cover before breaking the self-imposed trading rules.

For those who think we Fools have an awesome influence on the market, here are two pieces of evidence to the contrary. On news that this portfolio would be buying 1,170 shares of the company, the stock fell today. Although, it only fell $1/16 to close at $4 7/8.

The other piece of evidence was the anemic trading volume in Trump. The volume in the stock barely topped 100,000 shares (103,500 shares, to be exact), which made Trump, by far, the least-traded stock in the portfolio. The next highest stock in trading volume was 3dfx (Nasdaq: TDFX) at over 5x the volume of Trump. (568,500 shares, to be exact.) On the other end of the spectrum, AOL traded 10.3 million shares today, giving AOL a dollar trading volume of approximately $1 billion versus $0.5 million for Trump. That's right, roughly 2,000 times more money changed hands with AOL's stock as it did for Trump's.

For those who missed yesterday's recap, make sure not to miss David's tale of his encounter with Da Donald. Remembering back to that day, it was probably one of the few days I wish I was in New York City instead of camping in Utah like I was. It's just not that often that we Fools get to rub elbows with company CEOs. (Although, David, that lucky son of a gun, has a pretty good streak going since Amazon's Jeff Bezos was on the radio show last week.)

My feelings about covering the stock are pretty much the same as they were when the short was first made back in April of 1997. Back then, my primary gig with the Fool was watching and writing about the gaming industry, and I cautiously agreed with Jeff and David's decision to short the stock. I warned both of them repeatedly that Trump was a highly leveraged organization both operationally and financially, and leverage can cut both ways. But eventually, I came over to the "dark side" after seeing Trump fall short of expectations.

With the decision to cover, I again find myself cautiously, very cautiously, agreeing with the decision. Bankruptcy is still within the realm of possibility for the company, but it is several years off, if and when it does come. The company appears to be headed that direction very slowly, but it really wouldn't take much to reverse the trend.

One thing that Trump has been trying to do, unsuccessfully, is refinance the company's debt at lower levels. Right now, the company is running along with EBITDA (Earnings before interest, taxes, depreciation, and amortization... otherwise known as "blah blah blah.") roughly equaling the company's interest payments. If the company were able to reduce its financing rates even just a little, Trump would suddenly have free cash flow to either pay down debt and/or expand.

More importantly, I would contend that the difference between Trump at $1 and Trump at $15 is a 5% change in the company's top line. Since the casinos have relatively high levels of fixed costs and low variable costs, any revenue spike or shortfall would largely fall straight to the bottom line. If the company were to see 5% of its sales dry up from poor weather or increased competition, that would almost be enough to push the first domino over towards an eventual bankruptcy. On the other hand, a 5% surge in revenue is all it would take to get the company "ahead of the game," allowing it to start paring its debt and also increasing the probabilities of a successful refinance. This would be the start of cash flow spiraling up. (And any short position's profits down.)

Needless to say, a 5% change in the top line is a mighty thin margin of error for any Foolish investor to try and outsmart. From the short and the long side, Trump is an extremely risky stock thanks to the copious amounts of leverage built into the company. Probably the best thing to do is to just stay away from the risk altogether.

This isn't to say that I think Trump is on track towards becoming a healthy company. In fact, I would say the odds of bankruptcy five years from now are greater than the odds of the company digging out from underneath its massive debt and creating healthy free cash flow. But still, it's a very close call, and the consequences of being wrong are exceptionally steep from the short side.

The bottom line is that no stock is worth losing sleep over, and that includes shorts. I get the feeling that David just doesn't feel comfortable holding Trump short anymore, and that alone is reason to sell (or buy, as the case may be). After all is said and done, it's his money and his decision to make.

For more discussion about Trump and the decision to cover, make sure to swing by either the Trump message board and the Rule Breaker Strategies board where the discussion is hot and heavy.

Fool on!