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Capital Observer

A diary of the thought process behind my investment decisions

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Looking Through The Boardwalk Recontracting

Thu, 22 Feb 2018 15:41:00 +0000

Looking Through The Boardwalk RecontractingBoardwalk Pipeline Partners (BWP) trades at a rock bottom valuation due to uncertainties surrounding contracts that are set to expire in the coming years (ie. recontracting). The goal of this write up is to put forth a conservative estimate of where EBITDA will be following the recontracting and establish a value for the shares. Boardwalk operates natural gas pipelines and storage facilities. The vast majority of Boardwalk’s revenue is from long term contracts and as a result there is typically high visibility on revenue and EBITDA. When a pipeline is built customers typically sign 10 to 20 year contracts guaranteeing revenue for the pipeline regardless of usage.History Of The RecontractingWell over a decade ago Boardwalk started planning a pipeline system that would flow gas from the shale fields in the middle and southern part of the country to Southern Texas and Louisiana. After the pipeline system was built more economic shale gas was discovered in other parts of the country, primarily the Utica and Marcellus Shale. This led to less drilling in the areas which Boardwalk’s pipeline system served. Despite the decreased drilling, Boardwalk’s customers were locked in for 10 years and had to continue paying. These contracts will all be up for renewal over the next 3 years and revenue will decline.In 2014 Boardwalk management recognized the fact that this recontracting was looming. To plan for the recontracting they slashed the dividend and used the vast majority of the cash flow for growth projects to offset the looming revenue losses. Boardwalk has been successful in increasing EBITDA over that period. The table below from Boardwalk’s latest investor presentation shows the growth in EBITDA that resulted from the growth projectsBoardwalk is fortunate that its pipeline system feeds into Southern Texas and Louisiana, the area of the country that is seeing the largest demand growth for natural gas. A large number of LNG export facilities are being built in this area and exports to Mexico leave from this area. In addition, a large number of electrical and petrochemical facilities are being built in this part of the country.Boardwalk’s largest pipeline system coming up for recontracting is Gulf Crossing. Currently, 70% of the capacity is being utilized even as the vast majority of the pipeline’s capacity is under contract. Cheniere is building a large amount of LNG export capacity and needs natural gas to flow its facilities. In order to facilitate this they are planning a pipeline called Midship that will go from the SCOOP and STACK to Bennington. At Bennington, Midship can connect into Boardwalk’s Gulf Crossing and a competing pipeline. As a result it is likely that Gulf Crossing will be able to recontract close to 100% of its capacity, albeit at a lower price. Putting A Number On The Recontracting LossMost analysts estimate that Boardwalk will lose around $200 million from recontracting from 2017 to 2021. For the purpose of getting a very conservative estimate of the earnings power of Boardwalk I am going to assume they lose $250 million in EBITDA to recontracting between 2017 and 2021. It assumes a poor outcome for all regions coming up for recontracting but also assumes Midship gets built (which seems very likely). My estimate of recontracting losses is far in excess of any analyst I have seen, including Goldman Sachs which has a sell rating on the stock. Growth ProjectsBoardwalk currently has $1.3 billion of growth projects in the pipeline. This should lead to roughly $160 million in EBITDA based on industry returns and past Boardwalk growth projects. Boardwalk has already paid for the majority of this through free cash flow and should earn enough free cash flow over the next year to pay for the rest. These projects will be put into service by 2020 with the majority of the revenue starting during 2019.ValuationIn 2017 Boardwalk earned $845.5 million in EBITDA adding back a recontracting loss of $7 million. Over the coming years I estimate they will gain $160 millio[...]

Yahoo For Sale

Sun, 20 Dec 2015 12:37:00 +0000

Company For Sale"THE BOARD HAS A FIDUCIARY OBLIGATION TO ENGAGE WITH ANY LEGITIMATE PERSON THAT COMES FORWARD WITH A GOOD OFFER. THE BOARD WILL ALWAYS DO ITS FIDUCIARY OBLIGATIONS WHEN SOMETHING LIKE THAT OCCURS" - Yahoo Chairman Maynard Webb on CNBC, December 9, 2015The Fiasco At YahooTo say that the Yahoo's core business is being mismanaged is an understatement. To say Yahoo has been taking piles of cash and lighting in on fire would be a better description. Here are some examples of how Yahoo has incinerated shareholder money:Yahoo paid $20 million for rights to stream an NFL game. In addition, there were production and streaming costs. The result was $3 million of ad revenueYahoo pays Katie Couric over $10 million a year for a streaming show with low viewershipYahoo also created two original series that resulted in low viewershipYahoo has spent hundreds of millions of dollars buying zombie companies in order to hire programmersYahoo top management pays itself handsomely for the amazing feat of lighting cash on fireYahoo Core Value In A SaleI could make a page long list of how Yahoo wastes money but I believe I have made my point. Any half competent, non arsonist should be able to at least double Yahoo's EBITDA and cash flow. I am assuming that in a sale Yahoo would be able to fetch at least 8 times its very depressed EBITDA, which would be $6.4 billion or $6.81 per share. Some large Yahoo shareholders believe that Yahoo can fetch a price 50% higher but I want to be conservative in my assumptions. Despite complete mismanagement Yahoo is still one of the top visited sites on the internet with nearly $5 billion in revenue expected for 2016. Yahoo owns real estate that Starboard had appraised for a value of $1.5 billion (the crown jewel is a nearly 1 million square foot campus in Silicon Valley). Yahoo also owns $700 million worth of intellectual property and patents. I assigned no value to either the real estate or the IP in my estimate of the value of Yahoo. It is very possible that my assessment of Yahoo core's value is too low.Cash, Yahoo Japan and Alibaba Holdings Value (all values as of the close of December 16, 2015)The value of the remainder of Yahoo's assets are as follows: Yahoo has $5.8 billion in cash or $6.16 a share in cash. Yahoo owns $32.5 billion worth of Alibaba shares at yesterday's closing price of $84.63. I am assuming that once the core business is sold and the company is simplified into essentially a holding company that the discount on Alibaba shares will narrow to 20%, which I believe is conservative. At a 20% discount Alibaba is worth $27.66 per share. Yahoo's stake in yahoo Japan is worth $8.4 billion. I am assuming that Yahoo Japan will trade at a 40% discount as it currently is not clear to me how Yahoo will dispose of Yahoo Japan without paying taxes. If they find a way to do this than there is additional upside in the shares. At a 40% discount Yahoo's stake in Yahoo Japan is worth $5.35 per share.Yahoo Total Value (all values as of the close of December 16, 2015)Yahoo core                $6.81 per share (at 8 X depressed EBITDA)Cash                          $6.16 per shareAlibaba Holdings     $27.66 per share (at 20% discount)Yahoo Japan             $5.35 per share (at 40% discount)______________________________________Total value                $45.98 per shareRecent Price             $33.78Total upside              36.1%Yahoo Current ValuationI believe the market is currently pricing in a worst case scenario for the value of Yahoo (assuming that one hedges the value of Alibaba and Yahoo Japan). At the current valuation both Yahoo Japan and Alibaba Holdings are being valued [...]

