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Saturday, February 27, 2010

Fortune Tech Picks - No Sonic Foundry / Mediasite? Don't Discard Margin of Safety

Fortune Magazine's Investors Guide 2010 (from December) included this article: "Tech investing is all about the next big thing. Here are the trends that could really pay off."

The article opens with:
(Fortune Magazine) -- Technology trends can be easy to spot -- iPod earbuds become ubiquitous, people casually use the term "Google" as a verb -- but technology investing is hard. For every Apple and Google, there are plenty of tech companies that fail to turn their innovations into top-performing stocks.

So how to pick the winners?

The key is to find the companies best positioned to execute on massive shifts in the way consumers and businesses use technology.

The article goes on to highlight a handful of seemingly well-positioned, niche technology companies that are, in fact, posting excellent growth. However, there's only one minor problem: the Market is already aware of these growth stories and, thus, all companies appear to fetch fair to rich multiples of earnings, cash flow, and/or sales (if no "E" or "CF" to measure against).

As we've discussed previously, we believe high multiples leave little room for error and can lead to sub-par investment performance (disappointment and losses for long positions) if optimistic Market expectations are not met.

Here's how Fortune describes the valuation of one company, CommVault (CVLT):
Trading at 28 times earnings, the stock is expensive, but analysts expect the company's earnings to grow 17% annually for the next five years, while the S&P 500 is projected to grow just 11% a year during the same period. The company today holds its own against larger rivals, but analysts say CommVault is a prime acquisition target for a big tech outfit.
SO, the company is trading at almost two times its expected growth rate. We don't know this company well, but the numbers suggest there's no bargain here. Again, a high multiple -- in this case, a high P/E and a high "PEG" ratio, or P/E to growth rate -- does not allow for potential hiccups that may result in slower-than-anticipated growth and subsequent multiple compression.

Here's how Fortune describes the valuation of another company, EnerNOC (ENOC), which is trading at 85 times forward earnings (consensus 2010E GAAP):
The company's share price has been soaring of late, tripling in value since last November's lows. Still, the stock trades far below the $50 a share it hit in December 2007, not long after its IPO; analysts believe its earnings are poised to grow 33% for the next five years, suggesting the stock has a lot of room to run.
*note: EnerNOC is trading at a lower multiple (~26 times) of expected non-GAAP earnings, yet the company is very generous with stock compensation.

EnerNOC is delivering impressive growth, yet we're both amazed and disappointed that Fortune takes such a rose colored view ("lot of room to run") of the stock without consideration of current valuation and potential risk factors (i.e. the bullish five year forecast could be wrong).

Not surprisingly, our micro-cap Sonic Foundry (SOFO) receives no mention in the story although we see Mediasite as fulfilling Fortune's "key" to picking winners -
The key is to find the companies best positioned to execute on massive shifts in the way consumers and businesses use technology.
Moreover, we think Sonic Foundry might be trading at only six or seven times forward earnings for the year beginning this summer. We're the first to admit that forecasting is a dangerous game and often wrong, yet we'll explain our analysis in a follow-up post. In this regard, let's add to the "key" the following: uncovering companies driving "massive shifts" before the Market catches on is far more rewarding than otherwise, especially when positions are established at low valuation multiples. Of course, such a feat is not easy.

Below, for reference, we include valuation data from Yahoo! Finance for SOFO (a much smaller company in terms of revenue) versus ENOC, CVLT and select other tech companies:

Following Sonic Foundry's last earnings report, we promised to share our interpretation of the company's fiscal 2010 guidance sometime in February. The month has nearly escaped us -- we'll share our view in the next few days, prior to Sonic Foundry's annual meeting on Thursday.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Friday, February 26, 2010

Housing Market Still Challenged (We Know), But - Again - No One Sees Positives

Another headline story on Yahoo! Finance (and elsewhere) stoking the fear factor:

Housing market shows weakness for 2nd month - Big drop in January US home sales show housing market could falter after federal support ends

The article opens with the following:
  • (AP) -- Sales of previously owned U.S. homes plunged in January to their lowest level since summer, providing fresh evidence that high unemployment and tight lending standards are outweighing the government's attempts to prop up the market.
  • The results, the weakest since June, were far worse than forecast and suggest the housing recovery will sputter without government support. The Obama administration has spent billions to keep mortgage rates low and give buyers tax breaks, but both programs are set to end this spring.
Is it a big surprise that housing is/was slow in January? "Normal" seasonality -- which we discussed last October here -- might suggest a slight M/M increase, but then again, winter months are always slow and bad weather across many regions might have impacted sales. And, yes, we think a special government tax credit ended last November.

Buried in the article, we find this POSITIVE data point:

Home sales are still up nearly 12 percent from the bottom (emphasis added), but are down 30 percent from their peak more than four years ago.

Let's dig just a bit deeper -- going directly to the source, the "NAR":
  • Existing-home sales fell in January but are above year-ago levels, according to the National Association of Realtors®.
  • Existing-home sales – including single-family, townhomes, condominiums and co-ops – dropped 7.2 percent to a seasonally adjusted annual rate1 of 5.05 million units in January from a revised 5.44 million in December, but remain 11.5 percent above the 4.53 million-unit level in January 2009.
SO, we're up from the same month one year ago and, thus, making positive progress. To us, this is more notable than fretting over a slight M/M decline and missing impossible-to-get-right monthly forecasts by economists. We understand we're not out of the woods yet and housing may remain under pressure into 2011, but few seem to consider the Y/Y increase. For excellent graphs and commentary on the housing market, we recommend visiting Calculated Risk.

Happy investing,

Jeffrey Walkenhorst

Disclosure: n/a.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, February 25, 2010

More Mixed Signals - Yet, Give Look At This.... WTW to Durable Goods to TAL and Shipping

We may soon update our "How's the Economy Doing" series, but here's a brief cross section of tidbits for consideration - negative, followed by positive:

Weight Watchers (WTW) reported results this afternoon and provided 2010 earnings guidance well below our and Wall Street expectations of around $2.80. More evidence that the consumer economy remains subdued and, in WTW's case, lower earnings expectations may now be compounded by a compressed earnings multiplier for a lower near-term share price. This is the triple whammy that also impacted Clean Harbors (CLH) yesterday: (1) Market disappointment, (2) lower analyst estimates, and (3) lower multiple (although CLH rallied today -- support for a quality business likely trading well below replacement cost).

A return to Y/Y growth for Weight Watchers in 2010 now appears a question mark, although part of the lower-than-expected earnings outlook is a result of planned investments (opex) to build the brand and accelerate future growth.

We prefer to own growing businesses since we believe in John Neff's view that growth usually keeps investors out of trouble. However, we are willing to own out of favor businesses that possess well-established franchises such as Weight Watchers and 1-800-Flowers.com (FLWS) at the right price. Negative/flat top-line performance for these companies may limit near-term upside, yet the Market has been especially perverse over past year. Sometimes, the Market pushed shares of companies with poor fundamentals materially higher, while seemingly keeping others in purgatory (or worse), illustrating the perils of near-term forecasting and investing (or trading). We think high quality "merchandise" (another favorite Neff term we've adopted) purchased at a low multiple will ultimately see better days and take a patient approach.

Commentary from Weight Watchers' release:
  • David Kirchhoff, President and Chief Executive Officer of the Company, said, "In light of the difficult economic environment, I am gratified that we delivered full year 2009 results well within our original earnings guidance. As I look forward, I expect 2010 to remain challenging. While we will continue to aggressively manage our operations to maximize near-term results, we will also continue to invest in initiatives to modernize our offerings to drive long-term growth in our meetings business."
  • The Company provided full year 2010 earnings guidance of between $2.25 and $2.50 per fully diluted share.
Other news today from a NYTs article: Durable Goods Orders Rise; Unemployment Claims Climb:
  • A lackluster report on durable goods on Thursday resurrected doubts about the sustainability of a recovery for manufacturing. In addition, the number of people filing unemployment claims touched a three-month high, and a barometer of home prices unexpectedly fell.
  • Orders for durable goods, items like refrigerators and computers that are expected to last three years, rose 3 percent in January. The Commerce Department attributed the gain largely to a 126 percent increase in commercial aircraft goods. A closely watched measure that excludes volatile transportation orders and military goods fell 2.9 percent, suggesting that businesses remained timid about spending.
NOW, some positive news that is related to our interest in container shipping companies Seaspan (SSW) and Global Ship Lease (GSL):

Yesterday, TAL International Group, Inc. (TAL), "one of the world’s largest lessors of intermodal freight containers and chassis", reported results for 4Q09. Noteworthy commentary from the release:
  • “Leasing demand for dry containers, our largest product line, typically slows in the fourth quarter as the summer peak season fades, but leasing demand improved throughout the fourth quarter of 2009. Our customers have indicated that trade volumes have been stronger than expected since the middle of 2009, and many needed to add container capacity back into their fleets after aggressively returning containers in the first half of the year. Leasing demand in the fourth quarter was also supported by an almost total lack of new dry container production in 2009. Our core utilization (excluding idle factory units) increased 2.7% during the fourth quarter to reach 90.3% as of December 31, 2009, and our operating expenses and disposal gains improved during the quarter as well. The financial impact of improving utilization was partially offset in the fourth quarter by temporary pick-up incentives provided to certain customers and a reduction in fee income due to a sharp decrease in the number of containers returned off lease. However, we finished the year with strong operating momentum and expect our improved operating performance to be more fully reflected in our financial results as we head into 2010.”
AND, TAL is raising its annual dividend back to an implied $1.00 per share, up from $0.04 per share:
  • TAL’s Board of Directors has approved and declared a $0.25 per share quarterly cash dividend on its issued and outstanding common stock, payable on March 25, 2010 to shareholders of record at the close of business on March 11, 2010. Based on the information available today, we believe the distribution will qualify as a return of capital rather than a taxable dividend for U.S. tax purposes. Investors should consult with a tax advisor to determine the proper tax treatment of this distribution.
  • Mr. Sondey concluded “We are very pleased to increase our dividend back to a more significant level. We effectively discontinued the dividend in early 2009 due to the rapid decrease in global trade volumes and uncertainty about future market conditions. However, as I have noted, we were able to deliver solid results in 2009 despite the challenging conditions, and we are now expecting a much improved market environment and improved performance in 2010. Based on this, we decided it was appropriate to restart our dividend program and have set the initial quarterly dividend at $0.25 per share.”
Alas, despite some lackluster results/data scattered across companies and sectors -- often highlighted by the media -- there are positive signals worth considering that should provide comfort to investors (and signal opportunity in certain sectors).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long WTW, SSW, GSL, FLWS.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, February 24, 2010

Clean Harbors Again Disappoints - Still Not Enough Hazardous Waste

Briefly, following up on our waste services post yesterday, Clean Harbors (CLH) reported results and guidance that fell short of expectations (results here, Reuters summary here). The company cited lower utilization in its recently acquired Eveready unit, which is a Canadian-based business that "provides industrial maintenance and production, lodging, and exploration services to the oil and gas, chemical, pulp and paper, manufacturing and power generation industries". Pricing pressure was also a problem.

