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Wednesday, October 27, 2010

Big Runs for Gobal Ship Lease (GSL) and Seaspan (SSW) - Time to Sell?

Our asset-heavy container shipping companies Global Ship Lease (GSL) and Seaspan (SSW) (click for prior post) have had large, upward stock moves in recent weeks. A one-month chart from Google Finance (GOOG) comparing performance to the S&P 500 shows the index up only 3% versus GSL up 54% and SSW up 20% (click to enlarge):

Does this mean it's time to sell? While a short-term retrenchment is possible and even likely (happening today) as traders take profits, we continue to take a long-term view and believe the answer is no.

Both companies are moving higher on company-specific developments -
  • Seaspan: sale leaseback financing to remove all future funding commitments for the company's large new-build order book to be delivered over the next two years.
Also, note that Seaspan reported 3Q10 earnings today that again illustrate the strength of the company's stable, consistent business model.

Why keep holding? In both cases, fair values remain meaningfully higher than current trading levels based on excess cash generation and stable business models that adequately support high levels of leverage (debt). Our February post on Seaspan largely provides the answer for SSW, but we'll come back with more commentary in the near future, including discussion on Global Ship Lease.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long GSL, SSW.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, October 24, 2010

Sonic Foundry (SOFO): More Adoption, College Trends, TechSmith's Camtasia Relay

Shares of Sonic Foundry (SOFO) continue to push higher, finally moving toward what we view as a more reasonable $20-30 valuation range given the difficult-to-replicate Mediasite franchise. Three-month chart courtesy of Yahoo Finance (YHOO):

We think the "Market" is finally taking notice of the company's leading market position and favorable secular trends (e.g. video everywhere), as well as increased adoption for event/conference capture as more organizations embrace what we've been calling "the Mediasite memo." For example, last week, Gartner, Inc. (IT) used Mediasite to capture its largest conference of the year, Gartner Symposium/ITxpo 2010 (more than 7,000 attendees, certain keynotes available here).

Further, news on 10/13 (during 2010 EDUCAUSE) of the technology partnership with TechSmith served to validate Sonic Foundry's role in delivering a reliable platform to manage and distribute video content captured with third party solutions such as Camtasia Relay.

We'll share a tiny bit more on Camtasia, but first something on "secular trends." For this, we turn to insightful commentary from a 10/14 article in The Chronicle of Higher Education, Colleges Push for New Technology Despite Budget Woes. Some key points directly from the article:
  • Campus information-technology budgets showed signs of a gradual recovery in 2010, with 20-percent fewer programs than last year reporting financial cuts, according to the new Campus Computing Survey, which was released today at the Educause meeting in Anaheim, Calif.
  • That doesn’t mean the good times are rolling, however. With 41.6 percent of colleges still reporting cutbacks, IT departments continue to feel a pinch. Despite budget woes, the report shows many colleges are moving forward with plans for new technology in several areas.
  • Colleges are putting more course content online with wikis and lecture-capture techniques. Approximately 65 percent of colleges said they are developing a strategic plan to deliver instructional content through lecture capture and podcasting. The survey found, however, that only 4.4 percent of classes now use lecture capture and just 4.5 percent use podcasts. Only 3.5 percent of respondents used lecture capture and 3.9 percent used podcasting last year.
The third bullet is noteworthy as Sonic Foundry sits squarely in the middle of the lecture capture trend. Mediasite is playing a critical role in bringing more classes online as a reliable, effective, and secure enterprise-grade platform. To hear how certain customers are using Mediasite in their schools and/or other organizations, we recommend watching Mediasite User Group meetings. Most recent:
  • Sept 29, 2010 @ 11:00am CDT
    Don't have Silverlight? Download it here or watch with classic player.

    The key to successful learning spaces design is to consider how to match teaching and learning activities with the technologies you want to employ today, as well as in the future. Join Jim Jorstad from the University of Wisconsin-LaCrosse as he discusses Incorporating Innovation in Learning Environments - Getting Your Ideas to Take Flight. Jim will showcase examples of innovative learning environments in the U.S. and around the world. Learn how to make your rooms flexible, scalable, and successful. Learn techniques to "get a seat at the table" when technology choices are being made and learning spaces are being conceived. The session will also discuss how web streaming/lecture capture discussions can occur on your campus, and how to choose the correct solution for your faculty, the students, and for the administration. Learn techniques to match lecture capture with the room design you've chosen. This is a highly visual session. Get ready to travel the world of learning space design and how to successfully land safely at your own campus. Fasten your seat belts, we are almost ready for lift-off!

