NOOF -- First Signs of Future Problems

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. 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.

So where is the problem?

Per the 10K, total Pay TV revenue in fy2007 grew by 9.5% while the number of households reached increased by 39%. 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.

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.

Clearly, one of the bullish aspects regarding NOOF at that time was the valuation. 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:

Market Value at $8.5 per share = $209
Enterprise Value = $181
Latest 12M FCF = $22 (EBITDA-Cash Tax-CAPEX)
EV / FCF = 8.2x

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.

* 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.

NOOF -- First Look

Share Price: $4.5
Market Value: $107M
Enterprise Value: $88
Investment Type: Value Investment

New Frontier Media, Inc (NOOF) is one of the largest distributors of adult entertainment (aka porno) through U.S. cable and satellite networks. The company estimates that it can reach almost 140 million households. Recently, NOOF has started creating its own erotic and mainstream content.

The company is made up of several business lines:

1) Pay TV (recently renamed “Transactional TV”) has historically been NOOF’s largest source of revenue and income. This business unit has provided content for cable/satellite operators either in the form of subscription channels or Video-On-Demand (VOD). 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.

2) Film Production is a new business segment for NOOF, created almost exactly two years ago when the company acquired MRG Entertainment. 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. NOOF paid $21.1M for MRG in an all cash transaction in February 2006.

3) The Internet Group does exactly what the name implies – sell porno on the internet—and is the smallest revenue and profit generator for NOOF. NOOF provides the large cable/satellite networks with new channels and selected content and splits the revenue generated based on negotiated rates. Growth comes mostly by adding new channels to current networks.

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%. The other side of that coin is that NOOF has very little bargaining power when renegotiating revenue splits with the network providers.

I purchased NOOF in 3 parts between June 2006 and May 2007 for an average cost basis of $9.09. 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. 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.

* 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.

Thornburg’s Pain will be Chimera’s Gain

Thornburg Mortgage (TMA) has declined from $3.56 two days ago to $1.65 today. The stock traded at $26 in May 2007. The company is in technical default and it appears to be heading towards an actual default.

Thornburg Mortgage has historically been one of the best managed mortgage REITs in the world. 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. The management is dedicated, transparent and has put their own money on the line by buying in the open market.

There is no better way to describe what is happening to TMA other than a Black Swan event. 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.

What is happening to TMA?

The market for non-agency paper is all but closed. Trades that are completed price these mortgages at lower and lower levels. 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. 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.

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).

It appears that one or more of TMA’s lenders got spooked. 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. JP Morgan may have dealt the fatal blow, putting the company into technical default and triggering a waterfall of other debt covenants. 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.

So how does all this effect CIM?

Well, for every seller forced at gun point to liquidate there is a buyer with cash and time. 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.

The short term price drop of CIM and other mortgage REITs does not change the thesis I laid out in these posts.

CIM is still managed by some of the smartest people in the business. They are still one of the only buyers in the market and can set their own price. They have only been in operation since November 2007 and still have a very small portfolio that was already bought at the discount. And now CIM is trading at below book value of $14.25.

I have added to my initial position in the “Best Ideas” portfolio as well as my personal accounts. I will continue to add to my position if the stock continues to fall.

* 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.

INFS -- Comments from the Conference Call

As I discussed in the previous post, INFS reporting their first operating profit was certainly better news than the alternative. However, while analysts were congratulating the CEO on “a great quarter” there were two statements made that seem extremely disconcerting to me.

First, the CEO enthusiastically pointed out that 80% of the company’s products have been refreshed over the last 2 quarters. 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.

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?

Q4:2007 ASP=$856 94K units shipped
Q3:2007 ASP=$882 85K units shipped
Q2:2007 ASP=$1,022 72K units shipped
Q1:2007 ASP=$853 91K units shipped
Q4:2006 ASP=$1,090 79K units shipped
Q3:2006 ASP=$1,097 74K units
Q2:2006 ASP=$1,162 84K units
Q1:2006 ASP=$1,191 94K units

The second comment that is making me lose sleep at night is the following:

“the projection market is fiercely competitive excluding a few notable segments has been commoditized. … We [InFocus] will be faster to market with new products and better price points.”

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. 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.

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. This is why I am not bullish on the long term prospects for my INFS shares.

So why am I still holding on to my position and buying more?

Despite the long term problems, I feel that INFS is trading at least 50% below liquidation value. And that’s just to good of a deal to pass up.

I am not particularly bullish on Las Vegas 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.


* 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.

INFS -- Operating Income Turns Positive

Last time I posted on INFS 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.”

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. 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.

INFS reported fourth quarter earnings last week and posted an operating profit for the first time since anyone alive can remember. 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. Since I did not cover the 3^rd quarter, I will cover both at the same time.

The financials broke down as follows:

Q3:2007 results
Revenue $76M -- down 7% YoY
GProfit 13.8
GMargin 18.2% -- vs. 16.3% in Q2, 10.9% in Q1, 12.7% in Q3:06
EBT $(3.56)
D&A 1.0 -- estimated number since no CF statement yet
EBITDA $(2.56)

Q4:2007 results
Revenue $81M -- down 3% YoY
GProfit 16.5
GMargin 20.4%
EBT $1.1 -- excluded $3.7M lease write-off charge
D&A 1.0 -- estimated number since no CF statement yet
EBITDA $2.1

Q4:2007 ASP=$856 94K units shipped
Q3:2007 ASP=$882 85K units shipped
Q2:2007 ASP=$1,022 72K units shipped
Q1:2007 ASP=$853 91K units shipped
Q4:2006 ASP=$1,090 79K units shipped
Q3:2006 ASP=$1,097 74K units
Q2:2006 ASP=$1,162 84K units
Q1:2006 ASP=$1,191 94K units

Operating expenses excluding the lease charge were $15.4M, which was the target set previously by management. Based on comments made on the conference call, investors should not expect any further significant improvements in gross margins and operating expenses.

The balance sheet continues to be a thing of beauty with $84M in cash and zero debt or $2.11 per share in cash. In addition to the cash on hand, INFS still has over $200M in NOL’s.

In this post 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. So a stock trading at $1.70 has approximately $3.50 in cash on hand and NOL’s. The company also has an intellectual property portfolio that maybe worth something.

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. INFS represents 2.75% of the “Best Ideas” portfolio at a cost basis of $2.03 per share. I will be increasing the weighting to 4% of the portfolio.

* 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.

CIM -- Taking a look under the hood ….

CIM released their first ever quarterly earnings report a few days ago. It appears that things are moving along and the company is ramping up its portfolio.

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:

Book Value $539M
Earning Assets @ 8x - 10x leverage -- $4.85B to $5.93B
(book value * leverage factor + book value)
Spread on Assets -- 130 bps
Net Interest Income -- $63M to $77M
Base Management Fee -- $9.4M (book value * 1.75%)
Incentive Fee* -- $7 to $9.8M (assume 3% LIBOR)
Core Earnings -- $47 to $58M
Estimated EPS -- $1.24 to $1.54
Yield at current price of $19 -- 6.5% to 8.1%

*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.

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. The next step will be to build the portfolio of the portfolio consisting of actual loans. The yield on raw loans should be higher and should help push the spread beyond 130 bps.

What is a realistic estimate for Core Earnings going forward?

I think looking at NLY is the first step in answering that question. NLY also reported earnings a few days ago and ended the quarter with spread of 99 bps. NLY is currently priced for that spread to increase.

I think its safe to assume that CIM will earn a higher spread than NLY, they already do. At a spread of 150 bps I get a current yield of 7.5% to 9.5% (P/E of 10x-13x). At 200 bps spread which is not unreasonable I get a yield of 10%-13% (P/E of 8x-10x).

I think at current levels CIM represents an attractive opportunity to earn a decent return on investment. If the stock were to sell off closer to book value of $14.26 the stock would become even more attractive.

I initiated a ½ percent position in the “Best Ideas” portfolio, and I will be raising this position to 2% after this earnings report.

* 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.

BOOT -- 4th Quarter Earning Analysis

When BOOT last reported earnings, I wrote that next time I will be watching for “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. I will also be watching the change in A/R relative to sales.”

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.

BOOT reported Q4 earning on Januray 29^th of 38c per share which is up 8% YoY however below the 40c per share analyst estimate and my 45c per share estimate.

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.

The work market continued to chug along with 8% top line growth and both gross and SG&A margins improved on a YoY basis. 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.

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. I believe the CEO’s is hinting that almost everything that was not sold in Oct/Nov is being sold in Dec/Jan. It was also announced that the company instituted a 3%-5% price increase across the board on its products in January.

Today, BOOT announced a special $1 per share dividend as well as its regular quarterly dividend to be paid March 18^th.

So, how attractive is the stock today? Here is how the numbers break down at ...

Market Value $89M
Cash on Hand $15M
Enterprise Value $74M

Estimated fcf over next 12 months $7.5M - $7.8M
Current Cash Yield 10% - 10.5%
Current Multiple 9.5x - 10x

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.

At the time of the Q3 report I also wrote that “I think a fair price to pay is somewhere between $17.5 to $20. I am not wildly excited about paying 13x-15x forward cash earnings but would allocate new money to this tock since you do get a growing company with growing margins and a fortress balance sheet.”

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. 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. 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.

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. As always I will be looking for margin trends and changes in inventory and A/R relative to sales.

* 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.