Buying Och-Ziff is really making a highly levered bet on partial recovery in asset prices, except with little downside, due to the management fees the company generates. From those fees alone company makes 30 cents a share, or is otherwise trading at 17x EPS. Now, assume a 10% return in 2010 (09 is written-off due to high watermarks, however they reset in 2010), far below funds performance in 04-07, and OZM suddently makes 1.30 a share, or is trading at 3.5x FWD P/E. A good asset managers used to trade at 2x P/E premium to the market (17x vs 15x for S&P 500). Now you can argue that tough times demand tougher multiples, and that OZM is too reliant on its captain, Daniel Ziff. I am prepared to concede both points, apply a 10x multiple to projected 2010 earnings and still get to $13 a share target price. That's still 150% return from current stock levels. Not bad.
The risks to the investment: 1) industry outflows naturally impacting a large player like Och-Ziff 2) fund underperfomance 3) departure of Daniel Ziff. The first one is likely in the short-term, as HF assets have sky-rocketed to 2TR in Q2 08, declined 15% due to combination of performance and redemptions and now sit at ~1.7TR. Likely hf will decline further. Fund has outperformed however -15% YTD vs -40% for S&P and redemptions have been fairly mild. Over the last 5 years fund generated 7% annualized returns vs flat S&P. And given that Daniel Ziff is only buying more shares, his abrupt departure would be suprising. Summary? Still a no brainer.
Monday, December 15, 2008
Sunday, November 2, 2008
We've been so lonely
It's been quiet on the blog these days, but this weekend I plunged in with renewed energy into the process of updating my portfolio. Several stocks that I would like to buy on Monday: Autoliv, Volcom, Cynosure, Expedia, Men's Warehouse, maybe Crane? Other things that look interesting: managed care stocks, but I have yet to finish reading the managed care report.
Lets start with Cynosure: it makes medical devices for aesthetics market. They have 8% share of the market that's growing at 20%+ driven by desire of everyone to look younger, and they have been outselling the competition. The company was founded 20 years ago, but the growth really took off in 2003-2004. El.En bought 60% of Cynosure in 2002 (Italian conglomerate with focus on light tech), currently holding 30% of the company. Why have they been selling???? They're the ones that manufacture the product, can they decide they're better off with doing it themselves.
The machines that the company manufacturers cost around $100K. Penetration among dermatologist is estimated to be high - around 75%. It's tricky to know if the buying will just fall off the cliff at one quarter, which is concievable. Hard to see stock declining much futher but I see how the stock can sit at current levels for a while. I'm passing
Lets start with Cynosure: it makes medical devices for aesthetics market. They have 8% share of the market that's growing at 20%+ driven by desire of everyone to look younger, and they have been outselling the competition. The company was founded 20 years ago, but the growth really took off in 2003-2004. El.En bought 60% of Cynosure in 2002 (Italian conglomerate with focus on light tech), currently holding 30% of the company. Why have they been selling???? They're the ones that manufacture the product, can they decide they're better off with doing it themselves.
The machines that the company manufacturers cost around $100K. Penetration among dermatologist is estimated to be high - around 75%. It's tricky to know if the buying will just fall off the cliff at one quarter, which is concievable. Hard to see stock declining much futher but I see how the stock can sit at current levels for a while. I'm passing
Thursday, September 4, 2008
Google - Ever reaching a $1000?
Not so long ago the stock was at $700, now it's a $450 and trading lower along with the entire stock market. Is it a steal at these levels? Lets see.
Google has been putting out a lot of cool products out there: google maps, gphone, new browser... But the financial story remains all about online advertising and its penetration which currently stands at 8%. The key questions are: 1) what will this level be globally and in the U.S. 2) what is the overall advertising growing at? 3) What is the consensus expectation for 08-10 growth and what will actually happen.
Addressing the long-term issues first. Advertising share of GDP has been pretty constant at 2.0-2.3% since 1980s, so ad just grows at GDP lines long-term (actually slight lag in the last couple of years, but lets consider that noise). The GDP growth is 3% real + 2% inflation, so lets 5% long-term for ad spend.
The penetration is 8% now. I've heard numbers up to 15% in the next five years, lets take 12% by 2013. Currently U.S. ad spend is projected to be $297B for 2008, at 5% that's $379 in 2013. Internet is projected to be $25B in 2008 (8.4% penetration), at 400bps increase that's $47B in 2013 or 14% CAGR. Sensitivity? Each 1% in penetration = 350bps of CAGR. Quite a bit.
Now to short-term questions. Historically advertising is a high-beta play on U.S. GDP - although the long-term growth for both is the same, ad spend has fallen in the last two recessions (-1.2% in 1991, - 6.5% in 2001). The effect is typically lagged by a year because the 2008 budgets a while ago so do not incorporate the new economic outlook. The analysts however expect the recession to not impact advertising very significantly this time. They're saying in 1991 companies cut budgets and chose to focus on value which was proved to be an error, while in 2001 the recession was corporation vs consumer based? Perhaps I buy the first argument but not the second - consumer trickles down to corporate eventually. I think a particulary vulnarable area is Internet advertising that dropped 12% in 2001 and 16% in 2002. The analyst would rebut this by saying the area is much more mature now, companies are convinced or internet value, and look at the latest number - 16% growth in q2 2008 (bernstein tracker) while overall market is down 2%. I partially agree with all this. At the same time, I fear that a lot of the businesses advertising online a inherently lower quality than those using TV for example (low entry cost), and they're the ones that get squeezed the most in the tough economies like this one. So I'm cautious on the outlook, and think the 2009 online growth will likely be around 8-10%, below expectations. This is below expectations and seemingly a recipe for the fallout in stocks.
As for Google itself, the company faces several issues that I think raise a pink flag for me: increasing acquisition costs (TAC) that may be offset by decreasing R&D spend but operating margin improvement expected by the analysts strikes me as too optimistic. Second there's the competition from MSFT/YHOO, and third is the rising capex.
Google has been putting out a lot of cool products out there: google maps, gphone, new browser... But the financial story remains all about online advertising and its penetration which currently stands at 8%. The key questions are: 1) what will this level be globally and in the U.S. 2) what is the overall advertising growing at? 3) What is the consensus expectation for 08-10 growth and what will actually happen.
Addressing the long-term issues first. Advertising share of GDP has been pretty constant at 2.0-2.3% since 1980s, so ad just grows at GDP lines long-term (actually slight lag in the last couple of years, but lets consider that noise). The GDP growth is 3% real + 2% inflation, so lets 5% long-term for ad spend.
The penetration is 8% now. I've heard numbers up to 15% in the next five years, lets take 12% by 2013. Currently U.S. ad spend is projected to be $297B for 2008, at 5% that's $379 in 2013. Internet is projected to be $25B in 2008 (8.4% penetration), at 400bps increase that's $47B in 2013 or 14% CAGR. Sensitivity? Each 1% in penetration = 350bps of CAGR. Quite a bit.
Now to short-term questions. Historically advertising is a high-beta play on U.S. GDP - although the long-term growth for both is the same, ad spend has fallen in the last two recessions (-1.2% in 1991, - 6.5% in 2001). The effect is typically lagged by a year because the 2008 budgets a while ago so do not incorporate the new economic outlook. The analysts however expect the recession to not impact advertising very significantly this time. They're saying in 1991 companies cut budgets and chose to focus on value which was proved to be an error, while in 2001 the recession was corporation vs consumer based? Perhaps I buy the first argument but not the second - consumer trickles down to corporate eventually. I think a particulary vulnarable area is Internet advertising that dropped 12% in 2001 and 16% in 2002. The analyst would rebut this by saying the area is much more mature now, companies are convinced or internet value, and look at the latest number - 16% growth in q2 2008 (bernstein tracker) while overall market is down 2%. I partially agree with all this. At the same time, I fear that a lot of the businesses advertising online a inherently lower quality than those using TV for example (low entry cost), and they're the ones that get squeezed the most in the tough economies like this one. So I'm cautious on the outlook, and think the 2009 online growth will likely be around 8-10%, below expectations. This is below expectations and seemingly a recipe for the fallout in stocks.
As for Google itself, the company faces several issues that I think raise a pink flag for me: increasing acquisition costs (TAC) that may be offset by decreasing R&D spend but operating margin improvement expected by the analysts strikes me as too optimistic. Second there's the competition from MSFT/YHOO, and third is the rising capex.
Tuesday, August 26, 2008
Lear Corp. - Bargain in the Scary Auto Sector
The industry is desperately flailing its arms and trying not to sink, but the stocks have sinked already and provide a great value pick here. A great value in particular is Lear - manufacturer of seating systems with 20% share of the global market ($12B revenue) and electrical distribution systems ($3B). North America is ~45% of sales, and overall sales are projected to decline 7-8% - 15% in North America and flat in RoW. The key question is really normalized profit. I say the margins on the business should be around 4-5%, plus given the history of chronic restructuring you should shave another $100M off cash flow, so you get to implied $500-$650M EBIT. Say x9 multiple, and we get to the most conservative range of $4.5B valuation (and $4B to be ultra conservative). That means backing out net current debt of $1.8B the equity should be value in the ultra conservative scenario at $2.2B, 120% upside from current levels. I say lets get rich and buy some stock.
Wow it's been a while
I suck at this continual post things. But lets try again. The idea of the day is, drumroll, uranium. To pick a particular stock, lets say we go with Cameco.