Finally, TechSmith's Camtasia Relay. Going back to Sonic Foundry's fiscal second quarter conference call on 4/29/10, management spoke of enabling the "ingestion of third-party content," noting that CTO Monty Schmidt highlighted innovation in this area at the company's UNLEASH conference earlier that month.

We subsequently emailed CEO Rimas Buinevicius the following questions:
  • What exactly is meant by "content management and ingestion of 3rd party content"? what types of content are we talking about? Other video/file types/formats? Is this something customers were especially excited about at UNLEASH? How major is this?
He responded on May Day (5/1) with the following and gave us permission to relay here on CS$:
  • "The best example of third party content is probably the broad use of a product like Camtasia. This is a desktop software screen grabbing application that allows you to create a training video or teaching seminar at your desktop. Many professors use this sort of software to create their own video, versus going to a lecture hall. So, importing this content into Mediasite makes us more ubiquitous from a content management perspective with both types of content being managed centrally. It's "major" from the standpoint of customers wanting only one content management application to deal with, the idea being you can co-mingle lots of sources of instructional media, not just Mediasite content."
Given the recent news of the partnership with TechSmith, now is a perfect time to finally share this additional color. We are pleased to see Sonic Foundry's move to increase the attractiveness of Mediasite as a content management utility. More "ubiquitous" can make life easier for customers and, thus, further enhance the Mediasite franchise value.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO, YHOO.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, October 19, 2010

Why Buy More 1-800-Flowers.com (FLWS)? Consider an Owners' Perspective

In our Who's Driving the Bus? post back in September, we mentioned we'd come back to Weight Watchers (WTW) and 1-800-Flowers.com (FLWS). We touched on Weight Watchers the other week and, actually, have had most of the below in our back pocket for awhile. Now, with a few edits, we come back to "Flowers."

This Thursday, 1-800-Flowers.com (FLWS) reports Fiscal 1Q 2011 results before market open. Admittedly, we're not really sure what to expect given the ongoing weak consumer environment and cautious management commentary back in August (no guidance). We hope to see margin improvement -- even if the top-line remains challenged -- particularly in the Consumer Floral segment. That said, we think the company's current market valuation already reflects the difficult operating environment and significantly undervalues the company's cash generating assets.

In our Saturday 8/21 post, Double Dip? Check "Selfish" Discretionary Spending versus "Gifting" Discretionary Activity, we shared some surprisingly strong retail figures from a variety of discretionary retailers. Following lackluster results from 1-800-Flowers.com two days prior, we reached the following conclusion: what we'll call "selfish" discretionary retail segments are clearly outperforming "gifting" discretionary segments. We added that this current trend is negative for our 1-800-Flowers.com and makes life more difficult for a company with low historic margins and seasonality.

Well, that Monday a large institutional investor seemingly threw in the towel and shares plunged 11% on 17 times average trading volume (versus an approximately flat day for the S&P 500 index):

Of course, someone is always on the other side of any trade and, thus, someone accumulated a large number of 1-800-Flowers.com shares that day. Why would a buyer step in following disappointing results and a still weak, hyper-competitive consumer environment?

We think the answer is fairly simple: the company isn't going anywhere and generates plenty of excess cash flow (which underpins our core 1-800-Flowers.com long thesis). To illustrate the cash generation as well as capital allocation, let's revisit management commentary from the Q&A portion of the 8/19 conference call - thanks to SeekingAlpha.com:
  • Anthony Lebiedzinski – Sidoti and Company: During the year, you guys did a good job of generating free cash flow. I realized that you haven't given guidance for free cash flow. But what would your objective be for free cash flow usage during fiscal '11?
  • Jim McCann - Chairman & CEO: Well, I think you have to look historically first to get the best indication. And what we've seen here is, over the last two years – and I'll answer this because Bill is suffering terribly here from a cold.... What we've done with free cash flow is, we've said – we used to say we have three usages for our free cash flow, return it to our shareholders, make strategic investments, or improve our balance sheet and pay down debt.
  • Well frankly, in this environment, we're not looking to return it to shareholders. We're looking to maintaining our flexibility, increase our flexibility. So this year, we paid down $32 million in term debt. And over the last two years, it's over $60 million that we paid down our debt. So the evidence, historically, is as we're fortunate enough to generate excess free cash flow, we're using that to strengthen our balance sheet.
  • Going forward, we'll continue to strengthen our balance sheet. We'll continue to be prudent in the use of that cash. And generally, we hope to increase our cash generation over time from our operating side of the business and use that to [grow the] business either by improving the flexibility in our balance sheet or perhaps there's something we find that would be a perfect fit with one of our platforms that we already have in place that offers a broader package and leverage in revenue activities we get into.
HENCE, Mr. McCann correctly identifies the uses of excess cash we seek in our companies: return it to our shareholders (dividends or share repurchase), make strategic investments (reinvest in business or make acquisitions), or improve our balance sheet by paying down debt. YET, for the time being, he makes clear that the company will continue to use excess cash to de-lever the balance sheet, which is perfectly fine by us. He also makes clear that the company's operating businesses generated significant excess cash over the past two years, enough to repay $60 million of debt.

Here's a look at the top portion of the annual cash flow statement from Yahoo Finance (YHOO) over the past three years (click to enlarge):

SO, while 1-800-Flowers.com has encountered tough fundamentals over the past several years given (1) the weak consumer economy (widely recognized) and (2) aggressive competition from Liberty Media Interactive's (LINTA) ProFlowers.com, cash generation has NOT been a problem. Importantly, capital expenditures remain nominal for the "asset light" business with favorable working capital dynamics. Also, we still believe 1-800-Flowers.com has competitive advantages that should mitigate competitive pressures and support margins over time.

NOW, let's frame the long thesis another way: if someone presented you with the opportunity to purchase a diversified, established business that would give you and your family a 15-20% annual yield (normalized) in perpetuity (assume all FCF is paid to you and your family = the owners), would you take it?

Simple, readily apparent answer: Yes, indeed.... Ah, but wait: what's the catch? No catch - just like the Yahoo opportunity we've detailed, there's absolutely no catch. Only a bumpy economy that requires patience.

Finally, while some of you may like See's Candies, we continue to recommend Fannie May Fine Chocolates, especially Pixies:
Milk Chocolate Fall Leaves and Fall Balls
Milk Chocolate Fall Leaves and Fall Balls
Dark Pixies®
Dark Pixies®
Give them a try and, as you enjoy the chocolates, consider that the standalone value of only 1-800-Flowers.com's chocolate businesses to an informed private market buyer might be equal to the entire company's current enterprise value, which means you get everything else for free! We don't think this situation will or should last, even in a tough gifting environment. But, it gives us great comfort in owning and even buying more shares of the company.

Happy investing,

Jeffrey Walkenhorst

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

Monday, October 18, 2010

Yahoo (YHOO): Absolutely No Value, NONE... Except that Yahoo News Has 21 Times More Readers Than the Wall Street Journal...Yahoo Sports Double ESPN..

Contrary to the first part of our post's title -- which, like many observers, treats Yahoo as an also-ran Internet franchise -- our recent series on Facebook/Yahoo (YHOO) highlights an enormous sum of the parts (SOTP) discount along with evidence that the company remains highly relevant.

Others are apparently now also seeing the value, given new speculation last week of a merger or acquisition involving private equity players. Yahoo is said to have enlisted Goldman Sachs (GS) to fend off would-be suitors so the company can continue along its new path under CEO Carol Bartz.

When we published our 9/25 post, What's Facebook Worth? Is Yahoo or Facebook a Better Investment?, we mentioned that private equity buyers might be sniffing around Yahoo:
  • Given the head scratching public market discount, common sense would suggest that billions of private equity dollars looking for a home should be extremely interested in Yahoo, a leading franchise that generates fairly steady free cash flow. That said, a sizable control premium would be required to win the business.
Indeed, private equity firms are scooping up value wherever it can be found. As an example, the other week, the Greenbriar Equity Group announced it was acquiring Dynamix (DDMX), a neat little shipping company we mentioned back in June. The deal came at a 58% premium to the prior 30-day average closing price, which -- prior to the deal -- was arguably depressed for the high quality niche company.

