tag:blogger.com,1999:blog-52681482865698939642024-02-06T19:56:29.797-06:00Off The Beaten Path Investments ForumA place to shed some light on the little stocks with potential for big gains hiding in the nooks and crannies of U.S. stock market.Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.comBlogger83125tag:blogger.com,1999:blog-5268148286569893964.post-61049146636447697292008-07-28T22:07:00.002-05:002008-07-28T22:10:34.780-05:00NPK -- “Da Bulls” Part II<p class="MsoNormal"><o:p></o:p><a href="http://offthebeatenpathinvestments.blogspot.com/2008/07/npk-da-bulls-part-i_21.html">In the previous post</a><span style=""> </span>I discussed my calculation that place the downside price target for National Presto (NPK) shares at $45 which is approximately $25 or 35% below today’s closing price of approximately $70 per share.</p> <p class="MsoNormal"><o:p> </o:p><br />So what is the upside potential for NPK shares?</p> <p class="MsoNormal"><o:p></o:p>If we make an assumption that the company can grow revenue in the small apps business in line with inflation of 3% and stabilize EBITDA margins, the small apps business becomes a “going concern” and the valuation increases substantially to $54 per share.</p> <p class="MsoNormal"><o:p></o:p>If you assume that the defense business turns into a “going concern” and has annual free cash flow similar to 2007 and apply a below market average multiple of 10x the defense business value jumps to about $32 per share from the worst case scenario of $5 per share.</p> <p class="MsoNormal"><o:p></o:p>If the absorbents business every shows and operating profit or the company can sell it for more than 50% of what it cost to build the factory and buy equipment just a few years ago this also increases the upside for NPK shares.</p> <p class="MsoNormal"><o:p></o:p>Simply assuming that this 100 year old company's two main business lines are going concerns with no growth beyond inflation puts the target price close to $100 per share which represents about 40% upside from current levels.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>If one is to assume that the company’s small apps business can grow even slightly above inflation or the company uses its cash to continue to build out the defense business or to make an acquisition with decent ROE potential the upside keeps growing substantially beyond $100 per share.</p><p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com4tag:blogger.com,1999:blog-5268148286569893964.post-34774158293716828342008-07-22T20:52:00.003-05:002008-07-22T21:03:56.020-05:00NPK -- "Da Bulls" Part I (Corrected)I noticed that I made a pretty substantial error in the calculation of per share value for the small apps business posted yesterday. <br /><br />Instead of subtracting tax expense from free cash flow, I was adding it back and therefore substantially inflating free cash flow estimates. The other change I made is to decrease the amount spent on CAPEX as the small apps business declines in revenue.<br /><br />These changes produced a substantially lower per share value for the small apps business of $15 which lowered the worst case scenario share price estimate for NPK to $45 from previously estimated $61. Under this new worst case scenario the worst case scenario downside increases to aproximately 30% from the previously posted 8% downside risk.<br /><br /><a href="http://spreadsheets.google.com/pub?key=p3CMvDY2fLiKh_Pesq75NYg">Instead of reposting with the correct numbers here is the new calculation.</a><br /><br /> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p> <a target="_blank" style="font-size: 9pt;" class="aBlue" href="http://spreadsheets.google.com/pub?key=p3CMvDY2fLiKh_Pesq75NYg"></a>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com3tag:blogger.com,1999:blog-5268148286569893964.post-28269722617090945772008-07-21T19:53:00.003-05:002008-07-21T19:59:18.968-05:00NPK -- “Da Bulls” Part I<p class="MsoNormal"><o:p></o:p>The bull case for National Presto (NPK) is simply that at current levels the downside risk is very small.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>To calculate the downside price target I did a sum of parts valuation using VERY conservative assumptions.<span style=""> </span>Under this valuation methodology, NPK is worth only the value of the small apps business plus the liquidation value of the defense and absorbents business plus the cash on the balance sheet.</p> <p class="MsoNormal"><o:p></o:p>I assumed 1.6% revenue growth rate and an annual 50 bps decline in EBITDA margins to estimate the value of the small apps business which means that cash flow declines every year until the business is break even and assumed to be worthless.<span style=""> </span>The net present value of estimated cash flows from the small apps business using a 7% discount rate is $30 per share.</p>In calculating the value of the defense business I assume the worst case scenario under which NPK delivers on its $250 million stated backlog for 2008 with similar margins as in 2007 which would produce $22 million in after tax free cash flow.<span style=""> </span>At the end of 2008 the business is assumed sold at ½ the dollars invested in CAPEX over the most recent 4 years.<span style=""> </span>Under this worst case scenario the defense business is worth $5 per share. <p class="MsoNormal"><o:p> </o:p><br />For the absorbents business I simply assume that its dumped on someone else’s lap at ½ CAPEX over the last 4 years which produces a $2 per share business value.</p><p class="MsoNormal">The last two pieces are the working capital from the two liquidated businesses as well as the current cash on hand which combined is estimated to be worth $24 per share.</p><p class="MsoNormal"><a href="http://spreadsheets.google.com/pub?key=p3CMvDY2fLiIKK5FkS7W4DA">My detailed calculations can be viewed here.</a><br /></p> <p class="MsoNormal" style="text-align: justify;"><br />The sum of parts valuation under these assumptions is $61 per share which is $5 or 8% below the current price of approximately $66 per share.<span style=""> </span>A worst case scenario downside of 8% is substantially smaller than the potential upside under even modest positive assumptions which will be discussed in the next post.<br /><o:p><br /> </o:p></p> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com2tag:blogger.com,1999:blog-5268148286569893964.post-61621017688245116792008-07-17T23:00:00.001-05:002008-07-17T23:07:57.229-05:00NPK -- “Da Bears”<p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">As with all the stocks profiled on this blog the laundry list of problems with National Presto (NPK) is long and deep.<span style=""> </span>NPK’s second largest business is facing both short and long term pressures, success of the company’s defense business is based on large government contracts that may not be renewed, the company’s management has invested both time and money into the diapers business with very poor results thus far, and the stock is highly illiquid.</p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">National Presto’s appliance business has experienced 1.6% annual sales growth over the last 8 years with the company constantly stating that it cannot raise prices fast enough.<span style=""> </span></p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">While the decision in 1999 to outsource manufacturing to <st1:country-region st="on">China</st1:country-region> was certainly a positive it means that NPK will be negatively effected if the dollar continues to fall and/or inflation continues to stay high in <st1:country-region st="on"><st1:place st="on">China</st1:place></st1:country-region>.<span style=""> </span>These items have already taken their toll with EBITDA margin falling from a peak of 19.7% in 2005 to 18.7% in 2006 and 15.8% in 2007.<span style=""> </span>With the company unable to raise prices fast enough its likely that operating margins in the appliance business will continue to contract.</p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">There is very little visibility in the defense business.<span style=""> </span>Management has not indicated what percentage of defense revenue comes from the Department of Defense (DoD) and what percentage from other sources (police force, etc.).<span style=""> </span>The company has not provided any indication of whether they expect the Department of Defense (DoD) to expand the $1.3B contract after it is filled.</p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">NPK’s fillings state that it expects to deliver $550M of the $1.3B contract (up from initial award of $300M) and based on my calculation the $550M will be mostly filled by the end of fiscal 2008.<span style=""> </span>If this business is not replaced, company EBITDA will fall by approximately 50%.</p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">There is not much to say about the absorbents business other than it’s a mess, no pun intended.<span style=""> </span><br /></p><p class="MsoNormal">After combing through old SEC fillings, I calculate that since 2001 NPK has invested $36M in CAPEX for total EBITDA of $8M.<span style=""> </span>The annual rate of return has been 3% and that is without including working capital in the equation.<span style=""> </span>This is a very low margin, highly competitive business that is exposed to severe swings in commodity costs (wood pulp and energy) and NPK is never going to be a cost leader in this industry.<br /></p><br /><p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal" style="text-align: justify;"><o:p> </o:p></p> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com2tag:blogger.com,1999:blog-5268148286569893964.post-71994065197595038242008-04-10T20:35:00.002-05:002008-04-10T20:46:13.911-05:00NPK -- First Look<p class="MsoNormal" style="">Current Price:<span style=""> </span>$51<br />Market Value:<span style=""> </span>$350M<br /><st1:city st="on"><st1:place st="on">Enterprise</st1:place></st1:City> Value:<span style=""> </span>$210M<br />Investment Type:<span style=""> </span>Classic Value</p> <p class="MsoNormal" style=""><o:p></o:p>NPK (National Presto) is a designer of small electric appliances and housewares, produces armaments for the <st1:place st="on"><st1:country-region st="on">U.S.</st1:country-region></st1:place> defense department, and absorbent products.<span style=""> </span>Yes, this company makes toasters, bullets, and diapers.<span style=""> </span></p> <p class="MsoNormal" style=""><o:p></o:p>While operating income from the defense segment now accounts for almost 2/3 of total, NPK has been an innovator in the small appliances category for almost 100 years (a very interesting history <a href="http://www.gopresto.com/information/history.php">can be found here</a>).<span style=""> </span></p> <p class="MsoNormal" style=""><o:p></o:p>The last couple of <span style=""> </span>years have been eventful for NPK, to say the least.<span style=""> </span>Most importantly, the company <a href="http://www.gopresto.com/information/financial/2007may15.php">defeated the SEC in appeals court</a> reversing a decision forcing NPK to be classified as an investment company due to NPK’s large cash hoard. Being classified as an investment company means more government oversight and reporting costs.<span style=""> </span>Keep in mind that the original SEC action in 2002 was not due to accusation of destruction of shareholder value or executive wrong doing, rather due to SEC’s jihad on public companies prompted by the still fresh memory of the Enron and Worldcom debacles.<span style=""> </span></p> <p class="MsoNormal" style=""><o:p></o:p>NPK hired and than promptly fired its new auditors 12 months later.<span style=""> </span><a href="http://www.gopresto.com/information/financial/2007nov14.php">According to this press release</a><a href="http://www.gopresto.com/information/financial/2007nov14.php"></a> from the company, it hired one firm to perform the audit and another to perform the tax work.<span style=""> </span>It is common practice to have the same firm do the audit and the tax work so NPK asked for bids and the firm originally hired to do the tax won.</p> <p class="MsoNormal" style=""><o:p></o:p>On top of all that, the company’s CFO resigned “to pursue an opportunity as a financial advisor.”<span style=""> </span>While I have no evidence to the contrary, I have a hard time believing someone would willingly resign a high paying executive position to be a cold calling stock broker.<span style=""> </span><br /></p><p class="MsoNormal" style="">Despite all the “noise,” NPK had an outstanding operating year.<span style=""> </span>Revenues grew 38% (on top of 65% growth in the previous year) and operating income great 50% (after growing 83% the year before).<span style=""> </span>The company ended the 2007 fiscal year with $142M in cash & securities and no long term debt after paying $4.25 per share dividend on 3/2008 and $3.80 per share a year before.</p> <p class="MsoNormal" style=""><o:p></o:p>In the posts to follow I will discuss the bullish and bearish aspects of NPK.</p> <p class="MsoNormal" style="text-align: justify;"><br /><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com5tag:blogger.com,1999:blog-5268148286569893964.post-77611112967753776872008-04-07T18:16:00.002-05:002008-04-07T18:20:42.070-05:00The Quintessential Buffet<p class="MsoNormal">I was cleaning out some old emails and ran across <a href="http://www.nytimes.com/2007/12/29/business/29buffett.html?_r=3&oref=slogin&ref=business&pagewanted=print">this NYT article</a> dated <st1:date year="2007" day="29" month="12">12/29/07</st1:date> regarding Buffet’s decision to enter the bond insurance business but published prior to the offer he made to buy the municipal bond business of the troubled monolines.<br /><o:p></o:p><br />This article follows the basic boiler plate for Buffet related articles, mentioning that Berkshire is doing well while others are suffering, that buffet has added to his positions in USB and WFC, and talks about new positions in BNI and KMX (it was later released that KMX was bought by Lou Simpson who is the CIO at GEICO and a Superinvestor in his own right).</p> <p class="MsoNormal"><o:p></o:p>However, about half way through the piece came this gem of a quote from the maestro himself:<span style=""> </span></p> <p class="MsoNormal"><span style="font-weight: bold; font-style: italic; color: rgb(255, 0, 0);font-size:180%;" ><o:p>"</o:p>We had no compulsion at the start of the year to do anything ….. On the other hand, there was no limit to what we could do."<br /></span><span style="font-size:180%;"><o:p><span style="color: rgb(255, 0, 0);"> </span></o:p></span><br />I think most agree that Buffet and a select few other professional investors are simply better at their chosen profession than everyone else, much the same way that Michael Jordan and Tiger Woods are better and will always be better than everyone else.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>However, what many don’t realize and this quote again proves is that Buffet is playing a completely different game than everyone else.<span style=""> </span>I feel lucky to be able to watch and learn.<span style=""> </span></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com1tag:blogger.com,1999:blog-5268148286569893964.post-31418138359586590232008-04-05T10:18:00.003-05:002008-04-05T10:28:56.983-05:00FTAR Makes it OfficialYesterday morning FTAR <a href="http://www.sec.gov/Archives/edgar/data/1011308/000095012308003820/y53276e8vk.htm">filled the long expected 8K </a>stating that the KMart contract will not be extended beyond 12/31/08 which effectively means the company will wind down and cease to exist shortly after the end of this year.<span style=""> </span>KMart will pay $13M for FTAR’s intellectual property (i.e. ThomMcAnn) as well as honoring the post-bankruptcy master agreement which stipulates that KMart will buy all inventory at book value.<span style=""> </span>Also, the company will be terminating retiree benefits and life insurance which will remove $14.7M of long term debt from the balance sheet and result in a one time earnings gain.<span style=""> </span> <p class="MsoNormal"><o:p></o:p>This announcement essentially puts in writing what everyone already knows and makes the investment thesis even simpler.<span style=""> </span>I have updated my figures ( for the most recent news and believe that at worst FTAR is worth $7 per share (up 45% from current levels) and at best $8.4 (up 75%). <br /></p><p class="MsoNormal">[**I am still trying to figure out how to post Excel tables in Blogger so I will add my calculations for the $7 and $8.4 price as soon as I get a hang of this. If you have any suggestion on how I can do this other than posting a picture file that is all but unreadable let me know at offthebeatenpathinvestments@gmail.com]<span style=""> </span></p> <p class="MsoNormal">The biggest difference between the worst and best case scenarios is my estimate of 2008 FCF generated by FTAR.<span style=""> </span>In the worst case I assume sales down 10% over 2007 and some margin erosion while in the best case I assume flat YoY sales and slight margin expansion.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>There could also be upside if FTAR sells its HQ for higher than book value, if the non-KMart business is worth more than $0, $80M in NOLs are worth more than I expect, and wind-down costs are less than I estimate.</p> <p class="MsoNormal"><o:p></o:p>FTAR currently represents 10% of the “Best Ideas Portfolio” (and roughly that much of my own account) and I plan on raising the stocks weight to 15%. </p> <p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com8tag:blogger.com,1999:blog-5268148286569893964.post-44201490269966271072008-03-30T13:06:00.003-05:002008-03-30T13:07:15.633-05:00NOOF -- Final<p class="MsoNormal">The key bearish case for NOOF is that the company has no bargaining power against the cable/satellite companies and any above average profit margins will be constantly eroded which means the stock deserves a low multiple.<span style=""> </span>Also, the company is allocating a lot more cash to the very volatile content creation business essentially trying to build a tiny movie studio.<span style=""> </span>Due to the nature of the “content creation” business, movie studios have generally been very poor investments.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The key bullish case is the recent positive earnings news and trading at 7.3x EV/FCF the company continues to look cheap.<span style=""> </span>Also, all indication point that NOOF is the premier name in the business and should continue to win distribution partnership with brand owners like Penthouse.</p> <p class="MsoNormal"><o:p></o:p>Based on my estimates of FCF, the $0.50 per share annual dividend is safe.<span style=""> </span>However, there will be nothing left to reinvest in the business which stifles future earnings growth and any future dividend increase.</p> <p class="MsoNormal"><o:p></o:p>Keeping in mind that NOOF is hostage to the cable/satellite companies, I have a hard time envisioning any valuation expansion from current levels.<span style=""> </span>Even if growth returns to 10% annually and I assume a multiple of 10x FCF/EV in 3 years, I get an implied 3 year total return of 80%. </p> <p class="MsoNormal"><o:p></o:p>While 80% upside over 3 years certainly looks attractive, the downside is also substantial.<span style=""> </span>I think NOOF will continue to face both long term and short term revenue pressure from its other 3 customer who will expect to renegotiate their contract and get the same deal as EchoStar.<span style=""> </span>Any abnormal earnings return will be taken away by the network providers.</p> <p class="MsoNormal"><o:p></o:p>Adding to this company specific issue is the fact that traditional media companies will continue to face pressure from online players and while they will adjust their business models I have a hard time seeing much valuation expansion in a more competitive operating environment.<span style=""> </span></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>Simply stated, I don’t feel the downside justifies the upside and since I am not willing to buy more shares at this price I have now choice but to take the loss and liquidate my position.<o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><o:p></o:p><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-1194087751458746222008-03-27T01:37:00.001-05:002008-03-27T01:41:09.873-05:00NOOF -- “Da Bulls” (improved earnings + very low valuation)<p class="MsoNormal"><b style=""><u></u></b><o:p></o:p>The Bull case for the stock is that there has been some positive earnings news recently and the fact that the stock continues to look tantalizingly cheap based on free cash flow.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>NOOF has come off the $4 lows on the recent positive earnings news released on Feb. 5.<span style=""> </span>Total sales were up 8% while the market expected a double digit slide experienced in the previous two quarters.<span style=""> </span>EBITDA was up slightly which compares favorably to the 40%+ decline in EBITDA experienced in the previous two quarters.<span style=""> </span><span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>Looking at the revenue breakdown in detail, one notices that the company’s largest business – Pay TV –is still experiencing double digit revenue declines.<span style=""> </span>The upside came entirely from huge increase in revenue in the Film Production group as the company completed a “producer-for-hire” arrangement which was not there last year. </p> <p class="MsoNormal"><o:p></o:p>The CEO, Michael Weiner, stated on the latest conference call that he believes that the YoY revenue decline in Pay TV is over and next quarter will show positive YoY revenue growth.<span style=""> </span>This implies that the company has been able to offset the re-rate with new products which is a very good sign.</p> <p class="MsoNormal"><o:p></o:p>The stock also continues to look very cheap despite the huge decline in profitability. <span style=""> </span>Here is how I am looking at free cash flow:</p> <p class="MsoNormal"><o:p></o:p>Reported EBITDA<span style=""> </span><span style=""> </span>$5.43M<br />Adjust for large one time deliverables in Film Group<span style=""> </span>$(0.4M)<br />CAPEX<span style=""> </span>$(0.5M)<br /><u>Tax<span style=""> </span>$(1.8M)<o:p></o:p></u><br />FCF*<span style=""> </span>$3.0M<br />Annualized FCF*<span style=""> </span>$12M<br />EV / FCF<span style=""> </span>7.3x<br />Cash Yield<span style=""> </span>14%</p> <p class="MsoNormal"><o:p style="font-style: italic;"></o:p><span style="font-style: italic;">*Excludes “Content Amortization” expense and “Cash Investments in Content”. NOOF uses “film accounting” where they capitalize NOT expense the cash costs spent to produce films and than expense it over time in the form of amortization.</span> </p> <p class="MsoNormal"><o:p> </o:p>There has been some insider purchases recently as 3 different directors bought a combined $50K of NOOF on the open market.<span style=""> </span>It should be noted that one of the largest shareholders, an activist fund called Steele Partners, has been dumping shares recently. <o:p></o:p></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>If NOOF can string together a few consecutive quarters of free cash flow growth, the stock would look even cheaper.<br /><o:p><br /></o:p><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-59151977403084295042008-03-22T12:07:00.002-05:002008-03-22T12:16:07.208-05:00NOOF -- “Da Bears” (The Hammer Comes Down)<p class="MsoNormal"><o:p> </o:p></p>The Bear case is simply that NOOF has no bargaining power with its distribution partners – the cable and satellite companies – and future earnings will continue to be eroded by tough negotiations with these network owners.<span style=""> </span> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">The hammer came down in the first fiscal quarter of 2008 (6/2007) when the company reported that total revenue fell by 21% and decline by 17% in Pay TV segment, the company’s largest and most profitable.<span style=""> </span>On top of the sharp revenue decline, administrative expenses actually INCREASED so EBITDA fell by a staggering 49% and operating eps declined by 47% to $0.08 per share (eps declined slower than EBITDA due to slightly lower depreciation).<span style=""> </span></p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal">The market did not take this news lightly and the stock cratered from approximately $8.50 to $6 in the first two weeks of August.</p><p class="MsoNormal"><a onblur="try {parent.deselectBloggerImageGracefully();} catch(e) {}" href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXQFFWzGTBjjZ0Akoao2I-O5hnO6MAPbFRsPt_6ITUjogly-UnTCYYa9k2S6jLIhcVWYNCImetP07XJ2wlkNN3NVxyxnyaIayU3IrA69ADk4szNHllYTt3NPcGznph-ofztgniLCf3MMA/s1600-h/noof_stock+chart.PNG"><img style="margin: 0px auto 10px; display: block; text-align: center; cursor: pointer;" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEgXQFFWzGTBjjZ0Akoao2I-O5hnO6MAPbFRsPt_6ITUjogly-UnTCYYa9k2S6jLIhcVWYNCImetP07XJ2wlkNN3NVxyxnyaIayU3IrA69ADk4szNHllYTt3NPcGznph-ofztgniLCf3MMA/s320/noof_stock+chart.PNG" alt="" id="BLOGGER_PHOTO_ID_5180615457031249042" border="0" /></a></p><p class="MsoNormal"> </p><p class="MsoNormal">Why the sharp drop in revenue and earnings?<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The company renegotiated its contract with EchoStar and under the new terms they will be receiving less of the revenue split.<span style=""> </span>While not much more about the deal other than the 3 year duration was announced, it appears that EchoStar was able to increase its share of the split by 20%-25%.<span style=""><br /></span></p> <p class="MsoNormal">Because the company has such high operating leverage—high operating leverage means that a larger portion of each dollar of revenue drops to the bottom line—a 20% decline in revenue caused a much larger decline in operating earnings.<span style=""> </span></p> <p class="MsoNormal">The following quarter (second fiscal 2007) the performance was not much better.<span style=""> </span>Revenue was down 23%, EBITDA fell by 40% and eps was down 40% YoY.<span style=""> </span>On a free cash flow basis, NOOF earned $2.8M from $5.6 generated the previous year.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The recent fundamental and stock performance has clearly highlighted NOOF’s Achilles heel.<span style=""> </span>Despite all indications that NOOF is the premier adult entertainment content distributor in the business, the company has no pricing power with its distributors.<span style=""> </span>Future above average earnings will continually be eroded by cable/satellite operators.</p><p class="MsoNormal"><br /></p> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-16858288055235666082008-03-18T23:21:00.001-05:002008-03-18T23:22:50.528-05:00NOOF -- First Signs of Future Problems<p class="MsoNormal"><b style=""><u><o:p><span style="text-decoration: none;"></span></o:p></u></b>Looking back, the first signs of problems to come appeared in fiscal 2007 (fiscal 2007 ended in 3/2007 calendar) despite the fact that by all indications fiscal 2007 was a great year for NOOF.<span style=""> </span>Total revenues were up 35%, EBITDA increased 19% and the stock had a total return of 26% (3/2006 to 3/2007) and traded above $10 for a little while.<span style=""> </span><o:p></o:p></p> <p class="MsoNormal"><o:p></o:p>So where is the problem?<o:p></o:p></p><p class="MsoNormal"><o:p></o:p>Per the 10K, total Pay TV revenue in fy2007 grew by 9.5% while the number of households reached increased by 39%.<span style=""> </span>While you can’t simply assume that total Pay TV revenues and network households are immediately and perfectly correlated but such a huge divergence in reachable households and revenue should have set off warning bells that NOOF has no pricing power.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>In the 2007 10K, NOOF stated that network households increased due to addition of new channels to a current platform (good sign) but they also renegotiated a rate split in place since 2000 with that platform provider. </p> <p class="MsoNormal"><o:p></o:p>Clearly, one of the bullish aspects regarding NOOF at that time was the valuation.<span style=""> </span>Based on the stock price in June 2007 (when the fy2007 10K was filed) and the last 12 months of free cash flows the stock looked abnormally cheap:</p> <p class="MsoNormal"><o:p></o:p>Market Value at $8.5 per share =<span style=""> </span>$209<br /><st1:city><st1:place>Enterprise</st1:place></st1:City> Value<span style=""> </span>=<span style=""> </span>$181<br />Latest 12M FCF<span style=""> </span>=<span style=""> </span>$22<span style=""> </span>(EBITDA-Cash Tax-CAPEX)<br />EV / FCF<span style=""> </span>=<span style=""> </span>8.2x</p> <p class="MsoNormal"><o:p></o:p>When taking into account the fact that NOOF has grown revenues and EBITDA in each of the last 4 years and that average EBIDA margins for the last 4 fiscal years were north of 40%, NOOF seemed like an abnormally cheap stock.</p> <p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com1tag:blogger.com,1999:blog-5268148286569893964.post-85971078787410726572008-03-13T21:27:00.004-05:002008-03-13T21:34:13.107-05:00NOOF -- First Look<p class="MsoNormal">Share Price:<span style=""> </span>$4.5<br />Market Value:<span style=""> </span>$107M<br /><st1:city><st1:place>Enterprise</st1:place></st1:city> Value:<span style=""> </span>$88<br />Investment Type:<span style=""> </span>Value Investment</p> <p class="MsoNormal"><o:p></o:p>New Frontier Media, Inc (NOOF) is one of the largest distributors of adult entertainment (aka porno) through <st1:country-region><st1:place>U.S.</st1:place></st1:country-region> cable and satellite networks.<span style=""> </span>The company estimates that it can reach almost 140 million households. Recently, NOOF has started creating its own erotic and mainstream content.<br /></p> <p class="MsoNormal"><o:p></o:p>The company is made up of several business lines:</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>1)<span style=""> </span>Pay TV (recently renamed “Transactional TV”) has historically been NOOF’s largest source of revenue and income.<span style=""> </span>This business unit has provided content for cable/satellite operators either in the form of subscription channels or Video-On-Demand (VOD).<span style=""> </span>The company makes money buy paying the content providers and splitting the revenue with the network operators. It’s key to understand that historically NOOF has not created the content, primarily serving as a middle man between the content creator and owner of the distribution network.