Background on the market. Nuclear energy currently accounts for 20% of all electricity consumed globally and it's produced by 439 reactors, with a high concentration in the U.S. (~100) and France. The actual growth in the number of reactors has been virtually nonexistent recently, however there are plans out there for significant capacity additions globally - 9 applications have been approved in the U.S. recently, while China has planned/proposed 80+ projects. The actual forecasts for growth in nuclear electricity generation vary widely, but 2-3% growth is in mid-range of most estimates. Now to uranium which you need to carry out a nuclear reaction. Current demand for uranium is ~167M lbs a year, with consumption far outstripping production primarily due to the drawn-down of HEU (highly enriched uranium) - weapons grade uranium small quantities of which can be converted to lots of pounds of mined equivalent. This balance has existed for a while - since 1985, but has to reverse in the next, hm, 20 years?
Quick primer on nuclear fission. There are two key isotopes (atoms with same # of protons but different of neutrons) of uranium - U235 and U238. Both are used in fission: process in which atom is struck by a particle, it then disintegrates into two lighter atoms sum of the mass of which is smaller than that of the original, and the lost mass is converted into energy. During the reaction another neutron is produced, which in turn strikes another U235 atom and so on...
What should the price of uranium be? Costs of production are 10-$20, long-term price by analysts ranges from $25 to 70, companies are saying it should be $90, who really knows?
The only reasonable analysis I can point is a cost curve by World nuclear Association saying that if the production climbs to levels of current consumption, marginal costs will be ~$40. Drop in another $20 required to incentivize exploration and you get closer proxy for long-term price. I personally believe it can climb much higher because of production/consumption imbalance, as the delays at Uranium One and Cameco have shown it's really hard to increase production.
Background on the market. Nuclear energy currently accounts for 20% of all electricity consumed globally and it's produced by 439 reactors, with a high concentration in the U.S. (~100) and France. The actual growth in the number of reactors has been virtually nonexistent recently, however there are plans out there for significant capacity additions globally - 9 applications have been approved in the U.S. recently, while China has planned/proposed 80+ projects. The actual forecasts for growth in nuclear electricity generation vary widely, but 2-3% growth is in mid-range of most estimates. Now to uranium which you need to carry out a nuclear reaction. Current demand for uranium is ~167M lbs a year, with consumption far outstripping production primarily due to the drawn-down of HEU (highly enriched uranium) - weapons grade uranium small quantities of which can be converted to lots of pounds of mined equivalent. This balance has existed for a while - since 1985, but has to reverse in the next, hm, 20 years?
Quick primer on nuclear fission. There are two key isotopes (atoms with same # of protons but different of neutrons) of uranium - U235 and U238. Both are used in fission: process in which atom is struck by a particle, it then disintegrates into two lighter atoms sum of the mass of which is smaller than that of the original, and the lost mass is converted into energy. During the reaction another neutron is produced, which in turn strikes another U235 atom and so on...
What should the price of uranium be? Costs of production are 10-$20, long-term price by analysts ranges from $25 to 70, companies are saying it should be $90, who really knows?
The only reasonable analysis I can point is a cost curve by World nuclear Association saying that if the production climbs to levels of current consumption, marginal costs will be ~$40. Drop in another $20 required to incentivize exploration and you get closer proxy for long-term price. I personally believe it can climb much higher because of production/consumption imbalance, as the delays at Uranium One and Cameco have shown it's really hard to increase production.
Tuesday, July 29, 2008
Halliburton - a mess to understand
Damn, it's been a while since I've posted something here, but at least my portfolio performance decided to reward my lack of effort - portfolio is up more that 15% this month alone!
In the next few entries I'll try to review several of TPG-Axon's long picks. Why TPG? Well, the reasons are not sophisticated: it's one of the more well-known names on the street, and second of all their portfolio selection looks interesting at the first glance. So without further adieu we move to...Halliburton. The name has a dirty connotations for most people on main street, but I actually have a pretty limited idea of what do aside from having suspect connections to Dick Cheney and it has something to do with oil servicing.
Industry. There are several big oil servicing players: Halliburton, Baker Hughes, Schlumberger, Weatherford. Halli has historically traded at a discount to others due to shady connections, asbestos settlement and lower international exposure.
Alright, I just read more about Halliburton. My conclusion is it's practically impossible to make a sound judgment on the business unless you spend a week analyzing it - there are too many moving pieces (what happens to us market, to international market, share) and not enough perspective return to compensate me for this mess.
In the next few entries I'll try to review several of TPG-Axon's long picks. Why TPG? Well, the reasons are not sophisticated: it's one of the more well-known names on the street, and second of all their portfolio selection looks interesting at the first glance. So without further adieu we move to...Halliburton. The name has a dirty connotations for most people on main street, but I actually have a pretty limited idea of what do aside from having suspect connections to Dick Cheney and it has something to do with oil servicing.
Industry. There are several big oil servicing players: Halliburton, Baker Hughes, Schlumberger, Weatherford. Halli has historically traded at a discount to others due to shady connections, asbestos settlement and lower international exposure.
Alright, I just read more about Halliburton. My conclusion is it's practically impossible to make a sound judgment on the business unless you spend a week analyzing it - there are too many moving pieces (what happens to us market, to international market, share) and not enough perspective return to compensate me for this mess.
Thursday, June 12, 2008
American Dental Partners - In honor of my parents
The stock looks too small for my liking - after sustaining heavy losses in my portfolio primarily in small names without ultra-strong competitive advantages, i'm vowing to follow Warren Buffet and only purchase companies with moats (at least small ones). If I followed that logic I would have stayed away from China 3c and Aircastle - two companies that are driving my overall performance hugely in the red. But, going back to ADPI, my parents are dentist hence i feel obligated to take a quick look at this one:)
ADPI is a management company affiliated with ~500 dentists. It takes control of the business aspects of the practice and aims to improve revenue/profitability.
Litigation. The stock has nicely and calmly been trading at ~20 level before one of largest ADPI affiliates decided to get out the contract and sue ADPI alleging certain breaches of contract. The companies settled, with PDG (affiliate name) liberating itself from ADPI. PDG accounted for ~$15M of EBITDA (~27% of total).
Business model. Company was formed in 1995, it operates as a partner to large dental groups, managing non-clinical aspects of the business (like owning equipment and facilities). The dental group itself manages all the doctor-related aspects of the operation. The key question: is ADPI simply a source of capital, or is there something value-added about the business. ADPI says it provides valuable services like IT systems, planning, recruiting, facility management, administration. This doesn't sound like nuclear physics, but certainly makes the doctor's like easier.
The company doesn't technically buy the practice (it can't legally), but rather signs 40-year service agrreement, and is paid a fee that's typically based on a percentage of revenues - expenses.
I think the model theoretically sounds pretty good. HOWEVER defection of the largest customer raises a big red flag in my mind - if they defected, is the service actually that valuable/why wouldn't other ones follow? I assume there are many other organization who can provide comparable offering, so overall I'd stay awaaaay.
Industry. Overall dental care has grown at 7% CAGR and is projected doing so going forward. Industry is dominated by solo practioners, that account for 64% of total 160K dentist working in the U.S.
ADPI is a management company affiliated with ~500 dentists. It takes control of the business aspects of the practice and aims to improve revenue/profitability.
Litigation. The stock has nicely and calmly been trading at ~20 level before one of largest ADPI affiliates decided to get out the contract and sue ADPI alleging certain breaches of contract. The companies settled, with PDG (affiliate name) liberating itself from ADPI. PDG accounted for ~$15M of EBITDA (~27% of total).
Business model. Company was formed in 1995, it operates as a partner to large dental groups, managing non-clinical aspects of the business (like owning equipment and facilities). The dental group itself manages all the doctor-related aspects of the operation. The key question: is ADPI simply a source of capital, or is there something value-added about the business. ADPI says it provides valuable services like IT systems, planning, recruiting, facility management, administration. This doesn't sound like nuclear physics, but certainly makes the doctor's like easier.
The company doesn't technically buy the practice (it can't legally), but rather signs 40-year service agrreement, and is paid a fee that's typically based on a percentage of revenues - expenses.
I think the model theoretically sounds pretty good. HOWEVER defection of the largest customer raises a big red flag in my mind - if they defected, is the service actually that valuable/why wouldn't other ones follow? I assume there are many other organization who can provide comparable offering, so overall I'd stay awaaaay.
Industry. Overall dental care has grown at 7% CAGR and is projected doing so going forward. Industry is dominated by solo practioners, that account for 64% of total 160K dentist working in the U.S.
Wednesday, June 4, 2008
IKON - Bad Industry at a Bad Price
IKON's main business is selling and servicing printers manufactured by, well, anyone else but IKON. It also has a 20% of sales business managing corporate office centers - if your company has a mini post office, that nice lady there is actually an employee of ICON. Why would manufacturers need IKON to sell their products? For large corporate accounts they actually don't, but there are thousands of small businesses out there that Canon and HP don't want to be bothered with and that's where IKON steps in.
The main issue with IKON is that paper usage has been declining, pressuring service segment revenues (the less people print, the less things break down), while equipment sales have been flat because of combination of competition & declining sales of B&W printers. The company has started to aggressively push color recently and the analysts expect/suspect this initiative to show results in 2008/2009.
Company is currently trading at ~9X EBITA. I just don't see why this should trade any higher, given low-single digit long-term growth prospects and margins close to flat/improving by 50bps or so. Maybe some OEM would want to buy it, but given this would arouse lots of yelling among other OEMs whose products IKON sells, the buyer would need to be very suicidal. Overall I expect the stock to languish around the same level where it is right now for a long while.
The main issue with IKON is that paper usage has been declining, pressuring service segment revenues (the less people print, the less things break down), while equipment sales have been flat because of combination of competition & declining sales of B&W printers. The company has started to aggressively push color recently and the analysts expect/suspect this initiative to show results in 2008/2009.
Company is currently trading at ~9X EBITA. I just don't see why this should trade any higher, given low-single digit long-term growth prospects and margins close to flat/improving by 50bps or so. Maybe some OEM would want to buy it, but given this would arouse lots of yelling among other OEMs whose products IKON sells, the buyer would need to be very suicidal. Overall I expect the stock to languish around the same level where it is right now for a long while.