Qualcomm's CEO Sad Admission

Tue, 07 Jul 2015 07:32:00 +0000

"I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will." -Warren BuffettIn evaluating Qualcomm I came to the conclusion that expenses were out of control. Despite knowing this I was shocked by the admission of the CEO of how little thought has gone into Qualcomm's spending. The following is a quote from Qualcomm's CEO, Steve Mollenkopf, at the Merrill Lynch Global Technology Conference a few weeks ago:"But now we are in a position where you know looking at things like how much we are spending in R&D, are we getting the right return for R&D, are people in the right place, are we getting leverage in our supply chain" -transcript from Seeking AlphaSteve Mollenkopf and his management team are one of the highest paid in the world and they were not looking at how much they were spending? They were not analyzing their return on R&D spending? They were not maximizing their supply chain? They don't even know if people are in the right place (whatever that means)?. What were they doing? This same management team wants to do acquisitions before they get their house in order?Luckily, Qualcomm's business is so "wonderful" that even with a free spending management team that pays itself very handsomely the business generates loads of cash. Qualcomm's licensing business alone is expected to generate about $7 billion in EBIT next year. Qualcomm's entire enterprise value is roughly $70 billion. Qualcomm owns many of the patents related to 3G, 4G & 4G LTE technology among others. Money manager Andy Macken of Montgomery Funds makes the following analogy to Qualcomm's licensing business  "It's a bit like owning the English language and then charging anyone that learns to speak English."  To which I would add, I believe more people use 3G or 4G technology than speak English.The Qualcomm licensing business is a business that an idiot can run, to paraphrase Warren Buffett. This business is expected to generate the vast majority of profits at Qualcomm. The semiconductor business, which requires some management skill, has performed miserably. Even though Qualcomm is the market leader in its space with limited competition, Qualcomm has one of the worst profit margins in its industry. Qualcomm's profit margins are less than half of what they should be. With Qualcomm's scale there is simply no excuse for this.Despite mismanagement Qualcomm is one the cheapest large cap tech stocks with an expected free cash flow yield of greater than 11% (to enterprise value). With the admission of the CEO that they weren't really paying attention to their spending it likely means that there are easy changes that could further boost profits. If they can get their margins to the industry norm for a market leader the boost would be tremendous.Activist, Jana Partners, has taken note of Qualcomm's missteps and has been trying to prod management in the right direction. Some positive steps are being taken including returning over 20% of the market cap to shareholders over 2 years and a cost review by outside consultants. Qualcomm management is going along with these suggestions but it seems to be doing so in a  half hearted manner. Qualcomm waited months before beginning its accelerated repurchase program and then only announced a $5 billion program. Expense reductions have not yet begun in earnest even though management admits they are necessary. Further activist pressure on management will likely be necessary.Even in its current state Qualcomm is undervalued. With a management team that finds religion (or is forcefully converted) the return potential is tremendous.  [...]

Qualcomm : The Biggest Bargain In Large Cap Tech

Tue, 26 May 2015 12:32:00 +0000

Qualcomm BusinessQualcomm (QCOM) owns patents related to 3G, 4G & 4G LTE technologies (among others) that power smartphones. As a result Qualcomm receives a roughly 3% royalty on most smartphones sold in the world. Getting 3% of every smartphone sold seems like a pretty good business to be in but the market does not value Qualcomm that way.ValuationQualcomm trades at a roughly 10% free cash flow yield or 10 times earnings once one adjusts for the roughly $30 billion in cash they are hoarding. The reason for this valuation is that Qualcomm owns a second, less attractive business. Qualcomm makes chips for smartphones and this business has recently encountered more difficult competition. While semiconductors account for a smaller part of Qualcomm's profits they attract almost all the attention of analysts and investors.If one were to put a market multiple on Qualcomm's attractive, licensing business and add back cash Qualcomm would trade at $85 versus the roughly $69 Qualcomm trades at today. However, this valuation assigns no value to Qualcomm's "terrible" semiconductor business that produces roughly $2 billion a year in profit. Even putting a ten multiple on that business would raise Qualcomm's valuation to $95.Reasons For UndervaluationI believe there are a number of reasons for Qualcomm's undervaluation. Qualcomm's licensing business is simple and predictable. As a result this business generates few headlines, little news and as a result receives little attention. The semiconductor business generates constant news of design wins & losses, more recently losses. As a result it seems Qualcomm's business is constantly under siege, even though its main profit engine has been chugging along. Additionally, Qualcomm is mainly followed by semiconductor analysts and investors who tend to focus solely on design wins & losses instead of keeping their eye on the main profit engine.Qualcomm has grown its revenue nearly nine fold since 2002, attracting a number of growth investors. More recently growth has slowed due to the slowdown in the semiconductor business (even as earnings for the licensing business are growing at a double digit pace). As a result Qualcomm's investor base is transitioning from growth investors to value investors.Catalyst For ChangeAn activist has recently accumulated shares of Qualcomm and nudged management to make positive changes. Instead of hoarding cash management will repurchase over 10% of the outstanding shares of Qualcomm this year in addition to paying a nearly 3% dividend. Moreover, Qualcomm has hired outside consultants to review their cost structure.Almost every large cap technology company has had a period of transition after their explosive growth phase passed. Microsoft, Intel, Cisco, Oracle and even Apple's stock sputtered when growth slowed. In all these cases it was not until the stock became cheap and management began to return cash to shareholders in earnest that the stocks rebounded nicely. Qualcomm's stock has spent the past three years going nowhere while the market has exploded to the upside. As a result Qualcomm is now the cheapest large cap tech stock. Additionally, Qualcomm will likely return over $25 billion to investors over the next two years or greater than 22% of its market cap. If Qualcomm follows the script of any of these large cap tech stocks the stock price should rise by over 50%.Qualcomm has always been a fast growing business that did not focus on expenses in the same manner that a mature company would. As a result there is a good chance that there are significant savings to be had by cutting expenses, resulting in improved margins. Qualcomm's margins are well below their peers even though Qualcomm has the scale necessary to have industry leading margins. Qualcomm has never undergone a major restructuring and has now hired outside advisors to review their cost structure. If Qualcomm can improve margins they can greatly improve the profitability of their semiconductor unit ev[...]

