Owner-Oriented Investment Research and Commentary - Have a private comment or question? Email us at commonstocksense@gmail.com

Tuesday, September 29, 2009

Hazardous Waste Redux + August Durable Goods Down 25% Y/Y

This is a long overdue update to our 7/3/09 post, Hazardous Waste Cos Hazardous to Health, For Now regarding Clean Harbors (CLH, $57.19) and American Ecology (ECOL, $18.73). In that post, we noted that each company has established powerful franchises that arguably operate with insurmountable barriers to entry that, therefore, make them fantastic businesses from an owner's perspective (*although capital intensive). However, we also expressed concern that these are cyclical companies and fundamentals were still deteriorating. We also mentioned indications of intense pricing pressure from an industry contact. Both companies had previously highlighted weak trends in their 1Q09 reports and lowered 2009 guidance.

While share prices are slightly higher since our prior post, 2Q09 reports for the companies included a bit of déjà vu as weak conditions weighed on results and the outlook. Revenue and operating income for the quarter were down 19% Y/Y and 45% Y/Y, respectively, for Clean Harbors, and down 18% Y/Y and 42% Y/Y, respectively, for American Ecology.

Here's what Clean Harbors relayed in its 8/3/09 press release (we include a fair amount of text herein to provide context):
  • “While we experienced a sequential increase in revenue from the first quarter, our second-quarter performance fell short of our expectations as the challenging economic conditions continued to weigh heavily on several areas of our business,” said McKim. “Specifically, our results were affected by a number of factors including project delays by customers; ongoing weakness within our chemical, manufacturing and utilities verticals; and limited emergency response work.”
  • “Within our Technical Services segment, our results for the quarter were mixed,” McKim said. “Utilization during the quarter at our incineration facilities, which includes most of the 50,000 tons of capacity added in the past year, was 88%, consistent with the prior year level. Landfill volumes were up 10% year-over-year, although down from first-quarter volumes as a result of the significant reduction of project work. Our TSDF locations and general labor and transport business saw an overall decline as a result of the ongoing slowdown in certain industry verticals. A bright spot within Technical Services during the second quarter was our solvent recovery business, which continues to be a steady contributor. We made some enhancements to our Ohio facilities during the quarter to further capitalize on our momentum in this area. In addition, we remain on track with the second phase of our solvent recovery plant expansion at our El Dorado location, which we anticipate will be completed by the first quarter of 2010.”
  • “Within Site Services, we experienced a steep drop-off in projects, particularly from our petrochemical, specialty chemical, manufacturing and utilities clients, which are continuing to conserve their capital,” said McKim. “The silver lining to this shortfall is that the vast majority of these projects have been delayed rather than cancelled, and we are beginning to see a pick up in activity this quarter.
  • "Based on the Company’s first-half performance and current market conditions, exclusive of the Eveready acquisition and related costs, Clean Harbors expects full-year 2009 revenues in the range of $925 million to $950 million, and EBITDA in the range of $143 million to $150 million. Previously, the Company had projected 2009 revenue growth to be flat to slightly down, compared with $1.03 billion in 2008, and 2009 EBITDA in the range of $163 million to $167 million."
And American Ecology on 7/28/09:
  • "Weak economic conditions and more competitive pricing adversely impacted our business through the second quarter," commented Steve Romano, Chairman and Chief Executive Officer. "Waste volumes were much lower than the second quarter of 2008, only slightly above volumes received in the first quarter of 2009. However, recurring Base business with refineries and waste brokers held up relatively well, however, as we continued to strengthen our relationships with key customers and brokers. We are also pleased with our thermal desorption recycling operation in Texas, which continued to meet throughput expectations."
  • The Company reaffirms its 2009 earnings guidance range of $0.85 to $1.00 per diluted share. Management believes achieving the upper end of the range will be difficult without accelerated government spending and increased private sector clean up activity in the second half.
  • "The unsettled economic conditions amplify the uncertainty inherent to the disposal industry particularly with regard to the level and timing of event clean-up business," Romano commented. "Discretionary private sector clean-up schedules continue to lag and, while we expect to receive American Recovery and Reinvestment Act funds for multiple projects, specific timing and amounts are not presently known. The current economic climate has also led to downward pricing pressure on certain disposal and thermal processing services, which is impacting margins."
  • "Looking forward, we believe the long-term outlook for clean-up work is favorable based on pent-up demand from deferred private sector clean ups and a revitalized emphasis on environmental remediation by the federal government. With a solid foundation of recurring base business, efficient, upgraded infrastructure at our operating facilities, new service offerings and a debt-free balance sheet, American Ecology is well positioned to take advantage of long term business drivers, an improving economy and acquisition opportunities," Romano concluded.
SO, cautious commentary about the current weak state of affairs -- probably not surprising -- along with a few positives mixed in providing support for the long-term investment thesis (e.g. solid balance sheet, need for services, etc.). In fact, shares appear to have support at current levels given very attractive franchise characteristics and long-term, normalized earnings power. We understand why many investment firms with patient capital established initial or added to positions during the June quarter - see this Nasdaq.com link and note firms such as BAMCO, Epoch, Gilder Gagnon Howe, Pictet, TCW, and T. Rowe Price. From a free cash flow perspective, Clean Harbors generated TTM FCF of $54 million for an implied yield of 3.6% (not pro forma for $409 million Eveready purchase). American Ecology generated TTM FCF of $21 million for an implied current yield of 6%.