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>2)<span style=""> </span>Film Production is a new business segment for NOOF, created almost exactly two years ago when the company acquired MRG Entertainment.<span style=""> </span>This group creates original erotic content, acts as a representative for content created by others (porno agent), or as a “producer-for-hire” hired by major studios to deliver a movie or TV series.<span style=""> </span>NOOF paid $21.1M for MRG in an all cash transaction in February 2006.</p> <p class="MsoNormal"><o:p></o:p><span style="">3)<span style=";font-family:";font-size:7;" > </span></span><!--[endif]-->The Internet Group does exactly what the name implies – sell porno on the internet—and is the smallest revenue and profit generator for NOOF.<span style=""> </span>NOOF provides the large cable/satellite networks with new channels and selected content and splits the revenue generated based on negotiated rates.<span style=""> </span>Growth comes mostly by adding new channels to current networks.</p> <p class="MsoNormal">Historically, NOOF has not created the content or own the network allowing for very little working capital and Capex costs. Due to low investment requirements, the company has produced an average ROE over the last 4 years of 27%.<span style=""> </span>The other side of that coin is that NOOF has very little bargaining power when renegotiating revenue splits with the network providers. </p> <p class="MsoNormal"><o:p></o:p>I purchased NOOF in 3 parts between June 2006 and May 2007 for an average cost basis of $9.09.<span style=""> </span>In that time I have received $0.875 in dividends (one of my 3 purchases occurred after the special dividend of $0.60) which brings my costs basis to $8.215.<span style=""> </span>With the stock so much below my initial purchase price I can no longer just hold it, I have to make a decision to either buy more or start liquidating the position. </p> <p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-48516676676381339152008-03-07T00:44:00.002-06:002008-03-07T00:46:56.989-06:00Thornburg’s Pain will be Chimera’s Gain<p class="MsoNormal" style="text-align: justify;">Thornburg Mortgage (TMA) has declined from $3.56 two days ago to $1.65 today.<span style=""> </span>The stock traded at $26 in May 2007.<span style=""> </span>The company is in technical default and it appears to be heading towards an actual default.<o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><o:p></o:p>Thornburg Mortgage has historically been one of the best managed mortgage REITs in the world.<span style=""> </span>These have always owned AAA rated paper and did not change their stripes in the go-go days of the housing market to boost short term profits.<span style=""> </span>The management is dedicated, transparent and has put their own money on the line by buying in the open market.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>There is no better way to describe what is happening to TMA other than a Black Swan event.<span style=""> </span>Make no mistake about it, we are witnessing a dislocation in the credit markets that can be best described as tectonic plates shifting against each other and causing all kind of havoc with TMA caught in the middle.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>What is happening to TMA?</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>The market for non-agency paper is all but closed.<span style=""> </span>Trades that are completed price these mortgages at lower and lower levels.<span style=""> </span>That means that large holders of non-agency paper—like TMA which owned a $36B portfolio of non-agency, AAA rated, ARM loans at the end of the last quarter—have to constantly mark-to-market at lower prices.<span style=""> </span>At some point the portfolio gets marked so low the people lending money to TMA get scared and start asking for some of it back.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>This is where things get interesting, since the repo provider can either try to work out a deal with TMA and avoid a forced liquidation or ask for their money back NOW (a.k.a. margin call).<span style=""> </span></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>It appears that one or more of TMA’s lenders got spooked.<span style=""> </span>Faced with a margin call, TMA was than forced to sell at the worst possible time which caused further price erosion and decline in the stated value of the rest of their portfolio.<span style=""> </span>JP Morgan may have dealt the fatal blow, putting the company into technical default and triggering a waterfall of other debt covenants.<span style=""> </span>The rating agencies lowered their ratings on the company (not the mortgages they own) further into junk making it impossible for the company to borrow more money.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>So how does all this effect CIM?</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>Well, for every seller forced at gun point to liquidate there is a buyer with cash and time.<span style=""> </span>When TMA and others--and there are many others, just today it was announced that UBS is dumping its Alt-A loans and Citi will be liquidating $45B in mortgages over the next 12 months--are selling CIM will be buying at better spreads than they were even a month ago.<span style=""> </span></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>The short term price drop of CIM and other mortgage REITs does not change <a href="http://offthebeatenpathinvestments.blogspot.com/search/label/CIM">the thesis I laid out in these posts</a><span style=""></span>.</p> <p class="MsoNormal"><o:p></o:p>CIM is still managed by some of the smartest people in the business.<span style=""> </span>They are still one of the only buyers in the market and can set their own price.<span style=""> </span>They have only been in operation since November 2007 and still have a very small portfolio that was already bought at the discount.<span style=""> </span>And now CIM is trading at below book value of $14.25.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>I have added to my initial position in the “Best Ideas” portfolio as well as my personal accounts.<span style=""> </span>I will continue to add to my position if the stock continues to fall.</p> <p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com2tag:blogger.com,1999:blog-5268148286569893964.post-67177467344394054232008-02-19T21:12:00.002-06:002008-02-19T21:14:45.357-06:00INFS -- Comments from the Conference Call<p class="MsoNormal"><b style=""><u></u></b>As I discussed in the previous post, INFS reporting their first operating profit was certainly better news than the alternative.<span style=""> </span>However, while analysts were congratulating the CEO on “a great quarter” there were two statements made that seem extremely disconcerting to me.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>First, the CEO enthusiastically pointed out that 80% of the company’s products have been refreshed over the last 2 quarters.<span style=""> </span>New products are the only way a technology company can grow as they replace the old technology that’s quickly falling in price with newer, more expensive products. </p> <p class="MsoNormal"><o:p></o:p>So am I the only one concerned that with 80% of the product line upgraded over the last 6 months, ASPs (average selling price) are DOWN 20% year-over-year?<span style=""> </span></p> <p class="MsoNormal"><o:p> </o:p><br />Q4:2007<span style=""> </span>ASP=$856<span style=""> </span>94K units shipped<br />Q3:2007<span style=""> </span>ASP=$882<span style=""> </span>85K units shipped<br />Q2:2007<span style=""> </span>ASP=$1,022<span style=""> </span>72K units shipped<br />Q1:2007<span style=""> </span>ASP=$853<span style=""> </span>91K units shipped<span style=""> </span><br />Q4:2006<span style=""> </span>ASP=$1,090<span style=""> </span>79K units shipped<br />Q3:2006<span style=""> </span>ASP=$1,097<span style=""> </span>74K units<br />Q2:2006<span style=""> </span>ASP=$<span style=""></span>1,162<span style=""> </span>84K units<br />Q1:2006<span style=""> </span>ASP=$1,191<span style=""> </span>94K units</p> <p class="MsoNormal"><o:p> </o:p><br />The second comment that is making me lose sleep at night is the following:</p> <p class="MsoNormal"><o:p></o:p><i style=""><span style=""> </span>“the projection market is fiercely competitive excluding a few notable segments has been commoditized.<span style=""> </span>…<span style=""> </span>We [InFocus] will be faster to market with new products and better price points.”<span style=""> </span><o:p></o:p></i></p> <p class="MsoNormal"><o:p></o:p>My interpretation of this statement is that instead of trying to use its industry relationships and intellectual property to move up-market, INFS is going to try to compete on price.<span style=""> </span>Compete on price against giant Asian manufacturers (Sony, Sharp, Panasonic, etc) with unlimited financial resources, diversified streams of revenue which means they can lose money on projectors for a few years, and cheaper labor pool.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>When I look at INFS I see a company that can’t raise ASPs even with brand new products and a company that has decided to pick a fight it has a very small chance of winning.<span style=""> </span>This is why I am not bullish on the long term prospects for my INFS shares.</p> <p class="MsoNormal"><o:p></o:p>So why am I still holding on to my position and buying more?</p> <p class="MsoNormal"><o:p></o:p>Despite the long term problems, I feel that INFS is trading at least 50% below liquidation value.<span style=""> </span>And that’s just to good of a deal to pass up.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>I am not particularly bullish on <st1:city st="on"><st1:place st="on">Las Vegas</st1:place></st1:City> real estate but if someone offered to sell me a house in Vegas for half of what the cabinets, shingles and tiles inside were worth if sold separately I would jump on that opportunity.<br /><o:p><br /><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.