Amdocs: A Cash Machine On Sale

Sun, 16 Nov 2014 11:44:00 +0000

Amdocs (NASDAQ:DOX) has the type of strong, recurring cash flow stream that is normally highly valued by Wall Street. However, by looking at the valuation of Amdocs one would never know this. Excluding net cash (Amdocs has over $9 a share in cash), Amdocs trades at a roughly 10% trailing free cash flow yield and a little over 10 times forward earnings estimates.

Read the rest on Seeking Alpha(image)

Higher One's High Potential Reward

Fri, 14 Nov 2014 12:45:00 +0000

*this was originally published on September 29 on SeekingAlpha and share price was ~$2.50. All figures are based on a ~$2.50 share priceSummaryHigher One generates roughly $40 million a year in free cash flow & trades at 3 times FCF.Higher One has issues than can be worked through.If Higher One can work through these issues it could be a $10 stock again.Higher One's BusinessHigher One (NYSE:ONE) operates in two related lines of business. Higher One's first line of business is providing software to universities. One of their software tools facilitates the transmission of financial aid to students. Financial aid is paid directly to the university from the government & private lenders. The universities take out tuition, room & board and then give the remaining amount to the student. Higher One's software facilitates these transfers and the processes associated with them. Roughly 35% of revenue comes from their software.Higher One's second line of business is related to the software they provide for the transmission of financial aid. A student can choose to get their financial aid money in an ACH transfer to their bank account or receive a check. A third option is to open a Higher One account, mainly for students that do not have bank accounts. Higher One partners with banks to provide students with a debit/ATM card so that they could access their financial aid money. Roughly 65% of revenue comes from the Higher One account.There are numerous ways Higher One earns money through their Higher One account. 45% of Higher One account revenue comes from interchange fees, which is the money merchants are charged when somebody uses their Higher One card to buy something. The other 55% of revenue is earned on fees charged to the student. These are typical fees banks charge such as a $2.50 fee for using the ATM of other banks rather than the ATMs provided by Higher One.Higher One's ProfitabilityHigher One has an extremely profitable business. Over the past few years Higher One has generated roughly $40 million a year in free cash flow excluding the construction costs of their headquarters, which is completed, and similar onetime costs. Higher One is on track to produce a similar amount of cash this year excluding a onetime $15 million payment to settle a lawsuit.So why does a company generating $40 million a year in cash trade at a market cap of less than $120 million. Higher One has two major overhangs:The Federal ReserveThe Federal Reserve has told Higher One that they will seek up to $35 million from Higher One for misstatements & omissions related to the marketing of the Higher One account. Higher One believes they will be responsible to pay the FDIC an equal amount so the potential liability is $70 million. Currently the two parties are in negotiations. Higher One has taken a charge of $8.75 million relating to this matter but it will likely cost them more.Higher One has ample free cash flow to cover a $70 million fine over time, even though the ultimate fine is unlikely to be that high. The issue is that Higher One has $16 million in cash and owes $94 million on their credit line. Paying a large fine would put Higher One in breach of one of their debt covenants. Additionally, they may need to borrow more money to cover the fine. Higher One's management says that their lenders want to work with them but want to know the amount of the fine first.I believe the fine by the Federal Reserve is the biggest risk to Higher One as their destiny is not in their own hands. With that said, the most likely outcome is that Higher One's lenders work with them. It does not make any sense for Higher One's lenders to force a default. Higher One is not highly levered and is producing a lot of cash. I believe Higher One will have close to $40 million in cash by year end.The Department of EducationThe Department of Education (DOE) is attempting to make new rules concerning student bank accounts. The [...]

Updated Market Thoughts

Mon, 13 Oct 2014 12:10:00 +0000

I have not written a post in over a year about the overall market. For nearly two years the market climbed higher despite extreme sentiment readings, with only minor blips along the way. Historically, Investors Intelligence bears readings below 20% were a warning sign.  Yet for the better part of two years Investors Intelligence bears were under 20% with no repercussions. There are numerous such examples. After a while I decided to stop pissing in the wind and stopped writing posts about the extremes in sentiment. With all the nervousness out there (myself included) I thought this would be a good time to update my market thoughts.

I believe the reason sentiment stopped working was that corporations have been providing a steady bid in the market through share repurchases and cash M&A. In the past couple of years corporations finally started to use the nearly free money in the bond market to lever up in earnest. I believe this steady bid from corporations combined with a positive feedback loop from investors has led to this steady grind higher. I would note that the S&P 500 has outperformed both small caps and international equities, as the bulk of share repurchase and cash M&A occurred in larger cap US stocks.

The good news is that the backdrop of corporations using cheap money to purchase stock is still in full force. Corporations are still able to borrow cheaply and are doing so.  In a recent three week period about $60 billion of cash M&A was announced, while the steady repurchases largely continue. The economic backdrop of steady yet uninspiring growth continues as well.

The bad news is that investors have grown complacent after two years of relatively little pain. Individual investors have historically high allocations to stocks, margin debt is at a record and I have heard endless stories of institutional allocators in search of more beta.  It appears that this positive sentiment is being unwound and given the aggressive positioning of the investment community there could be more to come.

If the unwind of excessive sentiment continues it is likely to trump corporate buying in the near term and the sharp, painful correction is likely to continue. However, over the medium term the steady bid from corporations is likely to assert itself again. Corporate buying combined with positive seasonality starting in November, make it likely that near term losses would be recuperated over the next few months. But in the interim it could get ugly and a few more sleepless nights may be ahead for investors. 

My Trip To the Crimson Wine Group Annual Meeting

Tue, 05 Aug 2014 17:23:00 +0000

I recently attended the annual meeting of Crimson Wine Group, the owner of 5 wine estates that was spun off from Leucadia in 2013. In the tradition of Leucadia, Crimson does not communicate with Wall Street. There are no earnings press releases, conference calls or presentations and management does not take phone calls. The only way to get information from Crimson is through their SEC filings. When I heard that Crimson would have a Q&A at their Annual Shareholders Meeting I decided to make the trip to Napa as I had a number of questions for management.

The annual meeting took place in a wine cave at the Pine Ridge estate. Ian Cummings (Leucadia co-founder) was supposed to host the event but due to a surgery Joseph Steinberg (Leucadia co-founder) did so in his place. Joseph Steinberg has a reputation for being the bad cop to Ian Cummings good cop and he lived up to his reputation. When asked why Crimson was spun off he answered, “because we wanted to”. Management declined to answer many of the questions but I learned a good deal about the company none the less.

The first question I asked the CEO was about a newspaper article that quoted him as saying that he wanted to reach $100 million in revenue by 2016. He seemed to back off that statement and said that he wished he did not say it. In addition, Joseph Steinberg emphasized numerous times not to have too high expectations for the short term as progress in the wine business takes time.