Nonetheless, we believe a recovery in industrial demand and, therefore, hazardous waste creation/collection will likely remain sluggish into 2010, pressuring fundamentals (which probably explains why shares haven't fully participated in the ongoing Market rally). In this regard, trends in durable goods are probably a helpful indicator to track -- M/M data from the U.S. Census Bureau:
On a M/M basis, August turned negative following a bounce in July that was helped by increased orders for aircraft, communications equipment, and the cash for clunkers program -- see Bloomberg story re: July increase. We continue to believe that Y/Y trends are critically important and share this information from a Zacks report re: August figures:
  • "The numbers on a year-over-year basis are still rather dismal. Total new orders are 24.9% below a year ago, while excluding transportation they are down 22.2% (given the extreme fluctuations in transportation orders from month to month, it is interesting to see just how close the two are on a year-over-year basis). If Defense orders are excluded, we were ... off 26.6% year over year."
Looking at this graph, we will say that the slight uptick from the recent trough is encouraging. As we've discussed in the past, Y/Y comparisons will soon become very easy for virtually all sectors of the U.S. and global economy. Stabilization and/or slight Y/Y growth off of very easy comparisons should provide another psychological boost to the American public and the Market, even with slack industrial production and high unemployment.

For now, we stay on the sidelines and keep watching CLH/ECOL, as well as some other waste related names such as small-cap Casella Waste Systems (CWST, $3.04). We're not opposed to purchasing cyclical names trading at a discount to normalized earnings power and/or estimated replacement cost, but retain our preference for current growth and significant, consistent excess cash flow with limited capital requirements. Examples we own include American Oriental Bioengineering (AOB, $4.95), j2 Global Communications (JCOM, $23.15), and eBay (EBAY, $23.92) -- please see our prior posts. Except for EBAY, AOB and JCOM have not materially participated in the Market rally and offer estimated 2009 FCF yields of 16% and 9%, respectively. One concern, however, regarding JCOM is recent insider selling, which is often a red flag (if in size) and we were surprised to see (even if some relates to tax bills).

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long AOB, EBAY, JCOM.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Monday, September 21, 2009

Is M&A Deal Activity Perking Up? Tip of Iceberg?

Based on recent headlines regarding mergers and acquisitions, we thought M&A activity was on the rise until we came across this 9/09/09 CNBC article with YTD/monthly 2009 deal figures sourced from Thomson Reuters (including proposed Kraft / Cadbury deal). The article noted the following:
  • $1.3 trillion globally, down 37.9% compared to same time 1 year ago
  • $550 billion US, down 46.5% compared to same time 1 year ago
  • Avg deal size: $54 million globally, $87 million US
Supporting chart from article:

Nonetheless, let's highlight some recent activity in techland, both small and large:
  • Dell (DELL, $16.00) buying Perot Systems (PER, $29.60) for approximately $3.9 billion, a 68% premium to Friday's closing price, or 1.5 times 2009E sales, 31 times 2009E earnings, and 29 times 2010E earnings. See Dell's press release and deal presentation here.
  • Adobe (ADBE, $32.91) buying Omniture (OMTR, $) for $1.8 billion, a 24% premium to the prior day's close and 45% premium to the prior 30 day average close -- the deal is 5.1 times 2009E sales, 41 times 2009E earnings, and 33 times 2010E earnings.
  • Intuit (INTU, $27.52) buying Mint.com (private) for $170 million, a free personal finance Website that, according to the company, "is tracking $175 billion in transactions, $47 billion in assets and has identified more than $300 million in potential savings for its users", but likely generated little revenue (as yet) given its "free" business model. Intuit no doubt sees significant strategic value in the company.
  • Rumors surfaced last week that Google (GOOG, $493) was acquiring Brightcove for 6 to 9 times sales (based on 2009E revenue estimate of $80 million from an article by Dan Rayburn), but were later quelled (see blog post by Dan Rayburn here).
  • Google buying On2 Technologies (ONT, $0.59) for 6 times trailing twelve month sales, which we previously discussed here in relation to Sonic Foundry's (SOFO, $0.71) growing Mediasite franchise.
So, deals are happening, providing liquidity for sellers and, potentially, strategic value for acquirers so long as diworsification (as coined by Peter Lynch) isn't occuring. Also, a Bloomberg article today points out the following:
  • "Never before have U.S. companies piled up cash faster compared with interest costs than they are now, setting the stage for a surge in mergers and acquisitions."
  • "As the economy emerges from the worst recession in 70 years, cash flow may rise from the $1.5 trillion reported by the Commerce Department for the year ended in June, according to data compiled by Credit Suisse Group AG and Bloomberg. The amount reached a record in the past 12 months amid the biggest wave of firings since World War II and central bank interest rates near zero percent."
  • "Cash relative to share prices will climb to the highest in at least two decades next year compared with yields on corporate bonds, the data show. The previous high in 2005 preceded the two busiest years ever for takeovers."
Lots of cash generation and cash on the sidelines are surely good things for potential M&A activity and, in our view, the economy at large, so long as new jobs are created for those displaced through consolidation.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SOFO.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, September 17, 2009

Yahoo! Again Embraced by Wall Street - Online Real Estate is Valuable

Yahoo! (YHOO, $17.50) is rallying on renewed love from Wall Street -- Sanford C. Bernstein upgraded the stock Tuesday to "Outperform" and Barclays raised estimates/target today.

Although we recently lightened up on our Yahoo! position to reallocate some capital (full disclosure), we still hold shares and believe the franchise is extremely difficult to replicate. Last November, we shared the following with family/friends:
  • Briefly, on YHOO – with headlines such as “What’s Yahoo Going to Do?” and “Yahoo Is Finished and Must Sell!”, the media brouhaha over Microsoft is ridiculous. Seemingly lost in the mix is that Yahoo! is one of the premier Internet franchises in the world, with almost as much traffic as Google (source: comScore), the most popular email platform (comScore), and – believe it or not – the most popular sports portal (ahead of espn.com, per BusinessWeek / Yahoo). Yes, the advertising world is hurting because of the recession and Yahoo’s outlook may remain under pressure; yes, Google’s search offering is a highly effective, killer business; and, yes, results have been lackluster. Yet, the company has been investing in many areas (e.g.: ad exchange platform, video, mobile) that have crimped margins but should bear much fruit over medium term, especially when the economy turns the corner. Further, the company has no debt, generates plenty of free cash flow, and has more than $2 per share of cash on the balance sheet plus Asian properties worth perhaps $4-5 per share. This analysis suggests investors can buy Yahoo’s core business for just $4-5 per share, which appears an incredible bargain. Bottom-line: Yahoo owns an Internet franchise/brand that is impossible to replicate and that should only become more valuable with time as prime online real estate appreciates in value. I recently purchased more shares in the mid $9s.
Although shares are now substantially higher than last fall, we believe the above thesis still holds, albeit with numbers shifted around, e.g. cash per share now $2.77 and different values for Asian assets, plus business model questions related to the search deal with Microsoft (MSFT, $25.30). We continue to see significant franchise value for Yahoo! and expect incremental upside over time.

As additional fodder supporting the franchise, let's briefly look at information included in a recent Forbes cover story "Can Yahoo's Carol Bartz Outsmart Microsoft And Google?":
  • [Yahoo has the] ability to reach 500 million-plus people in 30 countries, putting ads in front of them all.
  • Yahoo Mail has 98 million users in the U.S. alone, almost three times as many as Microsoft's Windows Live e-mail and four times as many as Gmail from Google.
  • Yahoo News claims six times as many readers as the four highest-circulation dailies combined.
  • Three million photos a day go onto its Flickr photo service.
  • Two hundred and sixty million ads a month are submitted to Yahoo, and 20 million are manually reviewed for content. Six million are rejected for inappropriate content.
Thus, the company is well-placed to remain a dominant Internet/media player.

Still, despite our positive view of the franchise, there are some areas of concern for investors: (1) Internet dynamics/technology change quickly and traffic monetization is not a slam dunk (have Yahoo!'s many acquisitions [under prior management] been accretive or destructive for shareholders?), (2) the law of large numbers could yield only moderate top- and bottom-line growth for the company once the economy turns, and (3) excluding hidden assets (e.g. Asian assets), shares of Yahoo! currently offer a TTM free cash flow yield of only 3% and shares may remain expensive on a P/E basis for years to come (currently 44 times consensus 2010 estimate of $0.40). With respect to the last point, we're willing to cut a bit of slack given franchise characteristics that support sizable economic goodwill.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long YHOO.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, September 15, 2009

Update - Tale of Two Auction Franchises, plus BIDZ/EBAY

On 5/11/09, we wrote about two auctioneers, both established franchises protected by meaningful barriers to entry: Sotheby's (BID, $16.94) and below-the-radar Ritchie Bros. Auctioneers (RBA, $24.50). We like the entrenched market positions for both companies and think both will likely be around for generations. We thought we'd relay some points from June quarter results (now old news) and continue our tale:
  • One reported June quarter revenue down 48% to $167 million (somewhat better than March quarter's down 58% Y/Y) and operating income of $53.1 million (excluding $5 million of restructuring costs, a massive improvement from a March quarter operating loss of $50 million).
  • The other reported revenue up 3% Y/Y to $84 million and operating income of $28 million (+19% Y/Y) for the quarter.
  • One has net debt position of $368 million and generated trailing twelve month cash flow from operations of negative $37 million and implied negative free cash flow of $50 million (assuming normalized annual capex of $12.5 million).
  • The other has a net cash position of $152 million and generated trailing twelve month cash flow from operations of $167 million and near break-even free cash flow (as a result of planned expansion capital expenditures).
Which one is which? Readers can probably guess. Let's add a little commentary from earnings releases:
  • "We are on track to achieve the $160 million in cost savings in 2009 as compared to 2008 as announced last quarter. These substantial savings, as well as a new three year $150 million revolving credit facility that we expect to close with GE Capital later this month (subject to the conditions in the GE Capital commitment letter), have us on solid ground for the future.... We adjusted quickly to the different and difficult environment that suddenly presented itself and we are very well positioned to capitalize on a market rebound and benefit from our improved margins and lower costs.”

  • "We've seen two noticeable worldwide trends recently: there's more used equipment coming to market and more people are turning to our fair, transparent unreserved public auctions to meet their equipment needs. We're selling more lots, attracting more bidders and continuing to conduct record-breaking auctions in what many people would describe as a challenging market. Buyers and sellers of used equipment are turning to [us] in increasing numbers, and the investments we've made in developing our salesforce and expanding our global network of auction sites have enabled us to handle and benefit from that growth. We're pleased with our progress and believe we are on track to meet our goals for 2009."
Not surprisingly, the first series of bullets correspond to Sotheby's while the latter relates to Ritchie Bros. Auctioneers. In May, we expressed caution surrounding Sotheby's weakening financial condition (high debt load) amidst a challenged luxury market. Since then, shares are up almost 50% on the company's ability to reduce costs and Market expectations for an economic recovery. By contrast, RBA is up only 2% and the S&P500 is up ~15% -- please see graph below from Nasdaq.com:


What's going on here? We think investors are correctly assessing normalized earnings power of both companies and, in this case, choosing BID over RBA. If we simply take the five year average of reported earnings for Sotheby's and assume this represents a full economic cycle (in truth, we should probably also include the weak 2002-03 period), average EPS equals $1.56. Applying a 20 times multiple (or 5% earnings yield, awarded for difficult-to-replicate franchise) to this figure, we arrive a fair value of $31 per share. We include results from the company's 2008 10-K below:

The following table provides selected financial data for Sotheby’s (in thousands of dollars, except per share data).

Year ended December 31

2008

2007

2006

2005

2004

Net Auction Sales (1)

$

4,189,735

$

4,625,914

$

3,234,526

$

2,361,830

$

2,334,937

Income statement data:

Auction and related revenues

$

616,625

$

833,128

$

631,344

$

496,899

$

439,526

Finance revenues

14,183

17,025

15,864

8,302

5,907

Dealer revenues

55,596

62,766

12,776

5,131

3,604

License fee revenues

3,438

2,960

2,922

1,404

45,745

Other revenues

1,717

1,843

1,903

2,117

2,274

Total revenues

$

691,559

$

917,722

$

664,809

$

513,853

$

497,056

Net interest expense

$

(28,349

)

$

(14,166

)

$

(27,148

)

$

(27,738

)

$

(30,267

)

Income from continuing operations

$

28,269

$

213,139

$

107,359

$

63,217

$

62,397

Net income

$

28,269

$

213,139

$

107,049

$

61,602

$

86,679

Basic earnings per share from continuing operations

$

0.44

$

3.34

$

1.78

$

1.04

$

1.01

Basic earnings per share

$

0.44

$

3.34

$

1.77

$

1.01

$

1.40

Diluted earnings per share from continuing operations

$

0.43

$

3.25

$

1.73

$

1.02

$

1.00

Diluted earnings per share

$

0.43

$

3.25

$

1.72

$

1.00

$

1.38

Cash dividends declared per share

$

0.60

$

0.50

$

0.20

$

$


Meanwhile, Ritchie Bros. -- which is growing through the recession and, therefore, at peak/record earnings -- is already trading at 24.5 times current year earnings. We include results from the company's 2008 annual report below:

Consolidated Statements of Operations
(Expressed in thousands of United States dollars, except share and per share amounts)
Years ended December 31, 2008 2007 2006
Auction revenues
$ 354,818 $ 311,906 $ 257,857
Direct expenses
49,750 46,481 40,457
305,068 265,425 217,400
Expenses:
Depreciation and amortization
24,764 19,417 15,017
General and administrative
164,556 144,816 117,714
189,320 164,233 132,731
Earnings from operations
115,748 101,192 84,669
Other income (expense):
Interest expense
(859 ) (1,206 ) (1,172 )
Interest income
4,994 7,393 6,664
Foreign exchange gain (loss)
11,656 2,802 (451 )
Gain on disposition of capital assets
6,370 243 1,277
Other
1,375 1,471 1,079
23,536 10,703 7,397
Earnings before income taxes
139,284 111,895 92,066
Income tax expense (recovery) (note 8):
Current
39,101 33,797 33,757
Future
(1,217 ) 2,115 1,091
37,884 35,912 34,848
Net earnings
$ 101,400 $ 75,983 $ 57,218
Net earnings per share (note 6(e)):
Basic
$ 0.97 $ 0.73 $ 0.55
Diluted
0.96 0.72 0.55
Weighted average number of shares outstanding
104,713,375 104,266,113 103,639,380


Thus, with respect to Sotheby's, we appear to have missed an excellent opportunity to pick up a premier franchise on the cheap. That said, while our above analysis points to meaningful further upside, timing is uncertain and risk remains that Sotheby's operating results will be pressured for some time to come. We generally prefer companies with more favorable near-term fundamentals and limited debt burdens. Consistently high margin, high ROE Ritchie Bros. Auctioneers fits this billing, but the stock remains too expensive for our liking. We'll continue to watch both names and remain content with our auction franchise exposure via Bidz.com (BIDZ, $3.75) and eBay (EBAY, $24.44). Please see our prior posts here and here, respectively.

We believe BIDZ offers a substantial margin of safety at current levels, even with a skeptical view of "normalized" earnings power. We still like EBAY, too, although the margin of safety is gradually being eroded as shares march upward and Wall Street embraces the name anew (please see analyst upgrades today). However, we envision cash piling up on eBay's balance sheet as the core business chugs along and PayPal keeps growing, which should propel shares into the $30s over time (e.g. 20 times current consensus 2010 EPS of $1.62 = $32 per share).

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long BIDZ, EBAY.

© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, September 9, 2009

More Evidence of the Mediasite Franchise

Trading volume in Sonic Foundry (SOFO, $0.62) picked up in August, averaging 61 thousand shares per day compared to a three-month average of only 38 thousand per day. We are pleased to see increased trading volume and also glad to see institutions such as Oberweis Asset Management (269,000 shares) and Pennsylvania Public School Employee Retirement System (83,200 shares) initiate positions during the June quarter (see this link to enlarge - source Nasdaq.com):

That said, there remain some big sellers -- leading to a flat share price -- which is surprising given favorable fundamentals: revenue growth greater than 20% for fiscal 2009 (end September) with break-even operations. Short interest also remains shockingly high given light trading volume (although small as percentage of float) -- also from Nasdaq.com:

Meanwhile, certain other small cap stocks have recovered nicely in recent months. The only explanation for lagging SOFO: the stock continues to fly below the radar as the Market is implying that the company will run out of cash within the next year. While there are certainly risks, our model shows Sonic Foundry generating free cash flow over the next twelve months so long as growth remains similar to current trends (we discussed in earlier post).

Before we touch on very tangible evidence of the growing Mediasite franchise, let's first point to another opportunity for Sonic Foundry that is top of mind around the world: preparation for Swine Flu. A couple of weeks ago, the U.S. government stressed that schools should be prepared to keep education going even if many students can't attend - from an AP article sourced via the Chicago Tribune:
  • Speaking at an elementary school on the first day of classes in Washington, Duncan released recommendations on how educators can ensure instruction continues should the virus cause high absenteeism or school closings.
  • Schools should be ready with hard-copy packets and online lessons to keep learning going even if swine flu sickens large numbers of students, U.S. Secretary of Education Arne Duncan said Monday.
    • Duncan said schools should evaluate what materials they have available for at-home learning. The latest guidance provides more details on methods schools could use, such as distributing recorded classes on podcasts and DVDs; creating take-home packets with up to 12 weeks of printed class material; or holding live classes via conference calls or "webinars."
    The CDC has detailed guidance on its Web site, including the following:
    • IHEs should plan now for ways to continue educating students who stay home through distance learning methods. IHEs should also examine policy accommodations that might be necessary such as allowing high-risk students to withdraw for the semester, tailoring sick leave policies to address the needs of faculty and staff, or modifying work responsibilities and locations.
    • Increase social distances: Explore innovative ways to increase the distances between students (for example, moving desks apart or using distance learning methods). Ideally, there should be at least 6 feet between people at most times.
    We know many schools are taking the direction seriously - here's a link to UPENN's Web site regarding "Flu Prevention and Preparedness". Further, Sonic Foundry's blog, World of Webcast, noted on 5/20/09 that many customers were already using Mediasite to share Swine Flu news. As "the global leader for rich media webcasting and knowledge management", we see many opportunities for the company to help organizations manage through the situation.

    Okay, now to the tangible evidence that we think represents a still unappreciated positive catalyst: last week, a government "request for quotations" (RFQ) surfaced "for the purchase of Sonic Foundry Mediasite Recorders with Service and Maintenance"- link here. The RFQ is for "The Uniformed Services University of the Health Sciences (USU), located on the National Naval Medical Campus in Bethesda, MD". Salient points from the RFQ directly support our Mediasite franchise thesis:
    • USUHS has determined that Sonic Foundry is the only reasonably available manufacturer to meet the government’s requirement:
    • USUHS has determined that the Sonic Foundry Mediasite RL Recorder is essential to the Government’s requirements and market research has not produced any other companies’ products that meet the agency’s needs.
    • The Sonic Foundry MediaSite integrated platform provides a single manufacturer solution for lecture room capture and delivery of events at the USU over the Internet. The increasing demand for rich multimedia rendering of SOM and GSN courses coupled with the expanding demand for Podcast technology and a truly virtual campus drive the USU’s requirements to advance the use of Internet streaming.
    • All captured content is immediately available through Blackboard, the USU Internet or Intranet. Access can be controlled by UIS’ Active Directory system ensuring that the content can be accessed by the appropriate audience. The Sonic Foundry system integrates with our current information technology and supports our adoption of MS Outlook. Access to the system is only limited by our bandwidth and not per user seat licenses, thus enabling the USU to leverage the technology in support of the USU’s vision of a virtual university delivering distributed learning and CME.
    • Sonic Foundry provides a uniquely integrated solution of hardware and software that will enable the USU to deliver live, On-Demand and Podcasting multimedia content of the USU’s lectures, research findings and CME content. Specifically the new USU Center for Translation Science and the new focus on Traumatic Brain Injury research will be enabled to effectively and widely distribute the results of our research to the broader scientific community.
    Unfortunately, the RFQ also notes one of the challenges we know Sonic Foundry encounters with many large organizations, from government to education to enterprise -- lack of central IT planning and funds:
    • The ability to stream content over the Internet or podcast is possessed by multiple agencies and individual DOD offices/units however it is neither coordinated, seamless, widely available nor centrally funded. Each DOD entity must procure individual systems to meet local requirements.
    Finally, the RFQ also lists exact technical requirements that are likely included to document that Mediasite is, in fact, "the only reasonably available manufacturer to meet the government’s requirement" (as mentioned above). The very specific requirements also highlight the advanced functionality of the Mediasite solution, which we see as a competitive advantage. Once a system is installed and customers begin "Mediasiting", we see the solution as difficult to displace.

    What does the USU RFQ potentially mean for Sonic Foundry's finances? Looking at the draft solicitation document, we find the size of the desired system:
    • One (1) RL Recorder (MSL-CSR-500-Room-Based with EX Server Recorder License), with an additional five (5) RL Recorders (MSL-CSR-500- Room-Based, Rack Mountable)
    So, not a 20 or 30 room installation... yet. Assuming an average selling price of $12 to 16 thousand per unit plus a server license, maintenance, and support, we estimate that Sonic Foundry could possibly see a low six figure transaction.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long SOFO.
    © 2009 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Tuesday, September 8, 2009

    Surprise! Youbet.com Back in the Bargain Bin

    The bad news: prior to Friday's +9% move, shares of Youbet.com (UBET, $2.25) were nearly cut in half from July's high of $3.91, which we didn't expect given improved industry content relationships and the company's solid financial position (discussed in our prior posts, including this July post). Also, today, the company announced an accounting restatement related to YB's rewards program - link here, small non-cash impact. Shares are now retracing part of Friday's up move.

    The good news: As David Dreman writes in his 8/19/09 Forbes column, "Markets are always perverse and unpredictable" (link here). That is, the Market is irrational. How else can we explain certain financial names highly diluted by government ownership stakes seemingly trading on thin air? If interested on this latter topic, we point to some thought provoking pieces on SeekingAlpha.com regarding Citigroup (here) and AIG (here)....

    And, more good news: we, as investors, can be rational and take advantage of Market mis-pricing to profit so long as our fundamental analysis is correct (buy quality businesses cheap, sell them dear).

    And, shhhh, more good news: maybe the Market won't bid shares back up too quickly because we believe Youbet can now be active with company's share repurchase program (up to 10% of common shares outstanding, or approximately four million shares). Our understanding is that the company was previously restricted by potential M&A activity related to discussions regarding the tote business -- but, no longer, since that process is on hold given other properties for sale in the market and management sees no reason for a "fire sale". We would be disappointed if YB does not report repurchase activity for 3Q09.

    Although we would prefer for UBET to be trade closer to a 5% free cash flow yield (which we see as fair based on the company's established franchise as outlined in our initial post), or approximately $4.50 to $5.50 (assuming reduced 2009E FCF of $10 million to $12 million), we also prefer management to repurchase shares on the cheap. Buying back stock at $2-3 is far more accretive than buying in shares at $4-5. For example, if Youbet uses $10 million of free cash flow over the next twelve months (above current net cash of $5.6 million) to repurchase shares at $2, we estimate that annual EPS would increase by approximately $0.02. If Youbet instead repurchases shares at $4, then EPS might increase by about 7/10 of one cent.

    Last week, a reader posted interesting comments to our 8/6/09 pre-results post ("UBET Slides...") and, among other things, asked if our confidence has been shaken given industry handle declines. Our brief answer was that we believe franchise value remains significantly higher than current levels and is supported by current and expected free cash flows.

    Yes, some investors threw in the towel on weaker than expected June quarter results (we discussed here) and the subsequent downgrade by Brean Murray, one of the few brokerage firms that has long covered the stock and knows both the company and industry well. We are aware of key investor concerns such as (1) increased competition from an aggressive Churchill Downs (CHDN, $37.86), (2) lower wagering yields (related primarily to new content), and (3) the poor economy.

    With respect to the first point, Churchill Downs gained an estimated 470 basis points of market share Y/Y in 2Q09 to reach 21.5%, while Youbet gained only 0.33 bps of share. TVG and Magna ceded share to Churchill Downs, as shown in the below graphic (click to enlarge):

    With 2Q09 handle up 43% Y/Y, Churchill clearly did very well on the back of the Derby, besting Youbet's +13% Y/Y handle performance. We believe newly available content on Youbet cannibalized customer wagering on other tracks during the quarter (leading to lower same track handle), although YB performed better than peers TVG and Magna. Given a return to normalized content in 2009, we'll need to see how full-year handle/share results shape up for a better idea of winners/losers this year. We expect 3Q and 4Q to be more favorable for YB on seasonal track strength (e.g. Del Mar and Saratoga) despite fewer racing days at certain tracks.

    On the yield question, as noted in our post 2Q commentary, YB's net yield of 6.9% was actually higher than the 6.3% realized in 2Q06 (when YB last carried the Kentucky Derby and other Churchill content). Going forward, we look for yield levels to remain around 7.0%, plus or minus. Despite the lower net yield in 2Q, recall that income from operations of $2.6 million (for online segment only) represented a 29.1% margin on net revenue compared to 28.5% in 2Q08 and 27.1% in 1Q09.

    Finally, Equibase reported on 9/4/09 that US wagers for the month of August were down 12.4% Y/Y, with YTD wagers down 11.1% Y/Y (versus July down 13.4% Y/Y with YTD wagers down 10.9% Y/Y). So, August was a bit better than July, which was a bit better than June, and U.S. horse wagering continues to outperform the ~15% Y/Y decline in Nevada state gambling revenue (see this link, which we previously shared). Also, the Daily Racing Form noted that "U.S. race days, however, were down 8 percent in August compared to last year, from 709 to 650, in part because of a drastic cutback at Ellis Park in Kentucky and a decision to hold five days of racing a week rather than six at Del Mar this year" (link here).

    While some tracks are struggling amidst the weak economy, marquee tracks are holding up relatively well. Prior to heavy rainfall the other week, Saratoga posted fantastic figures through the first 18 days of the meet: attendance "up 8.4%, on-track handle up 12.3%, and all-sources handle up 4.8% from 2008 totals" (link here). Following a rainy weekend in late August, figures turned slightly negative: attendance "down 1.6%, on-track handle down 1.6%, and all-sources handle down 2.8% from 2008 totals through Week Five" (link here).

    Del Mar is also faring well in the hard-hit, I-O-U state of California -- from Bloodhorse.com (link here):
    • Through the track's 30th program Aug. 30, Del Mar was averaging 17,560 patrons a day with an on-track handle of $2,281,188 in 2009. Compared to last year's figures, when the track was running six days a week instead of the current five-day schedule, the on-track attendance jumped 12.4% from the 2008 average of 17,560 [per day] at the completion of six weeks. The on-track average handle for 2008, $2,076,270, was 9.9% lower.
    • This year's attendance figure, 526,551, is up by 2.7% over last year (512,941) when Mondays are eliminated. The current-year handle, $68,228,273, is a 1.4% increase over last year's $67,276,836, under the same scenario.
    Summary

    It's true that the ADW market is competitive, but this is nothing new -- nearly all businesses face competition, especially now. YB successfully managed through 2008 with reduced content and competition. We expect the company's franchise to allow Youbet to manage through the balance of 2009 and into 2010, even as the weak economy pressures industry handle. We imagine YB's new CFO (also announced today) -- who appears experienced and capable -- will carefully manage customer acquisition/retention costs to maintain and potentially improve margins over time.

    We believe our core thesis is intact: over the past decade, Youbet established an asset light business model with a leading online wagering franchise – brand, customers, platform, marketing partners, and track relationships – that is difficult to replicate. An important part of this thesis is that Youbet’s online business should generate steady, growing free cash flow combined with a high ROE/ROIC. Increasing net cash balances should allow owner-oriented management to return cash to shareholders over time (hopefully, during 3Q09 via share buyback!). We also believe growth is achievable given the secular shift to online wagering, especially whenever the economy rebounds. We will change our tune if YB's management is unable to both maintain/increase market share and grow the bottom-line (as measured by free cash flow) over time. Capital returns to shareholders also remain a must.

    Lastly, as noted above, valuation remains attractive in our view, and we could see shares fairly trading around $5 today assuming a 5% FCF yield on 2009E free cash flow. On a relative TTM basis, Youbet continues to trade at a significant discount to certain other niche franchise Internet businesses and gaming companies:
    • Youbet offered by Market at 9% TTM FCF yield
    • Blue Nile (NILE, $54.92) offered at 3% yield
    • The Knot (KNOT, $9.90) at 4% yield
    • Stamps.com (STMP, $9.05) at 6% yield
    • Churchill Downs at 4% yield
    • Penn National Gaming (PENN, $27.39) at 6% yield
    If Youbet traded at Blue Nile's valuation, shares would be at $8 today. We probably don't need to relay which one we'd rather own at current levels. Meanwhile, we should also mention Bidz.com (BIDZ, $3.77), another niche franchise online company that presently trades at a very compelling 18% TTM FCF yield (please see our prior posts).

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long UBET, BIDZ.

    © 2009 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer