Rate Fears Break the Breaker (Rule Breaker) May 14, 1999

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Rate Fears Break the Breaker
Trump's good news

by Paul Larson (TMF Parlay)

CHICAGO, IL (May 14, 1999) � Like most other stock portfolios in America today, the Rule Breaker portfolio lost a bit of its value this spring Friday. Increased consumer prices in April led to fears about higher interest rates, which brought stocks down. Finance 101 tells us that any given stock's value is inversely related to interest rates. Increased inflation leads to fear of higher interest rates, which leads to lower stock prices across the board. Got that?

Of course, we here at the Fool don't bother trying to time the market, much less trying to time interest rates. Periods of high interest rates will come and go just as economic strength and weakness will ebb and flow like the tides. The backdrop upon which our companies operate will change for better or worse from year to year, but we have found it to be much more useful to look at the companies and their business models instead of just the backdrop.

For instance, assume interest rates are hiked 1%, a fairly large jump from today's levels. Will this really affect sales of Amgen's (Nasdaq: AMGN) lifesaving drugs or the rollout of @Home's (Nasdaq: ATHM) revolutionary Internet service? Me thinks not. Interest rates affect just about every aspect of the business world, but it is a secondary affect next to the ideas, people, and products behind the companies we invest in.

An optimist might say the Rule Breaker is up 43.9% so far in 1999 while a pessimist might point to the 11.4% decline seen in this portfolio over the past ten trading days and proclaim, "The sky is falling!" As they say, it's all a matter of perspective. Whatever way you want to look at it, here are the numbers:

               Day       Week    Month    Year
Rule Breaker  -3.02%    +1.25%  -11.37%   43.92%
Nasdaq        -2.10%    +0.97%   -0.59%   15.29%
S&P           -2.18%    +0.54%    0.20%    9.15%

There were only two pieces of news that really stood out in the Rule Breaker portfolio today. First was the announcement that @Home (Nasdaq: ATHM) was teaming up with Rule Maker Microsoft. @Home will use Microsoft's software to run parts of its network while Microsoft will help market @Home's high speed Internet service. This comes as little surprise since Microsoft and Ma Bell, the company that owns a controlling stake in @Home, forged an alliance just last week in a separate cable deal. In other words, a friend of Ma Bell is a friend of @Home. The company did manage to buck the tide today and rose $13/16 to $150.13. Perhaps Wall Street is coming to the realization that @Home is at the epicenter of the broadband universe.

America Online (NYSE: AOL) was also in the news today after stories leaked last night that the company was considering a $1 billion investment in a high speed bi-directional satellite system from Hughes (NYSE: GMH). The two companies already forged a deal for AOL TV recently, so any further talks about escalating the relationship should come as little surprise.

Let's now shift our attention to the portfolio's lone short position, Trump (NYSE: DJT). It was little over a week ago that Trump released earnings that were far below expectations. The company reported a loss of $0.91 per share versus the $0.58 the Street was expecting. With lower earnings than expectations as well as operating cash flow (EBITDA) lower and net interest expense higher than the year before, one might think that Wall Street would realize this slowly sinking ship just dropped a bit lower.

Wrong. Instead of dropping on the bad earnings, the stock has rallied from $4.625 on last Friday's close to $5.313 today, or nearly a 15% jump in the last week. This is not a bad little rally, which has taken some of the paper profits away from the Rule Breaker's short position.

When looking at Trump one has to remember that the casino business is predicated on the idea of convincing players that it is possible for one to win. Casinos do everything in their power to highlight the few players that have beaten the odds and won by partaking in the slots and table games. Everything from having metal coin receptacles at the bottom of the slot machines (klank klank klank!) to putting pictures of the jackpot winners on the wall -- the casinos try their hardest to trick the player into perceiving that the odds are perhaps a little better than they really are. The fact that human nature is to exaggerate tales of winners while sweeping losing experiences under the carpet doesn't hurt.

I can't help but think that Trump is playing the same perception game on Wall Street as it does in its casinos. No matter how bad the news the company releases, it is always peppered with tiny bits of good news meant to divert attention away from the bad. I suspect that one of the reasons the company waited until May to report its earnings was not just because the numbers were below expectations, but because April was shaping up to be an outstanding month for the company. According to the press release, "For the first four months of 1999 through April, all of the operating subsidiaries' net revenues and EBITDA exceeded levels for the same period in 1998 with EBITDA increasing to $74.4 million in 1999 from $65.9 million in 1998."

I won't deny that this piece of news is good for the company, but my experience tells me that Da Donald's crew would have kept the information for as long as possible if it were bad.

Another piece of seemingly positive information coming from Trump is that Da Donald bought 250,000 shares of the company's stock and the CEO bought 24,000 shares. As they say, insiders buy for only one reason -- they expect the stock to go up. However, I'm not so certain this applies to Trump. The new purchase represents less than a 3% increase in Trump's stake in the company, yet the news has had a much greater impact on the shares Da Donald already owns. Remember, this is a company that repurchased shares at levels nearly double where the shares are trading today in an attempt at propping the stock up.

It's important to note that any temporary increase in the stock's price (and Wall Street's confidence) would make a debt refinancing that much easier. Refinancing Trump's mountain of debt is seen by many, myself included, as the only way the company can avoid some sort of bankruptcy down the road.

What does this all mean to the Rule Breaker's short position? Not much. I don't get the impression David is in any hurry to close out the position anytime soon. Either way, Trump really has been taking up more bandwidth than it should in this space since it represents less than 1% of the portfolio's total assets. The "A" stocks will be the primary drivers behind the Rule Breaker's performance for the rest of the year, not Da Donald.

One last thing -- make sure to check out The Motley Fool Radio Show this weekend if you're in one of the 55 markets the show is broadcast in every weekend. Even if you're in a market not yet getting the show (like Chicago), it is now available for your listening pleasure over the Internet. The show this week will be all about investing and Star Wars.

May The Fool be with you.

-Paul Larson

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