The company relayed the following in its release:
  • “While our EBITDA was 27% higher year-over-year due to the acquisition and the leverage within our network, several factors led to our EBITDA falling short of our guidance,” said McKim. “We ramped up our staffing levels at Eveready for the seasonally stronger fourth quarter. However, customer demand did not materialize as quickly as anticipated, resulting in lower billable utilization of our personnel and underutilization of Eveready’s fleet of specialized equipment. In addition, margins came under pressure from a highly competitive pricing environment.”
The stock isn't reacting kindly - from Google Finance:

Over the past year, we took a cautious view toward Clean Harbors and refrained from purchasing shares even though we believe the company owns/operates a high quality, near-impossible-to-replicate franchise. Our primary concern was weak fundamentals with potential downside to Market expectations that might also lead to multiple compression. Turns out that this was the right call. However, we're certain that whenever the economy rebounds, services offered Clean Harbors, including the oil/gas/commodity focused Eveready unit, will be in high demand with positive operating leverage returning to the company.

While many investors clamor for natural resource exposure in Canada or elsewhere (also impacted by slack demand), we might prefer to own Clean Harbors over the long haul. One side note is that we do have "natural resource" exposure through our ownership position in Harry Winston Diamond Corp. (HWD), which owns an interest in a Canadian diamond mine.

Although the bottom will be tough to catch, we suspect we have more time. We'll keep watching Clean Harbors as well as American Ecology (ECOL) while holding pat with our position in Casella Waste Systems (CWST).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long CWST.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, February 23, 2010

Waste Management Companies: Bandwagon Coming Around, Especially for CWST

Readers know that we've been tracking hazardous waste companies such as Clean Harbors (CLH) and American Ecology (ECOL) over the past year. We also previously mentioned Casella Waste Systems (CWST - solid waste services, not hazardous) and that we acquired shares last November.

The entire waste sector is now garnering more attention as the Market fixates on large ownership positions held by Berkshire Hathaway (BRK-A, BRK-B) and Bill Gates. For example, Berkshire Hathaway increased its position in Republic Services (RSG) in the December quarter -- various media reports covered the increased exposure, including this Forbes article. Of course, it's never a bad idea to own a well-positioned, difficult-to-replicate business -- at the right price -- that provides a necessary service that will always be around.

Last summer, we conducted research on the global energy and "clean tech" markets, including waste services. We presented our findings along with select long/short investment ideas in a September presentation to a hedge fund focused on these areas.

Casella Waste Systems, then at $2.60, was one of our recommendations. Today, the bandwagon is hopping on board -- give a look at all of the current headlines under CWST on Yahoo! Finance (YHOO):
  • Waste Management Hauls In Cash at Investopedia (Fri, Feb 19)
  • Strategist: Invest Like Buffett-With Garbage! at CNBC(Thu, Feb 18)
  • Buffett the Trashman CNBC(Thu, Feb 18)
  • Casella Waste Systems, Inc. Reschedules Conference Call on Its Fiscal Year 2010 Third Quarter to Accommodate Investor Interest Marketwire(Thu, Feb 11)
  • Your Very Own Templeton Basket at RealMoney by TheStreet.com(Tue, Feb 9)
  • Casella Waste upgraded by Wunderlich Briefing.com(Tue, Feb 9)
  • The Waste Management Dividend Play at Minyanville.com(Mon, Feb 8)
Our summary thesis on CWST in September was as follows:
  • Casella Waste Systems (CWST) – share price is up 5x from March lows, yet well below a 52-week high of $14.49 last September; levered 4.8x TTM EBITDA, but multi-year investment cycle to expand landfill capacity (now ~30 years) and modernize treatment (gas-to-energy and sorting) are complete; management pulling levers to improve free cash flow and reduce debt (e.g. higher pricing, cost controls) despite challenged fundamentals; potential positive catalysts include bottom-line improvement from pricing initiatives and value recognition of North Eastern landfill assets; CWST trades at an EV/EBITDA of 5.4x and P/S of 0.12x compared to RSG at 9.6x and 1.6x, respectively – company reports results 9/2/09.
Now at $4.77, Casella still remains inexpensive on a comparable company basis, but -- unlike larger companies such as Republic or IESI-BFC Ltd. (BIN) -- the company is a delevering story with a lower margin profile and no near-term potential for a dividend. That said, we think shares remain attractive for patient investors.

Our full presentation from September is below (available for download here) and includes substantial data on global energy trends as well as commentary on the "clean tech" sector. We hope you find the contents interesting.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long CWST, BRK-B, YHOO.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Friday, February 19, 2010

j2 Global Remains Money Making (Cash) Machine; Outlook for Growth Improves

As we've pointed out previously, j2 Global Communications (JCOM, $21.13) has been a large opportunity cost for us over the past year. Last spring, we considered using our position as a source of funds to acquire more shares of then extremely depressed REITs. Unfortunately, we didn't make the move and now these same REITs are 3-4x where they were while JCOM is virtually flat. Truthfully (full disclosure), we still may use a portion of our position as a source of funds to purchase out of favor names where we see potential for more long-term upside.

That said, like last year, we have a hard time parting with any of our shares because there simply aren't many (any?) companies that have the margin/return (ROE/ROIC) profile of j2. Please let us know if you're aware of similar companies. The company's incredibly high margins (gross > 80%, operating > 40%) and stable, consistent revenue base enable gigantic excess cash generation. Plus, we trust management and expect them to responsibly deploy excess cash to maintain high returns on capital.

Nonetheless, as indicated by a trailing twelve month P/E of 11x and a TTM FCF multiple of 9x (7x on EV basis excluding interest income), we think j2 Global gets little respect by the Market because of growth concerns. While the company still grew last year -- through the recession -- growth of 2% Y/Y (and 9% in 2008) are well below historic levels as the digital fax market matures and some businesses simply scan/email documents instead of using fax. To us, using scan/email versus fax for sensitive personal data still gives us the heebie jeebies. As a result, we still use plain old fax service (and have a free eFax account for inbound faxes).

