Friday, December 14, 2012

Short Framework Applied to Integrated Resources

Company Description: Integrated Resources was a marginal company ( a company has shaky financials, bad management and a history of aggressive but often poorly executed business strategies) that derives its revenue from 3 areas: Life insurance companies, Direct Participation Investment Programs, and Money Management. 

I. Short Sale Categories and Characteristics (There are some overlap):

1. Integrated Resources could be affected in a significant way by changing external events, in this case, the Tax Reform Act of 1986. 

2.Greedy and shoddy management:
i.  Executives were related-brothers. 
ii. Executives earned over 15 million when the company earned 49.8 million in 1986. 
iii.The company even paid medical cost not covered by insurance policies. 
iv. Creative stock bonus incentive plan: When granted stock option, they paid 5% in cash and the remaining balance in installment over the vesting period. 

3. Ugly balance sheet and Accounting Gimmickry:
i. Equity as a % of assets dropped from 20% to 10% (1986 10K). Eroding equity capital affects bargaining and credit standing in the market. 
ii. Integrated booked revenues from future rental proceeds and proceeds realized on sale of property up front when it closed the partnership. These are booked in deferred fees and contract rights. 
iii. Prepaid and acquisition cost up more than 100% with no explanation. 

4. Shift in business strategy: In 1987, Integrated decided to change the product emphasis to income-producing partnerships, variable annuities and money management. 

II Research the Short Candidates and Track Operating Metrics:
1. Q1 1987 income from operations down and cash flow continued to deteriorate. 
2. Q3 cash burn was ameliorated by long term debt and short term debt financing. Shareholder's equity as a % of asset is down to 8.6%. 
3. 1987 10K had a particular interesting footnote: A change in amortization of prepaid acquisition costs in the 4th quarter added $0.97 to earnings. The change was not booked as an extraordinary item. 
4. Also booked a gain from termination of a pension plan. 
5.Q1 1988: Pretax income was down, interest expense was up. The company will continue to require additional funds from sources other than operations. AP was up 270 million to 426 million in just 3 months. Drexel Burnman Lampert helped Integrated Resources with 100 million senior notes. 
6. Integrated resources owned 2 insurance companies: Integrated Resources Life and Capitol Life. The insurance subs, in turn, owned a fair amount of Integrated and Integrated affiliate paperstocks, bonds and notes. 
7. Integrated Resources Life had a surplus of only 77.3 million with 3.086 billion assets. 
8. Capitol Life had surplus of 61 million against asset of 1.9 billion. 
9.Q3 1988: Earnings down again, equity as % of asset down to 7.1%. 
10. Insider were selling in Dec 1988. 
11. On May 16, 1989, Integrated announced that first-quarter results would be late and that there would be a net loss after a preferred dividends. 
12. Around June 1989, the company admitted that cash was a problem and Drexel balked. The stock dived to 5 and Integrated filed for bankruptcy in early 1990. 
III.Important Points to Keep in Mind:
1. The short maxim: Wait to short until reality can be proved. 
2. Short sellers are often shortsighted about the duration of hope for a new industry and for concomitant stock-price decreases. Stock price parabolas can sometimes appear to bend back on themselves, but the rate of return on the short position might look like net income on a company in the interim. 

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