Friday, May 30, 2008
Kaydon - Good Company, Bad Time
After deciding to post idea a day on the blog, I've failed to do so the very next one. Let's try for two ideas a week now:)
The stock of today - Kaydon (KDN ticker). I've heard Cramer touting it as a "wind power play", and decided to check it out. Knowing Cramer also said Trinity Industries is a wind play when the company has 70% of its sales tied to railroad industry, I was highly skeptical, but doesn't hurt to check it out.
Segments. 1) Velocity control products ($60M in sales, 28% EBITDA margin), shock absorbers
2) Sealing products ($46M), customized and standard rings and seals (20% margin)
3) Friction control - basically different bearings. For those who don't know, bearings are used to allow parts to rotate freely. So most rotating things have bearings in them. Kaydon manufactures bearings for big industrial applications - planes, marine, heavy equipment, wind turbines...
The actual bearing market is huge and in fragmented. SKF group (Sweden) has ~20% share, Timken has 10% share. Kaydon is tiny, however it is a leader within subsegments of the market like custom thin section bearings.
In terms of industry exposure, Kaydon has a good mix of products with 20% from Automation, 10% from power gen, 15% from military, 50% from other industrial sectors.
I actually like the company a lot because of its leadership position in its machine markets, expensive (presumably not super-easy to replicate) products that allowed the company historically to generate high margins.
Wind capacity currently stand at $100, projected to increase ~125M in 2009. Long-term outlook for that market is great, with around 15-20% growth. For every 1MW of wind power installed, one need a bearing worth ~$25K, so with 20GW capacity being added, the market is around $500M.
HOWEVER. The company is still 80% tied to U.S. industrial cycle. And what is happening to the industrial? Going down in flames. What's happening to the margins? Going down too. The valuation right now is simply too high at 14X EBIT to justify buying this at the top of the cycle. Maybe when the stock drop to ~30 I'll jump in.
The stock of today - Kaydon (KDN ticker). I've heard Cramer touting it as a "wind power play", and decided to check it out. Knowing Cramer also said Trinity Industries is a wind play when the company has 70% of its sales tied to railroad industry, I was highly skeptical, but doesn't hurt to check it out.
Segments. 1) Velocity control products ($60M in sales, 28% EBITDA margin), shock absorbers
2) Sealing products ($46M), customized and standard rings and seals (20% margin)
3) Friction control - basically different bearings. For those who don't know, bearings are used to allow parts to rotate freely. So most rotating things have bearings in them. Kaydon manufactures bearings for big industrial applications - planes, marine, heavy equipment, wind turbines...
The actual bearing market is huge and in fragmented. SKF group (Sweden) has ~20% share, Timken has 10% share. Kaydon is tiny, however it is a leader within subsegments of the market like custom thin section bearings.
In terms of industry exposure, Kaydon has a good mix of products with 20% from Automation, 10% from power gen, 15% from military, 50% from other industrial sectors.
I actually like the company a lot because of its leadership position in its machine markets, expensive (presumably not super-easy to replicate) products that allowed the company historically to generate high margins.
Wind capacity currently stand at $100, projected to increase ~125M in 2009. Long-term outlook for that market is great, with around 15-20% growth. For every 1MW of wind power installed, one need a bearing worth ~$25K, so with 20GW capacity being added, the market is around $500M.
HOWEVER. The company is still 80% tied to U.S. industrial cycle. And what is happening to the industrial? Going down in flames. What's happening to the margins? Going down too. The valuation right now is simply too high at 14X EBIT to justify buying this at the top of the cycle. Maybe when the stock drop to ~30 I'll jump in.
Wednesday, May 28, 2008
Short Idea of the Day - ABB (ABBN ticker)
I'll attempt to devote 10-15 minutes each day to writing out at least one long/short idea. Probably the quality will not be great given the limited research time, but we'll see how it works out.
ABB is a good company that has gotten way ahead of itself in terms of growth and, more importantly, margins. The company generates 4B CHF in profits a year, and yet only has to spend 700M on Capex. I would believe that (maybe) if ABB was a far and away leader in its core markets, however it's not. In transmission and distribution it is the leading players, however it only has 15-20% share of the market. What's the implication? The products are probably not-so differentiated, and improved profitability is driven by capacity utilization rather than uniqueness. Hence in decreasing capacity utilization times (like recession) profitability will drop.
Quick look at the divisions.
Power Products. High and medium voltage products sold primary to utilities, but also a bit to commercial customers. $9.8B in revenues
Power Systems. Substantions, power converters, advanced cables and systems for power plant control. Division generated $5.8B in revenues in 2007
Automation Products. Switchgears, breakers, switches, generators, wiring, power electronics systems, mostly for industrial clients. $8.6B in revenues.
Process Automation. Process control systems. These can be devices that record/display the temperature or more complex-looking machines with multiple data display functionality. $6.4B
Robotics. The coolest sounding and also the smallest, only $1.4B
Valuation. I think just normalizing the margins to 6-7% (2B EBIT), then applying 10-11x multiple, gives you the intrinsic value of less than half current price. I think in 2009 this baby will start dropping like its hot.
ABB is a good company that has gotten way ahead of itself in terms of growth and, more importantly, margins. The company generates 4B CHF in profits a year, and yet only has to spend 700M on Capex. I would believe that (maybe) if ABB was a far and away leader in its core markets, however it's not. In transmission and distribution it is the leading players, however it only has 15-20% share of the market. What's the implication? The products are probably not-so differentiated, and improved profitability is driven by capacity utilization rather than uniqueness. Hence in decreasing capacity utilization times (like recession) profitability will drop.
Quick look at the divisions.
Power Products. High and medium voltage products sold primary to utilities, but also a bit to commercial customers. $9.8B in revenues
Power Systems. Substantions, power converters, advanced cables and systems for power plant control. Division generated $5.8B in revenues in 2007
Automation Products. Switchgears, breakers, switches, generators, wiring, power electronics systems, mostly for industrial clients. $8.6B in revenues.
Process Automation. Process control systems. These can be devices that record/display the temperature or more complex-looking machines with multiple data display functionality. $6.4B
Robotics. The coolest sounding and also the smallest, only $1.4B
Valuation. I think just normalizing the margins to 6-7% (2B EBIT), then applying 10-11x multiple, gives you the intrinsic value of less than half current price. I think in 2009 this baby will start dropping like its hot.
Tuesday, May 27, 2008
General Cable - Time to Sell
General Cable, as the name subtly suggest, manufactures cable. Cable for what? All sorts of industries really, key segments being electric utilities, industrial, construction and communication.
The company has been able to grow its revenue tremendously from from $2.8B to $5.0B (with a lot of the growth driven by raw material price increases), but, more importantly, has grown EBITDA margins from 2.9% to 8.8%. The outcome is a stratospheric price performance of the stock which went from $4 in 2002 to $70 recently. The general sentiment surrounding the stock is very bullish. It's labeled as a 'global infrastructure play', and is trading at a healthy 11x EBITDA multiple. Let's see whether this is warranted or not.
Business Description. Co
- Electric Utilities constitute 35% of sales
- Infrastructure (aka varied industrial projects) constitutes 25% of sales
- Construction (25% of sales)
- Communications (14%) of sales
Industry Overview. Global cable industry is $160B market, that historically has grown at GDP like rates. The largest players are
Bull Case. U.S. and Europe have old power transmission and distribution infrastructure that has been primarily built in 70s, hence is in dire need of repair. As a result, spend on T&D is climbing, with Edison Institute projecting increases from $8B in 2007 to $11B in 2007. Similar trend should play out in Europe, and General Cable should be a beneficiary of this. Additionally, company participates in fast-growing segments like umbilical cables (nice name, I know), which are used to transport power/liquids to offshore oil&gas location. Offshore production is projecting to grow strongly, and General Cable, again, benefits. Company also has exposure to incredibly fast-growing Asian markets.
Bear Case. Confessing right away, this is the side I'm on. And honestly I was on it right after looking at the company long-term financials. The margins and returns on capital look simply too good to be true for this ultra-competitive industry where vast majority of products are barely differentiated. (Note: vast majority, not all. Company may tout it's acquisitions all it wants and it's a very good strategy, but the truth remains that these high-tech products are a fraction of the revenues). The industry has benefited from high utilization rates that have propelled the pricing upwards, thus benefitting the margins. Where does company derive most of its revenue from? North American and European general industrial and construction markets. And in recession general industrial activity drops off, driving down utilization and sending margins off the cliff. The latest manufacturing data for April shows the first significant decrease in utilization, but that's only the beginning. I expect EBIT margins on all non-energy infrastructure segments to fall down to 2-3% by end of 2009, while the energy infrastructure will continue to do OK, growing at 4-5% with flattish margins. As a result look for EBITDA to decline by at least 50%, and the stock by even more than that.
The company has been able to grow its revenue tremendously from from $2.8B to $5.0B (with a lot of the growth driven by raw material price increases), but, more importantly, has grown EBITDA margins from 2.9% to 8.8%. The outcome is a stratospheric price performance of the stock which went from $4 in 2002 to $70 recently. The general sentiment surrounding the stock is very bullish. It's labeled as a 'global infrastructure play', and is trading at a healthy 11x EBITDA multiple. Let's see whether this is warranted or not.
Business Description. Co
- Electric Utilities constitute 35% of sales
- Infrastructure (aka varied industrial projects) constitutes 25% of sales
- Construction (25% of sales)
- Communications (14%) of sales
Industry Overview. Global cable industry is $160B market, that historically has grown at GDP like rates. The largest players are
Bull Case. U.S. and Europe have old power transmission and distribution infrastructure that has been primarily built in 70s, hence is in dire need of repair. As a result, spend on T&D is climbing, with Edison Institute projecting increases from $8B in 2007 to $11B in 2007. Similar trend should play out in Europe, and General Cable should be a beneficiary of this. Additionally, company participates in fast-growing segments like umbilical cables (nice name, I know), which are used to transport power/liquids to offshore oil&gas location. Offshore production is projecting to grow strongly, and General Cable, again, benefits. Company also has exposure to incredibly fast-growing Asian markets.
