Don Draper’s Friday News & Notes

Don is ready for the 4th- are you?

As we get ready for the long weekend and a celebration of the signing of Thomas Jefferson’s masterpiece,  today’s News & Notes is brought to you by Don Draper. Today marks the official spin-off date for AMC Networks (AMCX). AMC is home to some excellent shows such as Breaking Bad and The Walking Dead, as well as the disappointing The Killing, but is best known for picking up a show HBO rejected called Mad Men. Mad Men introduced us to the dapper, mysterious Don Draper (played by Jon Hamm) and made all of us thirtysomething guys want to live in the 1960s.

Anyways, as with most spinoffs, I did a bit of research and planned on dedicating a full post to the company, but there was one problem- there was nothing terribly interesting when looking at the potential value of AMC. But, there is one glaring problem at the company. The company’s former parent, Cablevision (CVC), loaded the newly independent AMC with more debt than a Greek bank – $2.4 Billion worth! While AMC, which also owns the We, IFC, and Sundance networks, will be able to generate good cash flows, my fear is that the heavy debt load will limit the amount of investment that can go into development of new shows which is the lifeblood of a company like this. At around $40 with negative shareholder equity, AMC appears overvalued to me.  If the stock sells off, or an interesting situation develops, I’ll write a follow up. Now onto some other notes.

  • Research in Motion (RIMM), the maker of the ubiquitous Blackberry, has been a hot topic among investors as of late. Lowered management guidance and fears of a rapid decline of its business to competitors like Apple have sent shares into the bargain bin and some investors are taking a look. The Reformed Broker entertainingly pitches the company to Warren Buffett (he declines) and Frank Voisin makes a terrific case for investing in the company. Bullish articles on RIMM at Seeking Alpha are routinely met with disgust by the majority of commenters, which is an excellent sign of the sentiment on the stock. While their devices are no longer cutting edge and retail smartphone users are staying away from the Blackberry, the company’s advantage is their deep penetration in the corporate space.  My company largely uses Blackberries and I spoke to one of our IT decision makers this week who felt that there won’t be a move away from Blackberry soon because of the entrenched enterprise software and higher security versus the iPhone. While I don’t currently have a position in RIMM, it is worth a deeper look given its ridiculously cheap metrics and high cash flow generation.
  • Frank Voisin continues to hit the ball out of the park this week with a very detailed post on Gamestop (GME).  While the headlines scream that GME is the next Blockbuster, Frank shows that isn’t the case. The company is still growing, holds net cash on the balance sheet, and possesses a strong management team. While I am not in touch with what the gaming community is thinking, I’m a little concerned that GME is more like Barnes & Noble (BKS). As always, paying the right price is key.
  • Staying on the tech front (how many cheap large cap tech stocks are there?), Adib Motiwala writes about his latest idea, Western Digital (WDC). The hard drive maker remains my biggest mistake of omission in the last year. I did a lot of research and analysis on WDC early in 2010, and when it fell to the mid 20s in the fall, I just couldn’t pull the trigger. Alas, its up 30% since then but Adib still thinks its  a good value. Meanwhile, my mind is anchored at WDC’s $27 October price point- damn these behavioral biases!
  • Finally, Jae Jun at Old School Value introduces us to the Absolute PE valuation model. Taken from Vitaly Katsnelson’s Active Value Investing, the Absolute PE model is a quick way of assessing the value of a stock. While there are many issues with using multiples, I’ve been playing around with this a little bit and like it. I’ll try using it in my next in-depth analysis.

That’s it for today. For my American readers, enjoy the long weekend! For the non-Americans, just enjoy the 4th of July.

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CVS Caremark Feeling the Heat

Last summer, the Miami Heat won a fierce free agent battle to sign LeBron James, arguably the best basketball player on the planet. He was to be teamed with the Heat’s incumbent superstar, Dwyane Wade, one of the most dynamic players in the league. Fans dreamed of James and Wade wreaking havoc on the rest of the NBA. Talk of multiple championships and “Best Team Ever” accolades echoed throughout the sports media. The hype reached a crescendo just before the season started when players celebrated like they had already won the title.