The most important piece of information I came away with from the meeting was finding out why Joseph Steinberg believes Crimson is a good investment. Joseph Steinberg alluded to the private market value of the wine estates being well above the GAAP book value. He called Napa the Hamptons of the Bay Area and noted how much prices have gone up since they purchased the estates. He also noted that as the Hamptons of the Bay Area, Napa/Sonoma real estate prices are likely to continue to rise over time. Steinberg views the rise in the estate values as part of his profits in addition to the profit of the actual wine business.

When an attendee asked Joseph Steinberg to value the five wine estates he replied “I’m not going to give you the NAV. You’re an analyst. I’m sure you can figure it out for yourself”. As an analyst I have taken many stabs at trying to figure the value of Crimson’s five estates and I believe that they are conservatively worth $15.50 a share (likely more). Assuming 3% a year asset appreciation on $15.50 of assets yields an additional 5% a year of return in asset appreciation on top of any earnings (at the current stock price). 

Joseph Steinberg spent most of the meeting playing down expectations and noting that progress takes time and patience in the wine business. However, he ended the meeting with a vote of confidence for the stock telling shareholders “we will get rich together slowly”.

Crimson Wine Group Asset Value

Tue, 05 Aug 2014 17:13:00 +0000

Valuing Crimson Based On AssetsCrimson has a stated book value of $8.12. However, this does not take into account the value of two of Crimson's most valuable estates. Crimson acquired Pine Ridge in 1991 and Archery Summit was started in 1993. These two estates are carried for next to nothing on Crimson's book due to GAAP accounting. In 2001 these two estates were put on the market for $150 million as seen in this Wine Spectator article. It makes little sense that they are assigned almost no value.Napa Valley estates trade at record prices and at significantly higher prices today than they did in 2001. It is estimated that the Araujo Estate in Napa recently sold for over $100 million (or $2,630,000 per acre) . Araujo, has 38 acres and produces approximately 6,000 cases a year. Inglewood Estate, recently sold for an estimated $20 million (0r $666,000 per acre). Inglewood has 30 acres and produces 5,500 cases. The new owners are rebranding the estate suggesting weakness of the Inglewood brand.Pine Ridge, which is located in Napa, currently produces 80,000 cases a year and has 168 acres. Pine Ridge has an additional 46,000 cases of capacity. Inglewood'd brand is clearly is clearly inferior to that of Pine Ridge. At Inglewood's valuation ($666.6 k per acre) Pine Ridge would be valued at $112 million. At Araujo's valuation ($2.63 million per acre)Pine Ridge would be worth $442 million. The answer to Pine Ridge's valuation likely lies somewhere in between. I believe that Pine Ridge alone could be sold for at least $200 million.Archery Summit is the premiere estate in Willamette, Oregon. Archery Summit has 100 acres and produces 15,000 cases a year. Archery Summit is able to charge $150 for its Pinot Noir, far more than any other winemaker in the region. I estimate the value of Archery Summit to be $20 million.Crimson's purchased its three other estates in recent years. Seghesio was bought for $86,000,000 in May 2011 and is located in Sonoma. Since then the value of Sonoma estates have risen significantly. Additionally, Crimson expanded capacity and has grown sales at Seghesio. Seghesio would likely sell today for over $100 million. Chamisal was bought for $19,200,000 in August of 2008. The purchase price of Double Canyon in 2005 and 2006 was undisclosed but I estimate it to be worth at least $10,000,000. Crimson recently sold land that it was not using at Double Canyon for 70% above book value. It is possible that even the land that Crimson bought in recent years is being carried drastically below market value.The table below summarizes my estimate of the value of Crimson's wineries:WineryValuePine Ridge / Archery Summit$ 220,000,000Seghesio Family Vineyards$ 100,000,000Chamisal Vineyards$ 19,200,000Double Canyon$ 10,000,000Total$ 349,200,000Adding my estimated land value to the $30 million in cash & investments Crimson will likely have at the end of this quarter yields a tangible book value of roughly $15.50, or a price 75% higher than the current quote.[...]

Dow Chemical's Risky Gambit

Mon, 03 Feb 2014 17:54:00 +0000

THE REPURCHASEDow Chemical announced that they will repurchase $4.5 billion worth of stock over the course of 2014 amounting to roughly 8% of the float of the stock at the current price. The vast majority of this repurchase will be done with borrowings as there will likely be very little cash left over after capital expenditures and dividends. Share repurchases of this size are generally very bullish for the near term performance of a stock but there is more than meets the eye to this repurchase.THE CONVERTIBLE PREFERRED SHARESIn 2009 Dow issued a total of $4 billion in convertible preferred shares to Berkshire Hathaway and Saudi Aramco (SA) in order to complete their acquisition of Rohm & Haas. These shares pay a preferred dividend of 8.5% and have a strike price of $41.32. It is unlikely that Berkshire or SA will opt to convert these shares because of the hefty dividend and the value of the call options. However, this large dividend is burdensome to Dow and Dow can force conversion if the common stock price exceeds $53.72 per share for any 20 trading days in a consecutive 30-day window. I believe this share repurchase is essentially a risky gambit to force conversion of these preferred shares. If this plan is successful then there will actually be more shares outstanding following the plan than before the repurchase.THE RISKSOn the surface this plan appears to be sound as it removes burdensome preferred shares paying an 8.5% dividend and replaces it with cheaper debt. The risk is that the plan fails (ie. Dow can’t force conversion) and that Dow enters the next down cycle with an additional $4.5 billion in debt, the burdensome 8.5% preferred and an enormous pension gap that would likely balloon further. It seems that Dow has the debt coverage ratio to take on the additional debt but that ignores the gaping pension hole and the likelihood that EBITDA would contract dramatically in a cyclical downturn. I am not predicting a cyclical downturn but noting the risks if it does occur. THE OUTLOOKMy experience with share repurchase of this size is that they are positive for near term performance even if they are not in the best long term interest of the company. However, once the stock price approaches $53.72 Dow becomes a compelling short. In addition to the very rich valuation there would likely be enormous selling pressure at that price. At that price Berkshire and SA would need to start selling down shares unless they want to be owners of Dow Chemical stock. If Berkshire & SA sold down their stake it would amount to over $5 billion, greater than the amount of the Dow repurchase. It is also possible that funds aware of this situation would sell ahead of that price.MY PLANDow Chemical is one of five chemical stocks I am short against Eastman Chemical, a stock I believe is far more attractive. As a result of the share repurchase announcement I covered a portion of my Dow short despite the fact that I believe shares are overvalued. I don’t want to stand in front of an 8% repurchase as there is no money in being a martyr and I want to be in a position to short with reckless abandon if the shares approach $53.72.[...]

