The Rude Awakening
Wall Street, New York
Wednesday, November 2, 2005

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THE NEXT ENRON
By Chris Mayer

A "seismic shift" is underway, Jim Chanos warned a packed
house at last week's Grant's Fall Investment Conference in
Manhattan, "and it will destroy the profitability of
several well-known American companies."

From the podium of the posh St. Regis Hotel ballroom,
Chanos identified the likely victims of this seismic shift.
The attendees seemed to hang on his every word. Chanos, is
afterall, the most famous short-seller in the land…and for
good reason. He rose to celebrity as the "Man Who Called
Enron." That is, Chanos publicly identified Enron as a
questionable operating enterprise - and therefore took a
very large shot position in the company's stock - months
BEFORE Enron's fraudulent activities cratered its share
price and forced the company into bankruptcy. 

Enron is only one feather, albeit a long and colorful one,
in Chanos' decorated cap. He also identified Tyco
International, Sunbeam and several corporate disasters
BEFORE the fact.

But these days, Chanos is operating on a new investment
theory. And, of course, he has a slate of companies that
could wither and die as a result. In his presentation,
entitled "Twilight of the Gatekeepers," Chanos noted that
the progression from an analog to a digital world has
reduced the marginal cost to transmit and/or store
information to nearly zero.

This phenomenon wreaks havoc on a number of older business
models, makes them obsolete and ultimately destroys them.
We've seen it in music retailing; We've seen it in film
photography; and we've seen it in video distribution.

It should be no surprise then that Eastman Kodak is one of
Chanos' short-side ideas. Free cash flow at the company has
fallen from over $1 billion annually to an estimated $300
million in 2005. Next year, Chanos believes Kodak's free
cash flow will turn negative. Far from a value play, Chanos
thinks the film company's business is in grave trouble.

Blockbuster Entertainment, like Eastman Kodak, has seen a
big drop off in free cash flow over the last two years.
That's because digital technologies and Internet
distribution have disrupted the business of video rentals.
Blockbuster, too, is a Chanos short pick.

Middlemen of all stripes - the Gatekeepers - are in
trouble, says Chanos. Movie theaters are another example of
businesses under siege. They face a compression of release
schedules (from movies to DVD, shortening the time movies
remain in only in the theaters), the constant need to re-
invest and long-term declines in theater attendance.

The cable companies are also facing a threat from this
digital revolution. Comcast and Cablevision were two short
candidates he discussed. Cablevision is "most exposed to my
thesis" Chanos declared. Perhaps another way to summarize
the Chanos thesis is this: Sell short pure distribution
systems that compete with the Internet, or with digital
technology or with any other content provider capable of
accessing the consumer directly.

Real Estate Headed Lower?

Jerry O'Connor, a professional real estate investor with 40
years of experience, continued the bearish theme. "Is real
estate overpriced?" he asked rhetorically. "Yes," was his
unequivocal answer.

O'Connor believes the U.S. housing market peaked - finally
- in July 2005. The U.K. is a year ahead of us, O'Connor
believes. If we follow the pattern set so far in the U.K.,
we can expect to see a flattening in home values, a build-
up in inventory, a slowdown in retail sales. We shall see.

In the world of commercial real estate, O'Connor offered a
similarly bearish view. Real estate equities have ballooned
from $380 million 1991 to $8.7 billion. As rates have
fallen, real estate valuations have skyrocketed. As a
result, the cash yield on real estate looks pricey compared
to the yields available in the bond market.

So-called "positive spread investing," the lifeblood of a
REIT, has almost disappeared. Spread investing is
profitable when the financing rates on real estate are
lower than the cash yield on the properties. But this
positive spread has nearly vanished, which means that the
appeal of leveraged investment in commercial real estate
has also nearly vanished.

Meanwhile, many real estate investment trusts (REITs) are
grossly overvalued, says O'Connor. Net Asset Values on
REITs have risen 80% since 2003 - far above the long-term
rate of appreciation. Looking at price-earnings premium,
REITs carry a 40% premium to the S&P 500. This compared to
a discount of 65% in 2000. Clearly, REITs no longer offer a
compelling value. Indeed, they look expensive.

Insiders seem to know this. REIT insider sellers
outnumbered buyers by a whopping 173 to 1 in the 2nd
quarter.

O'Connnor's advice: sell REITS. What to do now? Look for a
margin of safety in quality companies and don't be afraid
to hold cash.

Hmmm…O'Conner sounds like a faithful Capital & Crisis
reader.

Tomorrow, I'll bring you a few more highlights from this
very engaging conference…Stay tuned.

[Joel's Note: If you happened to be out of town during the
Grant's Fall Investment Conference, you missed some
information that will make a small group of people a lot of
money. No need to worry though, Chris Mayer has all these
investment ideas in his upcoming issue of Capital & Crisis.
Check out Chris's next charger right here:

www.agora-inc.com/reports/FST/WFSTFA37/

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[Joel's Note: You will recall that yesterday I foretold of
a "rebirth" of the Rude Awakening, a "metamorphosis" even,
to be announced later in the week. I was inundated with a
torrent of mail from a concerned Rude citizenry, worried
that their morning read would be drastically altering. So
maybe I should have just gone with "additions" over
"metamorphosis"…

Keep an eye, or two, on this space for tomorrow's
announcement of two new additions to your Rude reading
experience. You will still receive the usual insights from
Eric, Chris, Justice and the team so fear not. It's just
that, to tell you're the truth, Eric feels his junior
editor, me, is not "fulfilling his potential" and has set
me to work on a few new projects for you.

And the Markets…

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