The Market doesn't know if the the slower growth is cyclical or secular (e.g. is fax going away) and, therefore, seemingly views JCOM as a value trap. We think the company's digital fax business is somewhat impacted by both factors, yet still see a long life for digital fax services (enterprise and international are growing) that will generate mountains of cash for j2. Meanwhile, j2 will continue to expand into other digital communications markets such as voice and email, where the company is making strides.

Thus, we continue to believe j2 Global is not akin to Earthlink (ELNK), which is trading at an EV/EBITDA of 2x as dial-up revenue erodes but cash keeps building on the company's balance sheet. We could also look at Deluxe Corp. (DLX) which is managing a decline in its cash cow check printing business (fewer and fewer checks used these days) by diversifying into business services and digital solutions. Total revenue is expected to decline another 2% in 2010 before stabilizing in 2011. Deluxe's stock actually tripled over the past year but still trades at only a TTM P/E of 10x and offers current buyers a secure 5.5% dividend yield. j2 Global's margin and growth profile are also different from that of Deluxe, but risk exists that JCOM continues to trade at a low multiple and/or even sees further multiple compression if growth does not accelerate.

For the importance of growth and corresponding Market perception, look no further than the performance of Priceline (PCLN), VistaPrint (VPRT), and Google (GOOG) over the past year. Of course, there are plenty of low growth companies that garner high multiples -- see PF Chang's China Bistro Inc. (PFCB) trading at 18x forward earnings (27 TTM) and Iron Mountain Inc. (IRM) trading at 22x forward earnings (30x TTM). The latter company is a favorite of Warren Buffett/Berkshire Hathaway (BRK-A, BRK-B) and certain other value investors such as Davis Selected Advisers. Berkshire Hathaway apparently bought more IRM shares during the December quarter (please see this media report). Iron Mountain provides a necessary service that will always be around (arguably supporting a higher than average valuation), yet is a somewhat capital intensive business (~11% of revenue) with low historic returns on equity/capital (sub 10%).

The good news is that j2 Global reported 4Q09 results yesterday afternoon and guided to 2010 revenue growth of +3-7% Y/Y with a target of 5% Y/Y. The bottom-line is expected to remain similar to 2009 results as the company steps up marketing efforts to drive growth and build voice/email brands. Management believes the economy turned the corner and expects higher marketing expense to bear fruit going forward relative to uncertainty that plagued 2009 and brought j2 to reign in spending. Summary 2009 results from j2's 4Q earnings presentation:

After record free cash generation of $101.6 million in 2009, the company's cash balance stands at $244 million or 26% of j2's market capitalization. We thought we might hear news of a new share buyback program or even a first time dividend (please see prior post here), yet management indicated that potential M&A transactions remain priority number one with numerous deals in the pipeline. Recent deals and pipeline commentary:

Accordingly, for now, the company has no board authorization for other uses of excess capital. We look for more news on this front later this year. If high return uses for cash fail to materialize in the near-term, we expect to see at least a buyback authorization. A dividend would also be nice, although a repurchase is arguably more sensible if the company can buy in shares at current levels (i.e. FCF yield of 10% or more). Again, with no debt and annual free cash generation of approximately $100 million, j2 Global will have bulging pockets of cash.

Below, we include a slide showing historical development from j2's presentation (click to enlarge):

How many companies have this profile?

Happy investing,

Jeffrey Walkenhorst

Disclosure: long JCOM, BRK-B.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, February 17, 2010

More on the Container Shipping Market: Tight Capacity in Asia on Reduced Supply

The Journal of Commerce posted an interesting article the other day regarding trends and expectations for the container shipping market. We're tracking the sector given our ownership in Seaspan (SSW, $10.12) and another container shipping company, Global Ship Lease (GSL, $1.59). We've not shared details on the latter company, but concur with the GSL summary thesis included in this December SeekingAlpha post. We categorize GSL as a special situation that, like Seaspan should benefit from gradually improving market conditions (please see our sector outlook in our prior Seaspan post). Admittedly, macroeconomic conditions are a key risk factor and current overhang for both companies.

Anyway, back to the article. For those interested, we recommend giving a read for current market commentary and various graphs. Here are a few highlights:
  • Dean Tracy, director of international logistics at Lowe’s, had a devilish time getting his spring and summer merchandise on vessels leaving Asian ports in late January. The busiest time of the year for home improvement retailers was approaching rapidly, but space on vessels was unusually tight.
  • The capacity crunch in Asia likely will end with this week’s Chinese New Year celebration or shortly after. Carriers removed a large chunk of vessel capacity from the trans-Pacific for the winter months, as they do every year, but cargo volume leaving Asia before factories close for the two-week celebration were larger than anticipated.
  • Evidence of that strategy emerged in late January, when the strong demand in the run-up to the Chinese New Year spurred carriers to return nearly 50 idled container ships to service. The week leading up to Feb. 1 represented the first significant decline in idled container ships since November 2008, according to Paris-based consultant and analyst AXS-Alphaliner.
  • Although economists are divided as to how rapidly consumer spending will return, advance bookings in Asia-to-U.S. trans-Pacific lanes are strong into June, so retailers believe the recovery will be relatively robust. In fact, some factories in China say they will reduce the traditional two-week Lunar New Year vacation period to seven to 10 days because orders are so strong.
  • Therefore, after the customary dip in eastbound freight following the New Year celebration in Asia — a dip that could be far less pronounced this year, considering cargo backlogs — volume could pick up rapidly. That will happen just as importers meet with carriers to negotiate freight rates for their May 1-April 30, 2011, service contracts.
As noted in our "Which Way from Here" post, the best time to buy businesses is when no one wants them. While we prefer cash rich, asset light, high ROIC businesses such as eBay (EBAY, $22.68) and j2 Global Communications (JCOM, $20.83), we're not afraid to invest in downtrodden areas where we see long-term value. Also, recall that the Market can be manic and totally unpredictable.