Dow Chemical Is No Bargain

Mon, 27 Jan 2014 12:36:00 +0000

Dow Chemical is one of five chemical stocks that I am short against a long position in Eastman Chemical, a security that I believe is far more attractive (I explain my long case for Eastman in this article). In light of the Third Point letter on Dow Chemical I want to explain why I view shares of Dow as relatively unattractive. ValuationDow Chemical trades at an expensive valuation compared to its chemical sector peers. As seen in the charts below, Dow has one of the lowest EBITDA margins in the chemical sector yet trades in the middle of the group in terms of valuation. This comparison is generous to Dow as it ignores Dow’s $9 billion unfunded pension liability. If one includes the pension deficit in Dow’s enterprise value than EV/EBITDA is roughly 10 times. This adjustment puts Dow squarely in the high end of valuation versus its chemical peers despite a low quality mix of businesses.  An analysis based on P/E ratios would make Dow look even more expensive.TurnaroundThe Third Point letter points to “cost cutting and operating optimizations that could amount to several billion dollars a year in annual EBITDA”. Dow Chemical has announced multiple restructurings & layoffs over the years leading to the lowest SG&A/sales ratio in the chemical sector. Dow’s SG&A is only 5% of sales. This suggests limited room for margin improvement through cost cutting. Where else will the cost cutting come from if not from SG&A? Are they running their crackers inefficiently? Are they selling commodities at below market prices?The Third Point letter gives no details of what operating optimizations could save billions so it is difficult for me to refute that point. However, later in the letter Third Point complains about “poor segment disclosure combined with Dow’s opaque and inconsistent transfer pricing”. This is seemingly contradictory. If Dow’s disclosures are poor, than how can Third Point be certain these optimizations are possible?Spinoffs & Asset SalesJustifying a high price target for Dow Chemical involves placing a premium multiple on every business line (while ignoring the pension deficit). If one takes any diversified chemical company and puts rich multiples on every segment than all of them will look cheap, with tremendous upside. There is no reason to believe that Dow will achieve these rich multiples. Proponents of Dow point to spin offs and asset sales. It is unclear to me why spin offs will help Dow as their blended businesses already trade at relatively high multiples. Axiall, which is the comp for the business Dow is planning to spin off, trades at only six times EBITDA. Dow owns numerous low margin, commodity businesses that deserve to trade at low multiples. With Dow trading at roughly 10 times EBITDA (including pension) that means that the rest of Dow trades at well over 10 times EBITDA. Secondly, why would these spin-offs trade for best of breed multiples if they don’t perform like best of breed businesses?Significant asset sales seem like a pipe dream as well. Dow and Dupont are the two largest US chemical companies. Both have activists and both are looking to sell assets. If the two largest companies are sellers, who will the buyers be? It is possible that Dow and Dupont will find buyers for some businesses but any sales are unlikely to be significant to either company. SummaryDow Chemical appears to be among the most overvalued chemical companies relative to its peers. Spinning off a business is not a magic elixir that turns around a business. There are higher quality companies with great managements available at cheaper multiples (see Eastman Chemical). A fixer upper is not always a great deal and can often be a money pit.[...]

Four Investment Ideas With Upcoming Catalysts : Part 2

Fri, 27 Dec 2013 11:22:00 +0000

In this two part post I outline four value investments that I own with catalysts in the first quarter of 2014.  In part 1 of this post I reviewed Air Products and Chemicals (APD) and Annaly Capital Management (NLY). Here are my final two picks:

Eastman Chemical (EMN)
Catalyst: Aggressive share repurchase plan starting in Q1 2014

I laid out a detailed case for owning Eastman Chemical in late October. In summary, over the past decade Eastman has transformed itself from a maker of commodity chemicals into a specialty chemical maker with among the highest margins in the group. Specialty chemical makers tend to trade for a large premium to their commodity peers yet Eastman is among the cheapest stocks in its sector. Eastman has one of the highest free cash flow yields, lowest P/Es and lowest EV/EBITDA ratios in the chemical sector.

Eastman has spent the past few quarters paying down debt that resulted from an acquisition and will be done paying it down by the end of 2013. I believe that starting in the first quarter of 2014 Eastman will direct free cash flow towards shareholders in the form of an aggressive share repurchase.

Eastman management has stated numerous times that they will use their balance sheet and ample free cash flow to reach their earnings goal of $7 in 2014 and $8 in 2015. They have also said that acquisition targets are too expensive now, which points towards share repurchases to increase earnings. Management also mentioned in passing on a recent webcast that share repurchases have a larger effect on EPS when done earlier in the year. This leads me to believe that Eastman will start repurchasing shares aggressively in the first quarter of 2014, getting the ball rolling on a re-rating of the stock. I am long EMN short ALB CE DD DOW FMC

Muni Bond Closed End Funds
Catalyst: End of tax loss selling

Municipal bond closed end funds (muni CEFs) are down as much as 30% from their highs in some cases. Fed tapering and headlines from Puerto Rico and Detroit have brutalized the municipal bond market and muni CEFs even more so. This leaves many muni CEFs trading at high single digit discounts to NAV and yielding nearly 7%, which is the taxable equivalent of over 10%.

I believe that scary headlines like those in Puerto Rico and Detroit are outliers. For the most part municipal finances have improved over the past year as tax receipts have grown along with the economy. One could even argue that municipal bonds value versus treasuries should be higher than ever as tax rates are higher so the tax advantage has grown. Municipal bonds offer the best after tax, risk adjusted return of any asset class. Once tax loss selling ends the market should begin to recognize this. I am long NRK VMO VKQ PMO NAN(image)