Bear Case. Confessing right away, this is the side I'm on. And honestly I was on it right after looking at the company long-term financials. The margins and returns on capital look simply too good to be true for this ultra-competitive industry where vast majority of products are barely differentiated. (Note: vast majority, not all. Company may tout it's acquisitions all it wants and it's a very good strategy, but the truth remains that these high-tech products are a fraction of the revenues). The industry has benefited from high utilization rates that have propelled the pricing upwards, thus benefitting the margins. Where does company derive most of its revenue from? North American and European general industrial and construction markets. And in recession general industrial activity drops off, driving down utilization and sending margins off the cliff. The latest manufacturing data for April shows the first significant decrease in utilization, but that's only the beginning. I expect EBIT margins on all non-energy infrastructure segments to fall down to 2-3% by end of 2009, while the energy infrastructure will continue to do OK, growing at 4-5% with flattish margins. As a result look for EBITDA to decline by at least 50%, and the stock by even more than that.
Tuesday, April 29, 2008
UK Homebuilders - Time to Get Aggressive
It's no big secret that most developed countries were caught up in a housing bubble recently, with U.S. leading the burst, but many others following close by. The UK market is now among those showing signs of strain with housing prices down 2.5% in March and largest homebuilder reporting 24% decline in revenues, blaming the sudden evaporation of mortgages. The homebuilder stocks plunged further on the news, most are now down to multi-year lows. While I'm bearish on the housing prices and macro outlook in general, I believe that stocks in the sector have already priced in all the possible bad news and are trading far below intrinsic value, similar to the bargain levels U.S. homebuilders were trading at 6 month ago before rallying 50%+. There may not be good news to come for a while, and the stocks may come under further pressure, however I don't recommend bottom-fishing: when you see a bargain, seize it.
UK market overview and U.S. perspective
Prices. Similar to the U.S., UK experienced rapid price appreciation recently. According to Hallifax, new home price has increased from 72K pounds in 1990 to 196K in Q1 2008 - almost 3x. This increase is even higher than the one in the U.S., where average price went up from $151K in 1990 to $292K in 2007.
How much is the market overvalued by? One source is July 07 Fitch report which estimates that U.K. housing is overpriced by 20%. Applying a quick back-of-the-enveloped methodology gives a much more drastic potential for the downside: current average house price is~6 times the income of an average household, with historical average being 3-4x, which would imply that the housing prices should go down 50% to get in line with historical averages. Given the current low interest rate environment though I suspect the Fitch figure is closer to real downside, which is approximately what the analysts are now expecting in the U.S. as well.
Volumes. Here U.K. is in much better shape than U.S. The U.K private starts were 139K in 2006, compared to 119K in 2000, 17% increase, but down from 159K in 1989. Each year U.K adds 180K of households, so household formation alone, at ~70% home ownership rate, 70%x180=126K units a year. Add replacement on top, and you see that there was little to no overbuild in the U.K. Volumes are falling down this year, but that is caused by the bank tightening screws on mortgage lending due to their bleeding balance sheets, not because of oversupply of homes. Analyst expect 25% volume decline in 2008, with modest recovery in 2009. I expect that by 2011 overall volumes should get back to 2007 levels.
While the entire sector is poised to rally, I like Barratt's potential the most. The company is UKs largest homebuilder with 12% share of the market. Stock is down from 12 to 2.85 yesterday, with the company now trading at 0.3X Book. Investors have punished Barratt even more than most other players due to 1.75B debt on company's balance sheet, most of which was accumulated after acquiring Wilson Bowden, another UK developer. However the market seems to forget about 5B of inventory sitting on Barratt's books. Most of that inventory is not in already started projects that Barratt may be forced to dump at firesale prices, but in land acquisitions which are significantly more liquid. Even so, in declining market the inventory warrants a discount: applying a 20% cut to it reduces current 2.9B of shareholder equity to 1.9B. That's vs current market cap of 900M, or more than 100% potential return.
Friday, April 25, 2008
Airlines - Jump in When Outlook Is Bleakest
6 months ago I was going to start purchasing the homebuilder stocks, but was finally swayed by all the "experts" saying how things are only going to get worse from there, with further reductions in inventory revenues and precipitous drops in sales. I factored all those things in and still stocks seemed to very cheap both given their earnings potential and p/book values. Result? Most players since then are up 50%. Should have listened to Warren Buffet: is just next to impossible to time the market, you should just buy the stocks when they are selling far below intrinsic value and eventually they'll get back to it.
I think currently the airlines are selling far below what they're worth intrinsically. The combination of rising oil prices and weakening macro have created a tremendous pressure on profitability, leading to for every airline, and as a result all major U.S. airlines have lost up to 70% of their values. The current valuation levels seem to assume that the airline profitability will never recover to normative levels, with the permanent high oil prices and intense competition eating away all the profits. I meanwhile happen to believe that the industry's management is not masochistic, and likes to earn some acceptable level of return over the long run, even though that return may gyrate wildly year over year. What should this return be? Take Continental. The company has $6B worth of planes. These planes better make 12% a year in EBIT or why the heck do they own them? 12%x6=720M. On revenue of $14B, that's 5% operating margin. Multiply that by 10x, not outrageous multiple, and you get what I think is a fair EV for Continental, compared to the current $4B. Or otherwise, the equity should be worth $3B more than right now, or ~57 a share. While this whopping 235% return will not materialize anytime soon, I think that at least 100% should be attainable within two years. Buckle your seatbelt though.
I think currently the airlines are selling far below what they're worth intrinsically. The combination of rising oil prices and weakening macro have created a tremendous pressure on profitability, leading to for every airline, and as a result all major U.S. airlines have lost up to 70% of their values. The current valuation levels seem to assume that the airline profitability will never recover to normative levels, with the permanent high oil prices and intense competition eating away all the profits. I meanwhile happen to believe that the industry's management is not masochistic, and likes to earn some acceptable level of return over the long run, even though that return may gyrate wildly year over year. What should this return be? Take Continental. The company has $6B worth of planes. These planes better make 12% a year in EBIT or why the heck do they own them? 12%x6=720M. On revenue of $14B, that's 5% operating margin. Multiply that by 10x, not outrageous multiple, and you get what I think is a fair EV for Continental, compared to the current $4B. Or otherwise, the equity should be worth $3B more than right now, or ~57 a share. While this whopping 235% return will not materialize anytime soon, I think that at least 100% should be attainable within two years. Buckle your seatbelt though.
Thursday, April 17, 2008
Men's Warehouse - Are we liking the way they look?
I've decided to throw in some bad puns into the blog. Thankfully no one is paying attention anyway. 800 retail location selling suits + 450 tuxedo rental stores. The tuxedo rental business has been acquired in 2007 from Federated, and the After Hours brand has been repainted to MW Tux. The retail locations are operated under MW name (600 locations) and K&G (100) which caters to lower income consumer. Another 100 locations are in Canada operating under Moores name.
The company prides itself on having prices that are 20-30% below those in department stores. It sources ~40% of its merchandise directly, principally from Asia.
Average store economics. Retail location is 5.7K sq feet on average, MW Tux is much smaller, 1.3K, while K&G is much larger, 23K. Net sales per sq foot are 478 for MW and 220 for K&G. Comps have been tough recently, especially for K&G which declined 10%. Each MW location thus sells 5.7K x 480 = 2.6M., with almost 50% gross margin. SG&A is another 35% of sales. SG&A has grown as % of sales recently due to acquisition of After Hours which brought along 8 additional distribution facilities and also increase in salaries.
Future prospects. Management historically has rolled out stores aggressively, however 600 U.S. locations seems to be the cap. For 2007, company has opened 42 stores, in 2008 plans are to open 20 new MW stores, 22 Tux and 3 K&G. Assuming average store productivity, that's around 3% revenue growth. I expect comps to very tough - just look at the previous downturn and you'll see 10% decline. Making quick back of the envelope, assuming only 50% of SG&A is variable, you get ~20% decline in EPS. Take a more gloomy view, the gross margin will not stay flat as % of sales but will actually decline several percent, while SG&A will stay flat, and then you'll get ~30% decline.
Ok, now having written this I actually checked the most recent press releases, same store sales for Q4 and analyst commentary, and behold, the earnings are actually projected to fall 30%, and the traffic trends are down 7-8% already.
Valuation. Currently trading at 24 a share, or 12X 08 EPS. For a company with 5-6% growth prospects (2-3% sq footage growth, and 2-3% comps), 14X EPS feels like the right number. We can assume the EPS will revert back to 2.5 in 2009-2010, in which case the stock should be worth $35. Right now the risk reward is not overly compelling, but if the price dips below 20 again, I'd be a buyer.
The company prides itself on having prices that are 20-30% below those in department stores. It sources ~40% of its merchandise directly, principally from Asia.
Average store economics. Retail location is 5.7K sq feet on average, MW Tux is much smaller, 1.3K, while K&G is much larger, 23K. Net sales per sq foot are 478 for MW and 220 for K&G. Comps have been tough recently, especially for K&G which declined 10%. Each MW location thus sells 5.7K x 480 = 2.6M., with almost 50% gross margin. SG&A is another 35% of sales. SG&A has grown as % of sales recently due to acquisition of After Hours which brought along 8 additional distribution facilities and also increase in salaries.
Future prospects. Management historically has rolled out stores aggressively, however 600 U.S. locations seems to be the cap. For 2007, company has opened 42 stores, in 2008 plans are to open 20 new MW stores, 22 Tux and 3 K&G. Assuming average store productivity, that's around 3% revenue growth. I expect comps to very tough - just look at the previous downturn and you'll see 10% decline. Making quick back of the envelope, assuming only 50% of SG&A is variable, you get ~20% decline in EPS. Take a more gloomy view, the gross margin will not stay flat as % of sales but will actually decline several percent, while SG&A will stay flat, and then you'll get ~30% decline.
Ok, now having written this I actually checked the most recent press releases, same store sales for Q4 and analyst commentary, and behold, the earnings are actually projected to fall 30%, and the traffic trends are down 7-8% already.
Valuation. Currently trading at 24 a share, or 12X 08 EPS. For a company with 5-6% growth prospects (2-3% sq footage growth, and 2-3% comps), 14X EPS feels like the right number. We can assume the EPS will revert back to 2.5 in 2009-2010, in which case the stock should be worth $35. Right now the risk reward is not overly compelling, but if the price dips below 20 again, I'd be a buyer.
Tuesday, April 15, 2008
Genesis Lease - Lets repeat Aircastle's story
Genesis Lease was formed in 2006 after acquiring 41 plane from GE affiliate, and has so far expanded its portfolio to 53 planes. Fleet is even newer than Aircastle's (6 years average age), customers are airlines outside NA (which only accounts for 15% of revenues), only 5 leases are coming up for renegotiation in 08-08, and distributable cash flow is $2 per share. Current stock price? $11, implying 20+% yield. Only recently it has been trading in mid 20s. The only culprit here is investor panick, as U.S. recession is inducing fears that global recession is imminent, which will bring about collapse of all airlines and with them - the lessors. This negative outlook brings you an opportunity to buy the stock that I expect to generate 100% return over the next two years. I don't like the taste of my own words so lets hope I don't have to eat them.
And from Silgan we move to another packager, Crown Holdings. Different from Silgan in the fact that it is a) bigger ($8B in sales) b) much more international with the U.S. accounting for only 30% of sales c) operates in . Similar to Silgan, a lot of recent growth has come from acquisitions, as Crown grew from 2B in 89 to 8B in 97. And now we present the business segments:
Beverage Cans and Ends. $3B in revenues, aluminum beverage cans are sold to beverage and beer companies like Coke and Heineken.
Food Cans and Closures. $2.5B in revenues. In North America holds #3 position behind Silgan, but the fundamental business is the same.
Aerosol Cans. 25% share in the U.S. behind Ball's 45% share, produces aerosol cans for Unilever and P&G
Beverage industry. 230B of beverage cans are shipped worldwide, with U.S. accounting for almost 50%. Global growth is 1-2%, as some regions like Asia and South America are growing high-single digits, while U.S. is flat to slightly negative. Crown has 20% share of the U.S. market, behind Ball's 30%. Chinese market, as always, offers pretty good potential, but is currently only 10B cans vs 100B in U.S., Crown holds a 25% share.
Food industry. Crown has 20% in the U.S., where the market has been flat since 1990.
Aerosol market. 4B containers in the U.S. (10 per person a year vs 300 beverage containers. do we really drink a bottle of beer a day??). Crown holds 25% share.
Financials. Historical EBIT margins have been around 8% in the last three years and I don't see it changing much over time. Revenue growth? 4-6%, probably 2-3% in the U.S. and a bit faster in other geographies. I see no fireworks happening for the company, with the stock currently trading at 10x 08 EBIT, it is at exactly the same valuation level as Silgan, and I suspect their price movements will track each other pretty closely. Hm, maybe I'll just stop looking at this packaging sector, way too boring so far.
Beverage Cans and Ends. $3B in revenues, aluminum beverage cans are sold to beverage and beer companies like Coke and Heineken.
Food Cans and Closures. $2.5B in revenues. In North America holds #3 position behind Silgan, but the fundamental business is the same.
Aerosol Cans. 25% share in the U.S. behind Ball's 45% share, produces aerosol cans for Unilever and P&G
Beverage industry. 230B of beverage cans are shipped worldwide, with U.S. accounting for almost 50%. Global growth is 1-2%, as some regions like Asia and South America are growing high-single digits, while U.S. is flat to slightly negative. Crown has 20% share of the U.S. market, behind Ball's 30%. Chinese market, as always, offers pretty good potential, but is currently only 10B cans vs 100B in U.S., Crown holds a 25% share.
Food industry. Crown has 20% in the U.S., where the market has been flat since 1990.
Aerosol market. 4B containers in the U.S. (10 per person a year vs 300 beverage containers. do we really drink a bottle of beer a day??). Crown holds 25% share.
Financials. Historical EBIT margins have been around 8% in the last three years and I don't see it changing much over time. Revenue growth? 4-6%, probably 2-3% in the U.S. and a bit faster in other geographies. I see no fireworks happening for the company, with the stock currently trading at 10x 08 EBIT, it is at exactly the same valuation level as Silgan, and I suspect their price movements will track each other pretty closely. Hm, maybe I'll just stop looking at this packaging sector, way too boring so far.
Monday, April 14, 2008
Silgan Holdings is a packaging company with $3B in sales selling metal containers for pet/homo sapiens food, misc plastic containers and vacuum closures. The company was formed in 1987 through acquiring of Nestle's Segments and continued the acquisition strategy up to this day, which explains the heavy amount of debt on its balance sheet.
Metal food containers. $1.7B sales, $151M operating income. Steel and aluminum containers that are primarily used for soups, vegetables, fruit, meat and pet food. The market for metal containers has been flat historically however Silgan has grown through increasing its share from 10% in 87 to 50% now. 90% of sales are through long-term supply agreements.
Plastic containers. $600M in sales. Custom designed containers for personal and health care, including containers for shampoos, cleaning products and tablets. Market is highly fragmented and company intends to pursue additional acquisitions in the sector.
Closures. Leading global manufacturer of closures with $615M in sales, business formed through acquiring U.S. White Cap operations in 2003 and then international operations in 2007. Products include metal, composite and vacuum closures for food and beverage products like juices, salsa, soups.
Top 3 customers of the company are Campbell, Nestle and Del Monte that account respectively 12%, 11 and 11% of total sales. With Nestle for example, Silgan supplies 100% of total U.S food container requirements under long-term contracts with pricing adjustable based on input costs. Because of high costs of transporting containers, manufacturing is typically located within 300 miles of customer plants. Many customers, localized market leads to a lot of plants => Silgan has 69 manufacturing locations.
Industry. Throughout the last twenty years food manufacturers chose to focus their efforts on core business, divesting packaging arms that have been gobbled up by the likes of Silgan.
Return on capital and growth prospects? You can cans out of metal, which is, lets face it, no rocket science. Hence you expect you returns on capital to be around the cost of equity of ~11-13%. So what are they? Net PP&E is $940M, inventory is $420M, AP is close to AR, capital is ~$1400, while EBIT is $264M x .65% = $171M, which gives us 12%. Bingo. How will this business grow? Probably close to GDP, maybe slightly below. I ran a quick cash flow valuation assuming 12% discount rate and got the equity value of ~$1.4B, that is slightly below the current valuation. Conclusion? No upside, so I'm staying away from the shares that can only get pressured as the economy slows down further.
Metal food containers. $1.7B sales, $151M operating income. Steel and aluminum containers that are primarily used for soups, vegetables, fruit, meat and pet food. The market for metal containers has been flat historically however Silgan has grown through increasing its share from 10% in 87 to 50% now. 90% of sales are through long-term supply agreements.
Plastic containers. $600M in sales. Custom designed containers for personal and health care, including containers for shampoos, cleaning products and tablets. Market is highly fragmented and company intends to pursue additional acquisitions in the sector.
Closures. Leading global manufacturer of closures with $615M in sales, business formed through acquiring U.S. White Cap operations in 2003 and then international operations in 2007. Products include metal, composite and vacuum closures for food and beverage products like juices, salsa, soups.
Top 3 customers of the company are Campbell, Nestle and Del Monte that account respectively 12%, 11 and 11% of total sales. With Nestle for example, Silgan supplies 100% of total U.S food container requirements under long-term contracts with pricing adjustable based on input costs. Because of high costs of transporting containers, manufacturing is typically located within 300 miles of customer plants. Many customers, localized market leads to a lot of plants => Silgan has 69 manufacturing locations.
Industry. Throughout the last twenty years food manufacturers chose to focus their efforts on core business, divesting packaging arms that have been gobbled up by the likes of Silgan.
Return on capital and growth prospects? You can cans out of metal, which is, lets face it, no rocket science. Hence you expect you returns on capital to be around the cost of equity of ~11-13%. So what are they? Net PP&E is $940M, inventory is $420M, AP is close to AR, capital is ~$1400, while EBIT is $264M x .65% = $171M, which gives us 12%. Bingo. How will this business grow? Probably close to GDP, maybe slightly below. I ran a quick cash flow valuation assuming 12% discount rate and got the equity value of ~$1.4B, that is slightly below the current valuation. Conclusion? No upside, so I'm staying away from the shares that can only get pressured as the economy slows down further.
Tuesday, March 25, 2008
NCR - Leader in payment solutions at a discounted price, but near-term catalyst invisible
NCR stock has been hammered recently along with anything else financial-related. While the CDO, CLO and WFO abbreviations are not lurking in the company's balance sheet, the revenue for the company is expected to hurt in 2008 as its main customers, banks, cut on their capex in an attempt to hoard some cash. This fear has driven a stock down to $24 a share from $50 high, which presents a good buying opportunity, although it might be some time before it bounces back to $50: having not reacted to the news of UTX bid for Diebold, there are no other evident short-term catalysts.
Company Overview. NCR (originally National Cash Register) is in business of manufacturing and servicing payment solutions like ATMs and self-service counters. It also used to run a Data Warehousing Business (Teradata) that was spinned off in September 2007, so the company is now a payment-only beast. What does revenue look like by division?
Segment Overview. Financial SelfService (ATMs) - $1.6B, 13% operating margin. Revenue has increased 15% in 2007, 11% netting out currency benefit. Growth has primarily been driven by Europe and Asia, U.S. is flattish at this point. Revenue growth was 2% in 2006, not nearly as great, driven by lower international growth.
Retail Store Automation. (POS terminals, bar-code scanners, self-service tech). $1B in revenue, 13% growth in 2007, 10% on constant currency basis, 20% growth in self-service counters. Self-service now is ~30% of segment sales, and has higher margin, which should positively affect the margins for the segment, which are currently only 4%.
Customer Services. Support for NCR and 3rd party products, $2B in revenue, 7% margin, 7% 06-07 growth (4% on constant currency).
Systemedia. Printer consumables and products including paper rolls for ATMs. $455M in sales with paltry 3% margins. Admittedly this one does sound like a bad business, just like anything having to do with paper. Revenue has declined 3% last year and this trajectory will probably continue.
Payment & Imaging. Check processing hardware and software. Checks are on the decline, and so is this business, only 3% margins and negative 8% growth 06-07.
Geography: Mix is rather favorable, Americas are 46% of sales, EMEA 36%, Japan 7% and Asia 11%. Asia and EMEA are two high growing segment, 11% and 8% growth last year in constant currency while Americas and Japan are flat.
Overall 2007 P&L looks as follows:
Revenue: 4.970B
COGS: 3.930
(however 70M are in restructuring charges)
Gross Profit: 1.050B (1.11 w/o restructuring)
SG&A:684M (8 in restructuring)
R&D: 137M (2% of revenues)
Income from Operations: 219M
(including other income): 232M (~310 w/o restructuring)
Tax: 61M
Net Income: 171M
Industry. NCR is the leading provider of ATMs globally with ~40% share of the market. Diebold is #2 with 35%, Wincor is #3 players. In the U.S. NCR and Diebold hold a commanding position with Wincor making inroads, in Europe the situation is somewhat reversed. Penetration in all global regions is low compared to the U.S.: 1300 ATMs per million people in U.S. vs 700 in Europe vs 60 in China. The penetration story in the developing world should allow NCR to have 10%+ growth in its EMEA and Asia segments for some time.
Self-checkout is also a penetration story: only 5% of all retail transactions in the U.S. are self-checkout, however some retailers like HD that aggressively push the initiative have 40%+ penetration, implying large room for growth.
What 2008-2009 holds. Management guided 3-5% revenue growth in 2008, and 2009 will probably be similar. What will happen to margins? Right now excluding all the restructuring expenses they're 6.3%. Given company leadership in the industry and strong competitive moat (huge installed base of devices), long-term margins should improve to 8%, which would result in around $1.8EPS given current revenues. However this expansion will have to wait a bit, as short-term margins probably will stay close to flat/decline slightly driven by weaker U.S. markets. All in all, expect EPS ~$1.5 in 2008, with EPS increasing to $1.8-2 in 2010, growth rebounding to healthy 7-8%. Assuming NCR, as the leader in its industry with attractive long-term growth prospects, should trade at 16-17x EPS multiple, slight premium to the market, the shares should go towards $30-35 range. Current price level provides a decent entry point, but it's even better if you're able to accumulate on any pullbacks towards $20, potentially driven by overall market weakness or not-so-great short term company results.
Risk: Prolonged financial industry downturn in the U.S. forces a multi-year pullback on capital spending
Company Overview. NCR (originally National Cash Register) is in business of manufacturing and servicing payment solutions like ATMs and self-service counters. It also used to run a Data Warehousing Business (Teradata) that was spinned off in September 2007, so the company is now a payment-only beast. What does revenue look like by division?
Segment Overview. Financial SelfService (ATMs) - $1.6B, 13% operating margin. Revenue has increased 15% in 2007, 11% netting out currency benefit. Growth has primarily been driven by Europe and Asia, U.S. is flattish at this point. Revenue growth was 2% in 2006, not nearly as great, driven by lower international growth.
Retail Store Automation. (POS terminals, bar-code scanners, self-service tech). $1B in revenue, 13% growth in 2007, 10% on constant currency basis, 20% growth in self-service counters. Self-service now is ~30% of segment sales, and has higher margin, which should positively affect the margins for the segment, which are currently only 4%.
Customer Services. Support for NCR and 3rd party products, $2B in revenue, 7% margin, 7% 06-07 growth (4% on constant currency).
Systemedia. Printer consumables and products including paper rolls for ATMs. $455M in sales with paltry 3% margins. Admittedly this one does sound like a bad business, just like anything having to do with paper. Revenue has declined 3% last year and this trajectory will probably continue.
Payment & Imaging. Check processing hardware and software. Checks are on the decline, and so is this business, only 3% margins and negative 8% growth 06-07.
Geography: Mix is rather favorable, Americas are 46% of sales, EMEA 36%, Japan 7% and Asia 11%. Asia and EMEA are two high growing segment, 11% and 8% growth last year in constant currency while Americas and Japan are flat.
Overall 2007 P&L looks as follows:
Revenue: 4.970B
COGS: 3.930
(however 70M are in restructuring charges)
Gross Profit: 1.050B (1.11 w/o restructuring)
SG&A:684M (8 in restructuring)
R&D: 137M (2% of revenues)
Income from Operations: 219M
(including other income): 232M (~310 w/o restructuring)
Tax: 61M
Net Income: 171M
Industry. NCR is the leading provider of ATMs globally with ~40% share of the market. Diebold is #2 with 35%, Wincor is #3 players. In the U.S. NCR and Diebold hold a commanding position with Wincor making inroads, in Europe the situation is somewhat reversed. Penetration in all global regions is low compared to the U.S.: 1300 ATMs per million people in U.S. vs 700 in Europe vs 60 in China. The penetration story in the developing world should allow NCR to have 10%+ growth in its EMEA and Asia segments for some time.
Self-checkout is also a penetration story: only 5% of all retail transactions in the U.S. are self-checkout, however some retailers like HD that aggressively push the initiative have 40%+ penetration, implying large room for growth.
What 2008-2009 holds. Management guided 3-5% revenue growth in 2008, and 2009 will probably be similar. What will happen to margins? Right now excluding all the restructuring expenses they're 6.3%. Given company leadership in the industry and strong competitive moat (huge installed base of devices), long-term margins should improve to 8%, which would result in around $1.8EPS given current revenues. However this expansion will have to wait a bit, as short-term margins probably will stay close to flat/decline slightly driven by weaker U.S. markets. All in all, expect EPS ~$1.5 in 2008, with EPS increasing to $1.8-2 in 2010, growth rebounding to healthy 7-8%. Assuming NCR, as the leader in its industry with attractive long-term growth prospects, should trade at 16-17x EPS multiple, slight premium to the market, the shares should go towards $30-35 range. Current price level provides a decent entry point, but it's even better if you're able to accumulate on any pullbacks towards $20, potentially driven by overall market weakness or not-so-great short term company results.
Risk: Prolonged financial industry downturn in the U.S. forces a multi-year pullback on capital spending
Monday, February 25, 2008
Aircastle - Cheap or Catching a Falling Knife?
Probably both - the story of all my stocks so far! They all seem to be great values, fundamentals aren't changing or even become stronger, but yet the prices keep going down. This phenomena is starting to make me a convert of the momentum theory - you can outperform in the short term just by buying up recent winners and shorting losers. And behold - just this weekend I've read somewhere that this strategy is statistically a winner in the 3-6 month span, outperforming the indexes by 10%. Now, this may explain why Fool's CAPS data is what it is (highest rated stocks outdo lowest rated ones).
And now for the original topic of the post, which is Aircastle. The company generates ~$400M in revenue and ~$350M in EBITDA through leasing passenger and cargo planes to airlines all around the world. Currently the company owns +100 planes worth $4.1B and is committed to $1.6B more. Essentially the company leverages its own balance sheet to buy planes and then rents them out. Of course as a result it has a substantial amount of debt on the balance sheet - $2.5B, however given $350M in EBITDA this doesn't look so bad.
Normally I'm typically ultra wary of the airline space - too many macro factors to predict (fuel prices being on top of the list, however the traffic also has major implications - small slowdowns can have massive impact on profits due to high fixed costs). Aircastle of course is also exposed to these factors - its customers are airlines, so the industry's financial health determines how much and if at all they can pay for Aircastles planes. However due to the long-term nature of the contacts, short-term macro fluctuations don't put a dent in Aircastle's numbers, making it a much safer investment
Business description. Company was formed by Fortress in 2004. At the time the industry was distressed, with many airlines selling used crafts at firesale prices, and Fortress started the company to gobble those up. It went public in 2006, and continued acquiring planes. The stock started trading at $29, eventually went up to $40, however has recently dropped on fears of recession/looming troubles in airline space and disasters in the financing world, which made investors question whether the company can continue acquiring planes. Indeed, the company is planning to cut down on acquisitions, but are those necessary to make the stock a good value? Not at all, the company currently already has a 12% dividend yield, and that number will go up next year once leases on new planes take effect.
Key profitability driver. How much money the company makes is simple: total airplanes x lease rate per plane. The planes side of the equation is set, what about the lease rates? Some caution is warranted here: lease rates did half in the U.S. in 2002-2003, when a lot of the airlines were nearly bankrupt. However the leases are not renegotiated year by year: average lease length is ~9 years, and the company has claimed to have already renewed all 2008 leases. So in the worst case scenario we're in a deep recession that touches not only the U.S., but all airlines that AYR deals with and lease rates half in 2009 and 2010. If average lease rate is 9 years, then this would have impact on 22% of AYR leases, or have negative 11% hit on EBITDA. Even in this scenario, the valuation is very attractive. However, there are several factors that make me believe this scenario will not play out (despite me being ultra bearing on the U.S. economy).
Customers. Aircastle leases its planes to airlines in Europe (44% of net book value), Asia (26%), Latin America (7%), NA (12%). Almost by definition its customers are the airlines that are not too well-off, that can't afford buying planes on their own. This is of course a risk - if the s*** really hits the airline fan, those customers will default. However this is no subprime mortgage market and the company will keep its valuable planes as opposed to giving away foreclosed houses. High exposure to emerging markets where the rates of air travel are rising very quickly is a big plus.
State of the industry. Important dynamic for Aircastle is the supply/demand for leases planes. The supply side is driven by a) new planes coming to market b) available old planes. On both a) and b), dynamics for Aircastle are favorable. Boeing and Airbus are sold out of planes, and are supplying ~1100 total a year for the next three years. Given continued delays, I wouldn't be surprised if this number is lower. Demand on the other hand is higher: air traffic is growing at ~5% a year, and with 17,500 planes currently in operation worldwide, this implies a demand for 875 planes. However the old fleet also needs to be replaced, and assuming an average life of 40 years (which is very high!) results in 17.5K/40=437 replacement demand. When demand outstrips supply we typically have higher prices, and I believe this dynamic will be enough to offset U.S./Europe economic weakness.
Valuation. For a company in a growing industry that generates attractive ROIC, 6% yield seems fairly conservative, however I'll assume just that. Implied valuation? $40 a share or around twice where we are right now. And while we wait for the price to appreciate, I'm not forgetting to collect my fat dividend.
And now for the original topic of the post, which is Aircastle. The company generates ~$400M in revenue and ~$350M in EBITDA through leasing passenger and cargo planes to airlines all around the world. Currently the company owns +100 planes worth $4.1B and is committed to $1.6B more. Essentially the company leverages its own balance sheet to buy planes and then rents them out. Of course as a result it has a substantial amount of debt on the balance sheet - $2.5B, however given $350M in EBITDA this doesn't look so bad.
Normally I'm typically ultra wary of the airline space - too many macro factors to predict (fuel prices being on top of the list, however the traffic also has major implications - small slowdowns can have massive impact on profits due to high fixed costs). Aircastle of course is also exposed to these factors - its customers are airlines, so the industry's financial health determines how much and if at all they can pay for Aircastles planes. However due to the long-term nature of the contacts, short-term macro fluctuations don't put a dent in Aircastle's numbers, making it a much safer investment
Business description. Company was formed by Fortress in 2004. At the time the industry was distressed, with many airlines selling used crafts at firesale prices, and Fortress started the company to gobble those up. It went public in 2006, and continued acquiring planes. The stock started trading at $29, eventually went up to $40, however has recently dropped on fears of recession/looming troubles in airline space and disasters in the financing world, which made investors question whether the company can continue acquiring planes. Indeed, the company is planning to cut down on acquisitions, but are those necessary to make the stock a good value? Not at all, the company currently already has a 12% dividend yield, and that number will go up next year once leases on new planes take effect.
Key profitability driver. How much money the company makes is simple: total airplanes x lease rate per plane. The planes side of the equation is set, what about the lease rates? Some caution is warranted here: lease rates did half in the U.S. in 2002-2003, when a lot of the airlines were nearly bankrupt. However the leases are not renegotiated year by year: average lease length is ~9 years, and the company has claimed to have already renewed all 2008 leases. So in the worst case scenario we're in a deep recession that touches not only the U.S., but all airlines that AYR deals with and lease rates half in 2009 and 2010. If average lease rate is 9 years, then this would have impact on 22% of AYR leases, or have negative 11% hit on EBITDA. Even in this scenario, the valuation is very attractive. However, there are several factors that make me believe this scenario will not play out (despite me being ultra bearing on the U.S. economy).
Customers. Aircastle leases its planes to airlines in Europe (44% of net book value), Asia (26%), Latin America (7%), NA (12%). Almost by definition its customers are the airlines that are not too well-off, that can't afford buying planes on their own. This is of course a risk - if the s*** really hits the airline fan, those customers will default. However this is no subprime mortgage market and the company will keep its valuable planes as opposed to giving away foreclosed houses. High exposure to emerging markets where the rates of air travel are rising very quickly is a big plus.
State of the industry. Important dynamic for Aircastle is the supply/demand for leases planes. The supply side is driven by a) new planes coming to market b) available old planes. On both a) and b), dynamics for Aircastle are favorable. Boeing and Airbus are sold out of planes, and are supplying ~1100 total a year for the next three years. Given continued delays, I wouldn't be surprised if this number is lower. Demand on the other hand is higher: air traffic is growing at ~5% a year, and with 17,500 planes currently in operation worldwide, this implies a demand for 875 planes. However the old fleet also needs to be replaced, and assuming an average life of 40 years (which is very high!) results in 17.5K/40=437 replacement demand. When demand outstrips supply we typically have higher prices, and I believe this dynamic will be enough to offset U.S./Europe economic weakness.
Valuation. For a company in a growing industry that generates attractive ROIC, 6% yield seems fairly conservative, however I'll assume just that. Implied valuation? $40 a share or around twice where we are right now. And while we wait for the price to appreciate, I'm not forgetting to collect my fat dividend.
Oshkosh - Brace yourself for falling earnings
Latest earnings report is just the beginning.
I somewhat feel bad for
While Terex, its main competitor in the segment, can nurture a hope of being saved by international markets (of which I’m skeptical given Europe should promptly follow the
Simple statistic: JLG telehandler unit sales in 2000 were 15K. In 2002 they were around 8K, where they stayed until 2004. Same story for the overall aerial work platform
Valuation. Valuation is 13X 07 EPS which seems reasonable if you believe a) we’re at normalized revenue levels b) we’re at normalized margins. Both of those are unfortunately not true. Margins for
Monday, February 4, 2008
Archon Corporation - Get 500M Worth of Assets for 300M
Ok, this one is really simple: Archon's enterprise value is $300M while its real estate is worth $550M.
I am typically not a fan of real estate plays because this paper value might take eons to unlock, however this is not the case with Archon. Its main property, 27 acres on the Strip, is expected to be sold to a Texan real estate developer for $475M, $40M of which have been put for down payment this summer. Archon also owns wwo buildings in Massachusetts and Maryland bought for $82M and $63M each back in 2000. In addition company runs a small casino in Nevada that has lost $2M in 2007 - probably the factor that accounted for the stock reaching the levels we're at right now.
Applying a long-term capital tax rate to the Strip property gives $400M income once transaction is consummated. Assuming that other properties are worth what Archon paid for them gives another $145M. What is the casino business worth? It generates $30M in revenues, but because it lost money recently lets just ascribe it a 0 value. Altogether company's value is $550M, or backing out the debt - $79 per share vs $39 right now.
The catalyst here will obviously be the property sale which should happen this or next year. However even if the sale falls through, Archon still owns a piece of property in an incredibly fast-growing market, that even at a discount of 20% to currently agreed purchase price implies a very handsome upside to the stock.
I am typically not a fan of real estate plays because this paper value might take eons to unlock, however this is not the case with Archon. Its main property, 27 acres on the Strip, is expected to be sold to a Texan real estate developer for $475M, $40M of which have been put for down payment this summer. Archon also owns wwo buildings in Massachusetts and Maryland bought for $82M and $63M each back in 2000. In addition company runs a small casino in Nevada that has lost $2M in 2007 - probably the factor that accounted for the stock reaching the levels we're at right now.
Applying a long-term capital tax rate to the Strip property gives $400M income once transaction is consummated. Assuming that other properties are worth what Archon paid for them gives another $145M. What is the casino business worth? It generates $30M in revenues, but because it lost money recently lets just ascribe it a 0 value. Altogether company's value is $550M, or backing out the debt - $79 per share vs $39 right now.
The catalyst here will obviously be the property sale which should happen this or next year. However even if the sale falls through, Archon still owns a piece of property in an incredibly fast-growing market, that even at a discount of 20% to currently agreed purchase price implies a very handsome upside to the stock.
Friday, February 1, 2008
Infosys: Strong Position in a Still Growing Market - Concerns Overblown
Industry leader with 25%+ revenue growth prospects trading at 19X this year's earnings on concerns about 1) slowdown in tech spending 2) weak dollar vs rupee 3) rising wages in India. To address each concern:
1) Company managed to maintain 30%+ growth rate during the last tech spending downturn. To be fair, pricing did go down, eating into the company's operating margins which went from 33% to 28%. Management believes the pricing will be more sustainable now given the more established nature of offshoring model and extremity of tech bubble burst. I think the recession scenario for 08-09 is ~20-25% revenue growth combined with 200bps margin contraction
2) I don't really think anyone can predict what currencies will do in the short term, but company does engage in active hedging to mitigate any potential impact
3) Wages are indeed growing driven by shortage of qualified employees. However I believe
Thursday, January 31, 2008
China 3C - Barring Fraud, Should Double in a Year
Thesis. Chinese electronics retailer that operates mini-stores within Chinese malls with ~$280M in sales and ~9% net income margin. Despite strong history of both comps and sq footage growth, stock is trading at 6X 07 P/E due to a combination of 1) poor IR 2) pulled private placement in the middle of 07 3) Trading over the counter. Recently the company announced a change in their investment relations firm and confirmed existing process for NASDAQ-listing. The significance of private placement pull in my opinion is exaggerated, but here's what happened: stock was trading at $8 right prior to placement announcement in July. The placement itself was a small % of market cap (only $12M) and was at $5.60 per share. After the announcement the stock price tanked below $5.60. Management at that time was not too good at communicating with investors, so we don't know for sure what happened, but given the volatile price of the stock that sat at ~$6 per share in June, $5.60 does not look too unreasonable. Then, in September, with stock at $5, the sale was pulled. It's of course possible that investors did discover something negative about the company. More likely though investors didn't want to buy their mini stake at a premium, especially given the Chinese market that climbed 10% monthly.