Sometimes the sports world is mirrored by the business world.

Click here to continue reading at Seeking Alpha

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Mergers, Activist Widows, and Piles of Cash: An Update on 2 NCAV Stocks

Investing in companies selling at a discount to their assets requires a keen eye to monitor ongoing events. In March, I posted about 3 stocks selling below their NCAV.  Since then, two of the stocks have had significant developments.

At the time of my post, Audiovoxx (VOXX) held a cash pile so high, Scrooge McDuck could swim in it. Instead of distributing a portion of this hoard to shareholders, management spent $167M (and added debt)to buy Klipsch, a maker of high end home speakers. Some are saying that this will add to VOXX’s intrinsic value and spur the company beyond its mediocre recent performance.

However, if  you purchased VOXX expecting a liquidation or cash distribution, that hope is gone and you are now counting on management to successfully integrate this recent transaction. Paying a steep price (20x earnings) for Klipsch does not help matters.

Vicon Industries (VII), has started to move in a slightly different direction. 10% owner Anita Zucker, the widow of Hudson’s Bay’s Jerry Zucker, filed a 13D with the intention of shaking up management’s policies.  Specifically, she wants to see the company better use its cash through dividends or buybacks. Last week, Zucker and another activist investor were able to get a nominee of theirs a seat on the Board of Directors.  The company’s share price is currently at $4.60 and they have over $3 per share in cash. Frank Voisin is keeping a close eye on VII and covering the situation at his site.

The developments at these two companies show two of the potential outcomes for NCAV stocks. Always remember that for companies selling so cheaply, management has three choices with the cash: they can distribute it, waste it, or invest it wisely. It is important to think through the risks and potential rewards before purchasing.

Disclosure: None

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ADDvantage Technologies Group: Bad Quarter, Good Price

ADDvantage Technologies Group (AEY), a distributor of cable equipment (think set top boxes, encoders, etc) to large and small cable companies, reported a nasty looking Q2 earnings report last week .

Sales were down 16%, margins decreased, and every product category showed a decline compared to last year.

I was a buyer.  Why?

In this market, it is difficult to find a company with strong cash flow, margins, and return on capital at a cheap price.  After the shares declined 14% on the earnings news, AEY is cheap by almost any measure.

With a PE of 7 and an EV/EBITDA of 4, AEY currently sells below book value and around its net current asset value. These multiples are typically seen on companies that are in danger of bankruptcy, not a company that has delivered positive free cash flow in each of the last ten years- even in the meltdown of 2008 and 2009.

AEY does face some challenges.  Their customers, cable companies, are delaying capital expenditures and growth of cable subscribers is down- largely due to  lower housing starts and the general economic malaise.

However, the company’s business model is scalable.  Looking at the recent 10-Q, sales were down 16% but so were the cost of sales, keeping gross margins steady at 30% and in-line with their historical average. Earnings and free cash flow were still positive and the balance sheet remains strong with a small amount of net debt.

AEY also possesses a medium sized competitive moat- rare for a distributor.  The company holds on to large amounts of new and refurbished cable equipment to meet customers’ demands even on short notice.  This has earned the company a reputation as a “On Hand, On Demand” supplier and allows AEY to earn those 30% gross margins.  This large supply of inventory gives AEY a great opportunity when cable companies start spending again which due to increased competition from telecoms, will need to happen.

While the on hand inventory gives the company a competitive advantage, it does provide the greatest risk to the AEY investment.  In the latest quarter, the company held $27M worth of inventory, tying up a significant amount of capital (the market cap of the company is around $30M).  It is vital that management continues to control this risk as effectively as in the past.  Insiders own 50% of the company and have been in the business for 25 years, so I feel comfortable with this risk for now. The inventory also helps provide protection on the downside, as the company’s net current asset value is $2.43 per share.

The other major risk is the new contract AEY entered into with one of their major suppliers, Cisco (CSCO). Under the new agreement, AEY will no longer hold Cisco’s new products in inventory, serving as a reseller instead.  While this will lower margins on selling Cisco’s products, it should increase cash flow as inventory costs decrease.  The deal also limits selling into the faster growing Central American market. The long-term impact of this contract will need to be monitored.

Using conservative scenarios, I value AEY in the $4-$6 range, nearly a double from the recent price. The $2.43 NCAV provides downside protection. Saj Karsan and Whopper Investments have recently written about AEY here and here.

Disclosure: Long AEY

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Seeking Value in Barron’s Leveraged Buyout Candidates List, Part II

Last week I covered the first 9 companies from a recent Barron’s report of 27 possible LBO candidates. Today, I’ll look into the investment considerations of the next 9 on the list.

Click here to read part II of the article on Seeking Alpha.

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Seeking Value in Barron’s Leveraged Buyout List- Part I

Last week, Barron’s published an article featuring 27 potential LBO candidates. Easier credit, low rates, and growing cash piles are increasing private equity activity and make these 27 companies attractive targets. Using historical financial statements, I evaluated each of the firms on the list to see if any deserve further consideration in a value investor’s portfolio.

Click here to read Part I of the article on Seeking Alpha.

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Rip Van Winkle’s Thursday Morning Linkfest

Good morning readers! Its been  a long time since my last post. I’ve pulled a bit of a Rip Van Winkle and slept through March and most of April.  Well, have no fear, I am back and I do have a few posts in the pipeline.

I’ve noticed that other value bloggers have been slowing down a bit as well, which I attribute to the lack of good buys out there. With a few exceptions, the market has been going up seemingly everyday. Meanwhile we must exhibit patience and wait for the “fat pitches” that will inevitably come our way.

One of the best ways to be ready for the fat pitches is to build a “wishlist” of great companies and wait for something to happen to bring down the price. John Dorfman writes about some of these great companies and even found a few that are slipping near attractive valuations.

Geoff Gannon, in my opinion the best investment blogger around, has also returned from a long break to answer some reader mail. In this post, he writes about spinoffs, one of my favorite hunting grounds.  Speaking of spinoffs, Oddball Stocks covers Huntington Ingalls, the recent shipbuilding spinoff from Northrop Grumman.  While I believe that Huntington’s value can only be realized with higher growth and/or significant cost reductions, the post is very detailed and a good example of how to evaluate a spinoff.

Richard Beddard, an excellent blogger from the other side of the pond introduces us to the Residual Income model for valuation. I remember this model from my CFA studies as very easy to use but also risky because it relies on accounting numbers. Either way, its always nice to have another model in your toolbox and the comments and follow-up posts are enlightening.

Even the most dyed in the wool value investors invest in mutual funds from time to time. Barry Ritholz at The Big Picture explains his reasons for firing a fund manager when managing client accounts. The reasons are great for individuals and professionals alike. Barry also points us to an excellent article on the latest bubble– the cost of higher education. I for one hope college costs go down by the time my child turns 18!

Finally, in disappointing news, the Rational Walk will cease regular operations. Ravi has managed one of the best blogs for the last couple of years and we wish him the best of luck. Fortunately for us, he will keep his old posts available, so for those looking for excellent insight into Berkshire Hathaway or the value investing process, make sure you browse through the archives.

Its good to back. I’ll be back soon with some fresh posts. If you have any questions or would like to see something on this blog, contact me.

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Alexander Graham Bell’s Monday Morning LinkFest

On this day in 1876, Alexander Graham Bell was granted a patent for the telephone. Bell’s invention sparked a communication revolution that continues today. Just think, without Bell we wouldn’t have “No Texting” campaigns, international call centers, or dropped cellphone calls. Of course we also wouldn’t have some of the fine writing on the web these past few weeks. So in honor of Mr. Bell, here are some of the best Value Investing related posts from the last few weeks:

Small size? $105m Market Cap. Check.

Lots of cash? $35M. Check.

Misunderstood? UK Based with lots of exchange rate issues. Check.

Out of Favor Industry? Healthcare, government contracts, and staffing.

Check, Check, and Check.

I plan on researching this one more fully for a possible purchase.

If you have any links I may have missed, Contact Me. I am always open to new ideas and good analysis.

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3 Interesting Stocks Selling Below Net Current Asset Value

Benjamin Graham liked cheap stocks. He especially liked stocks that sold below their net current asset value. Why?

Let’s say you own a small, neighborhood bar.  You have a few regular customers, can get a good crowd if you can find a decent band to play on Saturday night, and despite the ups and downs, the bar generally brings in enough money to pay the bills. But would you sell if someone came in on a slow night and offered to buy it for less than the value of the cash in the register and the bottles of liquor on the shelf? The answer is no,  unless you were a very desperate seller.

The stock market often prices companies below the value of cash, inventory, and receivables, minus debt- aka net current asset value (NCAV). Graham liked to buy a diversified basket of these companies he called “net-nets” at 66% of NCAV.

In today’s market, it is difficult to find values that cheap, especially those that are not fraudulent or in risk of going out of business. You should look at the cash flow statements and balance sheets to find companies that have a history of positive operating cash flow.  It also helps to see what the insiders are doing. I like to see management owning a high percentage of stock.

I recently scanned a list of NCAV stocks and found three companies for further research.

Performance Technologies (PTIX)

PTIX manufactures networking and signaling equipment for telecom companies, with Alcatel-Lucent, Raytheon, and Leap Wireless among its largest customers. PTIX shares fell from the mid-teens in 2003 to $1.88 today primarily because it competes in a crowded industry constantly disrupted by technology changes.  Don’t let the poor performance fool you.  PTIX has a history of positive cash flow as recently as Q1 2010.  With $1.66 per share of cash, the company currently trades at 85% of its $2.20 NCAV and 15% of the shares are held by insiders.

Vicon Industries (VII)

Vicon manufactures security cameras and video systems for use in office parks, schools, and prisons. VII has weathered the storm in a heavily cyclical business, showing positive cash flow in Q4 2010. The company caught the eye of other value investors and rose from a September low of $3.60  to a recent $5.00. With a whopping 40% insider ownership, the company still looks attractive selling at a discount to its NCAV of $5.75.

Audiovox (VOXX)

VOXX, an electronics company best known for its consumer audio products sold under the RCA and Jensen brands, is a perennial NCAV candidate. With a market cap of $189M, it is much larger than most NCAV companies.  Things may be looking up for the company as operating cash flow has been up for the last two years and should continue to increase in fiscal 2010. Famed value investors Seth Klarman and the Kahn Brothers are major holders of the stock, though Klarman has been a seller as of late. VOXX sports a rising Piotroski score and 10% insider ownership, along with its NCAV of $9.63 versus its current price of around $8.26.

These companies are far from perfect. Each one boast several risks and compete in very difficult industries. Managing the risks are key. But remember when digging for “net-nets”, we aren’t looking for the next Arcade Fire. We’re just looking for a decent bar band that can bring a few dollars in the door while waiting for the overall market to get cheaper.


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ITT Spinoffs Create Potential Opportunity for Patient Investors

Recently, industrial conglomerate ITT (ITT) announced they will split the company into three separate businesses:  Defense, Water, and Industrial Products (The “New” ITT). The stock immediately jumped 20% in anticipation of the spinoffs, which are expected to be completed by the end of the year. After such a run-up, can a value investor still profit? I’ll take a look at each of the three businesses and attempt to value them.

Sometimes, valuing spinoffs early in the process can be difficult due to lack of individual segment data. Fortunately, ITT broke down the key financial information for each business in previous financial statements. I will value each business in three different ways: by applying a multiple of 15x “Owner’s Earnings” (Net Income + Depreciation – Capital Expenditures), 10x EBIT, and a multiple based on similar publicly traded competitors. I chose 15x OE and 10x EBIT as a starting point for fair value because both would provide an initial 7% after-tax “yield” on investment. Of course, I look for a Margin of Safety, so my buy price would be much lower. I also used total value (in $B) instead of stock price, since we don’t know the number of shares that will be used for the new companies.

Continue reading

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