Four Investment Ideas With Upcoming Catalysts : Part 1

Thu, 26 Dec 2013 12:28:00 +0000

Earlier in the week I outlined the difficult environment facing value investors. Finding new investments meeting a value criteria has not been easy after a nearly tripling of markets in less than five years. A couple of months ago my cash pile was growing as many of my investments reached their target and I could not find new investments to replace them. Much to my own surprise I have recently been able to put money to work and am excited about my portfolio. Four of my investments, which I will outline, have catalysts coming up in the first quarter of 2014.Two of the investment ideas came along as a result of tax loss selling. Tax rates have gone up this year and many market participants have large gains. Those looking to offset gains with losses have very few choices this year, so a small group of losing stocks have bore the brunt of this selling. Tax loss selling is similar to forced selling in that sellers are not basing their sell decision on the merits of the stock. The good news is that there are less than four trading days left in the year and tax loss selling will soon be over. The other two ideas are are long/short ideas with company specific catalysts. Without further ado here are my four investment ideas:Air Products and Chemicals (APD)Catalyst: Announcement of new CEOBill Ackman took an activist position in Air Products and Chemicals earlier this summer. He was quickly able to gain board seats and remove the CEO. Normally, this would cause the stock to fly but due to the adverse publicity Bill Ackman has received from Herbalife and J.C. Penney the stock has barely outperformed its peers. Bill Ackman has had many successful activist campaigns and a small handful of failures. Air Products and Chemicals has a lot more in common with his successful campaigns.Air Products has strong, recurring free cash flow that is being masked by a capex binge. Only $300-$350 million of Air Product's $1.52 billion a year in capex is maintenance capex, while the rest is expansion. New plants take three years before they are built and operating at the capacity needed to create strong cash flow. The benefits of the capex binge of the past few years has not been realized but will be realized over the next few years, resulting in higher cash flow. The new CEO is likely to reduce capex spending on new projects and direct more of free cash flow to investors.Air Products has the lowest margins in its industry. It largest competitor, Praxair, has margins nearly 50% higher. There is a lot of room for cost cutting and increased sales productivity to improve margins. With modest margin improvement and the realization of the benefits of their capex binge, Air Products could see over $14 in free cash flow per share annually some time in the next few years.Many people I have discussed Air Products with have been scratching their heads as to why Bill Ackman has chosen the company. Bill Ackman has still not laid out a detailed case for this purchase,as he is likely waiting for the new CEO to be announced. A new CEO has not been chosen yet but is likely to be chosen in the first quarter of 2014. The appointment of the new CEO is likely to act as a catalyst for the stock as the new CEO lays out his strategy and Bill Ackman lays out his investing case. I am long APD / short PX ARGAnnaly Capital Management (NLY)Catalyst: End of tax loss sellingI recently laid out a detailed case for owning Annaly Capital Management. In summary, Annaly trades for an unwarranted 20% discount to book value. Annaly has lowered leverage, hedged and diversified into commercial mortgage backed securities. Annaly is positioned well to withstand  future interest rate increases with minimal damage to book value. I believe the reason for this deep di[...]

The Current Value Investing Environment

Tue, 24 Dec 2013 14:50:00 +0000

I don't believe I am making a bold statement when I say that the US stock market is not cheap. Even if one takes earnings at face value and uses the bulls optimistic estimates for 2014, multiples are 10%-20% higher than average. If it turns out that artificially low rates have been boosting earnings and that five years into an expansion we may be close to peak earnings than the stock market is expensive.

For value investors whose primary goal is avoiding the loss of capital, the current market environment hardly provides a margin of safety. Of course, the overall market matters less if one is able to find individual securities with a margin of safety. Even in the year 2000, during the biggest stock market bubble in US history, there were bargains as many small cap & "Old Economy" stocks were being discarded in favor of "New Economy" stocks and blue chips. 

Finding bargains in the current market might be even harder than in the year 2000 as small caps trade at record valuations and dispersion in the S&P 500 is at an all time low. The lowest dispersion ever means that the difference between the most and least expensive stocks is smaller than ever. In some sense value investing has become a victim of its own success as "cheaper" stocks have been bid up. The cheapest part of the market, where value investors tend to fish, is as expensive as it has ever been.

What is a value investor to do in such an environment? This makes it much more difficult for a value investor but not impossible. I believe the most important thing is not to force investments or lower ones standards in any environment. If that means holding more cash so be it. 

(As an aside I am actually quite optimistic about my portfolio for the new year, although my positions are largely not traditional value investments (ie. long common stocks). I plan to write about why I'm optimistic about my portfolio some time in the next week.)

If there is anything that I have learned having lived through two bubbles its that expensive can become more expensive. I have also learned that few who say "I will dance until the music stops" find a chair when the music ultimately comes to an abrupt halt. Unless one believes that we are in a new paradigm where cycles have been eradicated than there will be better opportunities some time in the future for value investors. Will you have cash to invest when that happens?

Annaly For The New Year

Wed, 18 Dec 2013 19:38:00 +0000

SUMMARYAnnaly Capital Management trades at nearly a 20% discount to its book value, which is comprised of highly liquid securities. Annaly has recently delevered and hedged, which should limit further losses. The stock is currently priced for a disaster and anything short of that should lead to attractive gains. An end to tax loss selling season or putting the taper behind us could be the catalyst for gains.BUSINESSAnnaly Capital Management is a mortgage REIT that primarily owns a levered portfolio of agency securities. Through Annaly’s acquisition of its subsidiary, Crexus, Annaly has diversified modestly into CMBS as well. Annaly now deploys 11% of its capital in the CMBS market. Additionally, Annaly owns a small asset management business.Annaly has been in the agency RMBS business for over 15 years. The way the business works is that Annaly owns a levered portfolio of agency securities. Annaly makes money through two spreads, the spread between longer rates and shorter rates and the spread between agency securities and treasuries. This is a very simplified explanation of the business. Annaly has to choose what securities to own, how much leverage to employ, how to fund the portfolio and how to hedge based on the current environment.WHATHAPPENEDFor nearly 15 years Annaly had been in a great business with some minor bumps along the way. Over this period Annaly was able to offer a dividend that averaged in the double digits plus capital appreciation. When QE came along it compressed both the spreads that Annaly was profiting off of. QE succeeded in lowering interest rates and the spread between agency securities and treasuries collapsed. Instead of backing off the trade as the spreads became narrower many agency mortgage REITs increased or maintained leverage in order to sustain returns. When the Fed announced a possible taper in May this caused rates to go higher & spreads to widen. This led to losses across these leveraged portfolios. Most agency mREITs have locked in these losses and delevered their portfolios since.PRESENTAnnaly’s book value has fallen from $15.85 at the beginning of the year to $12.70 at the end of the most recent quarter. This is partially due to the large dividend they continued to pay out despite losses but mostly due to the increase in rates and spreads. In reaction to these large losses Annaly has delevered and hedged more aggressively. At the end of the latest reported quarter Annaly was levered 5.4 times, which is at the very low end historically. Annaly is 74% hedged, which is at the very high end historically. It is estimated that Annaly would lose 4.4% if yields were to go up by 100bps. Annaly has historically traded at approximately a 10% premium to book value. After this past years missteps it currently trades at a roughly 19% discount to its book value. The most common response I get when pitching Annaly is that rates are likely to go higher and spreads are likely to widen as the Fed tapers. However, even if rates went up by 125 basis points and spreads widened its unlikely that book value would fall much more than 10%. If that were to occur the Annaly would still trade at a 10% discount to book and the spread would come back into the trade that they do, making it attractive again. All the while one is likely to be paid a 10% dividend to wait (currently the dividend is 14% but likely to go lower). In November four different insiders purchased shares in Annaly at prices higher than current levels.CATALYSTIt is likely that much of the recent selling has been tax loss selling as Annaly is down more than 45% from its highs. Tax loss selling ends at the end of December and these sellers will no longer be pre[...]

