Rebel Traders – Analysis Without The Hype

Apple, the famed Iphone and Ipod maker has been on a rip ever since the apparition of the Iphone 3GS, rising to never-expected levels in a recession. Now, it has received a great helping hand from the FASB, the accounting institution of the US, which allowed it basically, to book as actual the revenue to be received from an Iphone subscription upfront.

Until now, Apple distributed the revenue from a subscription over 8 quarters (the typical duration of an Iphone subscription), instead of accounting for it upfront (which makes sense if  you think that the funds will come in over eight quarters). Now, under this change of accounting rules, Apple could recognize up to 95 % of the value of the Iphone upfront. Not indifferently, the Cuppertino firm lobbied hard for this rule, even if in accounting principles, it does not make sense in my view, in counting in your income revenues that have still to be perceived.

The estimation of MS’ analyst, Kathryn Huberty is that this could boost further the stock price of Apple, based on the recognition of a lower P/E than originally expected. What does this teach us? Never short a “cult” stock based on TA! There will always be ways for it to surprise you on fundamentals.

The Financial Accounting Standards Board (FASB), the organization empowered by the SEC to set accounting standards in the United States, is set to vote Wednesday, Sept. 23, on rule changes that could significantly affect Apple’s (AAPL) reported earnings and stock price, according to a report to clients issued Tuesday by Morgan Stanley’s Kathryn Huberty.

The new rules — for which Apple lobbied heavily — would put an end to iPhone subscription accounting, a balance-sheet sleight of hand that has confused analysts and investors from the day the iPhone hit the market.

Although the changes won’t affect Apple’s cash flow, Huberty sees short-term benefits “from a technical and sentiment perspective” including (in her words):

1. Inflows from quant driven strategies and retail investors as AAPL shares will screen cheaper on “New” GAAP consensus estimates vs. “Current” GAAP (19x vs. 23x);
2. Likelihood of larger earnings surprises given analysts have consistently underestimated iPhone gross margins which have ranged between 50-60% over the last year.

The bottom line, she writes, is that the new rules allow Apple to recognize the majority of the revenue and direct costs of an iPhone upfront (she estimates 95%), shifting value from the balance sheet to the income statement.

Although the rule change will affect many technology companies, Huberty points out, it is particularly relevant for Apple since the iPhone, which is subject to current subscription accounting rules, represents approximately 33% of its revenue.

The rule changes, if ratified, wouldn’t become mandatory until Dec. 2011. But Huberty believes that Apple will begin implementing them in their first fiscal quarter of 2010, which begins next week.

A Mad Money report on the proposed rule changes last Tuesday sparked a rally that sent Apple shares up nearly 10.8 points (6.1%) to a 15-month high of $186.79 before it ran out of steam. The stock closed Monday at 184.02.

The Financial Accounting Standards Board (FASB) buckled under pressure from lawmakers in Washington, DC and today has relaxed what is known as ‘mark to market’ accounting rules.

The Financial Accounting Standards Board, pressured by U.S. lawmakers and financial companies, voted to relax fair-value accounting rules that Citigroup Inc. and Wells Fargo & Co. say don’t work when markets are inactive.

Changes to fair-value, or mark-to-market accounting, approved by FASB today allow companies to use “significant” judgment in gauging prices of some investments on their books, including mortgage-backed securities. Analysts say the measure may reduce banks’ write downs and boost net income. Firms could apply the changes to first-quarter results.[...]

[...]“Today’s decision should improve information for investors by providing more accurate estimates of market values,” Edward Yingling, chief executive officer of the American Bankers Association, said in a statement.

Mr. Yingling, you don’t actually expect intelligent people to believe you.. do you? Accurate values are determined by marking assets to current prices. FASB now allows the use of “significant judgment”. Tell me how it is that provides ‘accurate estimates’…

[...]Fair-value [mark to market] “provides the kind of transparency essential to restoring public confidence in U.S. markets,” former Securities and Exchange Commission Chairman Arthur Levitt said in an interview yesterday.

Levitt is co-chairman, along with former SEC head William Donaldson, of the Investors’ Working Group, a non-partisan panel formed to recommend improvements to financial regulation.

“The group is deeply concerned about the apparent FASB succumbing to political pressures,”

—

[...]In a letter in Thursday’s Financial Times, Dutch securities regulator chief Hans Hoogervorst calls political meddling in accounting a “dangerous development”.

If accounting standard-setting is seen as a political process “confidence in the markets will be further undermined”, he said.[...]

Sources: Bloomberg & Financial Times

Banks Using Significant Judgement

The Financial Accounting Standards Board (FASB) is folding like a cheap lawn chair and will allow banks to essentially ‘name their own prices’ for the toxic garbage on the books.

The Financial Accounting Standards Board quietly buckled to banking-industry pressure last week and proposed new accounting practices that would allow banks to value assets at a higher price than they could currently be sold for.

Banks have long demanded the “mark-to-market” accounting rule change, arguing that it’s unfair to require them to mark toxic assets down to current market prices because the very market for those assets is frozen.

The move marks a shift for Robert Herz, head of the FASB, who recently told a panel of lawmakers that the harshest critics of mark-to-market accounting practices have been the very same banks that have gone under when regulators would not let them adjust their accounting. Herz and other regulators have been under intense congressional pressure to reform the rules.

“I will tell you that I get calls and visits from some of those institutions that are now in government hands, about two weeks before they get taken over, trying to get the accounting changed,” he said. “Clearly some of the most vocal opponents of fair value and mark-to-market have been some of those institutions that ultimately failed and have had to have billions of taxpayer dollars put into them.”[...]

[...]Rep. Alan Grayson (D-Fl.), who quizzed Herz on the accounting rule, said that the demand to change the rules is “representative of exactly the kind of thing that’s put us in this position in general…We have people who break every rule in the book and then they think that the answer to their problems is to break more rules. It’s given us some real insight into the human nature and the pathology of the people who have created these problems for America.”

If banks are allowed to determine the value of their assets without regard to current prices, investors have less trust and confidence in the integrity of their books and their assets, which could further freeze markets and further drive down prices.[...]

[...]if a bank asserts that the market for a certain asset is “inactive,” then it need not write the value of it down to market prices. Critics such as Grayson insist this change would allow banks to continue a fiction of viability when in fact they may be insolvent.

“I think the real reason this has come up now is because a lot of the institutions are genuinely insolvent and don’t want to admit it,” Grayson said.

Treasury Secretary Timothy, testifying before Congress on Tuesday, expressed some support for the rule change, calling it a “constructive set of changes” that struck a balance “between preserving confidence in the quality of public disclosure, which is very important to getting through this, [and addressing] some of the complications of applying those standards in a market like we’re experiencing today.”

The public is entitled to comment on the rule change until April first. Comments can be e-mailed to director@fasb.org — File Reference: Proposed FSP FAS 157-e. Or send snail-mailed Technical Director, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116, File Reference: Proposed FSP FAS 157-e.

Source: Huffington Post

Toxic Assets Turn To Gold

The Financial Times is reporting the following:

US proposals to ease controversial fair value accounting rules could alter practices around the world after the international accounting standard setter said it would also discuss the changes.

The US Financial Accounting Standards Board was poised on Tuesday to publish two staff papers that would allow banks and other companies more freedom in how they value financial assets. More securities would be valued by computer models rather than current market prices and many are expected to go up in value. A rule change could come into effect as early as next month.

The International Accounting Standards Board agreed on Tuesday to put out the papers for comment by those who follow its rules – a list of more than 100 countries.

Both the IASB and its US counterpart (FASB) have resisted changes to the rules in ways that could make accounts less transparent for investors. But political pressure in the US has led to these latest changes, while the IASB was forced to soften its own rules last autumn by the European Commission.

Fair value accounting requires companies to report most financial holdings at current market prices. Critics have complained that the plunging prices have slashed banks’ profits and undermined their capital reserves.

The impending rule change has attracted criticism and praise.

“I’ve been wondering for about two years why they haven’t done it already … to me it seems to be the simplest, fastest, cheapest way to deal with the heart of the problem which is the negative feedback loop between the economy and marking asset values in illiquid markets,” said Ed Yardeni of Yardeni Research.

“Mark to market implies that there is a market that provides accurate information, but that assumption clearly fell apart even in early 2007.”

But Shyam Sunder, an accounting professor at Yale and critic of fair value, said the move was ill-judged. “It is fundamentally a bad idea to switch accounting methods in response to what is happening in the markets. When you look at the market and decide the rules, it amounts to having no rules at all,” he said.

Lynn Turner, former Securities and Exchange Commission chief accountant, said: “They are taking accounting standard-setting back four decades.” He added: “The reality is that with this proposal, FASB is really suspending fair value accounting. The bottom line is that these type of things never gets reversed.”

Lynn Turner… you said it and I agree completely. The financial disaster that has befallen the world requires full transparency, to flush out the bad, and to take the losses where they exist.

The constant excuse that the reason for the changes is ‘due to an ill-liquid market’ is nonsense. The only reason the market is ill-liquid is because of the price spreads. IF the holders of the bad assets would simply bring the assets down to what they are worth ‘on the street’ then a fluid market would be opened up.

So now we just go and change the accounting rules in such a way to protect the bad assets and mark them to a ‘computer model’ based on a yet unknown methodology.

“Transparency” will take a step backwards if they proceed with this.