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

Tuesday, March 30, 2010

Youbet.com - Coming Months Should be Interesting: Three Potential Positive Catalysts

We've previously shared our estimate of implied value to Youbet.com (UBET) shareholders given the current share price of Churchill Downs (CHDN) and under multiple scenarios. Until last week, a sizable discount (approximately 10%) existed relative to the current implied value (if the deal were to close today).

Last Thursday, shares of Youbet spiked on higher volume:

Now, the gap is a more modest 5%. With shares of Churchill Downs at $38.32, the implied value to Youbet.com shareholders is around $3.26 per share. For a valuation range, please see our summary table posted in early March and in our initial post regarding the transaction.

While we've slightly reduced our Youbet position in favor of companies we believe are trading at larger discounts to fair value -- at this point -- we're inclined to see what unfolds over the next month or so. We see three potential near-term positive catalysts that could further close the discount (and excite merger arbitrage investors):
  1. Shareholder approval following 4/6/10 vote
  2. Transaction approval from the Department of Justice
  3. Short covering
Short interest remains elevated as some bet that the deal will fall apart -- from Nasdaq.com:

Yahoo Finance! reports Youbet's float at 24.1 million shares, although we suspect true liquid float may be even lower as certain institutions may retain shares through transaction consummation. However, assuming the 24.1 million figure, short interest stands at approximately 5% of float. If the deal goes through, the shorts will need to cover their positions by purchasing shares of Youbet, possibly pressing shares to or even above the implied value.

April/May could be very interesting.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long UBET.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, March 28, 2010

How Bad Could Things Be? People Taking AND Paying More for Cruises

Over time, we've loosely tracked the performance of Carnival Cruise Lines (CCL) and Royal Caribbean (RCL) . However, we've never owned shares of the capital intensive businesses. Somewhat akin to the container shipping industry, the cruise ship sector has a fairly sizable order book of new ships (supply) ordered pre-recession and to be delivered over the next several years. Still, unlike the former group, the cruise lines have been able to maintain reasonable occupancies and near-term demand may match/absorb new supply. Of course, pricing is a key variable and lever used to manage occupancies. For more industry details, the Cruise Lines International Association (CLIA) Web site has a wealth of intriguing information, including these slides from the "2010 Media Update"-

Supply (*occupancy definition below):
*Occupancy definition from Carnival 10-K:

In accordance with cruise industry practice, occupancy is calculated using a denominator of two passengers per cabin even though some cabins can accommodate three or more passengers. Percentages in excess of 100% indicate that on average more than two passengers occupied some cabins.


Passengers increased in 2009 (lower pricing worked magic!):

"International guests" more important:

A WSJ article caught our attention last week, highlighting the results/outlook of Carnival Cruise Lines (CCL). Here are some points directly from the WSJ article:
  • Carnival Corp. said it's starting to recover some of its pricing power in the U.S. as more leisure travelers open their wallets after the recession sent cruise fares plunging last year.
  • The world's largest operator of cruise ships estimated Tuesday that its net revenue yield—or how much it earns from each passenger—will rise 2% to 3% in 2010 after industry yields fell 10% or more last year as companies slashed prices to keep ships full.
  • Carnival raised its annual profit forecast on improving demand.
  • "We're surprised at the strength of the pricing that has come up this year," Howard Frank, Carnival's chief operating officer, said in a conference call.

  • North American consumers are driving the rebound, according to Miami-based Carnival, which operates 11 cruise lines including Holland America, Cunard and namesake Carnival Cruise Lines.

  • Analysts say the industry is benefiting from pent-up demand by consumers, many of whom skipped vacations last year to save money. That is helping keep ships full even as capacity increases—including last December's launch of Oasis of the Seas, the largest cruise ship ever, by Royal Caribbean Cruises Ltd.

  • Rich Tucker, head of business development at CruiseDeals.com, an online travel agency, estimated that fares for trips between June and August are up about 27% from a year ago. That's still down 7% to 8% from the summer of 2008, when cruise trip prices peaked, he added.

Thus, despite lingering worries about the economy, we think Carnival's results and commentary are yet another signal that the consumer-driven U.S. (and, increasingly, global) economy is on the mend. This is in line with our prior "Which Way from Here" discussion that we're in the acceptance phase where people grin and bear it, move on with lives.... How bad can things be if more folks are cruising, which likely draws a wide socioeconomic sampling of the public?

Of course, the challenge for investors is that many valuations now reflect more sanguine expectations. As a result, buying opportunities are markedly less plentiful than one year ago and require diligent analysis and selection. Per our prior posts, we still see certain out of favor areas begging for more attention. As an example, we recently added to our Seaspan (SSW) position.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SSW.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Friday, March 26, 2010

Media Headlines Can Be Silly - Yahoo! as Example

We sometimes use our Google (GOOG) Reader "subscriptions" to keep tabs on various news sources and company news. We also use My Yahoo! (YHOO) on occasion. Yahoo! headlines on Google Reader caught our attention yesterday, one because it a appeared so ridiculous -- can you guess which headline:

If you said, "10% Downside to Yahoo’s Stock if Ad Rate Declines Continue", you're right! Of course, the headline is designed to attract readers and, in our case, it worked -- we clicked on it.

Many investors try to quantify potential upside/downside under various scenarios -- which is smart -- but the specificity of "10% downside" under this "decline" scenario is what strikes us as silly since there are so many moving parts with Yahoo! (and most other companies). It's simply very hard to know exactly what might/will happen. However, in fairness to the source of the headline, clicking on the link takes us to a brief summary of the author's analysis, including an apparent sum-of-the-parts based target price of $20.58 for YHOO.

Our long thesis on Yahoo (YHOO), as shared previously, is based on common sense:
  • 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.
That is, in the spirit of Philip Carret , we look around us and strive to be aware of what's happening. The Internet is NOT going away and Yahoo is a well established brand/company that generates plenty of cash and is likely going to be bigger, better, stronger over time. We think the company can grow despite search competition from powerful Google, which -- admittedly -- is a major online franchise and a growing cash machine. Further, Yahoo's [relatively new] management team is especially focused on improving margins and returns on capital. Shifting Internet technology and media platforms present some risk, yet we're betting that Yahoo will be around.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long YHOO.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, March 23, 2010

Why Doesn't Sonic Foundry Announce More "Big" Deals? Smart Webinar Series Helps; Autodesk On Deck

We recently had questions from fellow Sonic Foundry (SOFO) investors on why the company isn't putting out more press releases for "large" deals. Longer ago, we actually asked management this question. If we recall correctly, the reason is that customer approval sometimes isn't straightforward/easy and -- even if a customer is willing/able to make a public announcement -- approval may sometimes require months after a deal is completed and/or the solution is installed. Where possible, we'd love to see customer announcements.

However, in our view, "PR" is most important for overall marketing and competitive positioning. What really matters to [us] investors is the results. If the "big deals" show up in results this quarter/year, the share price should move higher -- it's that simple (*even though we believe fair value today based on reproduction cost is somewhere between $20-30). Remember that share prices always track fundamentals (earnings/cash flow) over time. If Sonic Foundry delivers on guidance this year, fair value could be realized and shareholders would be rewarded. In this situation, the "Market" would be clamoring to own the stock.

Fortunately, Sonic Foundry appears to understand significant changes in business marketing trends. Please note this slide from the recent shareholder meeting (link here to Mediasite presentation with "original" player):
And, intelligent use of Webcasting, social media, and targeted marketing is apparently building traction per this slide, also from the annual meeting:
Still, Sonic Foundry today announced a high-profile event services win as well as another Webinar:

03/23/2010
Drexel University’s School of Education Selects Sonic Foundry to Webcast Virtual Symposium Keynotes
Hosted by Drexel University, Wainhouse Research and the World Bank’s Global Development Learning Network, second annual symposium connects presenters and viewers from around the world
03/17/2010

AND, in the Webinar pipeline -- Autodesk (ADSK): Webinar - Create an Online Learning Destination from Your Conference: Scaling the Autodesk University Experience with Mediasite

We think Webinars featuring satisfied customers who highlight practical Mediasite applications are some of the best marketing possible and showcase Sonic Foundry's growing reference base of customers (thereby attracting more customers). Importantly, insights from customers regularly confirm our view that the Mediasite solution is a comprehensive platform technology that effectively addresses a clearly defined market need and can scale into a large global market. We continue to believe the value of this platform is NOT reflected in the company's current valuation.

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SOFO.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, March 21, 2010

Fedex and Global Shipping, Plus a Bit More on Seaspan (Still at 3-4x 2012E Cash Flow)

As a brief follow-up to our mention of Seaspan's (SSW) results last week, we share a few items:
  • Seemingly all shipping companies rallied strongly Friday, including our Seaspan and Global Ship Lease (GSL). Although the move occurred late in the day, part of the surge might be related to positive results and commentary from Fedex (FDX) the day before.
  • Fedex relayed that "a recovery is well under way" and raised its outlook. Please see this WSJ article for more details. One point related to container shipping mentioned in the article that is helping Fedex (plus UPS and others in the air freight business):
  • "Air-freight service is booming at the companies amid a reduction in the amount of space that is available on container ships that travel between Asia and the U.S. Container-ship carriers have mothballed vessels to combat historic losses incurred during 2009."
  • Interesting, sensible benefit to Fedex et al. from last year's supply reduction. We note that some ships are now being brought back into service.
  • Separately, we mentioned we're seeing positive data points from various sources, including industry trade rags -- from Lloyds last week (3/16/10): "Bullish outlook for bigger boxships" - "POSITIVE trends in container shipping could lead to a return to full employment of all ships over 6,000 teu by the end of next year...."
  • Of course, positive data points are sometimes met by tempered views - see Orient Overseas' results on Friday. The below is sourced from The Journal of Commerce (JOC) -

  • “The recovery in the global economy and the pick-up in OECD consumer demand are likely to be sluggish,” Tung said. “On the supply side, there continues to be an excess of capacity in the form of outstanding new-build orders and laid-up vessels that will need to be absorbed over the next three to four years. An imprudent re-introduction of capacity currently idling or laid-up, if mismatched to demand, could see fresh rounds of rate cutting.”

    Tung said the industry’s challenge between short-term cash flow and longer-term stability will test the market’s capacity discipline over the next couple of years until trade growth eventually absorbs the surplus capacity.

  • We concur that the industry continues to have troubles and highlighted them in our earlier Seaspan post. However, you could also say that many other industries -- real estate, banking, etc. -- also have and/or face plenty of challenges (yet, share prices have still gone wild following the arguably irrational lows of one year ago). As in the other sectors, we suspect the strong will survive and get stronger. In the shipping arena, those companies with long-term contracts in place (e.g. 8, 10, 12 year leases) with strong, viable ocean liner companies (counterparties) will survive and prosper as the economy chugs slowly ahead. Ultimately, we expect the supply/demand imbalance will normalize and the world will need more ships.
  • Finally, Seaspan noted in results last week that fully diluted shares outstanding are near 96 million assuming full conversion of Series A Preferred Shares at $15 in 2014 with the liquidation preference increasing at 12% per year, compounded quarterly (e.g. non-cash interest expense compounding each year and ultimately converting into more shares). Seaspan's Annual Report Form 20-F includes more details on page 59. Fortunately, management seemed confident that additional financing will be secured to reduce/eliminate potential additional equity dilution to fund the company's remaining newbuild program. The 96 million share count is close to what we previously assumed and implies distributable cash flow of around $3 per share in 2012 once the full Seaspan fleet is delivered and in service under previously committed long-term contracts.
  • We continue to believe that container shipping companies such as Seaspan represent a very favorable risk/reward opportunity for patient investors. We would be extremely surprised if Seaspan trades at only 3-4 times distributable cash flow in 2012 (e.g. in two years).
Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long SSW.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, March 18, 2010

Jim Cramer on PETS and PETM; PETS Shorts Probably Betting On Patent Expirations -- We'll See....

We mentioned the other day that Jim Cramer pitched PetMed Express (PETS) on his CNBC show. We don't always watch Mr. Cramer (or CNBC), yet we share the video below because we've previously discussed PetMed Express and are currently long the stock. Plus, Mr. Cramer succinctly details the PETS "story" as well as the merits of Petsmart, Inc. (PETM), another company we've long admired but in which we have no position.












Following a sharp run on higher volume over the past week, PetMed Express "gave some back" yesterday and again on a broker downgrade today. Piper Jaffray made a "valuation call":
  • 'Piper analyst says, "We are downgrading shares of PETS to Neutral this morning based strictly on valuation, as the stock has surged through our $21 price target this week and is up over 14% since the beginning of March.' Please see this link for more details.

Back to the sharp "run" -- we think at least some shorts are covering, helping fuel the stock's recent surge. Short interest is at a 12 month high:
We're surprised by the increasing short position given PetMed's favorable fundamentals and margin/growth profile. However, we think "shorts" are likely betting on certain patent expirations related to key PetMed products that might become available as generic offerings at other online/offline stores sometime this year. We're less certain of the impact from potential changes in brand name and generic offerings, but -- in general -- have observed lower prices on similar products offered by Amazon.com (AMZN).

PetMed's valuation is now in our fair value range and, as in the past, we need to maintain valuation discipline. Still, for now, we're inclined to maintain our current exposure unless the valuation moves above our range and/or enters egregious territory, à la Amazon or Blue Nile (NILE), both of which are trading at approximately 65 times trailing earnings versus PetMed Express at 19 times. Put simply, if PETS garnered the same valuation, shares would be at $65 today. We note that PetMed Express has a higher margin profile than both companies, as well as a very healthy ROE/ROIC around 30% (including excess cash on balance sheet).

Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long PETS.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, March 16, 2010

AOB Disappoints, Again; Seaspan Just Fine; PETS Short Squeeze in Action

We're traveling this week and have limited time, but briefly:
  • We were disappointed to see American Oriential Bioengineering (AOB) miss guidance and estimates ONCE AGAIN -- contrary to our positive, patient long-term view, we actually decided to somewhat reduce our long position for reasons we'll share within the next couple of weeks.
  • Seaspan reported (SSW) results that we thought reaffirmed our positive view and, notably, the company indicated that it is pursuing alternate financing to reduce/eliminate the $180-240 million funding gap required for newbuilds in 2011-12. We continue to see improving data points throughout the container shipping industry.
  • PetMed Express (PETS) is seemingly (and happily) being squeezed higher thanks in part to Jim Cramer / CNBC (although he said to buy on dips).
Happy investing,

Jeffrey Walkenhorst
CommonStock$ense

Disclosure: long AOB, SSW, PETS.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, March 14, 2010

AOB - Key Questions and Why Something Good Might Happen (Timing Uncertain)

AOB reports 4Q09 results tomorrow morning. The company's track record since 2008 has been disappointing, so we look for improvement on this front (but are not holding our breath given various risk factors that impacted 2009). Below, we include current Wall Street estimates and AOB's history of earnings misses from Yahoo! Finance:


As with Bidz.com (BIDZ) in recent months, we also fielded questions on American Oriental Bioengineering's (AOB) business model, investment in China Aoxing Pharmaceutical Company (CAXG), risks, and outlook. In this post, we share somewhat modified/summary questions and our responses.
  • Why did AOB change its business model and start focusing on traditional "pharma" as opposed to enhancing its traditional Chinese medicine (TCM) offerings?
  • We're not sure management changed the business model all that much or at all. Instead, we think the company grew so quickly via acquisition that management wanted to take several years (2008-2010) to integrate/streamline the portfolio of product offerings. In addition, regulatory change in China put the whole sector somewhat on hold as companies apparently waited for clarity on how new rules would impact the business. Finally, we suspect TCM offerings will remain the lion's share of revenue for a long time, but think diversification into pharma (where possible) is logical and part of AOB's plan to further diversify the company's portfolio from both a growth and risk control standpoint.
  • Is CAXG a significant risk for AOB moving forward?
  • We see CAXG as a call option for AOB in the narcotic pharma segment to, hopefully, further diversify the company's revenue streams -- note that AOB's risk is limited to the amount invested in CAXG, or approximately $22 million -- from the last 10Q:
      The Company owns 37% equity interest in CAXG through an initial $18 million direct investment of its common stock in April 2008 and a subsequent conversion of approximately $4.5 million worth of promissory note into additional common stock in August 2009. The promissory note was an advance of RMB30 million to CAXG in May 2008. The note bears interest at a rate of 8% payable quarterly in arrears with an initial term of one year and was subsequently extended for an additional three months. The promissory note plus accrued interest was converted into CAXG’s common stock based on a predetermined conversion rate at maturity.
    • Do you have any opinion regarding the tilidine trials and CAXG's status going forward?
    • Not really. The challenge with AOB/CAXG is that it's extremely difficult for us to know what's happening in China and to understand regulatory/government pressures/risks. However, we gain comfort from our core thesis (despite lackluster 9M09 results):
      "we believe AOB's core business is stable, asset light and should generate meaningful free cash flow. The Market appears to be giving no credit for the company's franchise and numerous competitive advantages, including recognized brands/products that people need/want (customer habit/frequency), scale (manufacturing, marketing/selling, indirect/direct distribution partners), and intellectual property (patents/technology/know-how)."

      Plus, we have contacts who have toured AOB's facilities and conducted channel checks in China. Their feedback is that AOB's products and presence are legitimate with well-established brand recognition.

      As noted above, AOB's risk with CAXG is limited to the initial funding amount unless the company pours more capital into CAXG. Based on the latter's management commentary, CAXG should be better positioned in 2010 after 2009 events (including manufacturing facility consolidation).
    • The completion of phase III clinical trials for tilidine seems to be positive news for both CAXG and AOB, correct?
    • Yes, appears positive. Forward progress. Of course, CAXG has more than just Tilidine in the pipeline.
    • While the Beijing real estate purchase might have improved business/political connections and brought tax credits, why didn't AOB purchase a smaller, cheaper facility?
    • We think AOB is planning for the future with the large RE purchase. The company wants to be the J&J (JNJ) of China, somewhat to the chagrin of short-term oriented investors (and an often myopic Market).
    • Why do you think the bears are wrong?
    • It's easy for investors (or traders) here to criticize AOB, but China truly is a different world (culture, language, politics). As such, we'll never understand everything they do. We must acknowledge that Asian/Chinese companies sometimes do not put shareholders first. We know from our experience visiting companies that, in order of importance, employees and customers often rank ahead of shareholders. This is a risk factor, but also a FACT of investing in this geography (which is, no doubt, why some value investors stay out of China). Personally, we can't ignore the growth profile of this region and want to participate in Chinese style capitalism by owning attractively valued businesses poised for long-term growth such as AOB. We are aware of Chinese "bubble" fears and can envision potential troubles where demand does not match/meet excess supply -- for an insightful, if not scary read, please see this Forbes article.
    • At some point, AOB's margin compression slows/stabilizes and earnings growth should accelerate as top-line continues to grow organically (general market growth and company specific). Plus, we're fairly certain AOB will use excess cash to resume acquisitions at some point, which will bolster the top-line and, presumably, the bottom-line.
    • We believe barriers to entry are incredibly high for outsiders and even other Chinese firms without the right connections. We simply have a hard time NOT believing that AOB will be bigger, better, stronger in five years' time, with a much higher share price to boot.
    • What about a protective put strategy to protect against a decline in the stock price?
    • We've not explored options for AOB and are not sure such a strategy is necessary at the current low valuation. While anything is possible, we should have excellent downside support because of the company's very low multiple of earnings and cash flow. Aside from continued growth and margin stabilization, the key to regain and/or attract Wall Street interest is for management to announce something productive with all of the company's cash and additional free cash flow. Government pricing pressures remain a risk to margins and earnings, yet we're inclined to believe something good will happen at some point and push shares higher. We just don't know when.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long AOB.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Friday, March 12, 2010

    No Recession Here? Easy Y/Y Comps Helping, but Still... More Positives

    We know many mixed economic signals exist and we will soon update our "How's the Economy Doing" series, but we find the following data points interesting (even acknowledging easy Y/Y comparisons):

    Mattress business:
    • MINNEAPOLIS--(BUSINESS WIRE)--Select Comfort Corporation (NASDAQ: SCSS - News) today reported fourth quarter and fiscal 2009 results for the period ended Jan. 2, 2010. Net sales for the quarter totaled $136.5 million, an increase of 4 percent on same-store growth of 23 percent, compared to $131.1 million in the fourth quarter of 2008, which included a 14-week selling period as compared to 13 weeks in 2009.
    Furniture business:
    • DANBURY, Conn.--(BUSINESS WIRE)--Ethan Allen Chairman and CEO, Farooq Kathwari, will present at the Raymond James Annual Institutional Investor Conference in Orlando, Florida on March 9, 2010. This presentation will be webcast and can be accessed via the Company website at ethanallen.com.
    • In anticipation of questions about current business trends, Ethan Allen announced today that written sales (orders) for the two months ended February 28, 2010, have increased approximately 25% over prior year.
    • Farooq Kathwari, Chairman and CEO commented, “We are pleased that our marketing programs that focus on projecting our value proposition of style, quality, and design services together with significant savings are driving traffic to our design centers. This increase in traffic is resulting in higher written orders than we have seen in some time. It is important to keep in mind that for the most part, orders taken in this period will be delivered and reported as sales in our fourth fiscal quarter ending June 30, 2010.”
    AND, the Railroad business:
    • NEW YORK (AP) -- Railroad operator Kansas City Southern (KSU) said Wednesday it expects first-quarter sales to grow by more than 20 percent compared with the same period a year ago.
    • In the first quarter of 2009, revenue fell 23 percent to $346 million. A 20 percent jump would imply revenue of $415.2 million, well above the $384 million average estimate of analysts polled by Thomson Reuters.
    • Speaking at the JPMorgan Aviation, Transportation and Defense Conference, Executive Vice President and Chief Financial Officer Michael W. Upchurch said shipping volume is up 13 percent through the first eight weeks of this year. Volumes during the week of March 1 through March 7 were the highest since May 2008, Upchurch said.
    SO, when despair and/or concerns over the economy surface, please keep in mind positives being reported by cyclical/consumer discretionary companies. We see the higher railroad volumes as another positive indication for our container shipping companies, Seaspan (SSW) and Global Ship Lease (GSL).

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long SSW, GSL.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Thursday, March 11, 2010

    BIDZ - Execution Critical to Show/Realize Durable Earnings Power Like QVC/HSN; Risks Remain

    Per our post Monday, Bidz.com (BIDZ) reported results Tuesday afternoon. We expected revenue might come in short given continued consumer weakness and it did, along with lower-than-expected March quarter guidance - here's a brief summary from Eric Savitz of Barron's.com:
    Bidz.com (BIDZ), the online jewelery retailer, posted Q4 revenue of $27.5 million, below the Street at $30 million, and falling short of the company’s guidance range of $28 million to $32 million. The company posted a profit of a penny a share, at the low end of its guidance of 1-4 cents....
    For Q1, BIDZ sees revenue of $26 million to $28 million, with gross margin of 24%-26%, down from 29.6% in the fourth quarter, “as the company will push for market share to get back on a growth curve.” The company expects to break-even in the quarter on a pre-tax basis. The Street has been expecting profits of a nickel a share....
    SO, at least two risk factors are seemingly impacting the company: the weak consumer economy and a competitive marketplace, both of which are leading to margin compression. We need to monitor these risks as investors don't like to see lower revenue and lower margins (and a lower bottom-line).

    Here are key operating metrics from 4Q09 - ASP and average items per transaction higher Y/Y, but other metrics lower Y/Y:

    AND, from the company's 10-K, a five-year summary of selected financial data (click to enlarge):


    Despite the 4Q/1Q revenue shortfall and Y/Y declines in key metrics, we are pleased that the company maintained profitability for the quarter, albeit slight. Many retailers swung to huge losses during the recession and are now only returning to break-even or better. Management indicated on the conference call that earnings per share were negatively impacted by one cent because of ongoing legal expenses, but that legal costs should be much lower going forward (recall recent settlement of shareholder suit). We look for additional, near-term resolution related to various investigations/suits, which may prove positive catalysts.

    Further, management also relayed on the call that it expects March quarter revenue to be the "low point" for 2010 quarterly revenue with Q/Q improvement through the year as new initiatives and increased marketing are expected to bring higher revenue. The company expects to sacrifice margins somewhat to ignite growth.

    We don't think results/commentary answered our key question presented on Monday:
    • The key question is this: is Bidz.com a truly durable franchise with real earnings power?
    • i.e., can Bidz.com achieve consistent margins/results such as QVC (LINTA) and HSN (HSNI), which propelled both names significantly higher over the past year? Many investors favor these companies for their asset-light business models and large free cash flow. Plus, customers keep coming back for more even amidst a weak consumer environment -- amazing, right? Both QVC and HSN seem to have the secret sauce, established over many years. Is [much smaller] Bidz.com of the same ilk?
    As discussed in the past, we think established Internet franchises are more difficult to replicate than most persons/investors realize. Bidz.com has spent millions of dollars over the past decade building a brand and international online retail platform. During the process, the company succeeded in building tangible shareholder equity (please see financial data above). At this point, we believe the heavy lifting is complete, although execution is critical and economic conditions are a key risk. Based on recent signals and actions, we believe a return to profitable growth and renewed increases shareholder equity are attainable. Importantly, we believe shares remain inexpensive on an absolute basis and comparable basis, which should provide downside protection.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: Long BIDZ.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Monday, March 8, 2010

    Key Questions Re: BIDZ - Price, Catalysts, Time Horizon?

    The other week, we fielded questions on Bidz.com (BIDZ) regarding current valuation/downside, potential catalysts, and time horizon. Our now slightly updated responses are below:
    • Price - hard to say what could happen and we're not expecting much for 4Q results given weak consumer discretionary spending trends, yet low current multiples on virtually all metrics (P/E, P/CF, P/S, P/B) suggest shares should have downside support. Of course, we thought this when the stock was at $3. Micro-caps often swing widely without much logic, up or down.
    • Catalysts - yes, the economy is still weak with strapped consumers (and federal/state governments) everywhere, yet Bidz should now be up against easier Y/Y comps in 2010. Plus, the company is introducing new features (Bidz Bucks) and offerings (Modnique) enabled by the new ERP/inventory system that may spur growth. Also, Bidz has decent international exposure, particularly in the Middle East, that may offset slower U.S. sales. Finally, Bidz filed a motion to dismiss class action lawsuits on 12/4/09. So, we see potential catalysts on the horizon. [subsequent note: Bidz.com announced on 3/1/10 the dismissal of the case with the payment of a small $20,000 settlement -- this was one of the positive catalysts we highlighted in our initial post last August; market reaction last week: yawn].
    • Time horizon - as we've detailed previously, we take a long-term view as it's impossible to know what might happen near-term. Who knew banks and REITs would go crazy to the upside last year (although they seemingly couldn't go much lower)? We suspect potential positive catalysts noted above may push BIDZ higher, yet timing is uncertain. However, what we do know is that no one wants BIDZ at present and big money can be made by establishing positions in out-of-favor companies that later become bigger, better, and stronger (and then garner significant Market attention). The key question is this: is Bidz.com a truly durable franchise with real earnings power? If the answer is yes, then now is probably a good time to average down. Our bet is that Bidz will be around as we believe established Internet franchises are more difficult to replicate than some realize -- not to mention the appeal of QVC/HSN-like online business models -- but the Market apparently doesn't think so. Tough economic conditions may continue to weigh on results and, therefore, the company near-term.
    Please note that Bidz.com is scheduled to report 4Q09 results tomorrow afternoon. We look forward to a business update.

    Separately, for those who are interested in hearing/seeing management discuss the Bidz.com business model, please see this video from August 2007 (dated but still relevant). PetMed Express (PETS) has an informational video on its Web site and we suggested Bidz.com do the same -- management relayed that they also had a video and subsequently placed a link in the IR section of its Web site. We were pleased to see the action.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: Long BIDZ, PETS.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Saturday, March 6, 2010

    Churchill / Youbet Deal Gets Closer; Unfortunately, Fundamentals Remain Poor

    Churchill Downs (CHDN) reported results last week that fell short of Wall Street expectations. Churchill's management mentioned on the company's conference call that the environment remains challenging with no signs of near-term improvement. Based on Churchill's results and outlook, we're not expecting too much when Youbet.com (UBET) reports next week. In addition, we remind readers that the December and March quarters are seasonally weak for horse racing.

    In our view, ongoing sector weakness isn't entirely surprising since the consumer remains weak and monthly handle figures reported by Equibase are decidedly disappointing. The month of February was released on Thursday (click to enlarge):

    However, we are somewhat surprised by the Y/Y decline as we expected to see at least some improvement on what should be an easy Y/Y comparison. Also, Las Vegas / Nevada gaming results for the month of January were only down 4.8% Y/Y (source here). We can conclude that consumers and the average horse bettor remain stretched.

    Importantly, Churchill's management also emphasized that the proposed Youbet.com (UBET) transaction is progressing and that the Internet business is a critical component of Churchill's go-forward growth strategy. We briefly highlighted the importance of a strong online presence in our update last month. In addition, Youbet.com officially announced April 6th as the special meeting date for shareholders to vote on the transaction. While approval from the Department of Justice remains a necessary for the deal to proceed, news of the April vote is encouraging and, in our view, shows confidence from both companies that DoJ approval should be forthcoming.

    Since we're still long Youbet.com shares, we remain focused on the implied value to Youbet.com shareholders. Fortunately, even amidst unfavorable fundamentals, we see valuation support for Churchill Downs. Why? As noted in our December post, the application of historic median cash flow and earnings multiples suggests a fair value of $45-50 per share if we believe reversion to the mean can happen at some point. Despite economic and industry challenges, we're fairly certain that Churchill Downs will remain a major player well into the future. We think the company owns/operates a durable franchise. Of course, a return to growth may be necessary to attract more Market interest in the company and push shares back into the $40s.

    If the deal were to close Monday, the implied value to Youbet.com shareholders is around $3.20 per share based on the current share price of Churchill Downs. Recall our summary table from our initial post regarding the transaction (click to enlarge):

    * Please note that the 2010 consensus earnings estimate for Churchill Downs is now $1.54 (per Yahoo! Finance), down from $2.00 last fall.

    The valuation difference today offers merger arbitrage players an excellent opportunity to potentially make a quick 10% absolute return over the next month or two (even better on an annualized basis) assuming the transaction closes. Investors continue to discount the risk the deal will fall apart.

    We see two potential near-term positive catalysts for both CHDN and UBET, in no particular order: (1) Youbet.com shareholder approval and (2) DoJ approval. On the flip side, if these events fail to materialize, we would expect downside. Still, we think the odds favor consummation of the transaction.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long UBET.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Thursday, March 4, 2010

    Sonic Foundry/Mediasite + Philip Carret and Water Meters

    As a follow-up to our post Wednesday, Sonic Foundry's (SOFO) shareholder meeting today was as expected: consistent message that the business is moving in the right direction with large deals in process. Importantly, the company indicated that debt financing commitments are in place to finance working capital needs related to "rapid expansion". We recommend watching the on-demand replay of the meeting for full details. Several key summary slides -

    Unearned revenue is more meaningful:
    Poised to see operating leverage and working capital financing in place (as also noted above):
    More "platform deployments":

    Last month, we included a video featuring the late investment legend Philip Carret. We uncovered an insightful article from 1999 where he shares his advice - it's well worth a read.

    Similar to Peter Lynch's common recommendation, one of Mr. Carret's guidelines is as follows -- directly from the article:
    • For your best investment ideas, look around you. I've been following this strategy for more than 70 years.
    • Example I: In the early 1920s, not all water was metered in New York City. That wasn't going to last forever because water is a scarce resource, and there was no incentive for people to conserve water. Sooner or later, they were going to have meters for everyone. So I bought stock in a company called Neptune Meter, and it turned out very well.
    Our own approach is similar to that recommended by Mr. Carret. While some value investors may not understand our interest in a micro-cap technology company with a history of operating losses, we think Mr. Carret might at least acknowledge the following: (1) like TV in the 1900s, the Internet is evermore pervasive in our daily lives, (2) online video/media is evermore pervasive as a natural extension of broadband Internet, and (3) online education and "rich media" capture is evermore pervasive.

    Putting (1) through (3) together with
    the Mediasite franchise -- as we've previously established -- suggests Sonic Foundry is poised to deploy more "meters" around the globe. The company's +19% Y/Y organic revenue growth in fiscal 2009 (end September) also indicates that the "installed base" is growing. Unlike water meters*, "everyone" is not going to have Mediasite, yet the addressable market is sufficiently large and expanding.

    (*side note: water meter company Badger Meter (BMI) is an interesting little company)

    Recall our analogy last May, where we compared the Mediasite solution to a jet engine:
    • A less-than-perfect but still relevant analogy might be the following: Mediasite is to Webcasting as a jet engine is to flying. Many companies no doubt tried to make jet engines through the decades, but only a handful emerged as market leaders (e.g. General Electric, Pratt & Whitney, Rolls Royce). For Webcasting, Mediasite is increasingly the go-to platform with quality and reliability both immensely important since many customers (e.g. schools) use the system daily to capture and archive hundreds of hours of content.
    Anticipated large deals this year should further position Mediasite as the go-to platform and spur additional adoption, thereby strengthening barriers to entry that protect the Mediasite franchise.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long SOFO.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer

    Wednesday, March 3, 2010

    Sonic Foundry Thesis Revisited - Scenario Analysis and Potential Valuation

    In our post the other day, we mentioned that Sonic Foundry (SOFO, $6.80) might be trading at only six or seven times forward earnings for the year beginning this summer. In this post, we explain our analysis in a summary thesis we've shared with institutional investors in recent months.

    Before jumping into our analysis, we thought we'd relay something quite surprising (but potentially helpful to Sonic Foundry shareholders): the latest SOFO short interest report from Nasdaq.com:

    SO, despite posting better-than-expected results for the December quarter and raising guidance ("begin to see impact of large deals in March quarter"), short interest actually increased slightly in the latest period to 31.7 thousand shares (as of 2/12/10). "S/I" now represents approximately 10% of Sonic Foundry's estimated "float" of 3.02 million (per Yahoo! Finance). While not overly large (e.g. see Netflix's S/I at approximately 31% of float per Yahoo! Finance), the number is not insignificant and we think the real percentage is even higher than 10% acknowledging blocks of shares held by other long-time holders that, like us, believe in the growing Mediasite franchise.

    [CORRECTION! - an astute reader correctly pointed out that the S/I is only 1%, not 10% -- my mistake. As noted in my response to the reader, we're not sure what planet we were on when previously making the calculation and subsequently publishing....]

    For reasons described below, we see "shorts" betting on a decline in Sonic Foundry's share price as being in a highly precarious position. We expect shorts will need to cover their positions by purchasing shares. We suspect such covering could lead to very favorable upward moves in illiquid SOFO shares.

    SUMMARY THESIS AND ANALYSIS (familiar to many regular readers, except for our forecast analysis)

    Sonic Foundry (SOFO, $6.80, $29.9 million MC, $28.6 million EV - assuming fully diluted shares of 4.4 million; pricing as of 3/2/10)
    • Sonic Foundry sells a hardware- and software-based “rich media” Webcasting solution called Mediasite.
    • The Mediasite solution is a comprehensive platform technology that effectively addresses a clearly defined market need and can scale into a large global market. With a large, growing, and happy installed customer base, Mediasite is increasingly recognized as best-in-class and is emerging as the de facto global standard for lecture capture and Webcasting.
    • Several competitive advantages point to a powerful, sustainable: (1) Sonic Foundry/Mediasite is far along the learning curve with (2) intellectual property protection, and (3) very satisfied, captive customers that face high switching and search costs. Points (1) – (3) are both related to and strengthened by (4) economies of scale and (5) leading market share.
    • Despite tangible evidence of an established franchise, the company is trading at only 1.6x trailing twelve month (through December) sales of $19.1 million (+12% Y/Y) because of a history of operating losses (though shrinking) and the company’s small size.
    • However, an inflection point is now visible as management pointed to a “half dozen”, highly probable large-scale deals in mid-2010 that would be game changing in terms of Sonic Foundry's financial profile.
    • While no specific guidance was provided, layering in only several larger deals (assume $1 - 3 million each over several quarters) on top of Sonic Foundry’s existing book of business implies that annual revenue could scale from approximately $19 million to $25 - $30 million for the 12 months beginning in mid-2010 and ending in mid-2011.
    • Applying a conservative 75% gross margin (versus 77% in fiscal 2009) to revenue of $26.3 million (low-end of range) yields gross profit of $19.7 million. Subtracting cash operating expenses of $15.7 million ($3.9 million per quarter compared to initial fiscal 2010 guidance of $3.5 million per quarter) yields cash operating income of $4.0 million ($0.91, or nearly $1.00 per share). Net operating losses (NOLs) of $87 million should shield cash taxes for many years and, in our view, represent another under-appreciated company asset (*investors often assign limited value to NOLs if a company's ability to use them is unclear, yet our understanding is that Sonic Foundry will be able to apply NOLs).
    • Multiple scenarios are presented below - click to enlarge:
    • One caveat is that Sonic Foundry plans to add additional debt to fund rapid growth in working capital, with incremental interest expense slightly reducing expected earnings. The company had a net cash position of $1.3 million at 12/31/09, down from $2.9 million one year earlier (= burn of $1.60 million). However, if expected growth and positive free cash flow materializes, Sonic Foundry should be able to reduce debt and interest expense by repaying borrowings.
    • Applying a forward P/E multiple of 20x – 30x to $1.00 of cash earnings (rounded up from $0.91) implies a fair value of $20-$30 this summer. We're not an advocate of simply awarding high multiples, but again, please see our post re: Fortune tech picks for insight into how the Market might value SOFO once the company garners investor attention. Please note that we'll happily accommodate future Market interest by reducing our position at higher multiples.
    • Further, a reproduction analysis suggests a fair value per share range of $20 to $27 ($23.5 midpoint) today (please see our initial "Mediasite franchise" post). Recent M&A comparable transactions (e.g. Cisco/Tandberg, Logitech/LifeSize, Google/On2 Technologies) imply similar valuations would be awarded by an informed private market buyer, although non-public insights (under non-disclosure agreement) into Sonic Foundry’s forward pipeline could yield higher values.
    • Key risks to realizing fair value: delays in closing large deals, further reductions to IT budgets (especially in higher education), working capital financing needs, and potential competition. In addition, note that the stock is thinly traded with a small float and, therefore, subject to wide swings. Finally, we remind readers that forecasting is a dangerous game, especially for smaller companies such as Sonic Foundry. We could be wrong.
    We look forward to an update on business trends and timing for large deals tomorrow during Sonic Foundry's annual shareholder meeting. The Mediasite Webcast begins at 10am EST.

    Happy investing,

    Jeffrey Walkenhorst
    CommonStock$ense

    Disclosure: long SOFO.

    © 2010 Jeffrey Walkenhorst
    Please see important Risk Factors & Disclaimer