Back to Yahoo. We think it's amazing to us how little respect the company receives AND, likewise, how seemingly misunderstood the company is in mainstream media. An article from Sunday's NYTs opens with the following:
  • Even Under New Captain, Yahoo Seems Adrift By VERNE G. KOPYTOFF
  • SAN FRANCISCO — The board of Yahoo, the ailing Web portal, hired Carol A. Bartz as chief executive to apply a little shock therapy. Despite rumblings, Yahoo has a huge audience and is profitable. Now, nearly two years later, the patient is still suffering from many of the same symptoms: a stagnant business, shrinking market share and a shortage of innovation (emphasis added).
The article actually covers a number of key points and is worth reading for those following Yahoo. But, at a broader level -- across the media and on Wall Street -- there seems to be an impression that the company is standing still, has no idea where it's headed, and doesn't innovate. All this despite the fact that tens of millions of people daily use Yahoo Mail, News, Finance, Sports, etc. (ourselves included).

For example, one of Yahoo's "Fun Facts" from the company's press releases page:

Also, per our earlier post, Yahoo! Sports -- with 48.2 million visitors during the month of August according to comScore (SCOR) -- has nearly double the number of visitors versus number two player FOXSports.com (NWS) on MSN (MSFT) and number three player ESPN (DIS).

We could be wrong, but we don't think these functions are ALL going to be usurped by Facebook, Twitter, or any other new network that emerges. These are different mediums. Although more people -- especially teenagers -- are getting their "news" from social networks, we think a significant amount of content will still be delivered by Yahoo, either direct or indirect.

It is true that the deep relationship "social graph" that Facebook and Twitter are accumulating each day can be used for marketing purposes. However, Yahoo also has extensive "clickstream" and relationship data that the company mines daily to aid advertising placement and personalize user experiences. In fact, Yahoo was instrumental in innovating and establishing the underlying open source technology -- Hadoop -- that makes many new computing capabilities possible, not only at Internet companies, but also at "old economy" companies. There's more we could say here, yet suffice to say that we believe innovation is alive and well at Yahoo.

The company reports results Tuesday afternoon. Regardless of what happens with the quarter, we continue to see an incredible discount to a reasonable valuation for the company. If we assume Yahoo's core properties garner a 10% FCF yield versus the 15% recently awarded by the market AND include values for international assets including the Alibaba Group, shares might trade north of $20 per share.

Admittedly, we're not certain how the Internet landscape will unfold over the long-term. Fortunately, we're fairly certain Yahoo's SOTP value is real, providing a comfortable margin of safety.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Saturday, October 16, 2010

Stocks vs. Bonds: Where to Stash Your Cash? (Revisited)... Hint: "It's All About What You Pay and What You Get!"

In November of last year, we shared "Don't Forget About Dividends" and relayed "the power of payouts" compounding over the long-term. More recently, in early August, we shared this post: Where to Stash Your Cash? Listen to Hersh Cohen: Buy Equities that "Just Make Sense!". Here, we wanted to address common questions such as:
  • "Bond yields are so low, there's nowhere to generate any sort of decent return on our savings." Or, another one: "How are America's retirees going to live off of 1-2% interest income?" Or, "My CDs are expiring, where shall I roll them over?"

Our conclusion: the answer is surprisingly simple: invest in high quality companies with solid balance sheets that (1) sell or provide products or services that people need to buy (think cleaning supplies, food, beverages, telco services, etc.) and (2) offer reasonable, growing streams of dividends. To highlight this strategy, we shared Hersh Cohen's "Where to find income" from WealthTrack (video from 7/23/10).

We followed this discussion with another post (8/28/10) on stocks versus bonds, and again in Who's Driving the Bus? (9/14). We've been meaning to round out these posts with some additional commentary. Here we go.