As mentioned in our Seaspan post, shipping remains of the few areas still very much out of favor despite some signs that conditions are improving. For example, banks/financials and REITs have largely recovered, even with plenty of bad loans and surplus commercial real estate that will press fundamentals for some time to come (e.g. for a negative view on Wells Fargo/WFC, please this 12/10/09 Forbes article, Hooked on Tarp -- now somewhat dated, but risks still relevant). Of course, some investors may intelligently posit that that banks/financials and REITs are now poised to stumble following a short covering, hope-driven rally last year. We'll see.

So long as long-term lease charters remain in force for Seaspan and Global Ship Lease -- as we expect -- we're less worried about excess ship capacity plaguing the sector and are betting that the Market will award higher multiples as fundamentals gradually improve.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW, GSL, EBAY, JCOM.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, February 16, 2010

Blue Nile Begins to Fall Out of Orbit - Valuation Remains Rich; Offers No Safety

We wrote in December that insiders at Blue Nile (NILE, $49.11) were smartly taking advantage of the company's rich valuation (please see our October post) to unload personal holdings in the high $50s and $60s. Sales continued in January and February (from Yahoo! Finance):

Last week, the company reported results and guidance that fell short of consensus estimates (reported by numerous media outlets, including this AP article). This Reuters article also noted that results missed recent bullish commentary from Blue Nile's CEO:
  • "Expectations had been high for the Seattle-based Web retailer after bullish comments in recent months from Chief Executive Diane Irvine, who had said December revenues were projected to rise 26 percent."
Year-to-date, the stock already trended lower and then gapped down last week after the news:

Despite the Market's disappointment, results were respectable -- headlines from the release:
  • Reports Fourth Quarter Net Sales Up 20% to $102.9 Million
  • Non-GAAP Adjusted EBITDA Increases 38% to $10.6 Million
  • Full Year Non-GAAP Free Cash Flow Grows to $36.7 Million
Yet, as noted in our prior posts, it all comes down to valuation: expectations were extremely high and Blue Nile's valuation already gave credit for significant future growth. Even now, shares continue to trade at 40 times this year's estimated consensus earnings (and 19 times TTM free cash flow). For a forward valuation view looking out a few years, please see our summary model included in our October post. Although full-year 2009 results came in slightly higher than our October estimates -- implying higher out year financial results -- valuation multiples remain high and, in our view, suggest future multiple compression as Blue Nile "grows into" its current valuation. We see something similar happening to Amazon (AMZN, $117.53) -- note recent sell-off -- which also happens to be trading at 40 times this year's consensus earnings estimate (but only 17 times TTM free cash flow). By contrast, PetMed Express (PETS, $19.74) -- which we own and discuss here -- is trading at only 16 times forward earnings (but 17 times TTM free cash flow).

We continue to favor unloved, low P/E and/or low P/FCF multiple merchandise such as 1-800-Flowers.com (FLWS, $1.89 - post last week here) and Bidz.com (BIDZ, $1.93). The latter's business model is far more discretionary than Blue Nile's engagement ring centered model and conditions remain difficult, yet we believe things can get better for the company. Plus, we have protection from low multiples with plenty of room to expand whenever fundamentals turn and the Market takes notice.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long PETS, BIDZ, FLWS.
© 2009 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Friday, February 12, 2010

REWIND: Peter Lynch in 1982 and Philip Carret in 1995 (thanks to Youtube and WSW)

One Up on Wall Street by Peter Lynch is a favorite investment read of ours and is included on our reading list. Mr. Lynch's approach is logical and easy to grasp (largely common sense, which we also strive to leverage). His book is both straightforward, entertaining, and worth a read.

We came across this short video clip from Wall Street Week with the late Louis Rukeyser, which includes Peter Lynch at age 38 as well as a brief conversation with another investment legend, the late Philip Carret at age 98 (who started the Pioneer Fund in 1928 - more information here).

In the video, both investors share their long-held, strikingly simple pieces of wisdom:
  • Peter Lynch: buy what you know and avoid trying to catch the bottom in a falling stock.
  • Philip Carret: be patient and buy businesses with a five- to ten-year view.

Happy investing,

Jeffrey Walkenhorst

Disclosure: none.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, February 11, 2010

Many Funds Simply Can't Buy FLWS Right Now; But, We Can Because We Can Wait

In our post yesterday, we mentioned the best time to buy businesses is when no one wants them. Take 1-800-Flowers.com (FLWS), for instance.

Many mutual and hedge funds are focused on delivering +3%, +5%, +10% next quarter with minimal volatility. Accordingly, these participants are probably not interested in FLWS because no identifiable near-term positive catalysts are present as the business (revenue) is still shrinking amidst the weak economy (management again lowered guidance in its last report). For the same reason, brokerage firms that cover the stock are loathe to recommend the name. These brokers, along with the investment funds, typically want to recommend stocks that "will work" next month, next quarter, and possibly over the next year.

Of course, as soon as fundamentals turn (e.g. Y/Y revenue growth returns and signs of operating leverage arrive), watch out -- we can envision broker upgrades and funds clamoring for a piece of FLWS. By then, the stock is already back at $3-4 on the way to $5-6. We're not sure when the turn will occur, maybe later this year or perhaps in 2011. Yet, we suspect it will come, even as/if consumers grip their wallets tighter than a few years ago.

