Tuesday, November 28, 2006

Journey into the Whirlwind-Louis Lowenstein

Louis Lowenstein is the Rifkind Professor Emeritus of Finance and Law at Columbia University, a former CEO, a former corporate director and the author of "Sense and Nonsense in Corporate Finance" as well as "What's Wrong with Wall Street-Short Term Gain and the Absentee Shareholder" both excellent books. Another notable accomplishment...he is the father of Roger Lowenstein, one of the great business writers and in my view, the author of the best of the Buffett biographies. Both father and son are fixtures at the Berkshire annual (and I suspect long time shareholders.)

Louis Lowenstein is an enemy of that socially destructive addiction called trading. Columbia has published a speech he delivered about a year ago before the NY Society of Security Analysts which celebrated Value Investing and Irving Kahn's 100th birthday.

Here is a link to that fabulous speech.

A few highlights to whet your appetite! Lowenstein refers to the large majority of all equity funds that are managed "energetically so as to keep pace with the market." He tracks the record of the twenty largest large cap growth funds circa 1997 which due to mergers and style drift numbered fifteen survivors. These fifteen underperformed ten value funds (selected by Bob Goldfarb of Sequoia and Ruane Cuniff fame) by 18% per year. As Lowenstein describes it, "With a good tailwind, those large cap funds were not so great- underperforming the index by almost 2% per year-and in stormy weather their boats leaked badly."

He mocks the "senseless trading" that occurred in one mutual fund which will go nameless here...it is named in the article. Turnover at one point hits 305%. Of note,the fund's "investors" were just as bad...merely speculators who were trying to catch the next new thing. One year "investors" redeemed $17.5 billion in mutual fund assets and bought $16 billion in new shares, leaving the fund at year end with $14 billion. Clearly, management got the shareholders they deserved!

He later provides one of the great lines:

"While our large growth funds demonstrate that an investor can do worse than indexing, it remains true that an intelligent investor can do better."

Later in the speech, he focuses on Graham and Doddsville. He describes CAPM and other formulae as "an effort to reduce uncertainty to a quantifiable risk" but as he eloquently quotes von Hayek:

"They are measuring what is measurable, not what matters."

He quotes Bill Ruane's "Memorandum of Investment Philosophy" with five principles:

  1. Buy good businesses. The single most important indicator is a superior return on capital, because it means the company enjoys a unique proprietary position.
  2. Buy businesses with pricing flexibility, always true, but particularly in the inflationary period in which he wrote.
  3. Buy stocks at modest prices. While price risk cannot be eliminated, it can be lessedned materially by avoiding high multiples.
  4. Buy strong balance sheets, If this rule is violated, none of the others will matter!
  5. Buy cash generating businesses, those where the earnings are truly available to create future growth or for payment to stockholders.
He finally points out that if you are fretting that the VIX may be signaling fear this week, value investing is not for you!

This is truly a worthwhile read and a great reminder of the disciplines that are required for both value managers and their investors.

Disclaimer: I, my family, and clients proudly own a current position in Berkshire Hathaway.

Coinstar Costs a Pretty Penny Reprise -Correction

Coinstar (CSTR) was recently featured by Asif at SINLetter.com. I had included some free cash flow figures which were taken directly from a database without checking the validity of the numbers.

I checked the cash flow statements from several sources. Most had some discrepancies. The conclusion: Don't put too high a reliance on the accuracy of some commonly used data sources. Verify it directly from the financial statements. I apologize for the error.

Here are the cash flow figures (in $millions) for CSTR over the last five years based on continuing operations:

Year...Net Income.......CFFO.......Capex..........FCF






I apologize for the confusion. Thank you Asif for alerting me!

Sunday, November 26, 2006

Festival of Stocks Edition #12

Welcome back to the 12th Edition of the Festival of Stocks! Value Discipline is proud to host the Festival for the second time. Thank you to everyone who has submitted a post and thank you to all readers who are visiting Value Discipline. To our new arrivals, welcome and please have a look around!

We have been provided many excellent submissions for your entertainment and edification. As always, I try to add a few comments of my own. We welcome your additional insights and commentary!

A review of the past week. The Dow Jones Industrials dropped 62 points for the week ending down 0.51%, a rather surprising conclusion to the week, given the backdrop of takeover fever that seems to be closing out the year. Much of the weakness in the Dow can be attributed to Kirk "I'm just a passive investor" Kerkorian's dumping of 14 million shares of GM at $33 leaving him with a position of a" mere" 7.4% stake. This frees up $462 million just in time for Kirk to saddle up to an additional $825 offer for MGM Mirage . Why not stick to something you know, after all Kerkorian already owns 56.3% of MGM. The next time you hit the strip you will likely run into a Kerkorian property which includes Bellagio, MGM Grand, Mandalay Bay, The Mirage, Luxor, Treasure Island, New York New York, Monte Carlo, and Circus Circus. What happens in Vegas stays in Vegas and much of my activity seems to go directly into Mr. Kerkorian's wallet! GM was down 11.7% thereby costing Kirk $173 million on his remaining stake. However, MGM's 13.3% rise resulted in an incremental boost in Kirk's MGM holdings of $1.007 billion. I hope you had a good week too! Broader indices fared somewhat better than the Dow with the S&P 500 losing 0.02% but the Mid-Cap +0.73%, the NASDAQ Composite +0.59% and then Russell 200 +0.48%. Weren't all the strategists telling us that small cap was dead and big cap was the way to go?


Stock Market Beat, written by Trent, has noted a seasonal pattern in Intuit (INTU) an expectation that he had commented on a month earlier. The company has just announced a rather spectacular first quarter with revenues up 19% as a result of an early intro of a new edition of QuickBooks. Ex this, the company would have reported a 12% improvement in revenues. My only commentary is what a gorilla of a stock this has been. Even after this seasonal correction of 8% in the last month, the stock is still up 19.29% for the year. This is a great business with a ROIC of 23% on a TTM basis, the best it's been in three years. Consensus earnings growth rate for the next five years is 15.5% versus the last four quarters at 5.2%.

George of Fat Pitch Financials presents Sally is a Beauty of a Spin-Off. Sally Beauty Holdings (SBH) has just been spun off from Alberto-Culver (ACV.) George outlines why this fits the characteristics of a successful spin-off. These characteristics have been outlined by Joel Greenblatt in the past and George demonstrates their applicability to Sally. Institutional investors generally do not want a holding that is not part of an index...SBH isn't at least for now. The company is highly leveraged from inception. However, in my view, the business is fairly well insulated from economic cycles and has demonstrated consistent cash flow characteristics. Importantly, its retail stores require very little capital. The earnings growth should be strong as there is high financial leverage, there will be some de-leveraging and reduction in interest costs moving forward, and the store base continues to grow. This is a very large chain with over 3000 stores. George owns the stock, I don't...yet.

Coinstar Costs a Pretty Penny is a post by Asif Suria of SINLetter. com. Asif describes Coinstar (CSTR) as being grossly overvalued at this point. It appears that revenue and earnings are heading in two different directions; regrettably, it is earnings that seem to be heading south! The shares have been remarkable this year, advancing 49% YTD. The fundamentals provide a somewhat mixed picture.The stock is trading at a 23.9 times TTM EBIT. The return on invested capital for the last twelve months is a paltry 3.8% well below a five year ROIC of 7.9%. Free cash flow growth over the last twelve months is up by a substantial 42% and sales growth has been almost 50%. Though the stock looks expensive on a P/E basis with 2006 consensus estimates of $0.62 (P/E of 54.9 X ) and 2007 estimates of $0.95 (P/E of 35.8 X), it is important to remind oneself of the FCF picture. The company has a FCF yield of about 5.0% per TTM FCF. It is interesting to look at the huge differences that exist between net income per GAAP and the free cash flow over the last several years:

Year.....Net Income.......Free Cash Flow
05.........$22 million........$147 million
04.........$20 million........$103 million
03.........$20 million........$ 79 million
02.........$59 million........$74 million
01.........($ 7) million.......$65 million

Here is a link with Coinstar Ratio Analytics per Reuters.

Siu LI of Leopard Strategy writes about Utek Corp, (UTK) which is a company engaged in technology transfer from university research labs to a portfolio of small OTC (many pink-sheet) companies which currently number some 50 companies. In essence, UTK trades technology transfer strategic alliance agreements that it makes with researchers for shares in emerging micro-cap companies. Put simply, UTK provides a way for university research scientists to monetize their discoveries by developing alliances with emerging companies. On a trailing twelve month basis, the company has a ROIC of 31%, as compared to 2005's 13.2% and 2004's 4.1%. Free cash flow has been significantly negative. Insiders hold a 25% stake (fully diluted) The company has been under attack by some shorts and Siu LI comes to its defense in this post. At present, there are some 723,000 shares short representing about 12.3% of the float.The short position is up significantly from the prior month, 377,000. I do not know enough about this situation to comment and do not have a current position, one way or the other.

Yours truly wishes to submit Computer Programs & Services for your consideration. An interesting highly profitable business in a sector that could be a beneficiary of changing trends in healthcare spending.

Personal Financial Planning:

David B at How Do People Get Rich suggests the Top 3 Easiest Ways To Make Money. He suggests on-line savings accounts, many of which pay superior FDIC insured returns since these banks do not carry the overhead burden of a branch system. He also suggests that low cost Index Funds are a great way to invest. We all know the record of the average mutual fund manager who trails the market. Collectively, it is difficult for large money managers to beat the market...as Charlie Ellis points out, they ARE the market! An Index fund is an "easy" way to make money over time, but I continue to believe that great active managers who are disciplined do win the battle. They are just not that easy to find. Finally, David suggests that investing in a 401-K is a great way to invest. Who can argue? When companies provide matching funding, this is free money. NEVER turn down free money! Obvious, yet many people put off retirement investing in favor of current consumption. At the risk of sounding repetitive, NEVER turn down free money!

Markets, Macros & Miscellany:

SuperSaver at My Wealth Builder is decidedly bullish with a 6-12 month point of view. He cites both political and economic rationale. My comment: As many of you know, I do NOT have any skillset as far as predicting markets. I remain optimistic on markets whenever I can find securities at bargain prices that exhibit a margin of safety and don't require exorbitant growth rates to justify their valuation. Fortunately, I can still find some excellent companies at decent prices. Good luck in your search SuperSaver!

HedgeFundDomain.net presents some terrific logic for trading. Essentially, know thyself! As Jeff suggests, study your losing trades...herein lies the cost-cutting opportunity. Keeping your losses in check by limiting position size and pyramiding winners into positions of greater significance is the key. A very interesting read into the arithmetic of trading!

Experiments in Finance wonders about the implications of all of these takeovers. She draws a parallel to the housing market, essentially too much money looking for a place to participate but finding it necessary to accept lower returns for the privilege. Readers of Value Discipline will recognize that I share some of these concerns. It simply does not make sense that private equity capital has discovered perpetual motion; that is, bidding up public companies, paying a takeover premium, increasing leverage, paying out a dividend to themselves and their partners, and recycling the company back onto the public equity market onto the unsuspecting. Someone is going to get hurt!

The world of forex trading has been attracting a lot of trading interest. Definitely, not part of my circle of competence. However, for those whose nostrils flare at the opportunity to combine volatility with low margin requirements, may I suggest Maximum Profit Opportunities by Mark McRae at forexblog. He presents a discussion of Fibonacci numbers and their relevance to exiting a position. As many of you know, I am agnostic when it comes to technical analysis, simply not within my circle of competence, but I have always loved mathematics. For a discussion of the fascinating story of Fibonacci numbers please try this website link.

Finally, a problem for all of us in the investment business; heck, a problem for all of us period...dealing with Information Overload. Too many e-mails, too many RSS feeds, too big a stack of "research?" Paul of Paul's Tips provides some advice in dealing with this junk ( I was trying to be polite.) In fact, calling "it" information is being overly polite. Simplifying life so that we can build a reject pile quickly is so important in the investment world. Some ideas are so preposterous, so stupid, so extraordinarily expensive that we shouldn't spend five seconds contemplating such ideas. Buffett has mastered this, often being able to reject an idea within seconds. Find your circle of competence and develop it! Dwell there and ignore all the noise around you. That's the way to really enjoy your life and build some wealth.

Thank you for your attention this week. Next week's Festival of Stocks will be hosted by Frugal at My 1st Million at 33. If you have a post to submit, please send it to this convenient form. Previous editions of the Festival of Stocks are available at this link.

Saturday, November 25, 2006

Computer Programs & Systems

Computer Programs and Systems (CPSI) has an incredibly generic name that sounds like a circa-1960 course at college. However, this is a company with a far from generic or prosaic record. This is a business focused on delivering healthcare information services.

I believe that this business has a strong competitive moat given its focus on small community hospitals. One of the important characteristics of businesses with a competitive moat is "serious" profitability. This business has a return on capital of 42% over the last twelve months.

As an experiment, I have written a more complete overview of the business as a series of links to quicksharing.com files. You will find a discussion of changing economics of reimbursement, some discussion of street expectations, as well as links to a Wall Street Transcript interview with a portfolio manager who has a position in the security. As well, I have provided a couple of spreadsheets of ratio analysis that demonstrate the improving profitability that this company has experienced.

I look forward to your comments regarding this somewhat different approach to providing blog information.

CPSI Outline:

CPSI Financial Data:

CPSI Ratios & Analytics:

Disclaimer: Neither I nor my family have a current position in any of the securities mentioned. Some clients do own a current position in CPSI and in MCK.

Friday, November 24, 2006

Festival of Stocks

Value Discipline will be hosting the Festival of Stocks on November 27th. This will be our second time to host this blog carnival.

I'd love to have you participate in the festivities! If you have a blog and would like to participate, it is easy! Just use this link to submit one of your recent posts: BlogCarnivalLink

It's a great way to share ideas, gather new ones, and see what market participants are finding compelling and interesting.

If you would like to have your article posted for next week, I need those posts submitted by tonight!

Thank you everyone and have a great Thanksgiving weekend!


Thursday, November 23, 2006

Happy Thanksgiving!

Happy Thanksgiving wishes to our American readers! Certainly, no matter what the circumstances that life may bring you, there is always much for which to be thankful.

America's National Day of Thanksgiving actually was proclaimed by President Lincoln in October of 1863 which set apart the last Thursday of November "as a day of Thanksgiving and Praise." The nation was still in the midst of civil war and the battle of Gettysburg had occured just several months prior. Lincoln had not yet delivered his Gettysburg address.

Despite the horrible anguish of war, Lincoln delivered the following proclamation:

"The year that is drawing towards its close, has been filled with the blessings of fruitful fields and healthful skies. To these bounties, which are so constantly enjoyed that we are prone to forget the source from which they come, others have been added, which are of so extraordinary a nature, that they cannot fail to penetrate and soften even the heart which is habitually insensible to the ever watchful providence of Almighty God. In the midst of a civil war of unequaled magnitude and severity, which has sometimes seemed to foreign States to invite and to provoke their aggression, peace has been preserved with all nations, order has been maintained, the laws have been respected and obeyed, and harmony has prevailed everywhere except in the theatre of military conflict; while that theatre has been greatly contracted by the advancing armies and navies of the Union. Needful diversions of wealth and of strength from the fields of peaceful industry to the national defence, have not arrested the plough, the shuttle or the ship; the axe has enlarged the borders of our settlements, and the mines, as well of iron and coal as of the precious metals, have yielded even more abundantly than heretofore. Population has steadily increased, notwithstanding the waste that has been made in the camp, the siege and the battle-field; and the country, rejoicing in the consiousness of augmented strength and vigor, is permitted to expect continuance of years with large increase of freedom. No human counsel hath devised nor hath any mortal hand worked out these great things. They are the gracious gifts of the Most High God, who, while dealing with us in anger for our sins, hath nevertheless remembered mercy. It has seemed to me fit and proper that they should be solemnly, reverently and gratefully acknowledged as with one heart and one voice by the whole American People. I do therefore invite my fellow citizens in every part of the United States, and also those who are at sea and those who are sojourning in foreign lands, to set apart and observe the last Thursday of November next, as a day of Thanksgiving and Praise to our beneficent Father who dwelleth in the Heavens. And I recommend to them that while offering up the ascriptions justly due to Him for such singular deliverances and blessings, they do also, with humble penitence for our national perverseness and disobedience, commend to His tender care all those who have become widows, orphans, mourners or sufferers in the lamentable civil strife in which we are unavoidably engaged, and fervently implore the interposition of the Almighty Hand to heal the wounds of the nation and to restore it as soon as may be consistent with the Divine purposes to the full enjoyment of peace, harmony, tranquillity and Union."

Though war rages in many parts of the world, though terrorism remains an ever-present concern to all of us, though there remains "lamentable civil strife" in many nations, the magnificent words of Lincoln ring true today.

My Thanksgiving wishes for all of us include for you and yours the full enjoyment of peace, harmony and tranquillity.Have a good one!

Sunday, November 19, 2006

24/7 Wall Street moves web addy

As most of you know, one of the best blog aggregators of value investing information is 24/7 Wall Street. The site is run by Doug macIntyre and Jon Ogg. We are proud to be a contributor to this site.

As of this weekend, they have moved their site to :


from its prior blogspot location.

Please update your links and your feeds.

Thursday, November 16, 2006


MarketThoughts.com is a subscription based website run by Henry To, a fellow CFA and his friend Rex Hui. It has been operating as a subscription based service for just over a year. Henry recently asked me if I would participate as a guest commentator for his service. I have agreed to do so.

Having looked at Henry’s commentary, I can recommend it highly to you. MarketThoughts provides insightful analysis of capital markets as well as asset allocation issues. Sentiment, liquidity, and valuation are the major factors that go into the analysis. Commentary is concise, articulate, and well-presented. A Dow Jones Index timing model is provided as well. Currently, they are 100% long this market.

Individual stock highlights are provided by Bill and as of now, by yours truly. Since the intent is to provide such selection on a monthly basis, this will not interfere with my attention to Value Discipline and my loyal readers. As always, the purpose is to entertain and to educate and not to provide investment advice. If you are looking for portfolio management, I cannot do so without knowing your objectives and circumstances. If you wish to be an investment management client, please feel free to contact me.

Henry and Rex offer a free one month trial to their website. No obligation, no pressure. If the thought of a subscription worries you, their site is available on a three week delayed basis to the “free-riders.” I urge you to try it out.

Tuesday, November 14, 2006

Buybacks...Some Terrific Insight from Information Arbitrage

Gretchen Morgenson of the NY Times recently wrote an article on, "Why Buybacks Aren't Always Good News.” Buybacks, per se, will only create value if the stock is purchased at prices below its intrinsic value. Buybacks should be viewed much as any other capital expenditure, will this expenditure produce value in excess of each dollar spent? Likewise, a company must attend to its operating needs first...will the spending on share buybacks impede the company's ability to maintain its competitive position?

Buybacks completed at too high a price reward the sellers of the stock rather than the loyal shareholders who are left ehind. Buybacks in some cases seem to be in place simply to help support the stock. In some cases, such as Yankee Candle, they are a prelude to mopping up loose stock and essentially wrapping up the show.

The simplest test of the effectiveness of share buybacks is to look at the fully diluted share count after a share buyback program has been implemented. Has the share count been reduced, or is the share buyback merely sopping up stock created from employee options?

Some really terrific insight into the dynamics of share buybacks was recently posted in Information Arbitrage. This articulate discussion of share buybacks addresses the corporate finance reasons for undertaking such purchases (essentially, buying stock below intrinsic value increase the intrinsic value of what remains) as well as how GAAP handles such purchases. Reduced share count does NOT always equate to higher E.P.S. if its earnings that float your boat.

Buybacks should always be examined for their motives and their effect on the ultimate capital structure of the firm. Significant buybacks such as the Dutch auctions that we have witnessed in CBRL may not necessarily create a great deal of value. If the end result is a leveraged mess that is incapable of competing effectively, the CFO has traded the warm blood of equity for the cold reality of debt.

Disclaimer: Neither I, my family or clients have a current position in CBRL.

Monday, November 13, 2006

Real Money, Blog Watch and James Altucher

We are honored to have been included by James Altucher in his Top 100 list of favorite Finance and Investing blogs. As you probably know, James features on a daily basis his top finds among the many fine blogs that he checks out regularly. Value Discipline has been fortunate in having been featured numerous times.

Please check the link.

I am delighted to see so many friends on the list. Many of these are already featured in the Value Discipline links. I am proud to be in such good company!

How to Kill a Brand

One of the most important aspects of value investing that one can learn is the value of a brand. Developing the unassailable franchise requires a lot of work. Tending and grooming the public image to keep a brand relevant and authentic is the most critical task that consumer product managements have before them.

Advertising is not an extravagance. Advertising can set off deep emotional triggers that motivate the consumer to buy from certain companies and not buy others. How does the company stand out amongst a sea of competitors. The best way is to have a memorable presence in the head of the consumer! Shareholders benefit from the results, a growing stream of revenues, improved pricing, stability in downturns, higher profitability, and lower cost of capital.

Advertising is viewed by most shareholders as an expense. In my view, it is a capital expenditure, not terribly different than building a factory or buying equipment to build revenues, but with a very special bonus attribute...a 100% write-off in year one! Rather than a prolonged schedule of depreciation, Uncle Sam participates in the deduction, all in that first year.

Here's a look at someone who is killing a brand, Adidas.

Reebok under Paul Fireman did a lot of squirrelly things, at times leaving its premier brands completely unsupported. Many times through the 90's, as a pain in the butt activist shareholder, I reminded Paul of his obligations to shareholders, not to mention numerous unkept promises. Even Paul, who took some time to catch on, learned his lesson.

Reebok became masterful in capturing the authenticity that Paul had proclaimed, but previously failed to support in its product design, its professional endorsements, and its advertising.

Here's a look at Reebok's advertising spend over the years:

2004   $137 million
2003   $150 million
2002   $131 million
2001   $144 million
2000   $108 million
1999   $106 million

Here is the marketing support that Adidas has brought to the brand in the first half of this year:

2006   $7 million

Reebok orders have plunged 14%. Profit margins are narrower than expected. Retailers are likely fuming. In a never ending battle for shelf space, cutting back on advertising spending destines brands to oblivion.

Adidas is stepping up spending for next year with an incremental $63 million in spending. Looks like Adidas is learning the lesson that Paul Fireman finally did in the late 90's.

Disclaimer: I, my family, and clients do not have a current position in Adidas.

Sunday, November 12, 2006

That's the Way it Was

Years ago, that was the sign-off for Walter Cronkite on CBS News. Back then television and broadcasting were in their heyday.My purpose is not to reminisce, but rather to find today's parallels to what were very exciting times! In a lot of ways, Central European Media Enterprises (CETV) represents today's version of what was.

Central European Media Enterprises is the leading broadcaster in Central and Eastern Europe, operating thirteen networks in six countries and reaching about 92 million viewers. Launched in 1994, CETV, along with its local partners, operate ten stations that include TV Nova and Galaxie Sport in the Czech Republic, PRO TV, Acasa and PRO CINEMA in Romania, Nova TV in Croatia, Markiza TV and Galaxie Sport in the Slovak Republic, POP TV and Kanal A in Slovenia and Studio 1+1 in Ukraine.

Eastern European economies are growing at a much faster pace than the established Western European or US economies with growth rates of some 10-12% per annum. Advertising spending is still in its germinal stages accounting for only about 0.50% of GDP versus Western Europe at about 0.90% of GDP and the US at about 1.25% of GDP. As these markets grow in their sophistication and pricing, revenue growth for CETV should be some multiple of GDP growth over the next four or five years. This is particularly true as Eastern European society develops into a more consumption focused society.

CETV ranks first in each of its major markets except Croatia (where the network is only 2 years old) and receives over 50% of advertising revenues. To its viewers, CETV appears to be a local broadcaster so language, content, and independent local news seems to be authentic and local.

Like North America, the main barrier to entry is regulatory...government regulation determines the number of signals or channels that are allowed.

In last week's Wall Street Transcript (subscription required) there is an interview of the CEO Michael Garin and the CFO Wallace MacMillan. Michael Garin has an outstanding background in media having started at Time Inc (wel before AOL and Warner) and in co-founding Lorimar Telepictures which ultimately was sold to Warner Communications. He was a first rate investment banker at a first rate firm for entertainment and media investment banking, Furman Selz. He has extensive board experience in Europe including Cablecom, the largest cable TV company in Switzerland and Canal Plus Nordic, the top pay TV provider in Scaninavia. MacMillan was a finance type with Bertelsmann, Virgin Music, and EMI.

Garin describes the strategy as follows:

"Our revenues are approximately $500 million. Our EBITDA is approximately $200 million, so our company is of significant scale. We have two sets of aspirations looking forward to our future. One is to increase the number of outlets that we have within the current six countries in which we operate and also at the same time, to be a leading provider of media, including the Internet, telphony,and other forms of new media communications. The second is to remain the dominant broadcaster in each of our countries."

The Eastern European world looks quite different than what we are used to. Cable penetration in the Ukrained is only about 20% Only about 10% of the audience will be reached by broadband Internet access by 2011. The competitive advantage period appears to be elongated by these circumstances.

Cost advantages also seem to be sustainable. The cost of production can be amortized over a much bigger scale and bigger audience compared to its competitors. For some programming, the unit costs can be half that of the competition. Local culture can be respected, neighboring and adjacent cultures can be served with common programming and hence provide synergies.

EBITDA margins are very sizable at about 49.6% for the TTM period. This is about twice the profitability of a US TV network.

The recently reported third quarter seemed to disappoint some investors with a slight revenue miss. The stock traded down about 4% on Friday.

Regrettably, this kind of excitement comes at a fairly substantial price. The stock is trading at about 21 times TTM EBITDA and 29 times TTM EBIT, a royal price indeed. Given its growth attributes and acquistive nature, the business has yet to generate any free cash flow. Surprising, given the huge EBITDA margins.

Earnings estimates for next year on the Street range from $2.22 to $3.12. Such a range! The street remains quite bullish here with only two hold opinions and six buy/outperforms.

Discipline demands that one separate a good story from a good stock. The margin of safety at current levels is nil, the stock is fairly valued in my opinion, given the superb economics of its growth. Great story, great management, great properties but not enough downside protection at current prices.

Disclaimer: I, my family, and clients do not currently have a position in CETV.

Thursday, November 09, 2006

Democratic Victory and Healthcare-Think Positive!

With Democrats as "Masters of the House, " fear and trepidation seems to have swept the U.S. investment world.  Nancy Pelosi has promised legislation that would allow the government to negotiate directly with drug companies to purchase pharmaceuticals for Medicare, essentially equivalent to price controls in my view. Investors have headed for the hills...here are price changes in some of the major pharma companies since Tuesday's intraday highs:

Eli Lilly (LLY)                   -4.73%
Merck (MRK)                   -8.49%
Pfizer (PFE)                    -8.95%
Schering Plough (SGP)    -8.47%
Wyeth (WYE)                     -7.49%

I will have commentary regarding managed care and hospitals in a later post. One of the areas of great interest to Democrats has been drug safety, and rightfully so.

Senators Enzi (Republican-Wyoming) the Chairman of the Senate Health, Education, Labor, and Pensions Committee along with the Committee's ranking member, Senator Ted Kennedy (Democrat-Massachussetts) proposed a bill in August that would slow down the FDA approval process by implementing additional hurdles. New drugs and biologicals would have to undetake additional studies and clinical trials as part of a "risk evaluation strategy."

Here is Ted Kennedy's description of the bill.

Though delays in approval are clearly a negative for the pharma industry, there are other participants in healthcare that could benefit, namely the contract research organizations aka CRO's.

Examples of these companies and their performance since Tuesday are as follows:

Covance (CVD)   -3.21%
Parexel (PRXL)   -3.50%
Pharmaceutical Product Development (PPDI)   -5.90%

The potential for independent outsourcing of clinical trials at whatever phase seems to be enhanced by these proposed changes.

PPDI in particular is one that I like. It has generated free cash flow in six of the last seven years totalling $750 million
 of FCF. Over that time frame, capex has totalled only $315 million. Cash flow has been directed into reinvestment and why not, return on invested capital was 17.2% last year up from 15.4% and 9% in the last three years. On a TTM basis, ROIC is a healthy 15.7%. The company has not engaged in any share buybacks but has returned capital through its dividend of $0.10 annually. Last October, a special dividend of $0.525 was also paid out.

The five year revenue growth has been strong at 22.7%. Similarly, e.p.s. growth over that period was over 28%. FCF growth was 15%...strong numbers. On an EV/EBIT basis the company is trading at 17.6 times trailing twelve months EBIT.

PRXL trades at a slightly higher EV/EBIT at 19.25 times, has a spottier record of free cash flow generation and is generating ROIC of 10.9% on a TTM basis, up from its historical profitability but well below that of PPDI.

CVD, the largest and best known of the CRO's, has an ROIC of 15.1% similar to PPDI but sells at a fairly rich 19.3 times EBIT.

In adversity, one can often find bargain prices. In this case, it seems that the adversity is somewhat misplaced.

Disclaimer: I do not have a current position in any of the securities mentioned. Some clients have a current position in Covance and Pharmaceutical Product Development.

Sunday, November 05, 2006

Observations on Risk-Don't Confuse Liquidity with Brains

As my profile indicates, I have been in this business for more than 25 years, in fact come April, it will be thirty years. I suspect I may be one of the older bloggers around, but I still look at myself as someone who still has a long career ahead, God -willing. I would love nothing better than continuing to come into my office well into my golden years, following the examples of Buffett and Munger, or others you may not know such as Irving Kahn, or Roy Neuberger. Despite many years of experience, having influenced billions (yes with a B) of dollars of assets, having faced numerous investment committees, and many individual clients, I still view myself as someone who is still involved in continuous learning. I would far rather think about an investment issue, or read a 10-K or Q than watch most sporting events...a tough admission for a guy, but a very honest one.

What makes a good portfolio manager? In my view, there is a passion for excellence and learning. But most importantly, there is an appreciation of risk. The investment management business has a very long apprenticeship, perhaps longer than any other occupation. An appreciation of risk from what I see, is innate rather than taught. Being able to think in probabilities of outcomes with a respect for the downside is not just a mathematical exercise, it should be practically a reflex action from a good portfolio manager.There have been times during my business career when risk capital was in very limited supply. For example, in 1982, I can recall seeing investment pools that were supposed to be fully invested with cash positions of 40%! Though prices kept getting cheaper, it seemed that no one was interested in taking on the "risk" of the market. Yet, in retrospect, the real risk resided in not being in the market. Risk aversion for me and other value buyers was overcome by great prices.

Risk aversion unfortunately tends to get thrown out the window by higher rather than lower prices, by exotic instruments rather than traditional ones, and by mystery and intrigue!Risk aversion was defenestrated in the Internet phase of 1999 and 2000. Despite wonderful opportunities that existed in the decent stocks that were being dumped to provide the fuel to accumulate the crap, the desire for more risk overwhelmed most investors. Boring and decent was traded for excitement and lure.

Since that time, investors just can't seem to get that excited about equities. Though long term returns of 11 and 12% seem like impossibly high annual returns for the long term, those kinds of returns were the basis for many financial projections by financial planners. Now, most planners seem to have a tough time forseeing conclusion above 7%. Many clients find that conclusion less than satisfying and inadequate.

Unfortunately, this has resulted in stretching for returns. Stretching for returns generally means assuming more risks. The willingness to undertake new, unproven, and risky investments seems very high at the moment. The skepticism and apprehension that ordinarily causes vacillation and reluctance in many investors also seems to have gone by the wayside. In short, when it comes to hedge funds, to private equity funds, and to buyout funds, the usual insistence on high risk premiums is absent and the willingness to accept greater risk is strong.

When I consider some of the buyouts that have taken place this year, some of them which benefitted my clients as well as myself, I shudder to think about how these businesses will look when they come back to the public market. Please read my views on the Yankee Candle proposed deal. Similarly, Aramark (RMK,) Macdermid (MRD,) Petco all have either gone away or are going to buyout funds.

What an irony! If prospective returns on public equity are considered to be so substandard and below historical norms, that they are considered unexciting, how is it possible that the buyout funds can buy these companies at takeout premiums, charge huge fees, and generate superior returns to those available in the public equity markets? Combine that with greater competition for deals amongst the buyout firms and a consequent need to pay ever higher multiples and it seems that high buyout returns are history and are unlikely to repeat themselves, at least from current market valuations. How can it be possible???

Admittedly, there is magic in creating debt leverage. Running companies harder with thinner equity cushions heats returns. Unfortunately, recession or high interest rates also force these heated results into the pressure cooker.A great deal of liquidity and friendly interest rate environments have made a huge contribution to the wealth of many buyout dealmakers. If liquidity becomes grudging, highly leveraged transformations of previously sound balance sheets will face a sordid future. Finally, the dependence on creating some sort of public equity transaction as an exit strategy becomes unassured.

Witness how quickly some operators want to get out of their deals. Leonard Green et al got out of their FTD deal in a year. The folks who bought (or perhaps stole) Hertz from Ford are taking their investment out in 11 months.

Equity markets are not always that willing to help in the rescue. Streamlining of operations works best in expanding economies and floating rate debt cannot always be swapped into fixed rates when credit cycles are stingy.Don't succumb to the lure of past returns. Don't confuse returns with brainpower. And don't forget that buying businesses without a margin of safety will bite you in the butt eventually. Today's darlings of the buyout world will ultimately disgrace the capital markets and disappoint their investors.

Disclaimer: I, my family and some clients have a current position in Yankee Candle. Certain clients have a current position in Aramark and in Macdermid. None of us owns a position in FTD.

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