Own a strip club

I found this interesting link from MarketWatch on The Kirk Report. It seemed funny, but then I re-read it. Apparently, people still can't lay off the sauce, even when times are tough. They just move down the scale, rail instead of premium, Natural Light instead of Heineken, or getting blasted at home rather than at the local watering hole. I believe that this is what an economist would call satisficing.

I am trying to figure out how much this will affect my holdings in RICK as strip clubs make a killing on drinks. If people are going to be drinking less, than the company should take a hit.

There's some litigation risks that threaten to change how they do business in Houston where they derive 14% of their business. Local lawmakers want to them to charge a $5 cover and make the girls wear latex and bikini bottoms.

They are also a company that is aimed heavily at corporate clients. These guys are going to be throwing around less discretionary funds just like everybody else. As they acknowledge in recent SEC filings, "further reductions in the amounts of entertainment expenses allowed as deductions from income under the Internal Revenue Code of 1954, as amended, could adversely affect sales to customers dependent upon corporate expense accounts."

Still, things can't be all that bad since they issued a press release two weeks ago adjusting their 2008 guidance upwards by 7 cents per share due to improving margins, not deal making. This is pretty exciting since Rick's has been on an acquisition binge, executing their consolidation strategy.

Now this is not a typical value stock. It doesn't trade at low or depressed multiples. I like this stock because management is executing a private-public market arbitrage. On their most recent conference call, CEO Eric Langan said that they have never paid more than 6x EBITDA for a club. They actually bought their very successful Miami location for 2.5x EBITDA. The stock market than rewards the new entity with a 28x EBITDA multiple. What a business! These acquisitions will only get cheaper if the economy hits the skids. Also, the maze of local, state, and federal ordinances that they have to navigate makes for one hell of a moat. You can't just open up a strip club anywhere. Plus, cash flows are growing by leaps and bounds.

Notice that there were only six analysts on this earnings call. I've owned and been following the stock for about a year, and only now is any sort of institutional money starting to wake up to the possibilities.

Bond Crisis Profits

“A failure is a man who has blundered, but is not able to cash in on the experience.”- Anonymous

Last week, I wrote about the ongoing crisis in the auction rate securities market. Now I'm going to share my thoughts on how to benefit from this imbroglio.

1. Once more into the breach. As the Wall Street Journal reported in their weekend edition on Saturday, the market has recovered a bit. If you have $25K, you can directly buy these debts. The morbidly obese yields of 20% are largely gone, but 8-10% remains sufficiently corpulent for my taste. This is trickier than it sounds though, I wouldn't enter any market unless I really knew it. After the Maher brothers' experience with Lehman, I'm not sure that I would trust an investment bank to help me navigate these waters either.

2. Short circuit. You could short the money center banksA(individually or through an ETF) and the bond insurers who insure auction rate bonds. As I have written previously, shorting is not for the faint of heart. It helps to have a lot of capital. As Keynes famously said, "markets can remain irrational longer than you can remain solvent." Let's not forget, shorting involves a)going against the historic market trend and b)using leverage, which requires an extra amount of discipline to use wisely. Let's not forget that we are in a rate-cutting environment. Bernanke and the Fed are handing out money like the Joker during the parade scene in Batman. These stocks seem to be rallying every other day, often on rumors.

3. Train, say your prayers, and eat your vitamins. It turns out that this is great advice not only for Hulkamaniacs, but also investors. Buy short-term treasuries. They will benefit from the rate cuts, the perception that auction rate bonds are no longer where it's at, and the generally sickening volatility in the stock market. This is boring, but effective.What about the American peso, er dollar? I know that the dollar is a flawed currency and has been desceding through Hell like Dante, but I think that there's chance for a cyclical rally this year.

4. Keeping your options open. This is for the sophisticated. You can use a number of neutral and bearish options strategies to benefit. Be warned, options make use of leverage and despite what many of its advocates say, they are not less risky. They just allow you to take on a different risk than outright equity ownership does. The price of options doesn't step for step correlate with the price of the underlying security. Volatility, time erosion, break even points, and a host of other things help establish the price at which options trade. For more information on options, contact The Options Industry Council. They have a lot of good, free information for the beginning options trader.

You can do a long straddle or strangle on the XLF. These strategies allow you to benefit from a strong price move in either direction. A long straddle involves buying a call and a put at the same price. A long strangle involves buying a call and then a put at a lower price. Both these strategies limit your risk and take advantage of volatility. Either way, time erosion will hurt your position.

If want to take an outright bearish position, you can buy puts, use a bear put spread, or a put backspread. When you buy a put, it's a simple bet that the price of the stock will decrease. The farther the stock falls from the strike price, the more the put increases in value. A bear put spread constitutes selling a put, while at the same time buying at put at a higher price. Ther is limited downside, but also limited upside. Finally, you can employ a put backspread, selling a put, while buying two other puts at lower strike prices. Again, this limits your downside, but the upside is limited, but not as much as with a bear put spread.

5. Follow the yellow brick road. This is an old favorite for those afraid of the equity market. It's like throwing to the checkdown receiver coming out of the backfield, when there's nothing downfield. This works more as a result of perception than most trades because despite the fact that there have been many periods in which gold hasn't retained value, people continue to think that it has and always will. Buy the physical metal or one of the miners if you want to take advantage of leverage. Using GLD and GDX and proxies, year to date, the metal has outperformed the miners by about a 2 to 1 margin.

6. Catch the silver bullet. SLV is up about 14% year to date. As with GLD, it has been lapping the miners so far this year. While silver doesn't have the same fetish surrounding gold, but it benefits from having industrial uses.