<o:p></o:p></span></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com1tag:blogger.com,1999:blog-5268148286569893964.post-77913125002292600342008-02-14T22:14:00.002-06:002008-02-14T22:17:58.613-06:00INFS -- Operating Income Turns Positive<p class="MsoNormal"><b style=""><u></u></b>Last time <a href="http://offthebeatenpathinvestments.blogspot.com/2007/11/new-ceo-appointed-and-infs-no-longer-on.html">I posted on INFS</a><a href="http://offthebeatenpathinvestments.blogspot.com/2007/11/new-ceo-appointed-and-infs-no-longer-on.html"></a> I was pretty critical of the new CEO and stated that I am “seriously rethink[ing] my investment …. and I am considering cutting my losses.”<o:p></o:p></p><p class="MsoNormal"><o:p></o:p>I still stand by my statements and more I think about the long term prospects for INFS the more I want to push the SELL button.<span style=""> </span>However, the current undervaluation seems so egregious that I am willing to overlook the crumby business and less than inspiring CEO and hold on to my shares.</p> <p class="MsoNormal"><o:p></o:p>INFS <a href="http://biz.yahoo.com/bw/080207/20080207005725.html?.v=1">reported fourth quarter earnings</a> last week and posted an operating profit for the first time since anyone alive can remember.<span style=""> </span>Excluding the $3.7M charge for lease losses on vacated facilities, INFS posted Operating Income of $1.1M or $0.09 per share in the company’s seasonally biggest quarter. <span style=""> </span>Since I did not cover the 3<sup>rd</sup> quarter, I will cover both at the same time.</p> <p class="MsoNormal"><o:p></o:p>The financials broke down as follows:</p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal"><b style=""><u>Q3:2007 results<o:p></o:p></u></b><br />Revenue<span style=""> </span>$76M<span style=""> </span>-- down 7% YoY<br />GProfit<span style=""> </span><span style=""> </span>13.8<br /><b style=""><span style="background: yellow none repeat scroll 0% 50%; color: red; -moz-background-clip: -moz-initial; -moz-background-origin: -moz-initial; -moz-background-inline-policy: -moz-initial;">GMargin<span style=""> </span> 18.2%<span style=""> </span>-- vs. 16.3% in Q2, 10.9% in Q1, 12.7% in Q3:06</span><span style="color: red;"><o:p></o:p></span></b><br />EBT<span style=""> </span>$(3.56)<br /><u>D&A<span style=""> </span><span style=""> </span>1.0<span style=""> </span><span style=""> </span>--<span style=""> </span>estimated number since no CF statement yet<o:p></o:p></u><br />EBITDA<span style=""> </span>$(2.56)</p> <p class="MsoNormal"><o:p> </o:p><br /><b style=""><u>Q4:2007 results<o:p></o:p></u></b><br />Revenue<span style=""> </span>$81M<span style=""> </span>-- down 3% YoY<br />GProfit<span style=""> </span><span style=""> </span>16.5<br /><b style=""><span style="background: yellow none repeat scroll 0% 50%; color: red; -moz-background-clip: -moz-initial; -moz-background-origin: -moz-initial; -moz-background-inline-policy: -moz-initial;">GMargin<span style=""> </span> 20.4% </span><span style="color: red;"><o:p></o:p></span></b><br />EBT<span style=""> </span>$1.1<span style=""> </span><span style=""> </span>-- excluded $3.7M lease write-off charge<br /><u>D&A<span style=""> </span><span style=""> </span>1.0<span style=""> </span><span style=""> </span>--<span style=""> </span>estimated number since no CF statement yet<o:p></o:p></u><br />EBITDA<span style=""> </span>$2.1</p> <p class="MsoNormal"><br /><o:p></o:p></p> <p class="MsoNormal"><o:p></o:p>Q4:2007<span style=""> </span>ASP=$856<span style=""> </span>94K units shipped<br />Q3:2007<span style=""> </span>ASP=$882<span style=""> </span>85K units shipped<br />Q2:2007<span style=""> </span>ASP=$1,022<span style=""> </span>72K units shipped<br />Q1:2007<span style=""> </span>ASP=$853<span style=""> </span>91K units shipped<span style=""> </span><br />Q4:2006<span style=""> </span>ASP=$1,090<span style=""> </span>79K units shipped<br />Q3:2006<span style=""> </span>ASP=$1,097<span style=""> </span>74K units<br />Q2:2006<span style=""> </span>ASP=$<span style=""></span>1,162<span style=""> </span>84K units<br />Q1:2006<span style=""> </span>ASP=$1,191<span style=""> </span>94K units</p> <p class="MsoNormal"><o:p> </o:p><br />Operating expenses excluding the lease charge were $15.4M, which was the target set previously by management.<span style=""> </span>Based on comments made on the conference call, investors should not expect any further significant improvements in gross margins and operating expenses.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The balance sheet continues to be a thing of beauty with $84M in cash and zero debt or $2.11 per share in cash.<span style=""> </span>In addition to the cash on hand, INFS still has over $200M in NOL’s.<span style=""> <a href="http://offthebeatenpathinvestments.blogspot.com/2007/06/infs-da-bulls-part-iii.html"> </a></span></p> <p class="MsoNormal"><a href="http://offthebeatenpathinvestments.blogspot.com/2007/06/infs-da-bulls-part-iii.html"><o:p></o:p>In this post</a> I calculated that if only half of the NOL’s can be used over the next 10 years they are worth roughly $1.50 per share today.<span style=""> </span>So a stock trading at $1.70 has approximately $3.50 in cash on hand and NOL’s.<span style=""> </span>The company also has an intellectual property portfolio that maybe worth something.</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>While I am not particularly bullish on the long term prospects for this company I believe that the stock is currently trading substantially below liquidation value.<span style=""> </span>INFS represents 2.75% of the “Best Ideas” portfolio at a cost basis of $2.03 per share.<span style=""> </span>I will be increasing the weighting to 4% of the portfolio.<o:p></o:p></p><p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.<o:p></o:p></span></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-80444784491848318892008-02-09T00:38:00.000-06:002008-02-09T00:42:52.351-06:00CIM -- Taking a look under the hood ….<p class="MsoNormal"><b style=""><u></u></b>CIM released their first ever <a href="http://biz.yahoo.com/bw/080206/20080206006339.html?.v=1">quarterly earnings report</a> a few days ago.<span style=""></span><span style=""> </span>It appears that things are moving along and the company is ramping up its portfolio.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The key number from this report is the average spread on assets which is currently 134 bps annualized Here are my ballpark estimates of what earnings power for CIM will be over the next 12 months:</p> <p class="MsoNormal"><o:p></o:p>Book Value<span style=""> </span>$539M<br />Earning Assets @ 8x - 10x leverage<span style=""> </span>--<span style=""> </span>$4.85B to $5.93B<br /><span style=""> </span>(book value * leverage factor + book value)<br />Spread on Assets<span style=""> </span>--<span style=""> </span>130 bps<br />Net Interest Income<span style=""> </span>--<span style=""> </span>$63M to $77M<br />Base Management Fee<span style=""> </span>-- $9.4M<span style=""> </span>(book value * 1.75%)<br />Incentive Fee*<span style=""> </span>--<span style=""> </span>$7 to $9.8M<span style=""> </span>(assume 3% LIBOR)<br />Core Earnings<span style=""> </span>--<span style=""> </span>$47 to $58M<br />Estimated EPS<span style=""> </span>--<span style=""> </span>$1.24 to $1.54<br />Yield at current price of $19<span style=""> </span>-- 6.5% to 8.1%</p> <p class="MsoNormal"><o:p></o:p>*The incentive fee is even more of a moving target than net income estimates because it depends on net income and LIBOR which constantly changes.</p> <p class="MsoNormal"><o:p></o:p>Currently, CIM’s portfolio is almost entirely AAA rated mortgage backed securities and they are still building out the portion of their portfolio that will be in the form of securities.<span style=""> </span>The next step will be to build the portfolio of the portfolio consisting of actual loans.<span style=""> </span>The yield on raw loans should be higher and should help push the spread beyond 130 bps.<span style=""> </span></p> <p class="MsoNormal"><o:p> </o:p>What is a realistic estimate for Core Earnings going forward?</p> <p class="MsoNormal"><o:p></o:p>I think looking at NLY is the first step in answering that question.<span style=""> </span><a href="http://biz.yahoo.com/bw/080204/20080204006292.html?.v=1">NLY also reported earnings</a> a few days ago and ended the quarter with spread of 99 bps.<span style=""> </span>NLY is currently priced for that spread to increase.</p> <p class="MsoNormal"><o:p></o:p>I think its safe to assume that CIM will earn a higher spread than NLY, they already do.<span style=""> </span>At a spread of 150 bps I get a current yield of 7.5% to 9.5% (P/E of 10x-13x).<span style=""> </span>At 200 bps spread which is not unreasonable I get a yield of 10%-13% (P/E of 8x-10x).<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>I think at current levels CIM represents an attractive opportunity to earn a decent return on investment.<span style=""> </span>If the stock were to sell off closer to book value of $14.26 the stock would become even more attractive.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>I initiated a ½ percent position in the “Best Ideas” portfolio, and I will be raising this position to 2% after this earnings report.</p> <p class="MsoNormal" style="text-align: justify;"><o:p><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-26397469625855088952008-02-04T22:26:00.000-06:002008-02-04T22:34:31.622-06:00BOOT -- 4th Quarter Earning Analysis<p class="MsoNormal">When BOOT last reported earnings, <a href="http://offthebeatenpathinvestments.blogspot.com/2007/10/no-one-cares-about-boot.html">I wrote</a><a href="http://offthebeatenpathinvestments.blogspot.com/2007/10/no-one-cares-about-boot.html"></a> that next time I will be watching<span style=""> </span>for<span style=""> </span><i style="">“trends in gross margins and SG&A as % of sales and if revenue is trending above or below the 8% level set by management as the goal.<span style=""> </span>I will also be watching the change in A/R relative to sales.”<o:p></o:p></i></p> <p class="MsoNormal"><o:p></o:p>In that post I also stated that analysts (in BOOT’s case just one analyst) were underestimating the earnings power and I felt the company would report 45c per share in Q4 earnings.