Eastman Chemical : Specialty Chemical For A Commodity Price

Tue, 29 Oct 2013 16:19:00 +0000

In a little over a decade Eastman Chemical  has transformed itself from a producer of commodity chemicals into a producer of specialty chemicals. Despite Eastman's transformation the stock still trades at the valuation of a commodity chemical company. After paying down debt in 2013 Eastman will be able to use its strong free cash flow in 2014 for repurchases or accretive acquisitions that should lead to a rerating of the stock.

Read the rest at Seeking Alpha(image)

Why Crimson Wine Group Could Be Worth $20

Thu, 29 Aug 2013 12:49:00 +0000

My original decision to purchase Crimson was primarily based on my assessment that the stock, which was trading at under $8, was trading at a big discount to the assets of the company (over $13). Additionally, savvy management seemed eager to own this asset. Since that time there have been a handful of transactions of wine estates that make my asset value estimate look conservative (here and here). While I saw the potential in Crimson’s business it required somewhat of a leap to understand how Crimson would translate its assets into earnings. With the release of second quarter earnings I am now more excited by the business than the assets and believe that Crimson could be worth more than $20 a share.


In March Crimson President and CEO Erle Martin told the Napa Valley Register that he plans to double in size to half a million cases and roughly $100 million in sales by 2016. In the most recent quarter (Q2) Crimson reported 31% revenue growth over the previous year, which is well ahead of its plan to double revenue in four years. This was especially impressive because the rest of the industry did poorly as record bad weather hurt wine sales in the second quarter. Crimson is especially sensitive to weather as they rely on visits to their wineries to drive sales. Thus far weather has been excellent in the third quarter and it would not be surprising to see the sales momentum continue or even accelerate.

Gross Margins

In the longer term I expect gross margins to head from 51% in 2012 towards 60% as Crimson utilizes is full capacity. While 60% is unheard of for traditional wine companies it is the norm for well run, high end wineries (see NYT article and WVVI 10-Q). Crimson plans to increase production this year by 36% at existing facilities. This incremental production should have very high gross margins due to higher capacity utilization. The benefits of this increased production on gross margins should begin to be realized by the end of 2014.


Crimson has shown tremendous leverage on SG&A. Sales grew by 31% in the second quarter while SG&A expenses excluding public company costs rose by a mere 5%.

Crimson’s $100 Million Goal

Crimson’s goal of $100 million in revenue by 2016 seems conservative given recent growth rates. At $100 million in revenue Crimson should be able to do at least $30 million in EBITDA and possibly as much as $35 million. If Crimson trades at its peers valuation the stock could reach $20 or higher, with a margin of safety from over $13 in asset value.  One could argue that Crimson should trade at a premium to its peers as it is the only pure play high end wine company with rapid growth.(image)

A Tale Of Two Gas Stations

Wed, 12 Jun 2013 14:06:00 +0000

Susser Holdings (SUSS) and CST Brands (CST) both operate gas stations with convenience stores attached. Susser Holdings came public in 2006 with private equity backing, while CST Brands is a recent spin-off from Valero. On the surface a spin-off would seem far more attractive than a private equity backed IPO, but looks can be deceiving...    Read the rest of my write up at Market Folly(image)

Dissecting A Losing Trade

Wed, 29 May 2013 03:43:00 +0000

Taking a loss in investing hurts. There is  a mourning period of a few days after I take a loss where a gloom seems to hang over me and I constantly think about what went wrong. Fortunately, losses are also the best way to become a better investor if the proper lessons are taken away.

I took a position in DOLE about two weeks ago upon the announcement of a $200 million share repurchase, which amounted to about a third of the float. I have had very positive experiences with companies that repurchase a large percentage of their shares. I have never seen a company announce a share repurchase for a third of their float.

Aside from the large share repurchase there appeared to be value in the shares of Dole. The market cap was less than a billion dollars and net debt very low. There is as much as $600 million in underutilized real estate that could be sold. Dole is cutting expenses and should be able to produce over $250 million in EBITDA once the cost cuts are in effect. In addition to the seemingly cheap stock and enormous repurchase, an insider owns over 30% of the shares. The upside seemed very compelling.

There were also some aspects of  Dole that I chose to overlook. I prefer to own companies whose businesses are less cyclical and produce steady free cash flow. As a commodity producer in the midst of a restructuring Dole did not meet either of these criteria.

Yesterday, Dole announced a suspension of their share repurchase  two weeks after it was announced. That sort of a  turnaround is unprecedented and could not be expected. However, it was the aspects of the company that I chose to overlook that led to this turnabout.

Was my purchase of Dole an unforced error or a case of  "shit happens"? It is possible to make  a case for both sides, which will probably lead to a few more days of contemplation.(image)

Share Repurchase Fever

Tue, 28 May 2013 08:05:00 +0000

After a market rally that has lasted more than a half a year bullish sentiment recently reached the types of extremes seen once every few years. It used to be the case that this type of extreme sentiment would be a reliable indicator for an intermediate term market top. However, that does not seem to be the case this time around. The market pulled back for three days and now seems to be resuming its rally this morning. I believe the reason for this behavior is the historic level of stock repurchases we are seeing. From Bloomberg:
About 79 percent of buyback orders at Goldman Sachs Group Inc.’s corporate trading desk were active yesterday, the most this year, according to a note to clients obtained by Bloomberg News. Companies stepped up purchases as the Standard & Poor’s 500 Index fell as much as 3 percent from an intraday record reached May 22.

The buybacks may have limited losses in American equities after shares in Japan fell the most in two years and stock markets from London to Paris and Frankfurt saw declines of more than 2 percent.

In the current market environment it is crucial to monitor share repurchases.  Here are some things to be on the lookout for:

  • A change in the economic or interest rate backdrop that slows the pace of share repurchases.

  • As prices rise it takes an increasing amount of share repurchases to have the same effect. We could reach a point where share repurchases produce diminishing returns, although we do not seem to be there yet.

  • Insider selling and share issuance begins to outpace the share repurchases and cash M&A.

I used last week's decline to take in many of the shorts I had been scaling into and am now very modestly net long. The reason I did so was that it seems futile to fight these share repurchases, even though I believe the market has gotten ahead of itself.(image)

As Long As The Music Is Playing

Wed, 22 May 2013 05:43:00 +0000

Credit Suisse reports that through last week there have been $320 billion in announced share repurchases in 2013. For reference announced repurchases  for the entire year of 2012 were $477 billion and 2012 was a strong year for repurchases. At the current pace there will be well over $800 billion in announced share repurchases in 2013. If indeed corporations repurchase that much stock it would amount to over $3 billion every trading day. I don't believe that corporations will be able to keep up the current pace but even at a somewhat more moderate pace these numbers are astounding.

In the short run a steady buyer of billions of dollars of shares a day cannot be painted any way other than extremely bullish. In the bigger picture this is creating valuations that are unsustainable and will eventually lead to the third reckoning since the new millennium.