Auction rate securities

"The people you are after are the people you depend on. We cook your meals, we haul your trash, we connect your calls, we drive your ambulances. We guard you while you sleep. Do not fuck with us."
- Tyler Durden

This quote comes from one of the more disturbing scenes in Fight Club. It's the one where Project Mayhem kidnaps the police commissioner and threaten to castrate him. The statement perfectly encapsulates the current mess in the credit markets and specifically the problems in the area of auction-rate securities(ARS).

They are part of the plumbing in the financial world that no one notices until it breaksdown. Corporations, universities, municipalities, and even individuals enter and exit this market like Mario and Luigi. ARSs are a relatively small(only $250 billion) backwater of the collosal $25 trillion U.S. debt market. The market has recently come to a screeching halt due to problems elsewhere in the credit markets; this has meant higher borrowing costs for a variety of entities, as well as massive losses due to the failure of buyers to emerge at auctions.

One of the benefits? of any dislocation is that we actually get to see how markets work or fail to work. It's like standing next to Gil Grissom during an autopsy.

So what are auction rate securities? Auction rate securities are variable rate bonds with long-term(usually 30 years)maturities that pay short-term interest rates through a Dutch auction process that occurs every 7, 28, or 35 days. They are often listed as off-balance sheet debts, so you'll have to scour the footnotes of 10-Ks and 10-Qs to find out about a company's exposure. Why use them? They are a fairly common cash management tool offered by investment banks. ARSs are marketed as an alternative to tax-exempt money market funds, commercial paper, CDs, and Treasuries for holding short-term funds. Usually, they offer AAA ratings, preservation of principal, liquidity, and greater yield than the above-mentioned alternatives.

This is not the first whiff of trouble in these markets though. Problems began arising as early as 2004. Back in 2006, 15 banks settled claims that they favored certain clients in these auctions. On February 1st of this year, Bristol-Myers Squibb took a $275 million charge related to these securities.

So who got rich? The usual suspects. The big banks.

The bath that the Maher Brothers took courtesy of Lehman Brothers is actually a blessing in disguise. The rich brothers' travails have shed light upon and put a human face on what otherwise would've been dismissed as an arcane piece of financial engineering. We may now get prudent regulation or at the very least greater transparency.

On Tuesday, I'll discuss how to profit from this debacle.

Seth Tobias Update

“A successful man is one who makes more money than his wife can spend. A successful woman is one who can find such a man.”
-Lana Turner

A little more light has been shed on the sad saga or Seth Tobias, though the story has gotten no less strange since last May. What was already a bizarre tale that featured a male gogo dancer named Tiger, now gets the added allure of an Internet psychic and professional rabblerouser Gloria Allred. It seems like his wife, Phyllis was a real pill-popping harpy and may be responsible for his death. Their relationship was straight out of "Who's Afraid of Virginia Woolf."

Can you imagine give your money to a hedge fund manager who consults with a psychic? Perhaps the most unbelievable aspect of this whole case is that the police's main witness in a murder case is a con man, "psychic," with a long rap sheet who has constantly changed his story. I am incredulous.

CNBC's latest update on Seth Tobias. Notice that Maria Bartiromo calls him "occasional" CNBC guest, Seth Tobias. Even CNBC is trying to distance itself from this poor guy.

I'm never going to eat vodka pasta again.

Jamie Dimon eyeing a fat pitch

I just read this Reuters wire story about Jamie Dimon and his stewarship of JPM. JPM has for the most part avoided the subprime meltdown and has not needed infusions of foreign money to shore up its tier 1 capital. Tier 1 capital is a core measure of financial strength from the regulatory perspective, measuring how well the bank can weather unexpected losses. The finance textbook definition of it is core equity capital / risk weighted assets. It includes of common stock, preferred stock that is irredeemable and non-cumulative, and retained earnings(note, that these are all highly liquid assets). Think of it as a nitrous oxide boost for a race car or a cornerback's closing speed.

Dimon is the sort of conservative, cost-conscious manager that I want running a company, especially a bank. CEOs are often trigger-happy when it comes to acquisitions. CEO bonuses are often predicated on increasing EPS or selling the company, giving them a perverse incentive to go shopping. Granted, banking is an industry that is ripe for consolidation: there are thousands upon thousands of banks and thrifts in the United States in an industry that scales extremely well. Consolidation is a rational approach to growing earnings and the depositor base. However, M & A is not simply about what accounting tricks or financial engineering can be brought forth to squeeze savings out of the combined enterprise. Culture matters. Personnel matters(see Citigroup, Weill,Sandy, and Reed, John). And of course, the vision thing.

JPM is now in a position to pick through the rubbled and find some real gems. As the story says, he is looking to enter the troubled subprime and jumbo mortgage loan markets. For the past two years, phrases like "toxic waste" have been bandied about to describe these instruments, but that is an oversimplification. So many of these mortgages were originated and turned into CDOs and CMOs because they were highly profitable. After the repricing of risk has concluded, they will be less so, but still have better margins than lending at prime rates to the best consumers. Besides, do you think that the banking industry is going to stop lending money to the poor to buy homes? If so, then the Community Reinvestment Act would probably have something to say about that.

Remember, Citadel made a fortune buying Amaranth's natural gas positions and in 1998, Warren Buffett no less was trying to take over some of LTCM's positions. More recently, Berkshire Hathaway is entering the bond insurance business now that players like MBIA and Ambac are reeling. Chaos creates opportunity. Always has, always will.

If you are interested in learning more about bank capital reqquirements, visit this link that explains in detail the three tiers of capital .