The good news with FLWS is that we can purchase a business NOW that (1) will generate significant excess cash flow this year (>$30 million per guidance, which we think is reasonable) -- in a depressed economy -- and (2) is capable of generating higher amounts under normalized conditions ($40 million), whenever those arrive. We can purchase FLWS at four times this years' estimate (25% yield) and three times normalized levels.

However, as time marches onward, we'll be surprised if the Market doesn't see the value we see and award a more rational multiple to the business, maybe ten times free cash flow (still an attractive 10% yield). We don't know what happens near-term, but we're willing to wait a few years if necessary to potentially make 100-200% on our investment today and not worry about plus (or minus) 10% next quarter.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long FLWS.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, February 10, 2010

Which Way from Here? An Investment Strategy for All Markets + Stock Ideas

As discussed in our slide/video presentation posted the other week, we've been through the psychological ringer over the past two years. We've moved from shock and awe, to realization and, now -- in our view -- acceptance:

While we believe economic data suggests stability, plenty of challenges remain and mixed signals emerge each day, with various media outlets sometimes taking different angles on the very same news piece. For example:
  • BBC on 1/18/10: “IMF head in 'double-dip' global economy warning” (link here)
  • AP on 1/18/10: “IMF chief: global recovery stronger than expected” (link here)
Despite certain concerns, the market's monster rally from the bottom last year made "easy money" possible in many stocks across virtually all sectors for those with the fortitude to take advantage of opportunities. In our presentation, we mentioned four retail companies where stocks have tripled or quadrupled off of the bottom: Whole Foods (WFMI), Tiffany (TIF), William Sonoma (WSM), and Limited Brands (LTD).

We didn't purchase these companies, but did purchase a handful of REITs and other companies such as Harry Winston Diamond Corporation (HWD) that had similar performance. Of course, we also purchased American Oriental Bioengineering (AOB) and Bidz.com (BIDZ), which are flat to down from our average costs. Importantly, we acknowledge that we had no idea that the REITs and HWD would perform so strongly within six to nine months after our purchases -- we only believed we were buying cheap assets that no one wanted with a margin of safety. We continue to hold the REITs and Harry Winston, as well as AOB and BIDZ.

Of course, many keep worrying that now is "time to go to cash" and/or aggressively focus on the short side for the "inevitable" market crash. After all, the ever increasing debtor status of the U.S. and certain other developed markets, plus global imbalances and a "bubble in China", must lead to a correction, right?

We don't know. In fact, as noted in our presentation, near-term forecasting is a fool's game. What we do know is that certain businesses can be acquired on the cheap with very favorable risk/reward profiles for those willing to wait a bit (i.e. not next month or even next year, but maybe several years from now). Then again, like some of the top performers last year, maybe the Market will propel certain businesses back to more reasonable levels sooner rather than later.

Our strategy, as detailed in our presentation is the following: Think and Invest Like an Owner with a Long-Term View
  • Short-term is uncertain but long-term is highly correlated to earnings power
  • When evaluating businesses, ask these questions:
  1. Does the business have a strong financial position?
  2. What would happen if the business went away tomorrow? Would anyone care?
  3. Is management capable and motivated? Is disclosure full and adequate?
  4. Will the business be bigger, better, stronger if five years?
  5. Can the business be acquired with a margin of safety?
  6. Price is extremely important
On the last point, we like how the Fairholme Fund’s Bruce Berkowitz puts it: “Investing is all about what you pay and what you get”, which is a variation of advice from Ben Graham and Warren Buffett.

In our presentation, we highlighted three companies we believe meet our criteria: 1-800-Flowers.com (FLWS), Seaspan (SSW), and Weight Watchers (WTW):
  • While 1-800-Flowers.com is highly discretionary, several durable competitive advantages support long-term cash generation and the business can be acquired with a current year free cash yield to equity of more than 20%. This valuation appears incredible and unlikely to last over as the capital light business model will enable management to use excess cash to repay debt, grow the business, repurchase shares, and potentially pay a dividend. Interestly, Provide Commerce (e.g. ProFlowers) was generating annual revenue of approximately $220 million and cash earnings of approximately $14 million (6% margin) when Liberty Media (LINTA) acquired the business for $477 million in fall 2005 (2.2x sales and 34x cash earnings). We estimate that Provide might be generating $300 million in annual sales today versus 1-800-Flowers.com's floral segment sales of around $380 million (our FY10 estimate). FLWS is currently offered by the market at an enterprise value and price to sales of approximately 0.20x.
  • Per our prior posts, the container shipping sector faces significant excess supply, yet Seaspan’s 68 vessel fleet (43 operating, 25 to be delivered) are fully committed to long-term charters with COSCO of China and K-Line of Japan, which creates built-in growth over the next several years. We see the company as a means to participate in long-term global growth with diverse, creditworthy cash flow stream - high quality counterparties, 90% Chinese and Japanese. While the company does require some additional equity ($180 - $240 million per company) to finance new-builds, distributable cash flow is expected to triple to >$300 million per year with a full fleet in 2012 (perhaps $3.00 per fully diluted share, depending upon share count). During this period, annual revenue should more than double to $680 million with EBITDA growing to more than $500 million. So, we can purchase SSW today at approximately three to four times anticipated distributable cash flow in 2012.
  • Consistently high margins/ROIC and excess cash flow indicate that Weight Watchers operates a high quality business model with durable franchise characteristics. Over the past ten years, revenue increased an estimated 3.2x to $1.41 billion, operating income increased an estimated 4.1x to $398 million (28.3% margin), and free cash flow increased an estimated 5.2x to $248 million (18% of revenue). We see potential for dividend increases over medium term as debt is reduced, which might lead to higher valuation multiples. Historic median multiples imply ~100% upside from current levels and, even acknowledging that growth may be less than prior years, discounted historic multiples still imply substantial upside. The business can be acquired today at an approximate 10% free cash flow yield. We first mentioned Weight Watchers last December.
Finally, let's throw in one more for good measure: under-followed micro-cap Sonic Foundry (SOFO) that, based on our research, offers the best Webcasting solution available and has a growing installed base of happy customers. Looking around today, Webcasting should only become more important across virtually all sectors. Sonic Foundry grew revenue 19% Y/Y in FY09 (end September) is poised to deliver accelerated revenue growth in FY10 with positive earnings and cash flow. Yet, the company is offered at approximately one times sales and possibly a mid-single digit P/E multiple on forward earnings for the year beginning this summer.