</p> <p class="MsoNormal"><o:p> </o:p><a href="http://biz.yahoo.com/bw/080129/20080129006081.html?.v=1">BOOT reported Q4 earning</a> on Januray 29<sup>th</sup> <a href="http://biz.yahoo.com/bw/080129/20080129006081.html?.v=1"></a>of 38c per share which is up 8% YoY however below the 40c per share analyst estimate and my 45c per share estimate.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>I am not going to waste time by regurgitating the earnings release which you can read yourself and will just state that the company blamed the unseasonably warm October and November for the 2% decline in outdoor footwear sales and the earnings miss.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The work market continued to chug along with 8% top line growth and both gross and SG&A margins improved on a YoY basis.<span style=""> </span>The large inventory growth vs. sales was blamed entirely on the warm weather with the CEO stating on the conference call that BOOT is not going to take markdowns on this access inventory as its all basic, high turnover outdoor hunting products.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The CEO also hinted on the conference call that the decline in weather in the beginning of the first quarter is helping sell this access inventory.<span style=""> </span>I believe the CEO’s is hinting that almost everything that was not sold in Oct/Nov is being sold in Dec/Jan.<span style=""> </span>It was also announced that the company instituted a 3%-5% price increase across the board on its products in January.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>Today, <a href="http://www.reuters.com/article/marketsNews/idUKWNAS926720080204?rpc=44">BOOT announced a special $1 per share dividend</a> as well as its regular quarterly dividend to be paid March 18<sup>th</sup>.</p> <p class="MsoNormal"><o:p> </o:p><br />So, how attractive is the stock today? Here is how the numbers break down at ...</p>Market Value $89M<br />Cash on Hand $15M<br />Enterprise Value $74M<br /><br />Estimated fcf over next 12 months $7.5M - $7.8M<br />Current Cash Yield 10% - 10.5%<br />Current Multiple 9.5x - 10x<br /><p class="MsoNormal"></p><br />If in fact the weather effected Q4 sales, than there should be another few million that will be dislodged from inventory and into cash in Q1 as sales catch up and that will lower the EV/free cash flow multiple to 9x – 9.5x. <p class="MsoNormal"><o:p></o:p>At the time of the Q3 report I also wrote that <i style="">“I think a fair price to pay is somewhere between $17.5 to $20.<span style=""> </span>I am not wildly excited about paying 13x-15x forward cash earnings but would allocate new money to this <span style=""> </span>tock since you do get a growing company with growing margins and a fortress balance sheet.”<o:p></o:p></i></p><p class="MsoNormal"><i style=""><o:p></o:p></i>I think the recent earnings miss is just a short term bump in the road and I am getting more excited about the long term capital appreciation prospect as the multiple falls below 10x.<span style=""> </span>At this point, you get to buy a company with premium brands, fortress balance sheet with cash being returned to shareholders and you are paying a sub-10x cash flow multiple.<span style=""> </span>Even if the next 12 -24 months are a little bumpy, in the long term BOOT shareholders will benefit from 8%-10% earnings growth as well as multiple expansion from the current sub-10x level.</p> <p class="MsoNormal"><o:p></o:p>In the next quarter I will be primarily looking for indication that the misstep in Q4 was due to weather rather than some broad negative trend.<span style=""> </span>As always I will be looking for margin trends and changes in inventory and A/R relative to sales.</p> <p class="MsoNormal" style="text-align: justify;"><o:p> </o:p><br /><i><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.</span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-54732832510389523382008-01-27T23:11:00.000-06:002008-01-27T23:19:39.086-06:00My favorite commercial of all time ......<br /><br /><object height="355" width="425"><param name="movie" value="http://www.youtube.com/v/14qeu7JRwt0&rel=1"><param name="wmode" value="transparent"><embed src="http://www.youtube.com/v/14qeu7JRwt0&rel=1" type="application/x-shockwave-flash" wmode="transparent" height="355" width="425"></embed></object><br /><br /><br />Am I watching SBUX?<br /><br />Of coarse I am.<br /><br />Starbucks is the kind of company I dream of owning but never get to buy because of the valuation. The stock has almost been halfed in the last 2 years but I am still not buying shares. My guess is that Frapaccino's are susceptible to the laws of economics just like any other consumer discretionary item and as the recession plays out there will be more pessimism and a better opportunity to buy the stock.<br /><br />Buy I will enjoy this commercial while I wait.Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-47144559130648539152008-01-23T23:49:00.000-06:002008-01-23T23:50:40.147-06:00CIM – Final Thoughts<p class="MsoNormal">To get to this point I have written 4 long posts on CIM covering just about every aspect of this investment and company in great detail.<span style=""> </span>I can probably summarize all this verbiage by simply saying that CIM represents a pool of capital that will be invested by some of the smartest minds in the business at a time where they will be one of the very few buyers in the market and should be able to produce above average returns on invested capital over a 3 to 5 year period.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>At this point there is not much to CIM other than cash and the investments the company has made since going public 2 months ago.<span style=""> </span>For this, investors buying the stock today have to pay more than $4 per share premium to book value or 1.3x book value.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>While CIM certainly deserves to trade at a premium to book, I think many investors are overlooking the fact that CIM’s earnings are going to be very volatile and in this kind of market environment I believe the stock is going to move hard and fast around these data points.<span style=""> </span></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>I think CIM is going to be a long term winner and I will be adding it to the “Best Ideas” portfolio, however at current prices I am only willing to initiate a very small position in the stock.<span style=""> </span><br /><o:p><br /><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-20574714431714974812008-01-07T12:09:00.001-06:002008-01-07T12:10:35.664-06:00Abscense from posting ........I have not concluded my post on CIM as I left on vacation last week without writting out a few posts in advance. I don't plan on writting anything the rest of my vacation and will resume when I get back.<br /><br />In the meantime here is an example of a fairly common occurance when dealing with small/micro cap stocks -- unrelated and uncommon businesses. Attached below is a <a href="http://finance.yahoo.com/q/pr?s=EEI">business description for EEI</a>, a stock I decided to not research further for a reason I don't remember and a company I looked at for a reason I can't now recall. The highlighted part made me chuckle.......<br /><br /><em>"Ecology and Environment, Inc., an environmental consulting firm, provides professional services worldwide. The company offers a range of environmental consulting services, including environmental planning, management, and regulatory compliance support. It provides engineering design, and operation and maintenance; environmental emergency management; and environmental sustainability. Ecology and Environment, Inc. offers environmental services encompassing audits and impact assessments, surveys, air and water quality management, environmental engineering, environmental infrastructure planning, and industrial hygiene and occupational health studies. ....................<strong><span style="font-size:130%;color:#ff6666;">In addition, it produces tilapia fish for markets in the Middle East." </span></strong></em><br /><em></em><br /><em>* DISCLOSURE: I or accounts I manage may be long or short any and/or all stocks mentioned in this post. This is not a recommendation to buy or sell any security. For informational and educational purposes only.</em>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-47177508199412523172007-12-26T00:21:00.000-06:002007-12-26T00:27:25.092-06:00CIM -- Michael Farrell & Annaly Capital Management Inc.At this point CIM has been in existence for just over 1 month.<span style=""> </span>The company has not filled a single financial statement.<span style=""> </span>There have been no conference calls or presentations beyond the IPO road show.<span style=""> </span>The only piece of tangible news out of the company is the first minuscule dividend of $0.025 per share announced last week.<span style=""> </span> <p class="MsoNormal"><o:p></o:p>So why is the stock trading at $17.75 while it has an estimated book value of just over $14 per share?</p> <p class="MsoNormal"><o:p></o:p>The only explanation is that the market believes the involvement of Michael Farrell and his associates at FIDEC warrants a premium.<span style=""> </span></p> <p class="MsoNormal">While CIM has no operating history, we can certainly use Farrell’s 10 year track record at the publicly traded Annaly Capital Management (NLY) as a guide.<span style=""> </span>NLY has the same structure and business model as CIM with the big difference being that NLY’s assets are of the highest quality while CIM will invest at the lower end of the quality spectrum.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>Looking back to 2006 with NLY shares slightly off the lows after being cut almost in half and the great credit orgy reaching its climax, here is the key quote from the 2005 annual letter (published in March 2006)</p> <p class="MsoNormal"><i style="">“As 2005 played out, we prepared our business for the inevitable change in sentiment and shape of yield curve.<span style=""> </span>While other stretched for returns in the form of credit risk, mortgage derivatives, new business models or extra leverage, we stuck to our discipline of using AAA mortgage backed securities.<span style=""> </span>It cost us some earnings …..but I believe this discipline will only be appreciated by investors when viewed through history’s rear view mirror.”<o:p></o:p></i><o:p> </o:p><br /></p><p class="MsoNormal">While this scenario benefiting NLY seems “inevitable” today, it certainly was not so in early 2006.<span style=""> </span>This group stuck to their guns despite earnings and share price plummeting while it seemed like everyone else in the mortgage business was printing money.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>NLY’s net interest spread – the main source of NLY’s and CIM’s income <span style=""> </span>-- shrunk from 1.51% to 0.53% meaning that all other things being equal NLY would earn $1 in 2005 for every $3 earned in 2004. <span style=""> </span>This happened because the yield curve flattened and this is a risk of being in this business.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>One way to deal with a flattening yield curve is to buy less credit worthy assets which have a higher stated yield.<span style=""> </span>The name for this strategy that clients and shareholders never hear is “reaching for yield.”<span style=""> </span>The problem with this approach is while your net interest spread benefits initially, you are exposing your portfolio to bigger problems later if these higher yielding, less creditworthy borrowers start defaulting.<span style=""> </span>Instead of buying, NLY was selling.</p> <p class="MsoNormal"><o:p></o:p>In the fourth quarter of 2005, NLY took a substantial loss by selling assets that they felt were unlikely to meet return expectations.<span style=""> </span>Also, they did not buy any of the most recently issued loans made at higher yields but to less creditworthy borrowers.<span style=""> </span>They cleaned housed.<span style=""> </span>They shrunk their book of business just as the environment was at its most euphoric and it seemed like borrowers could refinance or sell their constantly appreciating homes forever. </p> <p class="MsoNormal"><o:p></o:p>By now Farrell and his group have been proven right and NLY is now growing and in a position to buy when everyone else is selling.<span style=""> </span>The stock has regained much of what it lost in 2005.<span style=""> </span><span style=""></span><br /></p><p class="MsoNormal">What does all this have to with CIM?</p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>CIM will make money the same exact way as NLY and will be run by the same exact people that manage NLY.<span style=""> </span>The actions this group took in 2005 show that they are willing to sacrifice earnings, share price, and their reputations in the short term to protect and reward shareholders in the long term.<span style=""> </span>This is a rare quality that certainly deserves a premium and should be a key consideration for every potential CIM shareholder.</p><p class="MsoNormal" style="text-align: justify;"><o:p><br /><br /></o:p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-88286629577276047002007-12-19T23:47:00.000-06:002007-12-19T23:49:02.056-06:00CIM -- Business Model<p class="MsoNormal">In this last “background” post on CIM, I am going to talk about how CIM actually makes money and the risks of investing in this stock. </p> <p class="MsoNormal"><o:p> </o:p><br />How will CIM actually make money?<span style=""> </span></p> <p class="MsoNormal">The company will take the $520M of cash it raised last month in the IPO (this is called equity) and buy real estate backed loans (these are CIM’s assets) that will produce an income stream in the form of interest and principle paid to CIM.<span style=""> </span>It’s a bit confusing, but CIM’s assets are loans made to someone else.<span style=""> </span>So at this point the company’s balance sheet essentially looks like this …….</p> <p class="MsoNormal">$520M in assets yielding lets say $25M in income to CIM<br />($520M in equity raised as part of IPO)</p> <p class="MsoNormal">Then CIM will use its assets as collateral to borrow money and will pay X% as interest expense to the lenders.<span style=""> </span>The company will than use this borrowed money to buy more assets hoping that its assets will yield X%+Spread.<span style=""> </span>So now CIM goes from having $520M in assets yielding $25M, to ……</p> <p class="MsoNormal"><o:p> </o:p>$520M in assets yielding lets say $25M in income to CIM<br />$5,000M in additional assets yielding $250M in income to CIM<br />($5,000M in new liabilities which cost CIM $200M in interest expense)<br />($520M in equity raised as part of IPO)</p> <p class="MsoNormal">So, by leveraging its equity CIM goes from earning $25M or 5% return on equity for shareholders to earning $75M ($25M on equity raised in IPO + $50M in difference between interest income on $5B in assets and interest expense on $5B in liabilities used to pay for those assets) and ROE jumps to almost 15%. <span style=""> </span>Since this is a REIT, 90% of the income gets paid to shareholders in form of a dividend so the shares will have a much higher yield than other equities.<span style=""> </span></p> <p class="MsoNormal">This is a very simplistic example but this example give a good example of where the cash will actually come from and how a company with $500M in equity can have 10x the buying power.</p> <p class="MsoNormal"><o:p> </o:p></p><p class="MsoNormal"><o:p><br /></o:p></p> <p class="MsoNormal">Seems easy enough, but what could go wrong?</p> <p class="MsoNormal">The first problem is that CIM’s business model is exposed to the yield curve because CIM will borrow using shorter term loans like commercial paper but will buy long term assets with that money like 30 year mortgage loans.<span style=""> </span>There is a mismatch in maturities that creates a big risk of the yield curve flattening.<span style=""> </span>If the yield curve flattens than the difference between costs and revenue will shrink and CIM will earn less money.<span style=""> </span>This is exactly what happened in 2005 and CIM’s parent Annaly Capital Management got whacked as a result, more on this later.</p> <p class="MsoNormal">The second problem is that the company will use a lot of leverage, that’s part of the business model, and is sensitive to what is happening in the credit markets beyond the shape of the yield curve.<span style=""> </span></p> <p class="MsoNormal">For example, if the banks CIM borrows money from all wake up one day and say that they want their money back at the same time or the assets that they are holding as collateral are now worth less than they were yesterday, CIM could be in some series trouble.<span style=""> </span>At this point, CIM either has to find someone else to lend them money, issue more stock which dilutes current shareholders, or have a fire sale on its assets to pay off its lenders.<span style=""> </span>This is called a “credit crunch” and is exactly what happened in early August and is happening right now.<span style=""> </span><span style=""> </span></p> <p class="MsoNormal">The third problem is that the value of the CIM’s assets is uncertain and changes every day while the cost of its liabilities is written in stone.<span style=""> </span>CIM’s assets are loans to others either in the form of actual loans it buys from a major bank that originated them or in the form of a credit security backed by mortgage loans.<span style=""> </span>Since these are long tem loans there is always a risk that borrowers will default and CIM does not get all the interest/principle it expects to get so the actual yield they realize on their assets is lower than expected.<span style=""> </span></p> <p class="MsoNormal">The other risk is that one day the market can simply decide that its assets are worth much less than originally thought but the liabilities CIM owns will stay the same.<span style=""> </span>If this happens there is a mismatch between loans and assets and that mismatch will be made up buy shareholder equity and will kill the stock.<span style=""> </span>This is by the way exactly what is happening with just about any financial institution that owns any mortgage related assets.<span style=""> </span></p> <p class="MsoNormal">So this is why CIM’s business model is a “catch 22” proposition.<span style=""> </span>On one hand its extremely simple – just borrow short at X and lend long at X+Spread—and leverage that trade up 10 times and you are printing money.<span style=""> </span></p> <p class="MsoNormal">On the other hand, CIM is exposed to the yield curve as well as the gyrations in the credit markets which can change overnight.<span style=""> </span>If CIM takes on to much leverage or can’t sell its assets to raise money in a credit crunch, the company can go out of business overnight or suffer a serious impairment to shareholder equity and therefore the stock price.<span style=""> </span>Also, the company may simply overpay for assets and not earn as much as it expected on them.</p> <p class="MsoNormal"><o:p><br /></o:p></p> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color: black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-26179041552435588762007-12-17T19:59:00.001-06:002007-12-17T20:11:48.526-06:00CIM -- Investment Structure<o:p></o:p>As I wrote in the previous post, CIM is essentially a publicly traded hedge fund structured as a mortgage REIT which means they have to pay at least 90% of their income out as dividends every quarter. <p class="MsoNormal"><o:p></o:p>For shareholders this structure exhibits two of the most attractive aspects of investing in hedge funds and one very unattractive aspect.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The first attractive aspect is that the group at FIDAC that will be managing Chimera will be paid on a standard hfund 2/20 structure.<span style=""> </span>Particularly, FIDAC will charge 1.75% of book value as a base fee and will take 20% of anything CIM earns beyond LIBOR + 50 bps.<span style=""> </span>The incentive fee makes perfect sense because FIDAC needs to earn a premium to LIBOR (which any shareholder can get themselves) before they start sharing in the bounty.<span style=""> </span>Also with this structure, FIDAC’s interests are directly aligned with shareholders’ interests.</p> <p class="MsoNormal"><o:p></o:p>It also appears that all fees that CIM pays to FIDAC will be adjusted downward to exclude any fees paid on Annaly sponsored products that Chimera might buy.<span style=""> </span>This eliminates the possibility of FIDAC double dipping on fees and benefiting NLY shareholders at the expense of CIM shareholders.