First, we ALL continue to see headlines such as the following:
  • Gold sets record as Fed easing hopes hit dollar (Reuters) - Gold surged nearly 2 percent to a record high near $1,375 an ounce on Wednesday, boosted by worries over currency depreciation after the Federal Reserve signaled it will resume buying government debt to stimulate the economy. It was the biggest percentage gain since September 14 for gold, which has rallied 25 percent so far this year. Investors have sought safe havens with the Fed and other central banks professing readiness to inject more money into the financial system, a procedure known as quantitative easing.
  • Stocks Dip, Treasury Yields Drop After Jobs Data- AP (10/6/10) - Stocks dipped Wednesday after a disappointing report on the jobs market renewed concern about the economy. Treasury yields sank to new lows as investors sought safety and anticipated more stimulus measures from the Federal Reserve. [note: yields inversely related to prices - lower yields = higher prices]
Not to mention regular talk of the "new normal" and weak personal incomes:
  • Gross Says Druckenmiller's Exit Marks `Old Normal' End in Capital Markets - Bill Gross, who runs the world’s biggest mutual fund at Pacific Investment Management Co., said the planned exodus of hedge-fund icon Stanley Druckenmiller helps mark the end of the “old normal” for investing.... “The new normal has a new set of rules. Leverage and deregulation are fading from the horizon and their polar opposites are in the ascendant,” Gross added.
  • No wonder New Yorkers are feeling the pinch - Personal incomes fell in the Empire State last year for the first time in 70 years, a new report revealed Wednesday.They tumbled "almost twice" as much in New York as in the rest of country - a 3.1% dent to local wallets totalling a staggering $908 billion in lost income, according to state Controller Thomas DiNapoli.
AS ALWAYS, the headlines can easily sway and/or cloud the minds of even the best investors. We're all human. That said, per our August post, we agree with Mr. James Grant that there isn't a "new normal" -- recall that he says, "there isn't any 'new'! It's always cycle after cycle, you go from extreme to extreme." Further, he sensibly reminds us of advice from Graham and Dodd - "can't know future, therefore seek margin of safety.... in investments in present.... can't know what will happen in 2010 let alone 2017, but can observe two things: opportunities in front of us as now priced; and, how the world is positioning itself for an expected outcome."

BUT, let's consider the rationale for putting money in bonds via an insightful perspective on the economic outlook and the confluence of trends impacting jobs, interest rates, inflation, deficits, gold values, and related subjects.

His key messages:
  • The FED's efforts to re-inflate the economy are merely countering post bubble credit contraction in an economy still filled with excess capacity.
  • As a result, we MIGHT be in for a prolonged period of price stability (potential good news).
  • However, deflationary pressures remain widespread and, thus, focus on bonds (*possibly over-weighting high quality corporate bonds versus alternative bond types).
  • As for maturities: "The higher the quality the longer the duration, the lower the quality, the shorter the duration."
  • While each client may have different needs, he recommends [only] 20% equity exposure into companies with solid balance sheets and products/services that people need to consume (e.g. consumer staples).
  • He recommends gold, silver mining companies.
  • "We're in a secular bear market."
He makes a number of interesting, well-articulated points, particularly around all of the well-known challenges that plague the American psyche and are regularly discussed in mainstream media. In fact, we've also covered popular risk factors in certain prior posts. We don't have answers for all of the problems. Then again, there's always plenty to worry about. If it's not one thing, it's another. The real question with any investment -- bonds or equities -- always comes down to this, courtesy of Bruce Berkowitz (variation on advice from Warren Buffett and Ben Graham): "it's all about what you pay and what you get."

In this respect, we recommend reading an 8/18/10 WSJ opinion by Jeremy Siegel and Jeremy Schwartz:
  • The Great American Bond Bubble - If 10-year interest rates, which are now 2.8%, rise to 4% as they did last spring, bondholders will suffer a capital loss more than three times the current yield.
Before we share a few points directly from the article, please note the background of the authors (cynics/critics might point to a bias conflict): "Mr. Siegel is a professor of finance at the University of Pennsylvania's Wharton School and a senior adviser to WisdomTree Inc. Mr.Schwartz is the director of research at WisdomTree Inc." Mr. Siegel is also author of Stocks for the Long Run and The Future for Investors: Why the Tried and True Triumph Over the Bold and New. We recommend both books.