Many point to the record cash on the balance sheets of US corporations as justification for the current binge. They ignore the other side of the balance sheet where debt has soared by far more than cash. JPMorgan reports that net debt at corporations ex-autos is at a record of over $1.9 trillion up from under $1.2 trillion at the beginning of 2007.

The S&P 500 is currently trading somewhere between 15 and 16 times forward earnings, well above the historical average. One can also argue that the earnings number is being artificially inflated by low interest costs and an economy artificially propped up by zero rates. However, there is nothing easily identifiable on the horizon that will derail the current share repurchase binge. All this places us squarely in a third game of musical chairs where the music is still playing.(image)

Does Sentiment Still Matter

Thu, 16 May 2013 02:28:00 +0000

I have spent far less time discussing market sentiment this year than in previous years. The reason being that I believe that the marginal buyers of stocks have been corporations repurchasing stock and buying other companies for cash. The level of float shrinkage is setting records. Corporations repurchasing shares have no sentiment. They just keep buying steadily on a daily basis.

I still believe that market sentiment matters but in the current environment it matters less than usual. It takes larger extremes in bullish sentiment to knock down the market when there is an underlying bid from corporations. I believe that we are nearing a point where sentiment is extreme enough to matter. The vast majority of the sentiment indicators I track are now urging caution and the market is stretched:

  • Investors Intelligence bears are below 20% while the bulls are at 54%

  • Newsletter writers tracked by Hulbert are recommending the largest long position in stocks since January 2002.

  • Rydex traders are positioned at a bullish extreme

  • Investment advisers tracked by NAAIM stock exposure remains at the upper end of historical allocations.

  • The most speculative of stocks are flying.

  • Margin debt is nearing record levels.

While sentiment has not mattered all year there are now a confluence of indicators in extreme territory. At the same time breadth has been lagging in recent days. If sentiment still matters at all this should be the time when it asserts itself. Normally, I would expect an intermediate term top under these conditions. But with the underlying bid from corporations still present I would not be shocked to only see a shorter term correction.  I am expecting a 3% to 5% pullback at a minimum leading me to take a net short position in the market.


Technology To Take The Lead

Fri, 26 Apr 2013 03:11:00 +0000

Technology has been one of the poorest performing sectors in 2013 and over the past 12 months. The S&P 500 has returned 13.98% over the past 12 months while the S&P 500 Information Technology sector has returned -2.93%, lagging by nearly 17%. The two main drivers of the market rally have been a chase for yield and the float shrinkage that has been occurring through cash M&A and share repurchases. Technology has not been one of the main beneficiaries of these trends but I believe the record cash return by Apple will mark a turning point.

The stock market has been shrinking. In February there was over $100 billion in share repurchases & cash M&A announced. This float shrinkage has helped propel the overall market higher but has been less prevalent in the technology sector. For the most part technology companies have continued to stockpile cash, with the Dell LBO having been an exception. That all changed this week when Apple announced the largest cash return in history.  Apple has pledged to return $100 billion to shareholders before the end of 2015. That works out to over $33 billion a year, a little over 8.6% of its current market cap. With this announcement technology has joined the float shrinkage party and the sector is likely to play catch up. Its also possible that Apple's technology peers will follow its example.

The poor performance in the technology sector does have some fundamental justification. There is a large amount of disruption occurring in technology. The PC related companies have been disrupted by tablets. The tablet and mobile device markets are becoming more competitive. The enterprise software companies are feeling the slowdown in global GDP as well as the move to open source and cheaper alternatives. However, there has always been disruption in technology and the lower valuations already account for this. Its not like everything is perfect in consumer staples, one of the best performing sectors. Companies like Coca Cola and Procter & Gamble have barely seen any revenue growth yet the stocks are flying.  The same can be said for pharmaceutical companies like Pfizer.

I believe that technology will be the best performing sector between now and year end and have positioned myself that way. Technology is by far my highest allocation with Check Point Software, Amdocs and Apple being my largest tech positions. All trade at greater than 10% free cash flow yields (to enterprise value) and all are returning cash to shareholders.


Rally On Fumes

Sun, 31 Mar 2013 16:31:00 +0000

I believe that the current rally is running on fumes. Before I get to the bearish side of the ledger I want to acknowledge the positives. The large float shrink (ie. share repurchases & cash M&A) is an undeniable positive. As long as the share repurchases and cash M&A continue at the current pace it is difficult to imagine much more than a correction. The second positive is seasonality. April is one of the stronger months of the year for stocks. Extended markets often become more extended during seasonally positive periods. The negative side of this is that in another month we enter the weaker part of the year where we have seen market corrections in each of the past 3 years.

Investor sentiment is troubling as the vast majority of the sentiment indicators I follow are showing excessive optimism. Whether it be hedge fund managers, investment advisers or newsletter writers the consensus in unanimously bullish. Former "Chicken Littles" suddenly have  a greater appetite for beta. The following excerpt from an article in the WSJ captures the current mood:
The market's record-breaking spree has raised a new fear in many American households—dread that they are missing out on big gains.

When stock prices collapsed in 2008, the bear market wiped out half of the savings of Lucie White and her husband, both doctors in Houston. Feeling "sucker punched," she says, they swore off stocks and put their remaining money in a bank.

This week, as the Dow Jones Industrial Average and Standard & Poor's 500-stock index pushed to record highs, Ms. White and her husband hired a financial adviser and took the plunge back into the market.

The economy is stumbling along and profit growth has slowed to crawl. The full effects of the tax hikes and the sequester have yet to be felt as spending habits do not change on a dime. A slowing economy with more headwinds ahead is not the ideal environment for profit growth. Valuations are full even with profit margins at record levels. It is difficult to see where further profit growth will come from.

Up until now the large float shrink has kept me from getting too bearish. But as we approach the seasonally weaker part of the year with the market even more stretched I am more likely to act on my bearish inclinations. The bears, if there are any left, may be coming out of hibernation soon.(image)

A Tidbit From The Oracle Conference Call

Fri, 22 Mar 2013 08:42:00 +0000

Amdocs (DOX) and Comverse (CNSI) both provide billing software and services for telcos. As a shareholder of both I found a portion of the Oracle Q&A very interesting. The following is a portion of the Oracle conference call on Wednesday from Seeking Alpha (my emphasis added):
Larry Ellison

We have a very, very significant presence in billing systems, in provisioning systems, in the telco space. And what we’d like to become is one of the most strategic suppliers to telcos overall, which involves broadening our footprint of what we supply them.

So you’re going to see us, through our own engineering, through innovation and acquisitions, greatly broaden our footprint as our ambition is to be the primary technology provider to the telecommunications industry. So that’s an area where we’ve been very successful, in certain parts of it, and we think we can expand that business by adding to the footprint.