<span style=""> </span><span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The second attractive aspect of CIM’s structure is that FIDAC has “skin in the game” along with other CIM shareholders.<span style=""> </span>As part of the IPO, FIDAC bought 9.8% of CIM’s stock spending roughly $50M dollars of its own money.<span style=""> </span>Technically, it was Annaly that bought the stock but I am using FIDAC and Annaly interchangeably.<span style=""> </span>Having a large chunk of their own money invested along side fund investors is very common with hfunds and is a substantial advantage to shareholders as interest are perfectly aligned.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>The only unattractive aspect of this type of structure is one that is unavoidable and not unique to CIM.<span style=""> </span>Whenever investors hand money over to professional asset managers whether it’s to a stock broker, a hfund, a mutual fund, or a vehicle like CIM the asset manager always has higher incentive to take greater risks than warranted by the mandate.<span style=""> </span>The reason for this is simply that the career/financial benefits to a professional asset manger of taking big risks and being right are almost always much greater than the downside of being wrong.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>Every professional money manager knows that if they take unnecessary risks and underperform or even blow up they might get fired or will have to shut down their firm.<span style=""> </span>But professionals also know that if they get fired they can go hide out at a trust department or an insurance company somewhere.<span style=""> </span>If they really screw up, they might have to get out of the business for a couple of years.<span style=""> </span>But everyone knows that things will be forgotten in a few years and they will get another chance to manage money.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>But if the managers take the big risks and are right ....... they will become superstarts.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>For professional money mangers -- like the people that will be managing CIM --<span style=""> </span>taking big, unessasary risks is like buying a call option on your career.<span style=""> </span>If you are wrong you lose the small premium (maybe your job or some bonus money) but if you are right, you win big.<span style=""> </span>The problem for investors is that while the manager might lose a little they might lose a lot.<span style=""> </span></p> <p class="MsoNormal" style="text-align: justify;"><o:p></o:p>The incentive fee and having the manager’s money along side shareholders is there to minimize the negative aspect that can never be completely eliminated.<span style=""> </span>In subsequent posts I will also make the argument that looking at the track record of Annaly provides substantial evidence that this management team will be very good stewards of shareholder’s capital and CIM’s hedge fund like structure is a net benefit to shareholders.<br /><o:p><br /><br /></o:p><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0tag:blogger.com,1999:blog-5268148286569893964.post-74951259917757612682007-12-16T14:19:00.000-06:002007-12-16T14:32:07.098-06:00CIM (Chimera) – First LookI was initially introduced to this company at 3:00 pm on November 16<sup>th</sup>, 2007 when I was getting ready for a conference call and overheard one of the CNBC anchors say “Michael Farrell celebrates Chimera IPO by ringing the closing bell at the NYSE.”<span style=""> </span>At that point I have never heard of Chimera but I have certainly heard of Farrell and immediately downloaded Chimera’s S1.<span style=""> </span> <p class="MsoNormal"><o:p></o:p>This analysis will be a bit different than those in the past and I will spend less time talking about Chimera and more time talking about Michael Farrell and Annaly Capital Management which is Chimera’s parent and Farrell’s main investment vehicle.<br /><span style=""> </span></p> <p class="MsoNormal"><u>Currently:<o:p></o:p></u><br />Share price: <span style=""> </span><span style=""> </span>$15.25<br />Market Value:<span style=""> </span>$564M<span style=""></span><br /><st1:city st="on"><st1:place st="on">Enterprise</st1:place></st1:city> Value:<span style=""> </span>$520M (this is book value for CIM)<br />Investment Type:<span style=""> </span>Time Arbitrage</p> <p class="MsoNormal">CIM completed its IPO almost exactly 1 month ago on November 15, 2007.<span style=""> </span>Per the filling on the day of the IPO, CIM planned to sell 33.3M shares at $15 per share raising $500M with an additional 5M shares optioned for overallotments.<span style=""> </span>Off the $500M raised, $31.25M would be paid to the investment banks doing the IPO so CIM would received $14.0625 per share in actual proceeds.</p> <p class="MsoNormal">Based on the 11/30/07 13D filling, Annaly owns 3.62M shares representing 9.8% of total shares outstanding, a maximum percentage of shares outstanding allowed to be owned by any shareholder under this structure.<span style=""> </span>This implies that the final number of shares sold was 36.94M for a net proceeds after selling expenses of $520M.</p> <p class="MsoNormal">CIM is basically a publicly traded hedge fund managed by an asset management group called FIDAC which is led by Michael Farrell (Annaly technically owns FIDAC but the same people that manage FIDAC also manage Annaly).<span style=""> </span>The company is structured as a REIT which means at least 90% of its income will be paid out as dividends and virtually all of its investments will be real estate backed mortgage loans and structured products backed by mortgage loans.<span style=""> </span><br /><o:p> </o:p></p> <p class="MsoNormal">I will spend more time in the next post on the company’s business model and may do a quick primer on the basic accounting of mortgage REITs. </p> <p class="MsoNormal"><o:p> </o:p></p> <p class="MsoNormal" style="text-align: justify;"><i style=""><span style="color:black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span><span style="color:black;"><o:p></o:p></span></i></p>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com1tag:blogger.com,1999:blog-5268148286569893964.post-72800084370948488952007-12-11T18:21:00.000-06:002007-12-11T18:46:29.426-06:00Some real evidence of a slowdown .......<p class="MsoNormal">One of the drawbacks of working for a traditional institutional asset management firm with a decent amount of assets under management is that I get a ton of Wall Street research and I am expected to read most of it and regurgitated it to colleagues, clients and prospects.<span style=""> </span></p> <p class="MsoNormal"><o:p></o:p>Needless to say that reading this stuff gets old fast so I get particularly excited when something useful/interesting/contrarian comes across my desk.<span style=""> </span>Here is the most relevant excerpt from a recent morning note from Merrill Lynch <span style=""> </span>…..</p><br /> <p class="MsoNormal"><i>"Mr. Rosenberg, I have been reading your economic reports since your arrival at Merrill. Last night I began my evening by tuning into Kudlow on CNBC. The topic was as usual "Will the slowdown in the housing sector send us into a recession?" <br /></i></p><p class="MsoNormal"><i>With that topic on my mind I ended the evening with a group of High School students meeting with a local cement contractor. He began his career 20 years ago with one truck and a second mortgage for capital. He now has 85 trucks that cost $175,000 each and 100 employees with salaries of $40,000 to $100,000. Business has been good the last 20 years. We began asking questions: How is business going? We have some road contracts but the housing business has almost stopped. Will you be buying any trucks this year? No. Will you be hiring in the next 6 months? No. Is there a cement shortage? 2 years ago there was a shortage but no shortage now. How much fuel do you use each month? 20,000 gallons. How much do you spend on benefits and insurance? About $10,000 per employee. Other questions were asked and my conclusions were these. This small businessman will not be buying any trucks this year. His employees who love to buy their own large 4 wheel drive trucks will not be buying either. Less fuel will be bought. Less cement will be purchased. Less money will go into retirement plans. Less money to insurance providers. The only expense that was going up was the legal expense for liens on contractors not paying.<br /></i></p><p class="MsoNormal"><i>Looks like the housing recession is affecting more people than I thought."<o:p></o:p></i></p> <p class="MsoNormal"><i><o:p> </o:p></i><br /><o:p></o:p>I believe that this is relevant since it provides more evidence in two particular areas of interest to investors……</p> <p class="MsoNormal" style="margin-left: 0.5in; text-indent: -0.25in;"><o:p></o:p>1)<span style=""> </span>The housing market slowdown is decreasing the amount being spend by Americans in real time and not just because they can’t tap the equity in their home, and<br /></p><p class="MsoNormal" style="margin-left: 0.5in; text-indent: -0.25in;"><o:p></o:p><span style="">2)<span style="font-family: "Times New Roman"; font-style: normal; font-variant: normal; font-weight: normal; font-size: 7pt; line-height: normal; font-size-adjust: none; font-stretch: normal;"> </span></span><!--[endif]-->it says something when the most relevant piece of Wall Street research I have seen in some time (and I am not singling out Merrill who to their credit have been sounding this alarm for a while) is contributed by a reader.</p><br /><p class="MsoNormal" style="margin-left: 0.5in; text-indent: -0.25in;"></p><i style=""><span style="color: black;">*</span><b><span style="color: rgb(17, 17, 17);"> DISCLOSURE: </span></b><span style="color: rgb(17, 17, 17);">I or accounts I manage may be long or short any and/or all stocks mentioned in this post.<span style=""> </span>This is <span style="">not a recommendation to buy or sell any security. For informational and educational purposes only.</span></span></i>Off The Beaten Path Investments Forumhttp://www.blogger.com/profile/16407731296007582014noreply@blogger.com0