Long-term growth. Management hopes to increase store count from current 1000 to 4000, and grow revenue to $1B. Ok, this seems a bit overly optimistic. More conservatively, assuming store count expands at 10% a year and comps grow at 8-10% (in line with Chinese GDP) we get to 20% growth.
Catalyst. 1) Strong full year 2007 sales and continued growth in Q1-Q2 2008
2) Nasdaq listing
Risks. 1) Fraud of some type is a risk of course but given the company hired new New York based accounting firm and that CEO himself bought 20K shares at $3.60 makes me more confident things are not too gloomy
Tuesday, January 29, 2008
DG FastChannel - Passing on uncertain long-term outlook
Company description: Delivery of audio and video spots from advertisers to cable, TV and radio stations. Customers (advertisers) upload their ads to DGIT ftp server, where their quality is checked and which are then either transmitted via satellite to DGIT-owned boxes installed at TV stations (for video content) or via broadband to servers at radio stations. DGIT also does traditional dub & ship delivery, which accounts for a relatively minor proportion of the sales.
DGIT's business model somehow reminds me of Office Space:
- "So you take specifications from the customers and bring them to the engineers. Well that just makes me ask why can't the customers do it themselves?"
- "I'll tell you why. That's because engineers are not good dealing with people".
Ok, I'm being a bit unfair, DGIT existence is somewhat justified.
Industry Background. There are a total of 11K radio and 5K TV stations in the U.S. that advertisers have to distribute their content to. Depending on whether the ad is local or national, the advertisers need to send it to a local station, or network center respectively. Traditionally delivery was done through dub and ship - a copy of the ad is made, and the duplicate (dub) is shipped to the station by mail. However increasingly networks started turning to digital delivery. DGIT owns satellites, transmitters and receivers that it uses to transmit the ads.
From 12% share of deliveries digital grew to currently account for ~58% of ad distribution. Management is projecting the penetration to increase to 80% by 2010, but recent penetration growth has been slow, as 2004 penetration was 54%.
Competitive position. DGIT is far away the industry leader in digital distribution, with almost 100% penetration of customer accounts. Company used to have ~50% share of the market, with Vyvx second at 28%, but after announcing Vyvx acquisition in Dec 2007, it is by far the biggest gorilla in the room.
There're a number of small dub and ship players that compete with DGIT but no one too threatening.
So if the technology didn't change I'd say the future for DGIT looks fairly bright, as they have a big competitive moat with 5000 units installed across the country. However, tech does evolve and there are risks to the model.
For example in company's 10-K DGIT states that "certain common and/or value-added telecommunications carriers and other companies, such as Pathfire, may develop and deploy high bandwidth network services targeted at the advertising and broadcast industries". For example AT&T could start delivering content which would be a huge hit for DGIT.
Another threat that is not really mentioned in the analyst reports: why can't a major studio like NBC just have it's own FTP server, where the advertisers would upload and studios download content. The process perhaps wouldn't be quite as fast as with DGIT, but if you spend weeks on creating an ad, why does another hour matter with delivery? Maybe networks don't want to bother cause they're not paying much for the service, but still.
To give company credit, to combat competitive entrants DGIT strives to provide additional services that would make customers more sticky: cataloging, closed captioning, archiving.
Financials.
Company revenue has actually declined from 2003 to 2005, after which DGIT went on a major shopping spree to revive growth. This fact, combined with historical digital penetration figures, makes me question the future growth figures. Management projects 10% growth next year, however going forward I doubt growth will exceed mid-single digits.
EBITDA margin projected to expand as Vyvx acquisition is integrated. I halfed the projected synergies from $8M to $4M, but even then, the margin right now is really high. The argument for the margin to keep expanding is a) high fixed cost base, so additional revenue should flow disproportionately to the bottom-line b) HD penetration, increasing the margins
Valuation. Valuing the company on basis of EBITDA and FCF multiples seems like a more appropriate methodology given earnings number are skewed by high D&A component. The analysts are talking about multiples of 12X EBITDA and 15FCF. I think a lower multiple is appropriate given slowing growth profile and volatility . On that you get to 2008 valuation of ~$600M . Assuming post-acquisition TEV of $367 (current market cap)+$170 = 537. That values equity at $430M or $24 per share. If you believe a higher multiple, value grows to ~$31 per share.
Bull thesis. 1) HD penetration. Currently HD is .5% of all ads. Management estimates that each 1% of penetration increases revenue by $5M, with a high % of that increase flowing straight to margin. 2) Election cycle. Huge ad spending already seen this year, and will only increase in the future to DGIT's benefit.
Bear thesis. 1) Poor history of organic growth rate 2) Fairly commoditized nature of the business 3) Recession putting will put pressure on a) ad spend in general reducing the number of ads transmitted b) pricing, including HD pricing which will eat into margin.
Outlook. I believe the company can be a decent performer in the 12-24 months time frame with potential for up to 50%+ return. Conversion to HD, high ad spend for 2008 Elections, integration of the acquisition, dominant position which should allow it to maintain (and hopefully push up) pricing are all factors that can propel the stock towards $30. However personally I am not a believer in the long-term success story and think company is fairly value based on long-term fundamentals, so if you want to buy and hold for five years - stay away.
It was hard, but I avoided playing any puns on the ticker's name.
DGIT's business model somehow reminds me of Office Space:
- "So you take specifications from the customers and bring them to the engineers. Well that just makes me ask why can't the customers do it themselves?"
- "I'll tell you why. That's because engineers are not good dealing with people".
Ok, I'm being a bit unfair, DGIT existence is somewhat justified.
Industry Background. There are a total of 11K radio and 5K TV stations in the U.S. that advertisers have to distribute their content to. Depending on whether the ad is local or national, the advertisers need to send it to a local station, or network center respectively. Traditionally delivery was done through dub and ship - a copy of the ad is made, and the duplicate (dub) is shipped to the station by mail. However increasingly networks started turning to digital delivery. DGIT owns satellites, transmitters and receivers that it uses to transmit the ads.
From 12% share of deliveries digital grew to currently account for ~58% of ad distribution. Management is projecting the penetration to increase to 80% by 2010, but recent penetration growth has been slow, as 2004 penetration was 54%.
Competitive position. DGIT is far away the industry leader in digital distribution, with almost 100% penetration of customer accounts. Company used to have ~50% share of the market, with Vyvx second at 28%, but after announcing Vyvx acquisition in Dec 2007, it is by far the biggest gorilla in the room.
There're a number of small dub and ship players that compete with DGIT but no one too threatening.
So if the technology didn't change I'd say the future for DGIT looks fairly bright, as they have a big competitive moat with 5000 units installed across the country. However, tech does evolve and there are risks to the model.
For example in company's 10-K DGIT states that "certain common and/or value-added telecommunications carriers and other companies, such as Pathfire, may develop and deploy high bandwidth network services targeted at the advertising and broadcast industries". For example AT&T could start delivering content which would be a huge hit for DGIT.
Another threat that is not really mentioned in the analyst reports: why can't a major studio like NBC just have it's own FTP server, where the advertisers would upload and studios download content. The process perhaps wouldn't be quite as fast as with DGIT, but if you spend weeks on creating an ad, why does another hour matter with delivery? Maybe networks don't want to bother cause they're not paying much for the service, but still.
To give company credit, to combat competitive entrants DGIT strives to provide additional services that would make customers more sticky: cataloging, closed captioning, archiving.
Financials.
Company revenue has actually declined from 2003 to 2005, after which DGIT went on a major shopping spree to revive growth. This fact, combined with historical digital penetration figures, makes me question the future growth figures. Management projects 10% growth next year, however going forward I doubt growth will exceed mid-single digits.
EBITDA margin projected to expand as Vyvx acquisition is integrated. I halfed the projected synergies from $8M to $4M, but even then, the margin right now is really high. The argument for the margin to keep expanding is a) high fixed cost base, so additional revenue should flow disproportionately to the bottom-line b) HD penetration, increasing the margins
Valuation. Valuing the company on basis of EBITDA and FCF multiples seems like a more appropriate methodology given earnings number are skewed by high D&A component. The analysts are talking about multiples of 12X EBITDA and 15FCF. I think a lower multiple is appropriate given slowing growth profile and volatility . On that you get to 2008 valuation of ~$600M . Assuming post-acquisition TEV of $367 (current market cap)+$170 = 537. That values equity at $430M or $24 per share. If you believe a higher multiple, value grows to ~$31 per share.
Bull thesis. 1) HD penetration. Currently HD is .5% of all ads. Management estimates that each 1% of penetration increases revenue by $5M, with a high % of that increase flowing straight to margin. 2) Election cycle. Huge ad spending already seen this year, and will only increase in the future to DGIT's benefit.
Bear thesis. 1) Poor history of organic growth rate 2) Fairly commoditized nature of the business 3) Recession putting will put pressure on a) ad spend in general reducing the number of ads transmitted b) pricing, including HD pricing which will eat into margin.
Outlook. I believe the company can be a decent performer in the 12-24 months time frame with potential for up to 50%+ return. Conversion to HD, high ad spend for 2008 Elections, integration of the acquisition, dominant position which should allow it to maintain (and hopefully push up) pricing are all factors that can propel the stock towards $30. However personally I am not a believer in the long-term success story and think company is fairly value based on long-term fundamentals, so if you want to buy and hold for five years - stay away.
It was hard, but I avoided playing any puns on the ticker's name.
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