In our view, the WSJ article makes a number of common sense points, some of which we relay here:
  • Ten years ago we experienced the biggest bubble in U.S. stock market history—the Internet and technology mania that saw high-flying tech stocks selling at an excess of 100 times earnings. The aftermath was predictable: Most of these highfliers declined 80% or more, and the Nasdaq today sells at less than half the peak it reached a decade ago.
  • A similar bubble is expanding today that may have far more serious consequences for investors. It is in bonds, particularly U.S. Treasury bonds. Investors, disenchanted with the stock market, have been pouring money into bond funds, and Treasury bonds have been among their favorites. The Investment Company Institute reports that from January 2008 through June 2010, outflows from equity funds totaled $232 billion while bond funds have seen a massive $559 billion of inflows.
  • We believe what is happening today is the flip side of what happened in 2000. Just as investors were too enthusiastic then about the growth prospects in the economy, many investors today are far too pessimistic.
  • The rush into bonds has been so strong that last week the yield on 10-year Treasury Inflation-Protected Securities (TIPS) fell below 1%, where it remains today. This means that this bond, like its tech counterparts a decade ago, is currently selling at more than 100 times its projected payout. Shorter-term Treasury bonds are yielding even less. The interest rate on standard noninflation-adjusted Treasury bonds due in four years has fallen to 1%, or 100 times its payout. Inflation-adjusted bonds for the next four years have a negative real yield.
  • From our perspective, the safest bet for investors looking for income and inflation protection may not be bonds. Rather, stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade.
  • Today, the 10 largest dividend payers in the U.S. are AT&T, Exxon Mobil, Chevron, Procter & Gamble, Johnson & Johnson, Verizon Communications, Phillip Morris International, Pfizer, General Electric and Merck. They sport an average dividend yield of 4%, approximately three percentage points above the current yield on 10-year TIPS and over one percentage point ahead of the yield on standard 10-year Treasury bonds. Their average price-earnings ratio, based on 2010 estimated earnings, is 11.7, versus 13 for the S&P 500 Index. Furthermore, their earnings this year (a year that hardly could be considered booming economically) are projected to cover their dividend by more than 2 to 1. Due to economic growth the dividends from stocks, in contrast with coupons from bonds, historically have increased more than the rate of inflation. The average dividend income from a portfolio of S&P 500 Index stocks grew at a rate of 5% per year since the index's inception in 1957, fully one percentage point ahead of inflation over the period. That growth rate includes the disastrous dividend reductions that occurred in 2009, the worst year for dividend cuts by far since the Great Depression.
IN OUR VIEW, Messrs. Siegel and Schwartz paint a fairly black and white picture: the ongoing mad rush into bonds is akin to investors blindly buying Internet stocks in the late 1990s at completely egregious valuations that we're bound to disappoint (i.e. lemmings following each other over the cliff). Meanwhile, today's shunned equities -- especially large, stable companies -- offer havens of safety with superior current yields AND a history of growing dividend income streams over time.

To bring home this point, let's look briefly at Johnson & Johnson (JNJ). The company's share price has been largely range bound over the past decade (unless shares were purchased in the mid-$40s in 2000-01 versus today's mid-$60s) -- from Google Finance (GOOG):

HOWEVER, Johnson & Johnson's annual dividend payout has increased dramatically (2010 includes only three quarters to-date):

While the company faces current challenges around product quality (please see this well written Fortune article: Why J&J's headache won't go away), we're fairly confident that J&J's dividend profile will remain strong and, likely, increasing over the coming decade.

We don't have a position in Johnson & Johnson, but do hold smaller companies that are dividend payers such as Compañía Cervecerías Unidas S.A. (CCU), Lance Inc. (LNCE), NTELOS Holdings (NTLS), PriceSmart (PSMT), and Weight Watchers (WTW). For some of these names, recent stock runs leave valuations somewhat less attractive than earlier this year. We also hold a large position in Seaspan (SSW), where we see potential for meaningful dividend increases over time. Likewise, our aircraft leasing company, FLY Leasing (FLY), offers a healthy payout and continues to trade at a discount to net tangible book value.

TO CONCLUDE: we hear Mr. Rosenberg's well-articulated rationale and are aware of the many problems facing our country, thanks primarily to the easy credit years and aging demographics that make earlier pension promises untenable. Nonetheless, we continue to see many values in equities and also note that (we believe) approximately 50% of S&P 500 earnings are now derived abroad, thereby providing an excellent growth engine for American equities. HONESTLY, while acknowledging that everyone faces different circumstances and needs, we're not sure why anyone would NOT have a large allocation to dividend paying stocks.

Why purchase bonds at 100 times projected payouts when high quality stocks can be purchased at low teens multiples with a 3, 4, 5% yield that will probably increase over time?

Happy investing,

Jeffrey Walkenhorst

Disclosure: long CCU, FLY, LNCE, NTLS, PSMT, SSW, WTW.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Tuesday, October 12, 2010

Sonic Foundry (SOFO): Mediasite Awareness Increasing as More Organizations 'Get the Memo'

We are pleased to see that shares of Sonic Foundry (SOFO) continue to move higher on (sometimes) slightly elevated for the micro-cap company. We think awareness of Mediasite continues to increase as the solution is used to capture more and more events around the world.

For example, positive news yesterday:
Also, the other week, BlackBerry maker Research in Motion (RIMM) used Mediasite to capture the keynote speech (and possibly other sessions) at its annual developer conference:
Like Autodesk (ADSK), RIM is another example a major company that 'got the memo,' realizing that most alternative Webcasting solutions (or, perhaps more accurately, offerings) are lackluster relative to Mediasite. We covered this topic in our August post, Webcasting Redux: Did Your Firm Get the Mediasite Memo? An Objective View.

Someone asked us if we think the uptrend in Sonic Foundry's stock will continue. We don't know. The near-term is near impossible to forecast correctly. We thought favorable fundamentals and results over the past year would already have pushed shares meaningfully higher. BUT, what we do know is that private market valuation (supported by recent M&A multiples) and earnings power suggest reasonable (non-egregious) valuations in the $20-30 range. Upside to estimates and additional, large-scale adoption around the globe could bring higher fair values for the company.

Happy investing,

Jeffrey Walkenhorst

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

Thursday, October 7, 2010

Equinix (EQIX): Look Out Beloooow! A Lesson in the Perils of High Multiples and Market Revaluation

Per our Who's Driving the Bus? post, we still plan on sharing a bit more on stocks versus bonds as a follow-up to our earlier discussion on this topic. But, thanks to trading action in Equinix (EQIX) on Wednesday, this post briefly relays the perils of investing in and/or holding high multiple stocks.

Let's give a look at what happened to shares of the company in this one-day chart from Google Finance (GOOG):

Down 33%? Wow - this is quite a decline, particularly when the overall market was flattish and the Nasdaq was only down marginally. What happened to EQIX? Technically speaking: not all that much. More specifically: expectations for upside to top-line forward estimates were squashed -- the wind behind the momentum sails went away, for now.

On Tuesday after market close, Equinix revised forward guidance, lowering its revenue outlook while raising its bottom-line forecast (partially on lower selling expense that would have been higher if revenue were higher). A Reuters article summarized the news, but directly from the Equinix press release:
  • Equinix now expects third quarter revenues to be in the range of $328.0 to $330.0 million, the midpoint of which is 2.2 percent lower than the midpoint of its previous outlook, and total revenues for the full year to be approximately $1,215.0 million, which is 1.2 percent lower than the midpoint of its previous outlook. This updated guidance is due to underestimated churn assumptions in Equinix’s forecast models in North America, greater than expected discounting to secure longer term contract renewals and lower than expected revenues attributable to the Switch and Data business acquired in April 2010.
  • For third quarter 2010, Equinix is increasing its adjusted EBITDA outlook to greater than $140.0 million. For the full year of 2010, the adjusted EBITDA outlook is also being increased to approximately $540.0 million. This increase in expectations is due in part to better than expected gross margins and lower than expected cash selling, general and administrative expenses.
SO, the company went to great pains to convey that its 3Q10 revenue forecast is only a smidgen lower (just 2.2%) than the company's prior outlook while the bottom-line is actually somewhat better. No matter.

Prior to the news, shares -- at $105 -- were trading at a healthy 42 times consensus 2011E earnings. Now, at $70, the forward P/E compressed to 28 times this figure. We acknowledge that many investors likely value the capital-intensive, telco-like Equinix based on multiples of cash flow, yet suffice to say these multiples experienced similar compression. Estimates from Yahoo Finance (YHOO) - likely pre-revisions:

THUS, sudden news of higher-than-expected customer defections and pricing pressure reoriented investors on key risk factors, away from visions of incessant growth buoyed by favorable secular trends - more and more Internet traffic and content/items that require hosting in data centers.

While we believe barriers to entry are reasonable in this business -- location, security, cooling, telco connectivity, etc. -- continual technology improvements bring higher performance per "box" and simultaneously offset at least some incremental demand for hosting space. Further, telecom carriers and other service providers all view this segment as a lucrative line of business and are actively chasing multi-year deals with pricing likely a key variable. Finally, many large companies are constructing their own data centers.

What's the lesson in Equinix? We've previously discussed the perils of high multiple stocks and, conversely, the merits of low multiple stocks:
Of course, the "Market" always places a premium on growth and shares of certain companies such as Amazon (AMZN) may keep charging upward so long as fundamentals move in the right direction with upside to Market expectations. In this case, Amazon's growth and franchise remain dazzling, preserving the company's rich valuation. Likewise for Netflix (NFLX), which we discussed the other day. Shares of numerous other growth companies have delivered amazing performance over the past 1.5 years, including Baidu (BIDU), MercadoLibre (MELI), Salesforce.com (CRM). Moreover, we agree with investor great John Neff that growth tends to keep investors out of trouble.

Nonetheless, by maintaining valuation discipline and, thereby, avoiding complacency (e.g. "the trend is your friend, stick with it"), we strive to avoid dramatic sentiment changes that often come when businesses garner extremely rich multiples of earnings and free cash flow. In other words, negative surprises aren't fun. Fortunately, they can be mitigated.

Here's one approach: play the other way - (1) purchase out-of-favor, low-multiple companies when sentiment is poor, (2) remain patient, and (3) then benefit from the usually inevitable shift back to positive sentiment that brings healthy multiple expansion. At that point, (4) sell into strength and (5) start over again. In all cases, aim for average holding periods in years rather than months or quarters. Aside from the rapid recovery since spring 2009 across virtually all sectors, wealth creation through equities typically takes years.

Happy investing,

Jeffrey Walkenhorst

Disclosure: none.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, October 3, 2010

Netflix (NFLX) is "Giving [Us] Nosebleed" = Time to Maintain Discipline and Reallocate

Patient, long-term shareholders of Netflix (NFLX) have been immensely rewarded this year as the company's share price has truly gone crazy -- here's a 10-year from Google Finance (GOOG), which reveals a mostly flattish trend prior to 2009-10:

In addition to momentum-oriented investment funds, long-time investors who still own the stock are no doubt jumping up and down.

One of our astute friends has been recommending Netflix since 2003 or even 2002, when the stock was between $5 and $10 per share. While his ownership position has shifted around somewhat during the years, he still holds a position in the company and strongly believes in CEO Reed Hastings, the business model, and growth prospects.

We, too, have long been a fan of Netflix's subscription based business model, yet have never owned shares. Here on CS$, we first mentioned the company in our May 2009 post, Some Cash Rich Franchise Businesses Still Growing - Not Kidding. But, it turns out that our stance late last fall was too conservative, stating that shares were arguably fairly valued back in the $50s in an October 2009 post and again at $100 in April of this year.

While earnings results have been better-than-expected and forward earnings estimates subsequently moved higher, a primary driver of the monster stock move is incredible P/E multiple expansion: on a trailing basis, the 2009A P/E moved from maybe 25 times to a whopping 78 times. We're not sure where 2011E earnings were last fall (e.g. how much lower than today's estimate), with the stock at $50, but using the current Wall Street consensus estimate of $3.72 from Yahoo Finance (YHOO), the out-year P/E multiple increased from a-now-clearly-attractive 13 times to a current 42 times. Key NFLX "valuation measures" from Yahoo Finance:

Our friend is understandably ebullient about the recent run, but also realistic that valuation is now getting crazy. We emailed him on Sunday 9/26 with congratulations and included the following comment:
  • "Amazing run. Solid fundamentals and business model, combined with Blockbuster's possible bankruptcy* and short squeeze are working magic. While the valuation is now on the high side, a manic market may keep pushing higher.... that said, it may be prudent to maintain discipline and trim at current levels...." *we weren't aware that this became a reality on 9/23/10.
His response:
  • "Yeah, NFLX is giving me nosebleeds."
We like how he put it and can't help but draw a parallel between Netflix's recent run and that of another small float, heavily shorted, episodic market darling, Blue Nile (NILE). We wrote about the latter last October in our post, Things That Don't Make Sense: NILE's Valuation. At least some gravity has returned to shares of Blue Nile, although shares continue to trade at 42 times the 2011 consensus earnings estimate - chart from Yahoo:

Alas, Netflix's share price turned south late last week -- please revisit the chart at the top of this post to see Friday's 5% decline. Silicon Alley Insider aptly chimed in with this: CHART OF THE DAY: Is The Netflix Stock Bubble Finally Bursting?

While there's a natural, human tendency to think things will continue in the same direction (in this case, up - ignoring the down move on Thursday/Friday), we would be sellers into recent strength (and would have been reducing exposure on the elevator ride up). Now, we would take these winnings and actively reallocate capital into out-of-favor, low multiple merchandise such as:
  • Seaspan (SSW) and Sonic Foundry (SOFO) - fair value potentially 2 to 3 times current levels.
  • Yahoo (YHOO) - fair value potentially 1.5 to 2.0 times current levels.
  • Weight Watchers (WTW) - fair value potentially 1.5 times (or better) current levels.
(click company name above for our prior post)

Admittedly, the trend can be your friend. Yet, in the case of extremely favorable nosebleed, history tells us it's always best to take the money and run... seeking out and investing in companies that offer tangible margins of safety.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW, SOFO, YHOO, WTW.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer