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Sunday, May 3, 2009

Some Cash Rich Franchise Businesses Still Growing - Not Kidding

Since the painful lows of early March -- when many thought the DOW was most certainly headed to 5,000 -- the market recovered meaningfully. Wow, how quickly things can change. Positive sentiment is creeping back into the American psyche as investors increasingly "look through the valley" of the recession and move beyond the initial shock and awe of the intense selling last fall (much of which, in our view, was driven by fund redemptions and shorts relentlessly piling on downward momentum). Now, the ever-so-slight shift in sentiment is madly squeezing shorts and helping fuel gains for many cyclical companies which were -- until now -- completely decimated (* more regarding the power of a short squeeze in a future post).

Of course, as always, the tug of war will continue between bulls and bears, especially in media, where pundits will debate "when to get back in" and on what sectors to focus (our favorite: "where to make money now"). As natural optimists here at CommonStock$ense, we can envision a scenario where slightly more positive national/global sentiment begets more confident corporations and consumers, which then begets more business investment and consumer spending, which leads to renewed hiring and a gradual recovery. Yet, we can also see a scenario where demand remains constrained into 2010 as unemployment rises and consumers further retrench. Hard, really impossible, to say. We need to acknowledge two things: (1) we're no better at forecasting near-term macro trends than the next guy (who generally isn't very good!), and (2) many companies are still reporting revenue down 15-20% Y/Y, citing weak demand, and further reducing headcount.

Although we're not opposed to purchasing beaten up cyclicals or asset plays where we see both a durable franchise AND a significant margin of safety from normalized values, we feel very comfortable focusing on secular growth franchises that will grow in 2009. More specifically: growing companies that have healthy net cash positions, limited to no debt, and a history of free cash flow generation. With many investors still largely clamoring for cash, we believe owning franchise type businesses that (1) have net cash and (2) generate significant excess cash arguably appear as attractive as simply holding cash, depending upon prevailing valuations in the market (we're seeking high earnings and free cash flow yields).

So, aside from names everyone knows such as Google (GOOG, $401.98) and Amazon (AMZN, $79.77), what cash rich companies are still growing in an economy that is currently contracting at 6% per year? Some examples:

Co-Star Group (CSGP, $36.28)
ComScore (SCOR, $11.50)
e-Health Inc (EHTH, $18.74)
j2 Global Communications (JCOM, $23.95)
Netflix, Inc. (NFLX, $44.94)
PetMed Express (PETS, $16.43)
Sina Corp (SINA, $28.84)
Shanda Interactive (SNDA, $52.43)
SOHU (SOHU, $57.55)
VistaPrint (VPRT, $38.96) * no history of free cash flow generation

To see share prices and other information, please see this nifty consolidation link from NASDAQ.COM here.

Most of these names are Internet companies, which is no surprise given favorable secular growth trends that should persist. Approximately one half are subscription business models, which we especially like at CommonStock$ense. If we had to guess, we believe these companies will be bigger, better, stronger in three to five years (so long as they remain independent). Of the above group, we only own JCOM and SINA at present and, for now, won't comment on which other companies or at what valuations we'd be buyers (saving for future posts, but suffice to say at least some appear fairly valued). Rather we just wanted to point out that some businesses are growing in 2009 despite serious macroeconomic woes that are bringing lower revenue to most businesses that dominate the headlines.

As an aside, we happen to think j2 Global Communications is a fantastic business and the company reports results tomorrow (see link here). While a sell-side analyst downgraded the stock two weeks ago because of the stock's recovery off of the bottom and organic growth concerns, we think j2's high margin, high ROIC subscription business model could surprise Wall Street this year and see incremental upside for the stock.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long JCOM, SINA.

© 2009 Jeffrey Walkenhorst

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