Let's close with one more point: the best time to purchase businesses is when no one wants them. For a variety of reasons (some obvious), no one wants 1-800-Flowers.com at present -- but that doesn't mean it's not a fantastic purchase at current levels. Seaspan and Weight Watchers are also out of favor, but are not quite as unloved as 1-800-Flowers today. We'll share more tomorrow on this topic. Please stay tuned.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO, FLWS, SSW, WTW, AOB, BIDZ, HWD.
© 2010 Jeffrey Walkenhorst
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Monday, February 8, 2010

Update on Churchill's Proposed Youbet.com Purchase - Online Business Evermore Critical

In our post last December regarding the proposed Churchill Downs (CHDN, $34.67) acquisition of Youbet.com (UBET, $2.64), the implied value to Youbet.com shareholders was $3.18 per share. Now, following a request from the Department of Justice for more information regarding the transaction and a pullback on broader macroeconomic worries, the implied value is down to $3.04 (still above $2.84 at time of announcement). This value is well above Youbet's current share price as investors discount the risk the deal will fall apart.

We're not entirely surprised that the DoJ requested additional information since we estimated that the combined entity will control more than 50% of the U.S. online horse wagering market. However, both companies reiterate that the deal should close during the first half of 2010.

On 1/28/09, Churchill presented at an investor conference and included several slides re: online wagering, Youbet.com, and financial results/outlook:

Overall industry handle on decline:

Online is the industry's growth area:

Youbet.com will bring "better innovation and features":

Online is an important piece of Churchill's growth plan:

And, EBITDA contribution by segment:

In the end, we believe the deal will likely go through, pushing shares of both companies higher as the anticipated close date draws closer (and CHDN likely higher post close, so long as the company executes on growth plans). If the transaction doesn't occur, Youbet.com remains well-positioned as an online category leader.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Friday, February 5, 2010

Cisco and U.S. Employment: Pulling the Cart Ahead of the Horse?

Cisco Systems (CSCO, $23.53) reported strong results and provided better-than-expected guidance the other day - information can be found here. Cisco stated the following in its press release:
  • "Our outstanding Q2 results exceeded our expectations and we believe they provide a clear indication that we are entering the second phase of the economic recovery. During the quarter we saw dramatic across the board acceleration and sequential improvement in our business in almost all areas," said John Chambers, chairman and chief executive officer, Cisco.
Cisco also said it plans to hire a few thousand workers over the next several quarters (please see this WSJ article and/or the conference call transcript from SeekingAlpha.com for more).

Meanwhile, the Labor Department reported this morning that unemployment rate ticked down to 9.7% in January. This Reuters article noted that the improvement came on the back of "a sharp increase in the number of people giving up looking for work helped to depress the jobless rate", with "the number of 'discouraged job seekers' rose to 1.1 million in January from 734,000 a year ago". Payrolls actually dropped by 20,000 positions, which isn't good, and Market jitters are returning.

Still, can we draw a parallel between Cisco's rosy results/outlook and overall U.S. employment?

Based on our prior work as an Equity Analyst at Banc of America Securities, global technology spending/investment is driven by US GDP and non-farm payrolls (which are ~87% correlated with GDP). In fact, correlation with US GDP is north of 90% for global semiconductor revenue and connector/ components revenue.

Therefore, a GDP contraction has an immediate, negative impact on the broad tech sector and non-farm payrolls. The tight relationship is further explained by realizing that approximately 20-25% of global technology revenue is derived from the financial services sector. On the flip side, GDP expansion can have an immediate, positive effect on the broad tech sector and non-farm payrolls.

The below graph illustrates Cisco's revenue versus non-farm payrolls for 1997 – 2006 and the impact of the 2001 – 2003 downturn. Unfortunately, we don't have an updated graph, but the correlation is clear:
Relative to 2008-09 troubles (not illustrated in graph), we suspect the revenue decline during the tech bust was more pronounced for Cisco and other tech companies, where the entire sector was plagued by excess capacity and surplus inventory following abnormally inflated demand (obvious parallel to residential real estate in the more recent period, except that this time around, the excess was widespread and seemingly touches many more sectors of the economy).

We included current non-farm payrolls data in our "Which Way from Here?" presentation the other week. Below, we include one of the graphs from the Bureau of Labor Statistics that shows/implies initial stabilization in total employment:

Even with favorable Internet trends everywhere around us, Cisco no doubt benefits greatly from higher levels of U.S. (and global) employment. However, in this case, rather than the jobs coming first, perhaps the revenue is arriving first? That is, maybe the opposite of what is normally a chicken and egg scenario for Cisco (and many other companies) is happening? Cisco is pulling the cart before the horse? Hard to say. More likely than not -- as in the past -- we believe they'll move hand-in-hand despite the wall of macroeconomic worries and nagging job market weakness.

While we acknowledge that (1) near-term forecasting is near impossible (again, please see "Which Way from Here?") and (2) new hiring may remain constrained, we feel comfortable that Cisco's results and outlook are a step in the right direction.

Happy investing,

Jeffrey Walkenhorst

Disclosure: none.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, February 4, 2010

Seaspan: Opportunity to Buy at 3-4x 2012E Distributable Cash Flow (as many investors shun the sector)

We again mentioned Seaspan in our post last Sunday and continue our discussion here. While Seaspan's stock recently began to push higher (not today as fear pressures the overall market), share prices of most shipping companies remain in the doldrums. Shipping is one of the few sectors yet to recover because of lingering economic concerns and a glut of new ships entering operation that were ordered during the easy money boom times. For more on this, please see scary NYTs article from 1/16/10: "New Ships Idle, Waiting for Cargo to Fill Them". A few points from the article:
  • "Most analysts say that container traffic will probably not recover to prerecession levels until 2012 or later. Drewry Shipping expects a 2.4 percent increase in global trade volume this year, after an estimated 10.3 percent decline last year.
  • “On the demand side, we do see some strength; we see continued strength in China,” said Vikrant S. Bhatia, chief executive of KC Maritime, a bulk-carrier shipping line based in Hong Kong. “The problem we see is really on the supply side.”
  • Until 2008, the liners were cresting; shipyards were humming, building ever larger ships as ports expanded and new services opened, underpinned by low-cost finance."
Nonetheless, the industry is working to reduce excess supply and, with the possible exception of a double dip recession (anything could happen, but we're not in this camp), we're fairly confident the world will need more ships in five years' time. For all of the negative articles regarding the sector, there are sometimes more positive takes, such as this 1/28/10 Bloomberg article: "Cheapest Route to Walmart From China May Skip Buffett’s Railway", which opens with the following points:
  • "Chinese toys and sneakers headed to Wal-Mart Stores Inc. and Target Corp. on the U.S. East Coast may bypass Warren Buffett’s $33.8 billion railway as the expansion of the Panama Canal slashes the cost of shipping them by sea.
  • The deeper, wider canal will allow A.P. Moeller-Maersk A/S, China Ocean Shipping Group Co. and other lines to ship more cargo directly to New York and Boston instead of unloading it on the West Coast for trains and trucks to finish the journey east. That could save exporters 30 percent, the canal operator said.
  • The $5.25 billion Panama Canal project, scheduled for completion during its centennial in 2014, may take business from ports including Los Angeles and Seattle, and railroads including Berkshire Hathaway Inc.’s Burlington Northern Santa Fe Corp. It costs as much as $1,000 more per cargo container to use trains than ships, said Lee Sokje, a shipbuilding analyst at Mirae Asset Securities Co. in Seoul."
Our bet is that shipping market will slowly recover over the next several years and the Market will realize that certain shipping companies such as Seaspan are inherently a stable operating businesses that can operate with a decent amount of leverage (although probably not with loan-to-value ratios of 80-90%, particularly when -- like real estate -- values are declining/down from peak levels).

We included our summary thesis for Seaspan in our "Which Way from Here?" presentation the other week. Seaspan is somewhat akin to a floating REIT with long-term charters to "liner majors" and a stable business model designed to distribute excess cash flow to shareholders in the form of quarterly cash dividends. The one caveat with the REIT comparison is that individual container ships have no terminal value at the end of their thirty year average lives. However, a well-run shipping company with a diverse portfolio of ships and customers having staggered lease expirations can certainly have a terminal value.

Seaspan's business model (from June investor presentation - link here):

Snapshot from the same presentation that shows contracted revenue and cash flow growth:
The growth is expected to occur despite ongoing economic weakness and excess industry capacity, although we can't fully ignore these risks. Market circumstances may impact ship values, debt covenants, and financing needs. Seaspan still needs to raise an additional $180 million to fund remaining "newbuilds", which implies incremental dilution (assuming equity offering at $10 per share = 18 million additional shares). We're including additional dilution in our estimated 3-4x purchase multiple.

In addition, operating risks are present. As an example, Seaspan reported the following in early January:
  • "on December 31, 2009 the CSCL Hamburg, a 4,250 TEU container vessel went aground in the Gulf of Aqaba en route to Singapore. Preliminary reports indicated that there were no personnel injuries or oil pollution as a result of the incident. The Company is coordinating with Egyptian authorities and other parties to inspect and refloat the vessel. Off-hire and repair costs are currently being assessed. Any repair costs are expected to be covered by insurance."
This could be a whole another post, but we share because it's interesting. Wikipedia describes the Gulf of Aqaba as follows:
  • The Gulf of Aqaba, like the coastal waters of the Red Sea, is one of the world's premier sites for diving. The area is especially rich in coral and other marine biodiversity and contains a number of underwater wrecks, some accidental shipwrecks, others vessels deliberately sunk in an effort to provide a habitat for marine organisms and bolster the local dive tourism industry.
As a result, a diving magazine and many others picked up on the story, with reporting here and a video below:

The good news: as of the last week of January, the CSCL Hamburg was moving again and is now out of the Red Sea sailing off the coast of Oman at approximately 10 nm/hour. We know this thanks to Seaspan's GPS tracking on the company's Web site:

Like all companies, Seaspan is not without risk. However, at the current price, we see the risk/reward profile as attractive given the company's inherently stable business model and anticipated growth of distributable cash flow. As the company's "built-in" growth continues, we expect to win two ways: (1) multiple expansion (i.e. 3-4x 2012E cash flow could be more like 8-10x, in our view) and (2) dividend increases (i.e. $0.40 reverts back toward Seaspan's initial $1.90 dividend, with potential for more depending upon capital needs). All the while, we anticipate collecting the current 4% dividend. Finally, we should add that Seaspan's founders own a large piece of the company and provided additional capital in 2009. We sleep well knowing they're truly behind the company with a owner's mentality.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer