The LEAPS Option Trader
105 W. Monument Street
Baltimore, MD 21201
Wednesday, October 26, 2005
#285
** Doral Update
I was looking for a payday from Doral in mid-November. That is when the company was supposed to restate its numbers and provide forward guidance. It is not going to happen… not in November anyway.
This past week, two Puerto Rican banks announced that their SEC informal investigations are now formal. In a formal investigation, the SEC has power to subpoena information related to what it is investigating. The high volume sell-off yesterday in Doral shares happened mainly because the two banks in question had dealings with Doral, bringing the company into the picture. It is pretty obvious that this news leaked prior to the official announcement based on the number of shares traded with “no news.”
The company does not believe that this “new” news will have any financial impact, but it must investigate the situation anyway, hence the further delay and the increased uncertainty.
The implication here is that if the banks in question had dealings with Doral, among other institutions, then Doral itself would also have to answer to a formal investigation. That is exactly what was announced after the close of trading on Tuesday. This also means that Doral will not file its restatement by the November 10 deadline either. This deadline was what we were counting on for our “exit” strategy, and now the date is certainly delayed.
What does this mean? Most likely, the shares will head even lower in the coming days and weeks. Stocks never do well in light of uncertainty. But, there are two points that merit consideration. The first is whether Doral did something illegal. That would be the dagger in the heart for this company. So far, from all the information available, it does not appear that they have committed any fraud.
The company still maintains a healthy business and has more than a billion dollars of cash on hand after accounting for all liabilities. And, the type of accounting issue, a non-cash issue, is not limited just to Doral, but several companies, all of which were following an accepted formula for calculating their exposure to rising interest rates and the accompanying spread trades they put on. Unless there is a conspiracy among four well known federally chartered lending institutions, the situation should play out in our favor. But, after Refco and other recent scandals, nothing is impossible on Wall Street. That is the greatest risk.
The second point to consider is that we are holding options that do not expire for another 14 months. Yes, they have lost value, but as we have witnessed time and again, it does not take much to make that money back. Recently, Doral was trading at $14, and the options were within 20% of our adjusted entry price. If this was a short-term position, it would be hopeless. But, it isn’t, and our risk capital is only what we paid for the option.
This recommendation is proving me very wrong right now. If Doral has greater issues than those already disclosed, then the stock will suffer further. In the coming weeks, there will be announcements regarding de-listing of their preferred shares and debt ratings downgrades. These are “after the fact” items and not related to what is happening at the business today. The company has ample cash to meet any debt obligation, and its preferred dividends will continue to be paid.
For now, I recommend that you sit tight, unless being in this position keeps you up at night. The truth and the results will ultimately be known when the company restates, and not before. And that may take a few months yet.
Regards,
Karim Rahemtulla
Bio:
Karim Rahemtulla is the former Investment Director of The Oxford Club. The editor of The Smart Options E-Report, The Income Trader – A Covered Call Strategy and The LEAPS Option Trader, Karim is also a regular contributor to The Oxford Club Communiqué. His highly successful trading systems use covered calls and LEAPS to boost returns on blue chip stocks, and during the bear markets of 2000 and 2001, his picks outperformed the major market averages. Educated in England, Canada and the U.S. and fluent in several languages, Karim travels the world to find the best investment opportunities for our members.
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