Berk Sure Has a Way

Six Picks for your Watchlist from the Value Investing Congress

Last week I attended the Value Investing Congress in New York.  The speakers were top notch and the presentations were very engaging. 

I enjoyed hearing the speakers' discuss their investment processes.  Lloyd Khaner’s talk on turnarounds was very well done.  Also, various presentations on the continued weak state of the housing market were very informative.  Overall, the tone was pretty bearish on the economy and the markets.  Many of the presenters professed concern about overvaluation but projected a sense of “the show must go on… so here are my stock picks." 

I agree that the markets feel stretched based on the woeful state of the consumer but some of the picks are worth watching.  Some longs do go up when markets go down.  Even better is to pick up great stocks on sale if the market does turn down again.  My favorites of the conference were:

Small Cap Long Ideas – Risky companies

IRDM – Whitney Tilson and Glenn Tongue presented an interesting pitch for Iridium (yes, the formerly bankrupt satellite phone company that used to be a punchline!).  According to Whitney and Glenn, Iridium has an unrivaled set of assets (satellites and services).  Iridium reaches 90+% of the globe has no cell towers (e.g. ocean, dessert, mountains).  The company was purchased by a SPAC a year ago on favorable terms.  Non-voice data services are growing dramatically and the voice business is growing nicely.   The bear case on IRDM is that they plan launch a new constellation of satellites starting in 2014.  Whitney and Glenn believe that IRDM might be about to launch it without borrowing funds.

CORE – Kian Ghazi provided a detailed bull case for Core Mark, a convenience store distribution player.  CORE is the number two operator behind Mclane (a Berkshire company).  Kian claims that while distribution may not be a sexy business, it can be a defensible one if the following conditions are met:  high route density for drop-offs, highly fragmented, high switching costs and small drops with lots of stops.  In his opinion, CORE benefits from all of these.  His bullish case for them rests on an emerging part of their business:  fresh food (prepared fruit cups, sandwiches, etc).  This high margin, high growth business should more than offset the secular decline in low margin cigarette business which is a big part of CORE existing revenue.

Mid / Large Caps Long Ideas – Safer, less risk of massive downside

CXW – Bill Ackman sparked a rally in Corrections Corp when he revealed he owned a 9+% stake (which hadn’t been publicly disclosed yet).  His pitch was funny and well thought out:  CXW is largely an inexpensive, safe real estate play with extremely creditworthy tenants, secular growth and room for market share gains.  He claimed that private prisons operate more effectively than public ones on many levels and that the trend will be towards privatization (especially for new prisons).   The stock probably won’t double but he thinks it has upside to $40-50+.

LH – Zeke Ashton laid out the case for Labcorp, the number two provider of laboratory testing behind Quest Diagnostics.  The growth rate of the company is high, the industry pretty defensible.  The only issue is a biggie though – healthcare reform.  The lab testing business has been bandied about as a rich target for cost cutting, but Zeke thinks that the concerns here are overblown.  There may even be a scenario in which LH and Quest benefit from expanded coverage and testing.

Shorts - Proceed with caution

ITB – Whitney Tilson presented the housing stock ETF as a short based on an updated version of his voluminous housing “head fake” presentation.  It lays out a compelling story that housing has not yet bottomed because of shadow inventory (7 million homes in various stages of delinquency and foreclosure), option-ARM exposure peaking in 2011, a stretched consumer, removal of stimulus and the eventual rise in interest rates.  His take was that there are more than enough homes for those that can afford to buy them and that the housing companies should basically build nothing for years.

O – Bill Ackman spoke briefly about shorting Realty Income – the “monthly dividend company”.  This is a company he has previous criticized for having risky tenants who have done sale-leaseback transactions with Realty Income.  He expects that the company will have a radical valuation readjustment once the market realizes that the dividend is not safe.   The company does a lot of shareholder marketing focusing on the dividend and if (when, according to Ackman) O sustains credit losses in its weak portfolio they will need to cut the dividend.

Overall, the conference was very interesting.  The slides from all the presentations were available after the conference as well. 

Disclosure:  I do not have positions in any of the stocks mentioned in this article.

SILC: Cheap, Cash Rich, Profitable with New Products and New Customers

Silicom (SILC) makes components for specialized servers and application appliances.  Part of their business serves the still growing WAN optimization market (see RVBD and BCSI), part of their business provides commodity products and an emerging part is providing new products to move SILC up the value chain.  

Margin of safety.  Normally, a micro cap provider of commodity electronics would not excite me… but check out these financial stats:  Market cap of $49.1 million ($7.22 a share), $40 million in cash in the bank ($5.88 a share), enterprise value of $9.1 million ($1.40 a share), TTM earnings of $3.7 million ($0.56 a share).  EV/Earnings – 2.5!   Compared to the potential (e.g. $1.02 a share in 2007), it is conceivable that SILC could earn more than its EV in a single year (e.g. 2010 or 2011).

Profitable during the crisis.  While many companies have been taking big hits to earnings during the ongoing crisis, SILC has remained profitable.   Admittedly, visibility is very low and revenue has suffered but they continue to sign up new customers -- including a tier 1 manufacturer. 

Catalysts.  The SILC Q2 earnings report is on Monday July 27th – a positive report would be a catalyst for the stock.  Downside is mitigated by the $6 a share in cash, and upside could be quite large if the company shows revenue and earnings growth in the quarter.  Other potential catalysts include new analyst coverage, potential for share buybacks, new customer announcements and new products.  Lastly, the company’s founders, the Zisapel brothers, currently own almost 30% of the company.  They may continue to buy more stock or buy out the company completely. 

Risks:

• Q2 could be a disaster – the economic environment has been bad, bad, bad

• Commodity producer – may need to lower prices or risk losing customers

• SILC would be a victim of US Dollar weakness or Shekel strength

• Micro cap stock – extremely low liquidity – don’t invest if you need the money

Bottom Line.  SILC is a very speculative investment with a good risk to reward profile.  It could dive below $6 (as it did in October of last year), but should recover to cash in the bank quickly.   I would not expect to hold this for the long term, but rather until the price becomes more in line with the company’s assets and performance. 

Disclosure:  I am long SILC at the time of this writing – 7/22/09

Peer to Peer Lending - an alternative asset class?

Last year was brutal for almost all assets classes across all markets.  Investors who diversified still had sizable losses.  Many investors have pulled in their horns and moved to safe assets like cash or treasuries.  Savvy investors have been trying to navigate the myriad opportunities offered in today’s markets – ideally enhancing returns without the risk of another 2008.  I attended the Finovate Startup 2009 conference in San Francisco last week and was excited and impressed by some of the companies trying to create alternative asset classes by cutting banks out of the lending loop.

Although credit markets have thawed somewhat since the deep freeze of in the Fall of 2008, it is still difficult for many people and institutions to get credit.  This creates a perfect opportunity for the expansion of peer to peer (P2P) lending.  P2P lending effectively takes banks out of the lending process by allowing people to borrow directly from other individuals (or sometimes pools of borrowers from pools of lenders).  There were four companies at the Finovate Startup conference focused on this space:  Lending Club, People Capital, Pertuity Direct and Prosper.  While the borrowing side of the P2P space is fascinating, I am focusing this post on the lending side – how these services stack up as an alternative asset class.

Prosper.  Prosper pioneered this field a few years back and ran into trouble both with the SEC as well as allowing too many deadbeat borrowers.  They have recently relaunched and remain the largest player in this nascent field.  I find Prosper’s process to lend money to be time consuming and clunky.  You have to handpick all the loans you want to fund plus bid on the interest rate you are willing to accept.  That said, among the four, Prosper seems to have the most opportunity for earning the highest yields for a motivated lender.  I expect that with their relaunch, risk management will be more of a theme since the losses on the first batches of loans were quite high.   In fact, Prosper made the point that they have raised the minimum FICO score for a loan application.  Prosper says a secondary market for longs that an investor would like to sell is coming soon.

Lending Club.  Lending Club was “fast follower” in this space and learned from Prosper’s challenges.  They filed with the SEC and grew quickly.  Their historical loss rates are lower and their risk management seemed to have been more rigorous from the get go.  I also think the process for creating a loan portfolio is a bit clunky, but easier than Prosper since there is no interest rate bidding.  Interest rates are set by the risk bucket a borrower is placed in when they apply.   This simplifies the process but may reduce potential yield for lenders.   Overall, I thought Lending Club had a nice balance of risk management, ease of use and potential yield.  Their demo showed an average yield of over 9.5%.  Since launch a report on their website says that average yield earned on the site is over 9%.  Lastly, Lending Club is the further along on the liquidity front – they have created a secondary market for loans if you do not want to hold them to maturity.  The Lending Club rep said that some loans are sold for more than par, some less but overall it is likely slightly less than par.

Pertuity Direct and National Retail Fund.  Pertuity Direct launched in January of 2009 and is the simplest of the P2P concepts from an investing standpoint.  Pertuity Direct is funded by the National Retail Fund that pays the average yield to all investors in the fund after fees.  I like this model from a simplicity standpoint.  This would be the service I would recommend to someone who was not a web expert or a credit expert.  It is simple, easy to setup and easy to manage.  That said, it remains to be seen what type of yield you will get from the National Retail Fund – the site suggests in excess of 13%!   A lot more rides on Pertuity Direct’s ability to attract, screen and retain high quality borrowers.   Liquidity in the National Retail Fund is currently quarterly but their reps indicated that they are working on more frequent liquidity windows.

People Capital.  People Capital will be launching later this year with a  focus on educational loans.  I like their focus on the educational market since it distinguishes them from competitors and potentially attracts a more creditworthy borrower.  People Capital expects that they will have competitive yield with the other services.  However, their CEO indicated he expects some lenders might be generous family members (e.g. Grandma), enabling a lower blended interest rate for borrowers.   This could be a big win for borrowers and the platform by lowering the overall interest rates that people pay for education.  Lastly, their CEO informed me that student loans are not wiped out during personal bankruptcy - effectively reducing risk by putting lenders in a higher place in the borrower's "capital structure." Overall, People Capital is an unknown quantity since it has not launched, but I see a ton of potential here.

I like the peer to peer lending model.  While banking has a bad reputation across the globe right now, traditional banking (deposits and loans) is a wonderful business.  By cutting out the bank, P2P allows borrowers and lenders to get better interest rates and yields than they would otherwise.   Success for these services depends upon risk management – if they set the bar too low for borrowers and defaults soar, they could kill lender demand before the platforms have a chance to succeed.  That is why all of them have trumpeted their focus on high FICO, “super-prime”, creditworthy, credit-savvy borrowers.  Transparency goes a long way towards ensuring good risk management.  I think transparency has been a big positive for Prosper and Lending Club.  I hope the Pertuity Direct and People Capital both emulate that element of the pioneers' services.

Going forward, P2P services are indicating yields of 9% or more on average (even after fees and delinquencies).  Your mileage may vary on what type of yield to expect given the deteriorating macro-economic background, but these yields are pretty juicy, even adjusting for risk.  Over time, I expect yields will come down when credit normalizes and the fees charged by these services rise (as I expect they will). 

With the possible exception of People Capital, I don’t expect these to appeal to institutions (bigger fish might want to check out Second Market or The Receivables Exchange – both very promising).   I would recommend each service to different type of small lenders - people looking to lend less than $50k.   For the savvy alpha-seeker, I would recommend Prosper.  For the “set it and forget it” mainstream investor, National Retail Fund seems like the simplest option.  Personally, I liked the balance that Lending Club has struck between yield and simplicity.  If the equity markets start to get frothy again, I would probably try Lending Club first.

I am now a contributor to Seeking Alpha

As of this morning, I am now a contributor to the Seeking Alpha network of finance blogs.  Seeking Alpha has emerged as the leading blog network for finance news and stock coverage.  It started with the Internet Stock Blog but has mushroomed to become quite a resource for folks in the finance industry.  Their conference call transcripts service will likely become an invaluable tool for many investors.  You should check it out if you have not already.

RIMM is likely to guide lower on April 6th

Research In Motion, the makers of the Blackberry, has lowered guidance on Q4 subscribers not once, but twice.  The main explanation was that uncertainty around the NTP patent has delayed purchases.  I am gonna have to call bullsh*t on that excuse.  I am sure some corporations and government agencies did put off purchasing, but I doubt it was the whole source of the shortfall.  I think that companies are increasingly looking at Blackberry competitors for viable alternatives: Good Technology, Microsoft, Visto, etc.  Also, it is problematic that over two thirds of RIMM's revenue comes from hardware sales - would Palm be a better play in that arena?

Interestingly, even with the huge Q4 miss RIMM pre-announced this month (slyly done the same day as the NTP patent resolution),  analysts have not lowered expectations for the May Quarter for RIMM.  I suspect RIMM is going to lower subscriber, revenue and earnings guidance for Q1 2007 (May) when they report on April 6th.  I've been burned shorting RIMM before, so this time I purchased in-the-money puts that expire in April.

BTW, I use a Treo 650 with Chatteremail and push-IMAP.  I used to use Good Tech when I worked at a corporation.  Both are better (and cheaper) than Blackberry.

I own puts on RIMM shares and calls on PALM.

[Post updated to add external links, my phone preference, PALM disclosure]

Marchex Mania on Mad Money!

Jim Cramer took a breather from pumping Marchex’s stock and on 3/7/06 gave some airtime to the often insightful Herb Greenberg. Herb was bearish on MCHX and made some of the same points I’ve made.  He said that their core business isn’t growing, domain names are their one good asset (and in perpetual beta), the domains business is not a long term growth business, and that Marchex is a “manana story” – always promising growth tomorrow.

Apparently, Cramer is a buddy of Marchex CEO Russell Horowitz.  On 3/2, he did a phone interview with Horowitz packed with softball questions.  My favorite was when Cramer asked “Do you have any competition at all?”  Russell responds “in some parts of our business, but nobody has the same combination of assets…”  That is a lot like saying that no one has my fingerprint!  Horowitz claims synergies between the businesses, but as one of my previous posts outlines, Marchex will not be able to monetize their own traffic better than Yahoo can so the synergies are limited.

Cramer is a smart guy and apparently a great trader.  Marchex has been a great investment for intrepid longs but not since Cramer picked it.  In this case, I think Cramer is wrong and Greenberg is right.  To add some food for thought, I will highlight a list of competitors for Marchex’s sprawling mini-empire of sub-scale businesses.  In most cases below, Marchex business is not even in the top 3 competitors!

Enhance (Tier 2) / GoClick (Tier 3)  – Syndication Business
  Tier 1: GOOG, YHOO
  Tier 2: MIVA, LOOK, INSP, ASKJ, Kanoodle – see Miva’s disastrous earnings report!
  Tier 3: INCX, EPilot, 7Search, BrainFox, GenieKnows

TrafficLeader – Outsourced Platform management
  MIVA, LOOK, INCX and other smaller players

TrafficLeader – SEO and Search Engine Marketing management
  Hundreds of companies – As a starting point, all the members of SEMPO (e.g. Efficient Frontier, Did-it, Bruce Clay, etc.)

Name Development - Subject Based Direct Navigation / Domains
  Bookmarks, anyone with a branded URL or existing traffic, browser navigation, search engines

Pike Street – Locally focused direct navigation (zip codes and Yellow.com)
  All yellow page players, GOOG, YHOO, INCX (Local.com), CitySearch, oodles of startups

Industry Brains – Publisher specific monetization
  Direct: Adbrite, Google OASU, Federated Media, BlogAds
  Indirect: Doubleclick, 24/7 Media, Yahoo Publisher Network

I own puts on Marchex’s stock.

Intel – Chipper Long-term Prospects

Intel is unloved right now.  AMD is kicking its butt on the low end and making inroads in high end chips.  Inventory is building up in the channel, margins are compressing, and analysts are downgrading the stock.  Intel’s stock has made very little progress in the last nine years.   However, on a PE basis INTC is cheaper than it has been since 1996. It is trading at below a 15 PE - even less if you back out its cash.  INTC has over $10 billion in net cash and is actively buying $25 billion of its own stock.  The dividend is 2%.  Apple is using Intel chips (and gaining share).  Windows Vista is about to be released which could drive a new upgrade cycle in PCs.  Intel’s competitive troubles with AMD may take longer to sort out, but INTC has the resources and infrastructure to out-innovate AMD.  AMD may be ahead on performance, but Intel is pulling ahead in price-performance, power consumption, and smaller chip-making infrastructure.  Intel is expanding via consumer electronics (with VIIV), NAND memory (a JV with Micron), and mobile chips (with XScale).

In short, Intel is a contrarian play.  Sure, it could get worse before it gets better as AMD continues to steal share and the inventory backlog gets worked out.  But with INTC buying back shares, you should rejoice if the price keeps declining - you and Intel can buy more for less.

Is Asia the Fountain of Youth?  My take is that Asia presents the greatest opportunity for Intel. Intel CEO described China as the fountain of youth for computing. China, India and the rest of Asia comprise an opportunity more than twice the size of the current developed world over the coming 20 years.  With less than 10% of each country online and likely less than 5% with computers, the long term opportunity is huge.  It is my belief that almost every household in the world will have a computer at some point (just like TV’s in the US today). Heck, even Russia has a computer penetration of only 20% according to BusinessWeek.

Will Desktop Linux and OpenOffice remove the Microsoft software tax?  In more price sensitive foreign countries, a computer fully loaded with Microsoft software could be prohibitively expensive.  As free open-source alternatives to Microsoft’s products become viable for third world consumers, prices of computers with pre-installed software will drop (Microsoft will likely drop their prices in these countries too).  Fortunately for Intel, every computer still needs a processor!  Admittedly, many of these processors may be on the low end, but there will be a spectrum of demand.

Currency play? Asia’s share of Intel’s sales is now 60% and growing - they are selling to the manufacturers.  Given that Asian currencies are expected to strengthen over the next decade as China’s currency policy allows for floating, Intel’s stock could be a very smart bet on strengthening Asian currencies.  As Asian currencies strengthen, Intel will get a boost to dollar denominated revenue and profits. Intel does hedge currency fluctuations for 12 months forward, but over the medium to long term, they should benefit tremendously.

Disclosure: I am long INTC and MSFT.  I also own calls on MSFT.  I was recently long AMD but have almost sold out of my position (all I have left is spoken for via in-the-money covered calls).

Marchex Earnings – Red Flags

I’ve been silent on MCHX for a while (been busy with a new baby), but I have another interesting post coming up soon!   In recent news, however, Marchex released earnings last week and have seemingly continued to convince investors that they are a growth business.  While their direct navigation top-line growth was intriguing (see marketing analysis below), I still contend that Marchex is overvalued and their stock price will correct.  Below are some of the red flags from the press release and conference call.

117% or 35%? The press release (and the business press too) proclaims that revenue was up 117% for the year.  However, if you look deeper, you can see that pro forma revenue (including all the acquisitions) was only up 35% for the year and a even smaller 27% Q4 over Q4.  Revenue growth is not robust and is decelerating.  For the businesses MCHX started the year with (Enhance, Goclick and Trafficleader) revenue was up only 9% Q4 over Q4 – going from $15.1 million in Q4 2004 to $16.4 million in 2005.  The Q4 over Q3 was a paltry 2% in those businesses – what happened to the famous Q4 bump? See my posts on their slow growing old businesses and lack of overall organic growth.

High PE with modest growth?  Pro forma revenue is projected to grow 19-27% from 2005 to 2006 ($105 mil growing to $125-133 mil).  That is pretty low growth rate for a company trading at EV/FCF ratio above 50.  If you take Q4 on a run rate basis (4x 29.8 mil = $119.2 million), growth will be in the 5-12% range - hardly the growth rate of Google or Yahoo.  Theoretically, it should be easier to grow a business off the smaller revenue base that MCHX has.  See my post on their cash flow ratios.

One million shares of dilution!  Another quarter and another million shares in dilution.  Shares outstanding went from 38.3 to 39.3 million from Q3 to Q4.  That is over $20 million in value dilution.  Marchex didn’t even have $30 million in revenue yet shareholders suffered over $20 million in dilution.

Eye-popping marketing growth!  Q4 sales and marketing expenditure skyrocketed by 261% year over year and 59% over Q3.  Marketing as a percentage of reported revenue has doubled from a recent 7.3% to 14.7%.  If you look at the businesses they acquired this year, the numbers are even more dramatic with marketing as a percent going from basically nothing to 22.4% of revenue from new businesses.  Management has indicated that they have been purchasing sponsored listings to drive traffic to their direct navigation domains.  This arbitrage window should close as CPCs rise on the terms MCHX is buying.   Is MCHX basically buying short term revenue growth?

I own puts on Marchex shares at various prices.

Has Slashdot traffic spiked because of Digg?

I am always looking for good investment data sources so I checked out a cool Google homepage module called Alexa Rank and noticed it pulled four years of Alexa data.

Turns out you can hack Alexa's standard URLs and change the range parameter to get up to ~4.5 years of traffic data.  This is particularly valuable for investors in web companies to see year over year growth in website traffic.  I've been following Slashdot and Sourceforge traffic since I first purchased LNUX in late July.

To see Slashdot's historical traffic, you change the range parameter of the URL of the two year chart from "range=2y" to "range=5y".  See below:

• Range = 2 Years: http://www.alexa.com/data/details/traffic_details?&range=2y&size=large&y=r&url=slashdot.org

• Range = 5 Years: http://www.alexa.com/data/details/traffic_details?&range=5y&size=large&y=r&url=slashdot.org

I added Digg.com as a comparison.  Interestingly, traffic has surged at Slashdot around the same times that Digg saw big increases in traffic.  My theory is that press coverage of Digg and user-generated content has lifted the interest in the old school Slashdot.  The Digg effect seems to have vaulted Slashdot to new heights but also underscores the impressive growth of Digg, surpassing Slashdot's historical traffic highs in less than a year!

I own LNUX shares - and should have blogged about it before the run-up!

Digg this!

Foolish MCHX Myths

Motley Fool’s Rick Aristotle Munarriz had an article about Marchex this week. I thought I would address some of what Rick said. All quotes in this article are his and the full article is here.

Rick: “Anyway, Marchex certainly wouldn't seem to be a company in need of fixing. The stock has shot up nearly 80% since bottoming out in August. Marchex is profitable and, last month, posted a 110% spurt in revenue. The company toils away in the lucrative online advertising market. It owns a few contextual pay-per-click marketing outfits like IndustryBrains and Enhance Interactive.”

Myth 1: 110% spurt in revenue – this is not on a pro forma basis. Y/Y revenue growth was 25% and the business has only grown 7% from Q1 to Q3 of this year. See my post about the lack of organic growth at MCHX.

Myth 2: lucrative online advertising business – this is true only for traffic owners. Enhance, IndustryBrains and GoClick are low margin businesses that need to share most of their revenue with their partners. In the case of Enhance and GoClick, these partners are likely low quality traffic sources. Less than a third of Marchex's revenue comes from traffic they own.  See my post on Enhance and GoClick.

Rick: “Anyway, if you want to know why I bought Marchex, it's because one of its biggest domains is hardware-update.com. It may not exactly roll off the tongue, but it was a site that Microsoft (Nasdaq: MSFT) used to send users of Windows 2000 to when they received hardware-related error messages. Some schmuck at Microsoft forgot to renew the domain, and a company that Marchex went on to acquire gobbled it up.

However, if you go there, you'll see that the sponsored listings have little to do with Windows operating system problems, computer upgrades, or attractive peripherals. No, most of the ads in the main body of the page are for replacement windows for the home. Talk about a blown opportunity. I have no idea how poorly targeted the other Marchex properties may be, but although this might be indicative, my excitement is still there. It's an easy fix, and it represents untapped profit potential that will come around once the company wakes up from its shortcomings.”

Myth 3: All of MCHX’s domains have long term value. Some of MCHX’s domains have inherent value (debts.com for example) as type in direct traffic destinations. But some of MCHX’s domains (e.g. hardware-update.com) are expired links with residual traffic from existing links on the web. Without the external links from Microsoft, no one would ever find hardware-update.com. Marchex could invest in making these domains more targeted, but over time (usually a few years) expired domains lose almost all of their traffic as links are removed or replaced. See the Alexa traffic chart below to see how this domain has lost traffic over time - even though it has been mentioned in a few articles recently it still is not in the top million sites even though it used to be. Revenue from these domains with expired links will need to be replaced with new sources or prove to be a drag on MCHX’s revenue and profits.

I own puts on MCHX shares.