ClearFish Research

Corzine rehypothecation perjury

2011-12-08T13:25:00.001-08:00

Jon Corzine just perjured himself. He stated that he had no knowledge of client assets ever having been pledged as collateral. Yet in earlier testimony and through a number of actions it was made clear that the MF Global business model depended on rehypothecation, and the benefits of the UK branch.

rehypothecation explained here.

update: original Reuter's acticle

Appropriate for Today - Guy Fawkes Day

2011-11-04T12:02:00.001-07:00

http://afawkes.wordpress.com/2011/10/09/a-note-from-your-boss/

This too.

Pandora has a Broken Business Model

2011-07-22T08:39:00.001-07:00

Pandora (P) just listed. Nice product for music discovery, where they attempt to put together a custom music station based on a seed song and continuing feedback from the user. They stream the content over the internet to various connected devices.

They have not been profitable, but a quick look at their numbers makes it appear that they are on the cusp of profitability. Unfortunately, there is a problem. Their costs scale with the number of songs they play, but their revenue scales differently, based on their various attempts at advertising. So far it appears that their core costs for revenue are something like 2.1 cents/hour of served music, and have held fairly steady, whereas their revenue/hour of music served has declined from 3.2 cents/hour to 2.7 cents/hour Q/Q, which is quickly approaching their cost level. So, as the hours of music served scales up, their model gets worse and worse.

They know this. That is probably why they limit "free" users (users subject to advertising) to 40 hours/month, or 480 hours/year. They sell an annual service commercial free for $36/year, which together means that their maximum revenue expectation is 7.5 cents/hour, although they have never shown that they can hit that. It's just where they top out.

In their prospectus they spend a lot of time talking about their need for growth of songs served so as to attract advertisers, but at the same time they limit how much they are willing to serve. A bit of a disconnect there. If growth was good, they would not limit it.

Many of their other numbers presented in the prospectus are suspect as well, with some acknowledged as such in some fine print somewhere but others not. For example, they headline 90M accounts in the US. Bald faced misdirection. There are about 330M Americans, so ca. 1 in 4 has a Pandora account? B.S., and they say it's B.S. later. They say they do about 1 minute of audio advertising/hour and give a number for the terrestrial radio industry that is likely much lower than is actually the case. I haven't heard any audio advertising in hours of listening, so they overstate their serve rate and understate the competition's serve rate, making it seem that they are closer together than than they are. Terrestrial radio advertises as much as it does because it has to to remain viable, so misstating that ratio is misleading. At the same time, they talk about their low serve rate as an advantage. Well, yeah, it's nice for users, but not for investors. They don't talk much about their competitor's models. As a quick example, consider Sirius/XM, that has fixed content costs and a subscription model that scales revenue with subscriber numbers. So every new subscriber costs them little and adds a lot of revenue. That's a viable growth model, and is just the opposite of Pandora's.

Unless a miracle happens (advertisers start flocking to them and paying unprecedented rates under their current model, or they change their model somehow) they will have trouble. I think the IPO was a survival bid.

Update: confirmation

Also, none of this says anything about how the stock will do in this most manipulated of all markets of the last 30 years.

Disclosure: no holdings as of posting date/time

Inadvertent Admission that Keynes Multiplier is <<1, etc.

2009-12-03T10:00:00.000-08:00

It has been widely reported, and widely touted by the administration, that the GAO recently determined that the $787B “stimulus” lead to a 1.2-3.5% GDP increase. On a ca. $16T economy, that is ca. $192B - $560B in GDP increase. Since that increase cost $787B, the multiplier for GDP stimulus from this round of government spending is something like 0.24-0.71. That’s right in line with what I said it was, and nowhere near the fantasy disproved number of 1.6 thrown around by the architects of the “stimulus.”

While I’m on ‘inadvertent admissions via numbers’ here’s another one: It has also been widely reported (that phrase means I’m too lazy to look up the link) that the administration has scored 600K-1.5M new jobs saved or created by the “stimulus.” That works out to $1.3M-$524K per job. (Damn, those must be pretty good jobs!) That’s a number the administration seems to be proud enough of as a “stimulus” even though it’s totally cooked and actually much worse than that. But assuming that number is ok, contrast it with the fact that sending a soldier to Afghanistan costs about $500K- $1M/year. That is certainly employment, we get something for the money, and it’s the same price or less per job. You can’t claim one is fiscally irresponsible without making the same claim for the other, but that is exactly what the administration has tried to do (‘oh the high cost of the war’ vs. ‘the “stimulus” has been great!’).

Electric Car Fuel Shock

2009-08-26T09:25:00.001-07:00

Nice article from the WSJ (subscription required) on coming electric cars and claims for huge mpg numbers (since not much gasoline is used). Nissan Leaf (all electric): 367 MPG; Chevrolet Volt: 230 MPG; compared to Toyota Prius: 51 MPG.

Those numbers make the electric vehicles seem like super winners, but they ignore the cost of the electricity. Here’s the money number: Nissan, using EPA guidelines, figures that “…82 kilowatt hours of electricity are the equivalent of one gallon of gasoline…” Using my PG&E bill, the lowest tier of electricity use costs $0.11/KWH, and the highest tier is $0.37/KWH. I almost always max out every month in electricity usage and have at least some electricity usage in the highest tier (the tiers were set in the 1950’s and the electric companies have tried very hard to insure that they have not been changed significantly since). I have a tiny house, but I have a hot tub, and an office, and that is enough to blow us into the top tier of electricity expense. People in McMansions will have it much worse.

So what does that mean? Adding an electric car is an additional electric load, regardless of time of day. At the lowest fantasy rate, I would be paying $9/gallon equivalent of electricity (82KWH x $0.11/KWH). But that is fantasy, since the real rate will be at the top tier that I have to pay every month, which would be $30/gallon equivalent (82KWH x $0.37/KWH). That makes the plug-in electric car seem like a horrible idea.

But, at $30/gallon, and 367MPG, it would cost $8 to go 100 miles (30/367*100). At the fantasy rate, it would be $2.45 (9/367*100). Compare that to an average gasoline car getting about 30MPG, with gasoline at about $3/gallon, which would cost $10 to go 100 miles (3/30*100), and the price seems competitive. But just barely. Maybe.

CDS Bear Raid - it's all a Hoax?

2009-03-26T11:26:00.001-07:00

Excellent analysis by Andy Kessler in the WSJ (with my take added):

Banks had long term holdings (MBS’s, CDO’s) with 10-30 year time horizons, but generally operate on a day to day basis with overnight funding. To count these and their derivatives as part of reserves, regulators demanded that they buy insurance against the derivatives defaulting. That’s credit default swaps (CDS’s) and AIG is the main player that sold them. Blamo! Drive the price of the CDS up, and it’s taken as a proxy for default likelihood, as well as used to value collateralized derivatives through the Gaussian Copula formula. So, drive the CDS price up, and the collateralized derivatives drop, which must be recognized via mark-to-market (i.e. writing off the supposed losses and hence taking immediate hits to the stock price), and so the bank reserves drop, and then they are regulated to have to raise more capital, which gets harder and harder as their reserves drop and their investment grade decreases (by the rating agencies) through a pro-cyclical cycle.

It’s a beautiful thing. Principally because apparently it doesn’t take much money in the CDS market to influence prices (say $25M or so). So for $25M in the CDS market you can make it appear that GE or Citigroup are close to bankrupt.

What a gorgeous bear raid.

That’s part of how a small change in house prices (the objects of collateralization) plummeted the world financial markets. Maybe it was all a big fake out.

Notes on Causes of Crises

2009-03-02T12:16:00.001-08:00

Kindleberger. – credit expansion

Mechanism – collateralization of debt by banks, moved loans from balance sheet to investment roster so it no longer triggers capitalization rules, and thus allows more lending. Result – we went to a 30:1 leveraged economy from a typical 10:1. 10:1 has historically been handled, 30:1 has not. Direct bank lending accounts for 20% of credit market, the other 80% is various forms of collateralization (e.g. the bank isn’t giving you that auto loan). Collateralized debt securities were purchased and copied worldwide. Legitimization of collateralization was triggered by Fannie/Freddie and rating agencies. Collateralization is the worldwide infection vector.

Consequence: more money sloshing around for hot investors (the collateralizers), who largely played the Yen carry trade funneled into the commodities market. (Oil run-up was consequence, not cause. In 80’s majority (ca. 80%) of US GDP was directly tied to oil consuming industries. Today it’s ca. 20-30% (having been replaced by electricity, which is not mostly oil based (it’s coal and nuclear etc.)). Oil run down is not causative of GDP contraction, but rather symptomatic. Also, oil is priced in US dollars which have been weak during the oil price run up. Priced in any other currency, oil didn’t really go up that much.)

Down Side Floor: moving back from 30:1 to 10:1, a 2/3 contraction. 67% drop in everything is probably the floor.

As bad as that is, it can be made worse. Before credit contraction is allowed to take it’s natural course, we will see (and have seen) policies leading to not-quite-hyper inflation due to a lot of irrelevant drink-the-punch-before-the-bowl-is-empty crazy socialism spending, and just-for-philosophical-fun killing off of a few perfectly healthy additional industries (e.g. healthcare).

Update 12 Mar 2009: Beautiful explanation in Wired of use of Gaussian Copula formula as infection vector for global financial meltdown (the problem with the methodology used for collateralization).

Multipliers

2009-02-12T11:47:00.001-08:00

I’ve taken a long hiatus from blogging, and expect that to continue, but thought I would mention this:

I am just a simple cave man, and perhaps I do not understand your ways, but I do know that whenever you do any sort of modeling (whether it be femtosecond chemical dynamics, protein folding, regional ozone formation, or financial markets – all of which I have done) your model must survive the simplest boundary cases to be prima facie correct. Or rather, if it doesn’t satisfy the simplest boundary cases, then you know it has to be wrong.

The theoretical premise of the current “stimulus” pork package is the “multiplier.” It is estimated by the Keynesian spenders behind the pork package to be something like 1.4 – meaning for every dollar spent by the government, we all get 1.40 dollars back. That is prima facie absurd. If it were so my best investment would be to give as much money to the government as I could, so they could redistribute it, resulting in my getting $1.40 back for every $1 I gave them. I would overpay my taxes to the 100% level because of the easy excess returns. I think you know that doesn’t work. By the way, it was tested – a little thing called Communism, and it sort of failed as an economic exercise. If I am taxed at 100%, I do not expect a 40% return. The multiplier on taxation, i.e. government spending, is more like zero.

At the other extreme, if I am not taxed at all, the one thing I know is that I will keep that dollar. So the multiplier on keeping my dollar (i.e. lower taxes) is something like 1. There are definitely services provided by the government that are worth paying for, so the multiplier isn’t exactly 1, but it is around there.

Any model that is not complete garbage has to have the multiplier for 100% taxation at about 0 and for 0% taxation at about 1.

But I am just a simple caveman.

Update 12 Mar 2009: Academically rigorous evidence (pdf) that the 1.5 multiplier is a fantasy of "old Keynesian" fallacies, when in fact the multiplier is much less than 1. Also, Numbers in WSJ give multiplier estimate of 0.1. ($14.3T GDP * 0.6% GDP growth = $87B growth, vrs. $800B spent -> 0.1 multiplier)

General Market Thoughts

2006-07-07T10:22:00.000-07:00

Is it just me, or is the market a bit shiftless right now?

The IPO market has taken a breather, it has become more difficult for private capital to cash out through the public markets, the technology market has been largely boring (no replacement cycle, hot new product trends, etc.), the ethanol market has taken a dive, the housing market remains ambiguous (consumption high, but producers continue to warn), and there are no large discernible secular trends. Does that mean we are stuck in a sideways market, on the first leg of a major downturn, or basing for a resurgent upturn?

It's hard to say with any confidence, but our sense is that the market is basing. The sell-in-May crowd clearly took over in, well, May. That is typical of most years, but has been a bit atypical for recent years. Interest rates, as well as geopolitics loom large in the market (the latter principally through oil and it's feedbacks). Can either of those get much worse (i.e. interest rates go up much higher, or oil prices continue to rise)? They could, but our guess is that there is not a lot of steam left in either of them.

At some point in the not too distant future, the Fed will pause. We think that will happen coincident with the typical timing for buyers coming back to the market after Summer. We don't expect much excitement until then. Individual plays continue to tick around, but big money flows are probably on the sidelines for another month or two. That means momentum investing is probably moribund for a bit, but it could be a good time to pick up quality, or to short junk.

A Bit of Geopolitics - North Korean Positive Developments

2006-07-05T09:11:00.000-07:00

Just as the ascent of Hamas in the Palestinian Territories provided a clarifying moment to all but the most ideologically locked regarding the Palestinian/Israeli conflict, the test firing by North Korea of a number of short, medium, and a long range ballistic missile will provide a similar clarifying moment. Good faith opposition to good ideas is generally founded on differing interpretations of murky facts, and clarifying moments help to tip the interpretation of those facts toward consensus. The short term may always have serious ups and downs, but we view the North Korean developments as a long term plus. North Korea is only a surviving Stalinist rogue belligerent because of enablers - principally China. Having North Korea as a belligerent served China's diplomatic purposes. That position will now seem considerably less tolerable. Similarly, it is now clear to Japan that their role in the world will be more directly active.

Long term, this means that the North Korea situation has begun the process of rectification, as the world players will begin to agree upon some commonalities, or look increasingly like nutters themselves. And that too is clarifying.

With clarity, eventually comes resolution. You can't solve problems until you agree on the facts. Solving problems may still be an arduous long road, but recognizing the interesting facts is always the first step.

1 Year Anniversary

2006-06-28T07:51:00.000-07:00

Happy Birthday to the ClearFish Research Blog!

If anyone want's to say thanks, please do leave a comment.

Public Storage (PSA)

2006-06-27T13:44:00.000-07:00

Story: A long-term reader asked about Public Storage, citing in particular that it's prospects may be a proxy for overall GDP growth, and adding that as people get older they acquire more stuff which they find difficult to get rid of. That highlights a possible demographics effect for PSA's prospects. The stock has been on a 3-year steady uptrend, with a recent ca. 12% pull-back. I have always found investing based on broad demographic changes to be difficult, as shorter term exogenous factors, as well as the usual business management factors, can derail the effectiveness of the overall shift. We'll just acknowledge that demographics probably are in PSA's favor, and see if we can make a case for them based on shorter term criteria as well.

There are a couple of things we would anecdotally add to the story, before launching in to the company: First, it is easier today to efficiently get rid of stuff via eBay or Craigslist, but that isn't as true of large items like furniture. But the disincentive to divest isn't always motivated by economics, as opposed to psychology. Storing, as opposed to selling, allows for putting off those psychologically jarring decisions to a later date. Second, there has been some anecdotal discussion of a shift from "large homes" (4000 sq. ft.) to "smaller homes" (2500 sq. ft.). By historic standards, both of those are huge, and both provide ample storage space. But a cluttered 4000 ft. home will not fit in a 2500 sq. ft. space, so retiring or downsizing baby-boomers may help the storage market. On the other hand, a lot of that excess stuff can go to the kids as they get set up, or moved to the vacation home. Both of those trends are likely slow moving ones.

Company: From their latest quarterly report (pdf) ending 31 March 2006, they have had Y/Y quarterly top line growth of 11% ($278.7M/$250.9M), or $28M. Of that, $2.2M, or ca. 8% ($5.075M-$2.893M) could be directly attributed to increased interest rates. That says 90% or so of their business is not interest rate dependant in a direct fashion. However, to the extent that a rise in interest rates slows the upscaling of homes, an interest rate increase may indirectly be good for their business. Similarly, to the extent that an interest rate rise stimulates downsizing of home, it would also work to indirectly augment their business.

Y/Y quarterly expenses increased 7% ($161.4M/$150.7M), or $11M, showing that revenue is growing a wee bit faster than expenses, for an overall Y/Y quarterly net income growth of 18% ($114.2M/$96.4M), or $17.8M, and a quarterly EPS of $0.48.

That all looks fine, but it's a bit boring.

If we look at their latest annual report (for 2005, pdf), and compare their numbers for year end 2003 - just prior to the current run-up in the stock - to the year end 2005 numbers we see that revenue has increased 19% ($1,061M/$894M), expenses have increased 7% ($604M/$565M), and net income has increased 35% ($456M/$337M), or absolute increases of $167M, $39M, and $119M, respectively (they have a few other line-items that account for those number not adding up). EPS have increased 54% ($1.97/$1.28).

Stock: At a 2003 year-end price of about $30/share, they had a trailing P/E of ca. 23 ($30/$1.28). For year end 2005, at a price of about $70, they have a trailing P/E of ca. 36 ($70/$1.97). A 2003 P/E applied to their 2005 earnings would give them a share price of $45 ($1.97x23). So, it seems that most of their share price increase has been due to a market multiple expansion, rather than fundamentals. That is perfectly reasonable if justified by their growth prospects, but we think they have gotten ahead of themselves. With Y/Y earnings growth in the 20% range or so, a market multiple of 23 seems about right. The current value of 36, we're guessing, is due to the demographic story without running the numbers. They are a Solid business, but we think their stock price deserves a pullback.

No Matter What You Do, You're Wrong

2006-06-26T09:31:00.000-07:00

If:

You buy on the way down, and it keeps going down (should have waited), or
You sell on the way up and it keeps going up (should have waited), or
You buy on the way up and it keeps going up (you should have bought earlier), or
You sell on the way down to stop losses and it turns around, or
You don't buy at all (opportunity loss), or
You don't sell at all and hold those losses, or...

You can always view whatever action you take (profitable or not) as poor.

The perfect is the enemy of the good. In this business no matter what you do you can beat yourself up over it. Only if you call the bottom and sell at the top can you really feel good about it, but even then you could be wrong on a different time frame.

That investor psychology issue (as well as profits) plays a big role in the attractiveness of momentum investing - buying on the way up and selling somewhere higher.

Not actionable information, but nevertheless it's good to remember that if one is so inclined, one must somehow escape any inherent negativity to survive in this field, as one can't optimize perfectly. Go for profits without perfection.

Housing Market

2006-06-26T08:56:00.000-07:00

The US Commerce Department released their report on housing sales (pdf) for May 2006 today. The headline in the WSJ is that they are unexpectedly up 4.6%, whereas "economists" were predicting a 4.0% decline. 1) Economic predictions of housing gyrations have been poor, and they continue to be so. 2) The numbers behind the headlines show something a bit different.

The seasonally adjusted numbers are what always get reported. In the latest report they give actual sales for 2005, as well as annualized numbers from the monthly snapshot for 8 different months. The annualization process has a lot of slop in it, and I have previously urged readers to discount it and just look at the actual numbers. Another way to use the annualized numbers is to put error bars on them. The actual number of homes sold in 2005 was 1.283M. The monthly annualized numbers from May through December vary from 1.236M to 1.367M. That says that the error bar on an annualized number should be at least 0.09M, or 7%.

That says that any variation in housing numbers that is less than 7% is just noise in the annualizing algorithm, and signifies nothing.

Similarly, if one looks at the error bars in the regional numbers, the variations due to the annualizing algorithm are always less than the error bars. All the sturm und drang over the housing market is noise in the annualizing algorithm.

For 2006, the latest annualized is 1.234M houses sold, which really means something between 1.148M and 1.320M, so 2006 home sales could be less than or greater than 2004 and 2005 homes sales.

Without seasonal adjustments, 2006 year-to-date home sales are down 11% from 2005 sales, but that means almost nothing as the summer sales season is not incorporated in that data yet, and month-to-month sales vary significantly due to exogenous (weather, gas prices, world events, etc.) and random factors.

The housing market implosion is overblown, or even non-existent.

Google's new Pay-for-Performance program

2006-06-22T10:10:00.000-07:00

It's always nice to be right, even if you don't fully expect to be. I harped for a while (here for example, and here too) about the disadvantages of Google's pay-per-click advertising model (advertising dollars change hands every time an ad is clicked), arguing that the trend for the future would be a transition to pay-for-performance (advertising dollars change hands only after an ad-stimulated purchase occurs). Now the WSJ (via the AP, via Seeking Alpha - of which I'm a contributing member) reports that Google has just such a program in place, deemed "cost-per-action." Kudos to Google for getting ahead of the transition and setting themselves up to own the space.

Such a transition has serious repercussions for the online advertising marketplace - for advertisers (more efficient use of dollars, better marketing budget cost controls, no click-fraud), ad-supported venues (less widely distributed ad revenue), and competitors. Google will now be a three-tiered advertising player, representing the full spectrum of online advertising evolution from pay-for-impression (CPM), to pay-per-click (CPC), and finally to pay-for-performance (CPA).

I thought the transition would take a couple of years, but I guess in internet time a few months is a couple of years.

[All previous Google advertising comments]

Cortex Pharmaceuticals (COR) Reports Negative Results

2006-06-21T11:16:00.000-07:00

Cortex Pharmaceuticals (COR) just reported negative results on their Ampakine drug for sleep deprivation, and will now re-evaluate the drug for "internal development." That's the nature of biopharmaceutical investing - punctuated developments.

Premium Cell Phone Services Not Selling Well

2006-06-20T07:35:00.000-07:00

The WSJ has a report on MVNs (mobile virtual networks - cell phone carriers that rent service infrastructure) that offer premium services like data, TV, radio, music, etc., that are mostly floundering amid losses. We predicted that here and here, and the reasons we laid out there are the reasons cited in the WSJ story. They cite an even slower adoption rate - 1% - for users watching videos on their cell phones, than for the other types of premium services offered. Reasons? Pricing and battery life - but you already knew that.

Old World Rate Thinking

2006-05-24T09:41:00.000-07:00

Here's a question I don't quite get. A fair portion of the supposed inflation we have today is from the increase in oil prices. The fed is still contemplating increasing interest rates in order to stem the rise of inflation. That means essentially that they are trying to stem the rise in oil prices by raising interest rates. Will that work? No. The theory behind it is that rising interest rates inhibit general economic activity, lowing economic activity across the board, and thus stemming inflation. But economic activity today is pretty much segregated from the oil sector. About 85% of GDP depends on electrical energy, with the remaining 15% dependant on oil/gas. That's vastly different from the 1970's, where 67% of GDP depended on oil/gas. Now, some of that electrical energy has recently shifted to natural gas, but it's still mainly coal and nuclear.

Raising interest rates to stem the tide of rising oil prices is a blunt instrument (understatement). High oil prices to stem the tide of high oil prices is a sharp pointy instrument.

A similar argument can be made for medical expenses, currently 15% of GDP. How does raising interest rates prevent people or companies from spending money on sickness? It shouldn't, and it doesn't. It just makes them more miserable in other areas of their lives.

Of the big three, that leaves housing, where one can make a pretty good argument that the mission has been accomplished.

Pulling those out, core inflation is just above the fed governors comfort zone. But the pain from getting smacked by the interest rate club takes a year or so to register, and the fed has done a pretty nice job of overshooting in the past.

Some of the governor's get these points, but we (and the market) are surprised that some of them do not.

Continental Resources (CXP) IPO Snack

2006-05-12T12:59:00.000-07:00

An oil and natural gas exploration and marketing company operating in the Rockies and other US locations.

We'll use a non-conventional measure to look at this oil and gas production company: Their prospectus gives financial data for 2001 through 2005, but production data only for 2003-2005, so we're forced to limit ourselves to that latter time frame. From 2003-2005 they had aggregate revenue of $1,112M, total operating costs (including interest payments, which are necessary for their leased operations) of $888.8M, and resulting total operating income of $223M. Over that same 3-year time frame they produced (prospectus, pg 11) 30.477M Boe (combined barrels of oil and barrels of oil equivalents for natural gas production). That gives them about $36/Boe revenue, $29/Boe operating costs, and $7.32/Boe operating income.

For comparison during the same time frame, ExxonMobil (pg 18) had $55.526B in earnings and ca. 8.4289B Boe, or about $6.59/Boe in income. (BTW, in relation to "price gouging," that's $0.16/gal, far less than the feds and states take in taxes). To make it a perfect comparison, we should really use the net income figured for Continental Resources (as we did for ExxonMobil), which would give $224.5M net income, or $7.37/Boe.

Hmmmm. An energy extraction company that is operating better then ExxonMobil. That sounds ok to me.

[Note: this "$/bbl" measure is for the here and now. Most analysts also worry about "proved reserves" - a fuzzy but SEC mandated measure of future production potential.]

Some Fishy Delphi Numbers

2006-05-11T13:51:00.000-07:00

The WSJ reports that Delphi (currently in U.S. Bankruptcy Court) will pay out $60M in bonuses and incentive compensation to it's 14,000 salaried employees and managers, in addition to the already scheduled $38M in executive bonuses. Those payouts will occur in July, just about the time that Delphi plans to cut the hourly wages for it's 34,000 union employees to as low as $12.50/hour, down from a current average of about $26/hour. Oh yeah, they also just posted $500M more in quarterly operating income than they expected. Uhh, that's a lot of money. That's not revenue, it's operating income. That's not annual, it's quarterly.

Let's do some funny comparisons:

With about 2080 hours in a man-work-year, and 34,000 hourly union employees, that combined $98M in salaried bonuses is $1.39/hour for each union employee, or about $240/month.
With 48,000 combined salaried and union employees, that extra $500M in quarterly income is about $10,400/employee, or about $3500/month.
At $12.50/hour and ca. 173 hours in a typical work-month, the average union worker will be grossing about $2200/month.

I don't think the negotiations between Delphi management and union workers are going to go well, and if the union strikes it may be the end for both Delphi and GM. I'm no fan of unions, but it's a bit unseemly (understatement) to be making huge income increases, paying out big executive bonuses, while cutting employee salaries by more than 50%.

If you f*%!'d something up, and even got paid to do it, it's your responsibility to fix it. If you need a bonus to be moral you are immoral. But that's just my quaint management philosophy, and doesn't correspond well to current practices. On the other hand, unions absolve management of some responsibility by hindering their actions. I don't see how this is going to end well.

InnerWorkings (INWK) IPO

2006-05-11T11:59:00.000-07:00

Story: Here's a nitty gritty back office play. InnerWorkings (NOT these guys) tag themselves as a "print procurement technology company." Every company has significant printing needs. Most companies satisfy some of that need in-house (e.g. the corner LaserJet), while some is outsourced (e.g. marketing materials or corporate reports, etc.). The outsourced printing market has traditionally been served by local players, and the market is quite distributed. In almost any town you will a printer, and perhaps many. So the market has existed for many years, satisfied by small or distributed players. More recently, we have seen a lot of increased information efficiency due to the internet (vertical portals and B2B was all the rage in the dot-com blowup). Some of that seems to now be hitting both the printing industry and the public market. We liked VistaPrint for it's ability to profitably serve the printing needs of small businesses.

InnerWorkings targets both small and large businesses as a middleman (rather than a printer, like VistaPrint). They have developed a network of ca. 2700 suppliers (e.g. printers, paper suppliers, etc.). Their main competitive moat is a database they have developed that in detail catalogues the capabilities of each of those suppliers, and allows them to optimize the match between supplier capabilities (and price) and the print-needing company clients. That all sounds imminently reasonable - a solid back-office play - but we have a couple of questions.

First, "optimization" gets bantered around pretty easily. Sometimes it means nothing more than an individual looking over some specs and deciding "these match." On the other hand, and I've done a lot of this is various different fields (e.g. ultrafast chemical physics, ozone monitoring, protein folding), really systematic and complete optimization between a goal and a universe of possibilities can be a very complex problem. They may not need a sophisticated solution, but the better the matches that they provide, the happier their clients will be, and the deeper will be their competitive moat. Second, how competitor proof is that database? Do they have exclusive licenses with their suppliers, or could another player easily come in and take half their business? First-mover advantage is often the opposite - a disadvantage. Once they prove that the print consolidation middle man market is a good profitable one, that could stimulate new competitive entrants that will learn from the first-mover, and target their products to undercut them. That's why the depth of the moat is key.

Company: From their initial prospectus, they've been gross, operational, and net income positive since at least 2003. Gross margins have run a bit better than 20% ($3.7M/$16.2M=23%, $8.4M/$38.9M=22%, and $15.6M/$76.9M=20%), OP margins (operating earnings/revenue) have run at ca. 5% ($0.765M/$16.2M=5%, $2.07M/$38.9M=5%, and $4.6M/$76.9M=6%), but OOP margins (operating earnings/gross revenue) have grown from 20% to 29% ($0.765M/$3.74M=20%, $2.07M/$8.40M=25%, and $4.60M/$15.60M=29%). So of the money they keep, they are keeping more. That says their costs are expanding more slowly than their gross profits. which, coupled with top and bottom line growth, is just what we like.

Y/Y top line growth has slowed to about 100% for year end 2005 ($38.9M/$16.2M=140% and $76.9M/$38.9M=97%), but in absolute terms has expanded by about 67% (from $22.7M for '03-'04 to $38M for '04-'05). Similar measures show operating income more than doubling Y/Y ($2.07M/$0.765M=170% and $4.6M/$2.07M=122%), with small but healthy absolute growth ($1.3M and $2.5M).

On the other hand, looking at the Q/Q data (prospectus, pg 34), they have had fairly consistent revenue growth of about $3M each quarter, with a couple of small hiccups, until they have flatlined for the last 3 quarters (Q1 '04 -> Q1 '06, in $M: 5.3->8.6->9.9->15.2->12.4->18.7->23.5->22.2->22.4). So we're going to stop here. With no recent growth in their top line, we don't feel compelled to answer our earlier questions, or to look farther. Blah.

[Disclosure: currently long VPRT]

Bidz.com (BIDZ) IPO Snack

2006-05-10T18:18:00.000-07:00

Just shows it always pays to check. I expected Bidz.com, an online jewelry auctioneer, to be a money loser fighting for survival, since sloppy internet models are not exactly new, there are many auctioneers that have come and gone, and jewelry sales are competitive. But they are refreshingly responsible, and have been net-income profitable or break-even for at least 9 sequential quarters (prospectus, page 33). Most of those quarters it was just a penny or two, but the last two were $0.08 and $0.14/share. Their revenue seems to go in stair-steps: They were doing about $15M/quarter, then increased to about $20M/quarter, and in the most recent 2 quarters jumped again to about $33M/quarter. That is likely due to a greater customer purchasing during the Christmas season (when the step up occurs), but the interesting feature is that the increased revenue level persists for the remainder of the following year. That may just be a direct return on the somewhat increased marketing budgets, but it's good regardless of the reason. In short, they are showing nice consistent growth.

For FY 2005, they had a gross margin of 21% (19.3M/$90.6M), OP margin (operating earnings/rev) of 3% ($2.7M/$90.6M) and the more important OOP margin (operating earnings/gross profit) of 14% ($2.7M/$19.3M). For Q1 2006 they had a gross margin of 26% ($9.18M/$34.7M), OP margin of 10% ($3.37M/$34.7M), and OOP margin of 37% ($3.37M/$9.18M). So they have had some pretty serious margin expansion, just what we like.

In terms of absolute numbers and Y/Y returns, they had more operating earnings in Q1 2006 than for all of 2005 ($3.37M vs. $2.71M). Annualizing that latest number would give them $13M operating earnings in 2006, for a ca. $10M Y/Y increase. Almost all (98%) of operating earnings drop to the bottom line.

With ca. 24M shares outstanding, that gives them a projected 2006 operating EPS of $0.54 ($13M/24M). We don't know whether they will price attractively or not, but they have second tier underwriters and it is a $57M deal, so the chances are reasonably good that they may be under-followed. We wouldn't pay much of a market premium for them, but we do find them interesting.

Burger King (BKC) IPO Snack

2006-05-09T12:04:00.000-07:00

All data taken from latest prospectus. Likely listing next week.

Currently into first 9 months of fiscal 2006.
FY 2005 EBITDA up Y/Y 65% or absolutely $89M ($225M/$136M). Annualized 9 month 2006 EBITDA up Y/Y 30% or absolutely $67M ($219M/$225Mx4/3). So growth is healthy but slowing.
FY 2005 operating income up Y/Y 107% or absolutely $78M ($151M/$73M). Annualized 9 month 2006 operating income up Y/Y 38% or absolutely $57M ($156M/$151Mx4/3). Again, healthy, but slowing.
FY 2005 net earnings up Y/Y absolutely $42M ($47M-$5M; % change irrelevant since small number). Annualized 9 month 2006 net earnings up Y/Y 5% or absolutely $2.3M ($37M/$47Mx4/3). Flat and boring (although a non-recurring $14M charge is included in there).
They recently paid out about $350M in debt from the company to the private investors. Almost all of the stock proceeds to the company from the current offering will go to retire that company debt. The IPO listing will not financially improve the company, but rather just get it back to where it was prior to the February debt payout. As the proceeds do not change the company prospects, past is the best performance prologue.
The private equity sponsors currently have 95% of the company stock, and will still have about 75% after the public listing, so they are not abandoning their interest in the company, despite the big balloon debt-based payment.

Expected offering of 25M shares at $15-$17, with ca. 132M shares outstanding. Say operating earnings growth stays flat at $60M next year (better than their current rate). That gives them forward operating earnings of $268M ($156Mx4/3+$60) on 132M shares, or forward operating EPS of about $2.00. At the high end of the price range that gives them a forward operating P/E of 9 ($17/$2). EBITDA and operating earnings growth has dropped about $20M Y/Y. Projecting that forward gives $40M in operating earnings growth, a projected forward operating EPS of $1.88 and a similar operating P/E of 9.

Net income, on the other hand, could increase 80% (from ca. $49M to $89M), all else being equal (which it is likely to be). That gives forward net EPS of $0.67 and a forward net P/E of 25, which is about right or a little high (MCD trailing P/E is 18, forward P/E is 15).

More Ethanol News

2006-05-08T11:36:00.000-07:00

The WSJ has another interesting commodities report today indicating that because the fuel prices for a farmer to harvest an acre of corn are significantly higher than what is necessary to harvest an acre of soybeans ($11 vs. $7), farmers have indicated to the Department of Agriculture that they will seed a record amount of soybeans this spring, and reduce corn plantings by 5% to 78M acres ("...the smallest seeded area in five years...").

Ethanol in the US is produced from corn, ethanol pricing is determined by corn supply and demand, as well as market prices for gasoline. So this shows yet another of the many feedback mechanisms that make predictions of success in the ethanol production market difficult. That is, high fuel prices, which have stimulated the ethanol market, will lead to a decrease in the supply of corn (possibly leading to increased corn prices and lower ethanol gross margins). The same forces that stimulate the market hinder the market. Classic feedback, and very complicated to simulate or predict.

On the other hand, both ethanol and gasoline prices could drop if both of these happen.

Ethanol News

2006-05-05T11:36:00.000-07:00

The WSJ reports that "Energy Secretary Samuel Bodman urged Congress to consider lifting the tariff on imported ethanol..." The tariff, which was designed both to protect and stimulate the domestic industry, currently stands at $0.54/gallon. Eliminating it would very rapidly lower the domestic cost of ethanol as foreign importers (likely Brazil) step up sales. This increased competition may separate some of the better domestic players from the others, particularly those that are only teetering on profitability under current conditions. Here's a list of some of those we've reviewed.

Currently there is supply crunch driving up the ethanol price as it replaces MTBE in gasoline. Pricing is not pure supply and demand, however, but also what the market will support. As ethanol is functioning as a gasoline replacement (although only providing ca. 67-75% of the mileage), it's market pricing is influenced by the price of gasoline, which currently is going through it's annual run-up as the balkanization of the refining of reformulated blends used across the country for summer smog abatement creates gasoline supply constraints. If a similar call for a unification of refining standards gains traction, the price of gasoline will likely drop, which will also adversely effect ethanol profitability.

Alien Technology (RFID) IPO Snack

2006-05-05T07:01:00.000-07:00

Story: Alien Technology makes RFID tags, which are small passive antennas that gather enough energy from a transceiver to send a signal back. They are being used as bar code replacements, spurred on mainly by an on-and-off-again deadline by Wal-Mart for all vendors to use them. They've been a hot investment idea for the last couple of years.

Company: I look at a lot of bad companies in my searches and examinations, but I rarely see them this bad. From their prospectus, it costs them more in raw materials to make their products than they can sell them for. Put another way, they had $19.8M in revenue for 2005, but cost of revenue was $43.5M, for a $23.7M gross loss. That's just raw materials and manufacturing. Actually running their business cost them another $29.6M in operating expenses. They would have a better chance at making money if they just stopped making products. Their chances would still be zero, but that would be better than their current odds. It get's even funnier - they actually had a small nominal profit...in 2003. So their numbers really prove pretty definitively that their model scales well, except it's anti-correlated with profits. If you want to lose money as fast as you can, these guys can help. I'm just appalled they would throw a balance sheet like that up and expect RFID hype to carry them.

Here's what I'm guessing is their plan: please, oh please don't look at our SEC filings.

Dog Dog Dog.

Stock: Here's something better.

Riverbed Technology (RVBD) IPO Snack

2006-05-05T06:58:00.000-07:00

We almost don't care what these guys do (wide area networks), except that it got us to look at their S-1, where it was pretty easy to see why they thought they were worthy of public financing. Their gross profits have grown at 14x Y/Y ($14.4M/$1.04M), while their expenses are "only" growing at ca. 3x Y/Y($31.4M/$10.9M) so, hey, they just need to ramp up a bit more for a huge profit stream. That was sarcasm. They lost $17M last year, or $1.85/share. In absolute terms, they increased their gross profit by $13.3M Y/Y, while increasing their operating expenses by $20.5M. Percentages are irrelevant and misleading for very small companies, and the absolute numbers show that every dollar they get to keep costs them $1.54 to acquire ($20.5M/$13.3). They might have a fine product, but they are not running their company well. They need to wait another year or so to prove they know how to do more than just burn money. Dog.

MasterCard (MA) IPO

2006-05-04T14:24:00.000-07:00

Story: Credit cards. You surely know who these guys are, and I have nothing interesting to say about the sector overall, except that the Japanese barely use them (credit cards), so there is plenty of international growth left even in some industrialized countries, and the form factor (credit card) may have more options soon (key fobs, cell phones, etc).

Company: A huge ($2.5B) IPO. Will they be a Spectacular Story? It's hard to say, since on the one hand their products have been around for a long time (no big excitement), but on the other hand they have great name recognition. Turning to their latest prospectus, we were surprised. We expected them to be Solid, but they are not. They suffered from the loss of a lawsuit in 2003 and as a result had non-recurring payments between 2003 and 2005. We'll back those charges out, but all their other costs, for an old line company, are operational. So in this case, operating income is Net Income without the lawsuit charge. The surprise is just how inconsistent that has been. From 2001-2005 their FY operating income has varied Y/Y by -18%, 224%, -31% and 31% ($116M/$142M, $378M/$116M, $260M/$378M, $342M/$260M). For Q1 2006 they had Y/Y operating income growth of 36% ($127M/$93.2M). They've been operating income profitable for every year from 2001-2005, but for 2006 will their operating income increase, decrease, or stay the same? We don't know, as their growth is not predictable. Blah, except for the name recognition.

Stock: MA is a very big offering, with good name recognition, and is likely to be properly valued. With the trailing 2005 operating earnings of $342M, and what they figure to be about 100M ($267M earnings/$2.67EPS) shares outstanding, that gives a trailing operating EPS of $3.42. They are shooting for a target price of $43/share, which would give them a trailing operating P/E of 13 ($43/$3.42). That could probably expand a bit in the marketplace, so there may be some upside, nut we expected MA to be a possible long term buy-and-hold candidate, which is it is not. They are just as likely to shrink in 2007 as they are to grow. We'll probably pass.

That means that of the three big offerings in the pipeline (BurgerKing, Vonage, and MasterCard), all of which have increased their offering size during or prior to their roadshow (from $400M to $500M, $250M to $530M, and $2.45B to $2.84B, respectively), we find none of them compelling, either due to truly atrocious finances (Vonage), a private-equity unsustainable quick flip (Burger King), or being an unpredictable behemoth (MasterCard).

Wintegra (WNTG) IPO

2006-05-04T12:23:00.000-07:00

Story: Wintegra makes "network access processing semiconductors." Huh? If you are going to get on a network (via WiFi, GSM, WiMax, Ethernet, etc.) some chip somewhere is going to have to do some processing to make that happen. These guys make some of those. As such, they have big competitors (Broadcom, Intel, Cisco, etc.), and their products are almost commodities. Bu they have the advantage of being fabless, giving them low overhead, and having pretty good product positioning (WiMax, DSL, 3G chips). We'll let the market tell us whether they are winning or losing.

Company: From their most recent prospectus, it's a 5M share deal, with 3.17M going to the company, so of the ca. $75M deal, they will keep ca. $48M, which as of Q1 2006 is far larger than their total liabilities of $10.2M. So this chunk of change is material for the company, which from 2003-2005 has been growing gross profits at a bit over 100% Y/Y ($7.20M/$3.55M, $15.3M/$7.20M), and has operating expenses that are nearly fixed and below the latest gross revenue ($12.3M, $11.7M, $13.7M 2003-2005). So, they are operating (and net) profitable. Using the latest 2006 Q1 data, gross profits continued to grow Y/Y at over 100% ($5.6M/$2.6M), while operating expenses modestly ramped up by 28% ($4.1M/$3.2M). In summary, they currently have more cash coming in than they need to spend, and the cash they keep is growing a lot faster than the cash they spend. This is just the kind of model that we like. They are small, but Solid.

Stock: WNTG has not priced yet, but they are shooting for a $14-$16/share target. Annualizing their current quarterly operating income (which given their growth will lowball the estimate) and using the resultant 22.4M outstanding shares gives them a forward projected EPS of $0.27 ($1.521Mx4/22.4M). At the high end of their target price range, that gives them an estimated projected P/E of 60 ($16/$0.27), which is a bit high but not crazy given their growth and my lowball earnings estimate. (Note: 60 is ca. a 3x P/E market multiple, and ca. 75% operating earnings growth (100% gross revenue growth - 28% operating expense growth) is something like 1-5x better than the average competitor - so the target price is not unreasonable). If, on the other hand, we project forward their earnings growth of 100% that gives them a projected EPS of $0.37 ($1.521Mx(1+1.25+1.5+1.75)/22.4M) and a projected P/E of 43. We'll probably be buying, but as with Himax, there is likely to be no real hurry, and we may wait to see if it dips.

[Disclosure: currently long HIMX]

Cellulosic Ethanol Players

2006-05-03T13:51:00.000-07:00

We've highlighted a number of ethanol players (mostly corn-based) and given some background on the cellulosic ethanol sector. Now we're going to look at some of the players in that latter field. The field is far less developed than corn based ethanol production, and in general is still struggling with R&D issues, let alone production and/or profits. Because of that there is a lot of talk and hope, but not so much actual production. Thus anything in this area is inherently more speculative than in corn-based production (which is also speculative, but not on technology, just profits). Some players, in no particular order:

Xethanol (XTHN) - discussed in-depth here.
SunOpta (STKL) - discussed in-depth here.
Abengoa (Pink sheets - ABGOF - no float in US) - Based and traded in Spain with US divisions and presence. Abengoa Bioenergy has 4 US ethanol plants, with construction dates of 1994, 1982, 1985, and 2007, and capacities of 50M, 25M, 30M and 88M annual gallons of ethanol, respectively. Except for the one under construction, they have all been updated since initial construction. They all exclusively use corn. Their cellulosic efforts (and here) are all R&D, no production.
Genencor (small division of Danisco, not really traded in US - pink sheets DNSOF) - Based in Denmark, traded in Berlin. Genencor is in Palo Alto, CA, but they are 1 of 10 divisions, and apparently financially unimportant. At least they have had some success in their R&D efforts, but that is still where they are, and they have been working intensively on it for 6 years.
Iogen (private, recent $30M Goldman Sachs investment) - developing and testing enzymes for cellulosic ethanol production. These guys are in the right place, with plenty of similar experience, but they are private. We don't know anything about their financials, nor how far along they are.
Novozymes (Pink sheets - NVZMF - no float in US) - Based in Denmark. A big enzyme player, but looks like nothing useful yet in the cellulosic ethanol area. Even so, it would be one tiny part of their operations.

That's it for now. These are all either bad investments, or plausibly reasonable investments but neither pure plays nor US based, or private. (The European fuels market is a whole different ballgame - average fuel cost is about the same as here, but taxes triple it - so consumption drivers are by command, not market). None of them are good cellulosic ethanol investments. Too bad one can't buy stock in NREL (where the '$0.10-$0.20 enzyme cost per gallon of ethanol, and 30-fold improvement in cost' quote that everyone throws around came from) or just the whole DOE.

SunOpta (STKL) has the Cellulosic Ethanol Glow

2006-05-02T14:06:00.000-07:00

Story: A reader made me aware of SunOpta, primarily because of its organic food lines, but also because it has some marginal business in ethanol. 90% of revenue comes from the SunOpta Food Group, 9% of revenue comes from Opta Minerals, and 1% comes from the SunOpta BioProcess Group. That last one is the one exploring cellulosic ethanol. Organic produce has been a bit of a market darling for a few years now. We'll avoid the politics, the balkanizing turf wars, and the hype, since the only thing we care about here is the market direction for organic produce. The two best known plays on that are Whole Foods and Wild Oats. WFMI shows a steady smooth stock price increase for many years, until it broke down at the start of this year. OATS has a much choppier history, but generally trades between $10 and $15 until a breakout earlier this year from which it is now pulling back. So, that was a quick-and-dirty way to say that the easy growth in the organic food sector is probably over.

We'll ignore, at our peril, the mineral stuff. The BioProcess group doesn't actually produce ethanol. The main thing that they do is provide the equipment necessary to process any raw materials for downstream ethanol production. The main game here is surface area, so their systems are designed to pulverize, wash, explode, powder, or otherwise process the feedstock for maximum contact with the reagents that will be used for the production of the desired chemicals (ethanol being one possible target). That makes them sort of a picks-and-shovels play on the ethanol industry, although I have no handle whatsoever on how (we suspect very) competitive or balkanized this side (engineering of processors) of the market is. In addition, they don't have to mess with the whole enzyme issue, since they are upstream from that. On the other hand, they are likely to only get one-time, rather than recurring, revenue from each of their ethanol plant installations, since they profit from sales of the plant equipment, not the plant product.

Ethanol has a lot of interest right now (we were tempted to say hype, but some of it is justified), and cellulosic ethanol especially so. Abengoa in the biggest cellulosic ethanol producer, and SunOpta has sold their biomass pretreatment system to them, generating some buzz for themselves. That's a pretty weak link. We'll take a quick look at the numbers to see if they justify the stock.

Company: These guys are no start-up. They have been around at least since the 1980's, so operating earnings (what they really get to keep) are Net Earnings, not some other measure (e.g. EBITDA - earnings before interest, taxes, depreciation and amortization), since all those other long term or otherwise imposed expenses are operational at this stage of business development. From their 2005 annual report (pdf), they have nice healthy Y/Y top line growth from 2001-2005 of 31%, 64%, 54%, and 39% ($121M/$92.4M, $199M/$121M, $306M/$199M, $426M/$306M). In absolute terms that's a revenue increase Y/Y between 2001 and 2005 of $29M, $78M, $107M and $120M. They have a fairly consistent gross margin of about 16% +/- 3%. 2001 they had a net earnings loss. Net earnings growth Y/Y between 2002 and 2005 was 142%, 23%, and 24% ($8.97M/$3.70M, $11.0M/$8.97M, and $13.6M/$11.0M), or in absolute terms $5.27M, $2.03M, and $2.6M.

So, they are increasing their revenue by over $100M/year, but they are only increasing their earnings by less than $3M/year, and earnings growth rate is slower than revenue growth rate. That is, only about 2% ($2.6M/$120M) of their top line growth drops to their bottom line. Their top line looks good, but with that small a margin their bottom line is boring. Blah.

The bioprocess group ended 2005 with 10 employees (annual report, pg 23).

They reported Q1 2006 numbers today. Quarterly revenue up 55% Y/Y, net earnings up 47% Y/Y to $0.05/share. (Annualizing that gives $0.20 for the year, which is less than their reported 2005 earnings, so we're not impressed). All their growth came from the food products division.

Stock: They have been around for a long time, and a historic chart of STKL shows that they are currently trading near the all-time high of their price range. With a 2005 EPS of $0.24, and a current price of ca. $10, that gives them a trailing P/E of ca. 40, which there is no way whatsoever to justify from their earnings growth. Ethanol and cellulosic ethanol may boom all over the world, but these guys, as explained above, won't make any money from it, and they certainly haven't in the past. Their stock is up on hype. We might short.

CPI International (CPII) IPO Snack

2006-05-01T11:25:00.000-07:00

CPI International - a maker of microwave systems - just came public at $18 (CPII). A very cursory perusal of their prospectus indicates they are uninteresting for us - declining margins and earnings - but too good to short. Ho Hum. What we really want to point out is that they, or these guys, have some sort of trademark or other legal issue to work out with one another, as their name dilution clearly causes confusion. Very surprising to see something like this that hasn't already been worked out between two successful businesses.

Cellulosic Ethanol Background

2006-04-28T11:45:00.000-07:00

For previous comments on the ethanol sector see here. Most of those highlighted corn based ethanol producers, but the holy grail in ethanol production is to do it from woody waste products, rather than from a valuable commodity like corn. Now for a little background:

In fermentation, yeast consumes sugar, and produces alcohol (e.g. ethanol) and CO2 as waste products. When making wine, the high concentrations of alcohol eventually kill off the yeast and terminate the fermentation. When making leavened (rising) bread, the consumption of the sugar eventually terminates the fermentation process (where the desired product is the CO2, which makes the bread rise), or it is ended by baking. Table sugar is sucrose, which is a two part (disaccharide) sugar easily cleaved into glucose and fructose. Fructose is one of the most digestible sugar for yeast. Honey, along with a bunch of impurities that give it flavor, is a nearly equal mixture of glucose and fructose derived from the cleavage of sucrose.

Corn is high in starch, which is a polymer (polysaccharide) of glucose, meaning starch is made up of a bunch of glucose molecules linked together. Cellulose - the structural component of green plants - is a slightly different polymer of glucose. Wood contains cellulose as well as lignin and many other non-sugar related compounds. So, to use fermentation to get alcohol, as all ethanol production does, you need to start with some digestible sugar for the yeast. But the raw materials at your disposal (corn starch, cellulose, wood) are not those sugars, but rather polymers of those sugars. Think of the sugars as bricks, and the polymers as walls made of bricks. For the yeast to get at the bricks, you have to break the walls - cleave the polymers into their basic sugar monomer units. One of the basic ways to do that is using enzymes, which are very complicated molecules that have just the right structure to take large, stable molecules and cleave them at just the right place. Think of enzymes as a really smart construction guy with a jackhammer. You don't want to break all the bricks, you just want to separate them. You can do dumb things like run into the wall with a truck (an analogy to acid or base baths, etc), but that will break a lot of the bricks, and leave big sections of the wall intact. If that were good enough, it would already be done (and it is as a precursor step). But it's not good enough for a profitable business (as history proves), so the smart (enzyme) approach is mandatory. But enzymes are complicated (difficult to manufacture), and finicky molecules that demand to be treated right (precise chemical conditions).

So, the big basic issue in cellulosic ethanol production, the reason we haven't been doing it for 30 years already, is the enzymes. Some of the enzyme chemistry is well characterized, for instance for the production of high-fructose corn syrup from corn starch. Because that process is well known, and the necessary enzymes can be had for cheap, corn has been the preferred feedstock for ethanol production.

Now, most of this knowledge is at least 30 years old, and some of it is thousands of years old. So the enzymatic production of sugar from cellulosic and/or woody sources has been worked and worked and worked on. It is not new. Science is a tough game - mostly things don't work. Even when they do work in a lab, they often don't work on a larger scale. If you've ever tried doubling or quadrupling a recipe and have it not come out quite right, you'll have some taste for this. Even if you can get it to work on a large scale, you still have to do it profitably. And that part is particularly difficult, since there are thousands and thousands of chemical reaction pathways that give only trace products. That might look good enough in a lab, and on a bench-top production level, but be completely unprofitable on a large scale. And it is decidedly not the case that you can just take any old chemical reaction pathway and with a bit of tweaking increase the product output. It's more likely that you can't.

Now, in a new field where something has never been tried before, new entrants deserve some slack since nobody really knows what the odds of success or failure are. But in old fields, it's a completely different ballgame. There you know that the odds of failure far outweigh the odds of success, and in these sorts of endeavors we hold to a high standard of proof-of-production. Talk is cheap. Lab results are less cheap, but still cheap. Small scale bench production is cheap. We want real proof-of-production since the road is littered with previous failures that almost got there but then didn't.

Only after that proof-of-production, is it worth delving into whether the particular player has any hope of profitable operations. So that's the standard, and that's the reason for the standard. We'll see what we can find in this sector over the next few posts.

Houston Wire (HWCC) IPO

2006-04-28T06:56:00.000-07:00

Story: They make wire. All kinds of wire.

Company: Why be interested? For one, we were so sick of looking at crap companies with crap financials, that it's just sort of exciting to find a company coming public that actually deserves the financial help by having proven that they have a functioning business model. That is, they've been profitable for 3 years. The sector is boring, but there is a particular little spin on their financials I'm going to highlight that makes them worth a look. Bear with me a minute.

In their prospectus they give FY 2003-2005 data. Revenues of $149M, $173M and $214M, gross income of $35.1M, $41.3M and $55.7M, and operating expenses (after adding a couple things back in) of $28.445M, $29.057M, and $32.723M. That gives operating income of $6.7M, $12.2M and $23.0M, OP margins (operating income/revenue) of 4%, 7% and 11%, and the more important OOP margins (operating income/operating revenue(=gross income)) of 19%, 30% and 41%. The OP margins are small, showing it's a low margin business, but the fact that they are expanding shows that they run the business well, have their operating expenses nearly fixed, and are growing their top line. On top of that, the fact that their OOP margins are expanding shows again that their expenses are fixed, and they get to keep an ever greater chunk of their top line growth.

Exactly what we like, and refreshingly Solid. The main concern is that they have some significant other expenses we've classed as non-operational, of which taxes (going up) and interest (going down) are the two biggest terms. But even with those they have been net-income profitable each year ($0.216M, $4.8M and $12.5M).

Stock: Here's the real kicker: after they list they anticipate only ca. 9M shares outstanding. That gives them a current operating EPS of $2.60 ($23.0M/9M) and an EPS of $1.40. But given their controls, both their net and operating earnings are likely to expand by $9-10M/year. Not a lot, but on a per-share basis, given the low share number, they could quickly double EPS. They are shooting for a $112.7M deal on ca. 9M shares, so that gives them a target of ca. $12.50/share. At that price they would have a P/E of 9 and an operating P/E of 5, which could even be something of a discount to the market.

We'll have to wait until HWCC prices and lists, but if they come out at a market neutral P/E they may be interesting. If they get a market multiple, they are probably not dynamic enough to be interesting.

American MoldGuard IPO?

2006-04-27T12:26:00.000-07:00

American MoldGuard just came public. They are issuing "units" representing 2 shares and 3 warrants of a couple different kinds. What's up with that? We're not going to bother to find out, since they lost $3.29 a share (page 5) in just the first 9 months of 2005. Nice story - mold abatement through polymer coatings during new construction - but atrocious financials. Nevertheless, a few people at least have bought their AMGIU units. Why?

Goodman Global (GGL) IPO

2006-04-27T11:17:00.000-07:00

Story: Not our usual cup of tea (we usually like to have some insight into the growth prospects of a sector), Goodman Global makes HVAC (heating, ventilation, air conditioning) equipment marketed under the Goodman and Amana brand names. We generally don't pay too much attention to industrial type companies as they are often slow growth and low margin in competitive industries, but GGL just came public (11Apr06), priced at the upper end of it's expected range ($16-$18), and opened up on a very big deal ($423M). So somebody thinks they are worth a look, and because of that we'll do a quick scan of their numbers.

Company: They just issued Q1 2006 numbers. They had loses in Q1 2005 due to a non-recurring charge, without which they had nominal profits ($3.4M), and profits for Q1 2006 ($8.4M). Revenue increased 29% Y/Y ($381M/$296M). Costs of goods sold was 91% of revenue in 2005 ($268M/$296M), but only 77% in 2006 ($295M/$381M 2006). All they do is build stuff, and the only thing in "costs of goods sold" is the prices they pay for the stuff that goes into the stuff that they build, so one wouldn't normally expect there to be much change in their gross margins, but a shift from 9% to 23% Y/Y is dramatic. It indicates that they must have found a new parts supplier, or otherwise somehow requires explanation. Otherwise we would consider it a red-flag for mysterious book-keeping. But they plausibly explain it as due to a federally mandated shift to higher efficiency products (the 13 SEER minimum efficiency level, effective from 23 Jan 2006 forward) which are higher margin. So the new margins are probably sustainable going forward. But then they explain that the 2005 "cost of goods sold" number has $39.6M in non-recurring charges and a $2M gain on commodity derivatives, and backing those out their 2005 margin would have been 78% ($268M-$39.6M+$2M/$296M). They claim their new margin is a 0.3% improvement over their old margin, but we find it 1% worse due to rounding errors. So 1) their margin improvement is a rounding error, and 2) any improvement due to product shifts is irrelevant.

At this point, we do not find their books at all transparent, and the red-flag is back. What are commodity derivatives transactions doing in costs of goods sold? We shouldn't have to read text to figure that out - it should be line-itemed on their P&L statement. They have about a Billion bucks in debt, so interest payments are material for them.

They have "...continued to leverage SG&A." but what they mean by that is 0.6% improvement Y/Y. Boring.

They are an IPO in an industrial area. There is always window dressing prior to an IPO, but industrial companies that have been around for a long time ought to be fairly transparent. Frankly, we don't trust that we can look at their numbers and really see what is going on. At first blush, their gross margins seemed to have improved, but really they are flat. At first blush their top line, and bottom lines seem to also have improved, but again they are by such large quantities that it is mysterious. They claim 29% top line growth due to increased sales volume and a shift toward higher margin products. We've seen that that latter term is irrelevant, so somehow they managed to sell 29% more air conditioners Y/Y. Wow, that's a huge increase, and seems awfully implausible. But from their annual report, they have had 2001-2005 Y/Y top line growth rates of 5%, 5%, 10%, and 19% ($1.136B/$1.082B, $1.193B/$1.136B, $1.317B/$1.193B, and $1.565B/$1.317B), so maybe it's plausible.

At this point, we still don't see how there could be ca. 30% top line growth for a billion dollar air conditioning company. Maybe we could figure it out if we did a lot more reading (we would have to rule out channel stuffing and look for some international market share growth or other very significant change), but instead we're just going to Pass, despite the...

Stock: ...that has done ok so far. (GGL)

Couldn't Help But Notice the Similarity

2006-04-27T08:53:00.000-07:00

Left: Ken Lay; Right: Mr. Magoo.

Genetically Targeting Medications - Perlegen (PERL) IPO

2006-04-26T13:11:00.000-07:00

Story: The Human Genome Project began in 1990 with federal funding and took 10 years to map out 1 full human DNA sequence. Toward the latter part of that methodical exercise, Craig Ventnor formed Celera Genomics (CRA) to do the same thing using a 'shot-gun' approach, that instead of progressively, methodically, and accurately reading and transcribing a DNA strand, chopped it up into tiny bits, transcribed as fast as possible those tiny bits, then put them back together in the right order using complex pattern matching algorithms based on Single Nucleotide Pairs (SNP's). Sounds impossible, and when Ventnor proposed it to the original Genome Project, it was rejected, which stimulated him to form Celera, and ultimately to beat the Genome Project and prove the validity of his approach, which has now become standard. Human Genome Sciences (HGSI) did the same thing, and both were high flyers based on the promise of the commercialization of their results.

Simultaneously in the pharmaceutical industry, drug design went away from 'rational design' to 'combinatorix'. Rational drug design uses the insights of chemists to pick target compounds that may have efficacy against a particular disease mechanism. It's very hard work, requires smart people with lots of experience and insight, and can not be standardized easily. It is also largely responsible for everything we have in new and novel drugs, which make the world an unbelievably better place than it was only 50-100 years ago.

Combinatorix came up in the early 1990's with the advent of automated chemical manufacturing and diagnostic tools (e.g. Affymetrix), and used a somewhat different approach. Given a particular target compound, 1000's to millions of possible variants would be screened for binding or other interaction with the target, and then only those showing the expected screening would be pursued. The thinking behind combinatorix was rational and complex:

Many drug variations require only small side chain modifications for drastically increased efficacy, so performing those modifications automatically makes sense.
Doing anything systematically in drug development holds the promise of vast rewards, unlike the current lottery system where years of rational labor may very suddenly lead to nothing, or to a blockbuster. Rationalizing and systematizing the research processes could lead to more stable business.
The necessary computing power and other tools to pursue this idea had not been previously available at the right price, so the idea had to be pursued.
Rational design gets locked into certain ways of thinking, and not applying those rules may jump out of that limit-cycle of thinking and find new interactions.

The drug industry pipeline took a major nosedive during the 1990's, from which it has only recently begun to recover, and much of it is blamed on the failure of the combinatorix idea to live up to the hopes. The reasons are complex - a simple initial screen doesn't tell you much about the whole disease chain efficacy, the number of possible compounds is enormously bigger than the number that can be screened (for the same reason, with only 26 letters, we have not yet run out of words), etc. - and not vital for the current discussion.

So, combinatorix as a stand alone technique has failed, and it is now largely used, if at all, as just one adjunct to the rational drug design approach. But given the combinatorix excitement among scientists, one can understand how that same thinking would translate to the fruits of the Human Genome Project. So, the question for Celera and Human Genome Sciences was always: how are you going to make any money? The answer was multifold, involving selling access to the DNA databases, and assisting in targeting drug design.

That last part is the big deal, and the whole promise of DNA research - better drugs targeted to patients with particular genetic profiles. The general way companies trying to do this talk about it is they take the DNA profiles of a particular disease-expressing cohort of patients and compare them to a disease free cohort, looking for genetic markers that distinguish them. Those markers then become the drug design targets. You can see how that's a combinatorix-meets-DNA approach. There are some variations in how cohorts are selected, etc., but the approach is always 'do some statistical correlation studies of DNA samples to find possible drug targets.'

The big point: it sounds fantastic, and has huge promise, but has been tried since at least 2000 and nothing really has come of it. That's the nature of research - mostly failure and dead ends.

Perlegen Sciences is another player in this field, that has just filed to come public.

Company: Given the sordid history of these efforts, coupled with the large failure rate in drug design, we were hoping that Perlegen, like Affymetrix (of which they are a spin-off), would be something like a tool company that sells to all the other players, but rather they seem to be pursuing their own drug designs, and assisting in clinical trial efficacy enhancement (just like the other players). I fail to see what they bring to the table that is novel, although there are so many subtleties involved in successful research that there is almost always room for another team. But the most likely thing is that they will fail, so the question is whether they have jumped over those odds by already proving viability.

According to their initial prospectus the answer is No. "We have incurred $153.1 million in cumulative net losses since our inception in 2001, and we expect losses to continue for the foreseeable future." They are just another biotech gamble, with bigger risks than average, but also bigger - if however unlikely - potential rewards. If you are into biotech gambling, they are as good a dice roll as any. That is, there is absolutely nothing predictable nor assured about their financial returns. Sort of a Dog and sort of just Blah.

Stock: They have filed to list under PERL. For comparison, HGSI and CRA have been flat for 3 years, the current market for biotech IPO's has been brutal, and Symyx (SMMX) - a similar Affymetrix spin off focusing on using combinatorix to develop useful inorganic compounds - has not had a particularly interesting stock pattern for the last couple of years. The Genome Project excitement of 2000 is no longer, and based on other biotechs coming public recently, we expect PERL to be boring. Pass.

[Disclosure: currently long SMMX]

Dirty Rotten Coal

2006-04-25T12:04:00.000-07:00

Coal. Dirty, old world coal. Surely, after a couple hundred years of use, there's nothing particularly interesting about such an anti-environmental dirty, destructive (strip mining and acid rain, particulates and mercury) commodity. Solar and ethanol are the way to go, right? Well, yeah, except for one little niggling bit about them both being completely uncompetitive with coal based on price alone. So there are lots of market manipulations (taxes, 'total environmental impact accounting', etc.) to try and make the 'green' energy sources look price competitive with the 'dirty' sources. But at the same time, there has been 30 years of work (since the 1971 Clean Air Act) to make those 'dirty' sources clean, and those efforts have been enormously successful.

Today, the drivers toward 'clean' energy are not really pollution derived, since almost any energy source can be used today in a relatively pollution-free fashion. They are rather price-based, and more nebulously political. On the political front there is the environmental contingent that is wedded to particular 1970's based ideas (that are seeing a current resurgence), and not wholly disjointed from that movement there is a wider dislike for sending petro-dollars to distasteful foreign regimes. That's the 'energy independence' crowd. Coal dovetails with both those desires.

The energy independence bit is easy. The US has more energy reserves in the form of coal than Saudi Arabia has in oil. If you want to keep the money here, using US coal is one way to do it. In fact, the transformation of our economy since the 1970's is the reason that the current high prices of oil are not having the same deleterious effect of high oil prices after the Yom Kippur War (cf. #3 here, and supported here - in summary, we're just as energy dependant today, but it is now mostly electrical (60% of energy and GDP), which is nearly 100% non-oil based, and only minorly oil based (40% of energy but only 15% of GDP), although important for transportation).

The new shift is the greening of the coal industry. Scrubbers to eliminate sulfur (and mercury, etc.) from coal smokestacks have been required for all new sources for some time. The industry chose to fight the regulations tooth and nail, claiming that major repairs were minor repairs, and refusing to build new plants, to avoid the scrubber mandate (they are expensive). But that approach stymied the industry growth, so there was a shift to 'clean' coal, which meant 'low-sulfur' coal, since the smoke stack pollution monitoring could be satisfied with that feedstock even without the latest scrubber technology. Finally, some of the players have decided that instead of retrograde fighting, maybe they should just go with the spirit of the regulation and see if they can make a business model for it, and it turns out they can. The absurdity of this paradox is that the shift is now towards high sulfur coal.

The WSJ did a nice job on this yesterday. They looked at 3 coal sources: Northern Appalachia (NA), the Powder River Basin (PRB), and Central Appalachia (CA). The NA coal is high sulfur, and as a result has 40% more heat content than low-sulfur PRB coal, and 10% more heat content than low-sulfur CA coal, but sells for $53/ton, whereas PRB and CA coal sell for $55 and $71/ton, respectively, including transportation costs. So who wouldn't want to get 40% more heat for between 4% and 25% less, for a total $/btu differential of ca. 44-65%? The only problem is that using high-sulfur coal necessitates scrubbers, but for that price differential, it's worth it. Currently "...between 30% to 40% of the nations coal-fired electricity output is generated by facilities that use scrubbers, but that figure is expected to jump to about 60% during the next five years..."

So, that was a long-winded background (although much more could be said). We haven't completely decided if we are interested enough, but we may take a look at some coal producers.

Bausch & Lomb (BOL) Distress an Opportunity?

2006-04-21T11:15:00.000-07:00

Bausch & Lomb (BOL) has a pretty serious two-front problem: accounting issues, and a fungal eye infection that may be linked to their ReNu cleaning solution, although attempts to confirm that have so far been ambiguous. As a result, the stock has dropped from $69 to around $47 - a 32% drop. Is that an opportunity, or not?

The last quarterly report they filed was for calendar Q2 2005, pretty outdated, but it will give us something. For the 6 months ending with that quarter they showed $1.1626B in revenue with Y/Y growth of 8%, and $0.2685B coming from "Lens Care" also with 8% Y/Y growth in that segment. The WSJ reports that so far they have reported about $9M in sales reductions over 3 1/2 years due to accounting errors, and that they typically trade at a P/E of 20, although it is now 13. There have been 30 confirmed eye infections, 26 of which used ReNu, and ReNu was used by 10M Americans.

The fact that there are counter-examples to the ReNu-causing-eye-infection theory says pretty boldly that it is probably not the culprit, so we expect them to eventually have no liability. Nevertheless, we will kill off all their Lens Care sales, use an arbitrary 10x factor on the accounting issues and plug it into a single year, since those tend to blow up larger than at first estimated, and annualize the numbers from above assuming no growth. That gives annual estimated revenue of $1.7B (2x($1.1626B-$0.2685B)-$9Mx10). They don't break out expenses by segment, so we will just assume all the expenses remain and continue going forward. That gives operating expenses of $2.0438B ($1.0219Bx2). So, under perfectly plausible, but harsh, assumptions, they may be showing losses going forward.

Here's another way to see the problem: they only had annual $281M ($140.7Mx2) in earnings before any of the problems surfaced, and those problems have put, at a minimum, something like $537M (2x$268.5M) in annual revenue in jeopardy.

On the other hand, if they get both issues resolved, and the numbers go back to what they were, then their current share price drop provides a nice opportunity. You will likely have noted that there is a lot of slop between those two possibilities, but financial projection is NOT science, and does not allow for any sort of real precision, although most people act like it does. We could use very specific numbers, and make very specific projections, and then be very wrong because our false precision was garbage. Instead, what we like to do is properly recognize the slop, and look for opportunities that are good even outside those wide error bar ranges.

BOL isn't quite there. One might make good money on them by buying now, but it's gambling.

Google (GOOG) Snack

2006-04-21T08:21:00.000-07:00

Q1 2006 numbers just released yesterday, accounting for a ca. 10% share price jump. Y/Y quarterly revenue growth of 79% ($2.253B/$1.256B), operating income growth of 67% ($742M/$443M), net income growth of 60% ($592M/$369M). That growth justifies an operating P/E something like double the market multiple. Annualizing current operating earnings, and diluting their share base forward gives a conservative forward operating EPS of $9.21 ($742Mx4/304Mx1.06) and at a current share price of ca. $450 that gives a forward operating P/E of 48 ($450/$9.21), which is just about right. Doing the same calculation but using net earnings gives them a forward P/E of 61.

On the other hand, if we use the last Y/Y growth rates to project operating and net earnings, and assume completely linear growth, that gives them a forward operating P/E of 46.8 ($450/($742Mx1.67x(1/4+2/4+3/4+4/4)/(304Mx1.06))) and a forward net P/E of 61 ($450/($592Mx1.60x(10/4)/(304Mx1.06))), again just about right. They are neither over nor under-valued by these measure.

They plan increased capital expenditures, but also increased and improved product rollouts, so those compensating effects do not sway the estimate one way or the other.

Basin Water (BWTR) IPO

2006-04-21T07:21:00.000-07:00

Story: Basin Water provides turn-key (or near so) ground water purification systems for cleaning up contaminated wells or otherwise getting a water supply to a desired contaminant level. They use ion-exchange resins, a well established technology. Old industry = lots of competition and commodity prices. My main question - what is there to possibly be excited about over water purification. Desalination, maybe, but trace impurity removal? Boring. But then again, these guys are bothering to try and come public, so maybe they have something. Or maybe not.

They claim a bunch of patent protections for removal of key trendy contaminants - arsenic (well, that one's not trendy), nitrate, perchlorate, chromium VI, and uranium. I have not read their patents, but there is no way they can be broad enough for industry dominance, as this is very standard chemistry and chemical engineering. So the patents are likely for some specific feature that could be worked around by a competitor. The patents are not their moat. On the other hand, their modular system design approach and easy servicing sounds like a good product, so I'm betting that design and execution are their real moats, and with that, pricing. Let's see what the market says.

Company: Hmmmm. I'm getting sort of interested, until I hit page 2 of their prospectus, where they show FY 2005 $12.2M revenue and $0.6M net income, versus $4.3M revenue and -$0.6M net income for 2004. So far, tiny, but good, especially when they indicate that they closed 2005 with a $77.0M revenue backlog. Looks like they just got profitable and are ramping up quickly, but then, this: they closed 2004 with a $35.0M revenue backlog.

Now wait a minute. They talk about how, after water testing, they can set up their systems in a matter of days to weeks. They started 2005 with $35M in orders, but over the course of the entire year they only realized $12M in revenue? Where did the other 2/3's of the orders go? Later (page 10) they make it clear that their contracts have a typical life of 5 years or more, so of that $77M backlog, only ca. $49M ($77M-$35Mx4/5) of it is new, and they may only see $10M ($49Mx1/5) in 2006. The problem now is that there is no possible way that I can make any reliable projections about their prospects that make them seem compelling, and they are currently too small to be of interest (they could easily be squashed by a bigger player, although they aspire to be the biggest).

Unrateable.

Pass.

Ethanol Plays - Xethanol (XTHN)

2006-04-20T13:22:00.000-07:00

Story: Xethanol is in the R&D stage of trying to develop and commercialize processes for creation of ethanol from non-corn based cellulosic sources. That makes if a bit different than the other players we have highlighted. Cellulosic ethanol, as far as story goes, is a much better idea than corn, in that the raw materials for ethanol production are scrap yard waste and other woody type products, as opposed to relatively expensive corn. The sourcing of these waste products allows for a more distributed ethanol production infrastructure, since corn proximity is unimportant, and demands smaller production plants, since woody waste production is often of a smaller caliber than corn. They state that those two properties will allow them to charge premium prices for ethanol, but I think it's just the opposite - they will be able to undercut the corn-based market price.

But that is all pie-in-the-sky until they actually have some products, which they do not. They have a fairly rounded newer management team, although it seems to me that the cellulosic ethanol problem is an enzyme issue, and thus they need some greater chemical and/or bioengineering expertise in-house, rather than only through their research agreements. The Board of Directors seems first rate. Otherwise their website is fairly devoid of content.

Their big move is to begin production of plants the use a beetle derived product discovered by the USDA to assist the fermentation of woody-products.

They seem to have some internal control issues, as it has been necessary for them to repeatedly issue amended corrections to their previous SEC filings, although in the cases that I have looked into, the corrections are generally insignificant. Their latest annual report for year end 2005, issued 7 Apr 2006, shows that they 'came public' in Feb 2005 by reverse-merging into a defunct shell company, which is cheap and doesn't require an investor road show. That puts them in a potentially lower quality tier. They claim to be a "biotechnology-driven company", which is true in theory for their future, but is not true of their current production capabilities, nor apparently of their in-house capabilities. They currently have a refurbished candy-to-ethanol processing plant that has been around for about 10 years and has a capacity of 1.6M gal/year of ethanol, and another bankruptcy acquired mostly corn based plant that they have refurbished for 6M gal/year ethanol production capacity.

Small potatoes, neither cutting edge, nor novel.

Their corporate history is scary (annual report "Corporate History and Recent Developments", pg 3). Basically a bunch of junk companies with no relation to ethanol (Freereal-Timequote.com ->LondonManhatten.com -> Xethanol -> Zen -> Xethanol), that kept changing their names and business plans until settling on the current one. Also, I've never seen anything quite like this front-and-center in an annual report (pg. 5-6), but they have what looks to me like a legally binding pump-and-dump incentive with Fusion Capital, whereby they can force them to buy more stock dollar volume on a daily basis as their stock price rises. Fishy.

They hope to be able to ramp the candy plant up to 4M gal/year in cellulosic ethanol production.

They plan to co-locate smaller cellulosic plants at waste-stream producers (like paper pulp mills or lumber processors).

Any technology that they do hold has come from UTEK, a university technology transfer company. Here's a sad general truth: most university research is, frankly, useless crap. It takes 99% junk to find the one gem. The average science paper costs $10-20K in R&D, and what tiny fraction of those do you think ever lead to a useful market product? So, just having some university based research in your pocket is no where near a viable business. Put another way, if the stuff they bought from UTEK is so great, why didn't UTEK sell it to ADM for 100-1000 times more? Answer: because it's utility is far far from assured.

That doesn't stop them from planting little nuggets like "So, if you look in terms of what the company is going to look like in three year's time, hopefully you'll see about 300 million, 400 million gallons of capacity in the marketplace." How about a single co-location licensing agreement today?

Company: They have almost no business, they are all R&D story and hope. For 2005, they had $11M in losses on $4.3M in sales. Given their corporate history, and their recent performance, they are junk. They have no disclosed licensing agreements for their on-site cellulosic ethanol production plants. All story. Big fat Dog.

Stock: Given all that, take at look at XTHN recently. No volume, sitting around at $4 (which was already too high but was held there by the agreement with Fusion Capital). Then suddenly millions of shares changing hands, and the price has quadrupled. I've read every one of their press reports for 2006, prior to and during the recent rise, and other than yet another new business organization, there is absolutely nothing there. They did just receive $34M in private equity funding, but private capital gets pissed away on bad ideas or poor execution all the time. That alone as a validator is not sufficient.

EarthLink's (ELNK) Amazing Churn

2006-04-20T10:16:00.000-07:00

The WSJ reports today on EarthLink's Q1 2006 numbers, and they are atrocious, but at least they have plus signs. Net income of $16.4M on revenue of $310M, for a margin of 5%. Those were both down 51% - $16.9M absolute ($16.4M/$33.3M) and 7% - $25M absolute ($310M/$335M) Y/Y, respectively. A 7% top line decrease leading to a 51% bottom line decrease shows the top line is operating at just about break even, and they desperately need about $300M quarterly revenue to stay positive. They offer some gobblygook about their new services being delayed, in an attempt to keep hope alive. But the truly stunning figure is that they have a monthly churn rate of 4.6%. That is an annual churn rate of 55.2%. For every 100 people they sign up in December, 55 of them will have decided that the service sucks enough to cancel before the next December. That's amazingly bad customer retention, and shows how desperately they need new compelling services. When 55% of old customers leave, why would anyone new sign up with them? Customer acquisition is expensive, and 55% of that expense is being thrown away.

We previously thought their story was worth a look, and the story is compelling, but the facts don't seem to be. Annualizing their current EPS ($0.12x4) gives them a forward P/E of 20 at a current ELNK share price of about $9.75. That's not crazy, but this is one very slowly turning ship, and the torpedoes are coming fast.

Local Matters (LOCL) IPO

2006-04-19T11:46:00.000-07:00

Story: Local Matters works with Yellow Pages companies to create an online or otherwise electronic version of their products. On the one hand, we love the local advertising idea, but we have not yet found a good on-line player in that field, although there are many aspirants. Local Matters, unlike the other search engine companies trying to enter this space, is rather trying to leverage the excellent current or ex-Bell telephone Yellow Page products with an online presence. They have a number of various products for internet, voice, and mobile local searching, both on the back-end (e.g. facilitating 411 calling) and on the front end (e.g. local city guides based around AreaGuides.net).

When I use the AreaGuides.net search in my local area for an esoteric business that I know exists just around the corner from me I get a number of accurate hits that are non-local, and when I restrict it to only local hits I get "no listings found". Believe it or not, that's good, in that, as I outlined in one of the links above, their precision is high, and they only suffer from a lack of completeness. That is, I got no spurious results. That means that if they were to extend their technology to my local area in the category I searched, they have a hope of providing a useful product (unlike anything I have seen from the online search oriented companies). In other search categories, they provided useful local results, and again no spurious results. However, the results are polluted by "advertisers". For example, under "Roofing Contractors", first 56 listings were claimed, but then only 36 returned after clicking in. Of those, 8 of them are actual roofers, and the remaining 28 were services which offer to hook one up with a roofer, and a number of those were duplicates. Utility factor pretty darn low.

As another curiosity, the top of the page says "Powered by AreaGuides.Net", while the bottom says "Powered by Verizon SuperPages.com", with "data by Acxiom". It's unclear to me, from that, what value-add Local Matters brings to this over Verizon alone. This is not a thorough analysis, but in the one meager area tested their technology is not junk, but it is no where near good enough to be a destination. For other searches, of which they provide many, they extensively use third-party products (dating, jobs, car rentals, etc.). So the AreaGuides.Net are aggregators, and suffer or excel based on their component qualities.

As we have tried to emphasize previously, we love the idea of local search, but execution is everything, and so far these guys do not stand out. Perhaps their back-end or otherwise untested (by me) products are compelling though. We'll let their P&L speak for itself.

Company: From their prospectus (pg 7), they are tiny ($8.4M revenue in 2005), growing their top line (347% Y/Y or $6.6M absolute - $8.5M/$1.9M), but growing their operating expenses a lot faster ( 220% Y/Y or $8.8M absolute - $12.8M/$4.0M), and they have never turned a profit. I can generate losses faster than revenue growth just by not showing up. What do I need them for? I doubt this company will get publicly funded - it certainly shouldn't. Dog.

Stock: Not public yet, probably never will be without significantly cleaning up their operations. We were hoping this would finally be a promising play on local advertising, but that cherry is still waiting to be picked, despite all the efforts.

Visicu (EICU) IPO

2006-04-18T12:06:00.000-07:00

Story: Visicu sells a system for remote monitoring of patients in hospital intensive care units (ICUs). They claim their "...eICU solution has been proved effective at reducing mortality by more than 25%." Their marketing story is that patients in intensive care need high levels of monitoring, and they claim that about 10% of deaths that occur in ICUs could have been prevented through greater monitoring. They claim a doctor shortage, and their system is designed to allow those well trained physicians that do exist to remotely monitor more patients, more effectively.

Those claims seem wildly inflated to me. I'm not a health care specialist, so I could be wrong, but I think the situation is quite different. First, almost all doctors, during their medical school training, go through a stint in an emergency room, and almost all of their other general training is also applicable to "...care for critically ill patients...", so if there is any doctor specialty shortage in this field, I'm guessing it has only to do with interest and compensation, and not with skill set shortage. Second, it is my impression that there is no place in a hospital that is better monitored than the ICU. It's just not the case that patients languish unmonitored, at least not in any hospital I have ever been in in America. So the dire need for more monitoring seems overblown. Finally, 10% of ICU deaths preventable? If that were true, I hope the tort lawyers are going crazy on the negligent medical care givers. That just seems like an absurdly high number. 1-2% I would believe, 10%? No way. Maybe overall, but not in the ICU, and if in the ICU, how do you measure and prove it?

So, rather than their marketing position of dire unmet need bridged by their technology, I think the market position is something more along the lines of they have a better replacement technology, that offers cost savings as well. That is, marginal improvement, not disruptive technology.

Here's what the eICU system provides:

Video-conferencing/Video-assessment - web cams to watch patients. That seems useless and a big step down in service to me, if I were a patient. It may provide a hospital some liability coverage though. Medically useless, and can be duplicated for about $30 from Office Depot.
Image acquisition - scanning of x-rays and doctors notes for network transfer and availability. Medically useful, but can be duplicated for about $100 from Office Depot.
Remote Bedside Monitoring - medically vital, but as far as I know it's been around for about 15 years already, and every ICU already has something along these lines. Their implementation has some barriers to entry, but it depends on the "...tools supplied by bedside monitor vendors..." Not unique.
Dedicated hot phones - dedicated instant line between physician and ICU. Medically useful, but can be duplicated for about $50 from Office Depot. The real point is having the doctor available.

Are they serious? Those are all fine ideas, but so is putting on your shoes before you go outside. You wouldn't today build a business model around that. Their hardware technology is a joke. They do state that they have all received FDA clearance, and are HIPAA privacy compliant, so that is a bit of a barrier that they overcame. Still seems like a joke. With a web cam, remote wireless weather monitor, and a scanner, I think my office system compares to theirs. And mine is cheaper, and close to cutting edge, but not FDA approved.

On the other hand, they offer software that they claim allows for the detection of problems much earlier than conventional monitoring systems, pipes all the info to a central location, tells the people there what to do, and tracks the outcomes. Again, this seems to me to facilitate lower quality care on the cheap, rather than higher quality care. Ever called an advice nurse today with a medical problem and got a diagnostic chain of questions and opinions that you had just read on the internet? That is, a monkey could just as well be reading them back to you. That's what the eVantage software facilitates, and it is not the same thing as talking to the doctor, who has first hand experience, and will offer you a quality opinion, although their system facilitates the analogy to that too. And remote monitoring is the standard already.

Their only competitive barrier is the FDA approval. I am unimpressed with the hardware and software, and view market adoption as driven by cost cutting, not quality. That may be a fine market driver. Let's see.

Company: From their prospectus, they have had operating losses for every year of the five years shown, and while revenue has increased recently, so have operating expenses. They have no demonstrated profitable business model, but a possible path to profitability. For example, using their 2005 data Y/Y revenue increased by 232% ($18.3M/$5.5M) or $12.8M, but operating expenses increased 47% ($20.0M/$13.6M) or $6.4M. So if they scale up large enough they may finally be operationally profitable, but they should have proven they can do that before asking for our money. They seem weak.

Since they have operating loses, we can't even calculate operating P/E's, etc.They show GAAP net earnings only because of an income tax benefit. Dog. They are not complete trash - their products work fine - they are just no where near good enough for a business investment.

Stock: EICU priced at $16/share on 5Apr2006, above it's initial estimate of $13/share, and could be had easily for around $23/share on the open market. I'm surprised they received any sort of premium in the marketplace. Pass.

Ethanol Plays - MGP Ingredients (MGPI)

2006-04-17T14:35:00.000-07:00

Background: For background on the ethanol market see here and here.

Story: MGP Ingredients is a bit different than the other players we have highlighted (here, here, here and here, and who have largely been pure-play fuel ethanol producers), in that they have a long operating history, have ethanol production as just one branch of their business, and have fuel ethanol as just one branch of their ethanol business. They also produce food-grade ethanol for vodka and gin, etc. sellers. That's a higher grade of ethanol (i.e. fewer allowed impurities, although water is ok) than necessary for fuels, but not spectroscopic grade like specialty chemical manufacturers produce. The point - they have ethanol refining skills that exceed those necessary for fuel production, as well as fuel production experience.

Company: From their latest quarterly filing for calendar Q4 2005 ending 31Dec05, they had $76M in revenue, with $54M (71%) of that coming from ethanol production. Of their $1.682M in operating income (pg 10-11), $3.86M, or 229% was from ethanol production, and their other operations accounted for a $2.17M loss. Since ethanol is the only profitable portion of their business, we would expect them to enhance that segment going forward.

But still, even though it is better than their other segments, the ethanol segment only had a margin of 7% ($3.856M/$53.659M). That's not thrilling. There is also quite a bit of haphazardness to their performance, which likely has to do with market ethanol prices, but clearly has not been hedged or otherwise smoothed by them through forward contracts. For example, Y/Y their quarterly ethanol revenue went up by 27% ($53.6M/$42.3M), while their income from that segment went down by 10% ($3.856M/$4.301M). On the other hand, their 6-month Y/Y comparisons show the ethanol segment revenue increasing 22% ($108M/$88.4M) and income increasing 108% ($10.8M/$5.18M). So, while their ethanol business top line seems to be growing consistently at >20%, their bottom line is a bit more problematical, which they attribute to their increased costs for natural gas.

From their annual report from 30 Jun 2005, although this data is outdated, we can see that of the $183M in ethanol related revenue, 54% came from fuel grade ethanol, 31% came from food grade ethanol, and 15% came from distiller by-products (Distillers Grain). They verify that they do hedge their corn costs, have some longer-term ethanol contracts, and are active in trying to hedge and/or manage their energy costs, so we do not find their later explanation of inconsistent performance due to natural gas prices particularly convincing.

You would think that somewhere in their literature, preferably front and center, they would list their ethanol production capacity. I can't find it, and I'm tired of looking for it, but it can be had from a completely different souce as 45M gal/year.

In their quarterly reports they generally break out the distillery segment revenue and operating income, although in their annual report they do this only for the year, and not for that current quarter. I thought that was odd, but now that I have gone and back-calculated it, I understand why. Using the annual report, and subtracting out the values from the 3 preceding quarterly reports, we can get the calendar Q2 2005 ethanol revenue of $47.313M ($182.682M-$46.941M-$42.304M-$46.124M) and operating income of -$0.227M ($8.524M-$3.576M-$4.301M-$0.874M). Now I understand why they didn't highlight it, since they somehow managed to lose money even though they had consistent revenue. Weird.

For ethanol production in calendar year 2005 (abstracted and calculated from their last 5 quarterly reports and their last annual report) they had revenue of $202M ($53.6M+$54.6M+$47.313+$46.9M) and operating income of $14.2M ($3.856M+$6.949M-$0.227M+$3.576M), for an OP margin of 7% ($14.2M/$202M), $4.49 revenue/gal of ethanol capacity ($202M/45M), but only $0.32 of operating income/gal of ethanol capacity ($14.2M/45M).

Again, weird. They have significantly more revenue/capacity than VeraSun or Aventine, which are between $1.03 and $1.38, but their operating income/capacity is squarely in the middle of those company's ranges of $0.18 to $0.47. The only way I can see that that is possible is that they make much higher revenue for each gallon of ethanol since they have significant sales to the beverage industry, and those sale prices may not compare to the fuel sale prices. But if that is the case, then their fuel production costs are also much much higher. If they were the same, we would expect their 4x greater revenue to translate to 4x greater income - as it is, it looks like their production costs are something like 4x higher than the other players.

Again, we're surprised, but Blah, even borderline Dog given their superior competitors.

Stock: Like all the ethanol players, MGPI trades on the idea that a ramp-up in ethanol production is favored by the current market forces. But these guys are different. There are no market forces driving an increased demand for beverage ethanol (insert depression jokes here), only fuel ethanol. So, if these guys were to ramp up production for the fuel industry, their seemingly hugely higher production costs would prohibit their competitiveness. Their processes are good for the beverage industry, but poor for the fuel industry. And the rest of their business is a loser. The ethanol growth story just doesn't apply here. Pass, or wait for a peak and short.

Ethanol Plays - VeraSun Energy (VSE) IPO

2006-04-13T19:55:00.000-07:00

Background: For background on the ethanol market see here and here.

Story: As pointed out in a WSJ story today, VeraSun Energy is the second largest domestic corn-based ethanol producer (led by ADM, and followed by Aventine Renewable Energy), with 230M gal/year of current ethanol production capacity at 2 dry-grind plants (in Aurora, SD, and Fort Dodge, IA), and a third 110M gal/year plant under construction and expected to start up in Summer 2007. Just like everyone else, the also sell Distillers Grains (left over corn meal after the fermentation process) as an agricultural feed.

Company: The Aurora plant uses 43M bushels of corn to produce 120M gal ethanol and 390K tons of Distillers Grain, while the Fort Dodge facility uses 39M bushels of corn to produce 110M gal ethanol and 350K tons Distillers Grain. VeraSun gives the actual numbers (not capacities) for 2005 (prospectus, pg 7), which show for 2005 they sold 126M gal ethanol at an average price of $1.59/gal. That would account for $200M of their $235M revenue, the remainder coming presumably from sales of Distillers Grain. That means they offset their corn costs by $0.42/bushel capacity ($235M-$200M/43M+39M) through selling of Distillers Grains. It's cute to know exactly how much they produced, but all we really care about is revenue and income. Of note though is that they report ethanol sold (not produced) as 126,346,295 gallons for 2005. I just like the precision of their accounting - it's a perfectly countable term the way they defined it (if it was a production number, or transported number, etc., I would laugh, but gallons sold is an easy line item), and it's nice to see they have their processes well managed, and their language precise.

But about those numbers, we could just say that they generate $1.03 revenue/gal of ethanol capacity, and their $23.7M operating income gives them $0.18 of operating income/gal of ethanol capacity. By those measures, they are operating far less efficiently than Aventine ($1.38 and $0.47, respectively). That is the cleanest measure we can come up with that accounts for their ability to run their plant at or near capacity (the dollar figure goes up or down if run above or below capacity), the price of corn and every other production cost, and is comparable across companies. In the spirit of comparability, we also have their OP margin of 10% ($23.6M/$235M).

For their profitable 2004 they had a gross margin of 21% ($39.7M/$186M), which dropped to 15% ($35.5M/$235M) in break-even 2005. That's not the sort of trajectory we look for. Breakeven ($0.01/share earnings) on selling ethanol in 2005? We're surprised, but Blah.

They intend to use the IPO proceeds for the construction of 2 additional 110M gal/year ethanol plants, one in Iowa, and one in Minnesota.

Stock: Not listed yet, but given their unspectacular operating history, when all the stars were aligned for them, we're skeptical of how they would fare if the price of ethanol took a nose dive. Unless they are available for a truly compelling price, we're likely to pass.

Ethanol Plays - Aventine Renewable Energy (AVR) IPO

2006-04-13T11:22:00.000-07:00

Background: For background on the ethanol market see here and here.

Story: Aventine Renewable Energy, unlike the two ethanol players we highlighted earlier, already produces corn based ethanol, and like Pacific Ethanol, has as their principal business the marketing and distribution of ethanol. They own a 100M gal/year wet-mill ethanol production facility in Pekin, IL, and have a 78.4% interest in a 50M gal/year dry-mill ethanol production facility in Aurora, NE. The IL facility is undergoing a dry-mill expansion of 56.5M gal/year capacity, with completion expected for early 2007. With the dry mill process they get about 2.8 gal ethanol/bushel corn, and recapture 37% of their corn cost through selling the secondary products, versus 2.5 gal ethanol/bushel using the wet-mill process, and a 55% corn cost recapture. The secondary products differ for the two processes.

Company: From their prospectus, using FY 2005 numbers, they had $192M in revenue from ethanol production, which represents 20% of their overall revenue of $935M, the remainder coming from the marketing and distribution business. However, almost all of their $66M in operating income came from the ethanol production business, confirming the low-to-no margin nature of the ethanol distribution business we saw with Pacific Ethanol. They generated $60M in revenue from ethanol production co-products (distillers grain, etc).

It's nice to finally have some concrete numbers. The ethanol marketing and distribution business is financially a wash, and we'll ignore it, although functionally it is an enabler of their production profits since producing ethanol doesn't do any good if you can't sell it. For ethanol production, they generated $192M revenue with 139.2M (100M+0.784x50M) gal/year capacity. That gives them $1.38 revenue/gal of ethanol capacity. Similarly, their $66M in operating income from ethanol production implies an OP margin of 34% ($66M/$192M) and $0.47 of operating income/gal of ethanol capacity.

They have a corn-usage capacity of 54M bushels/year (100M/2.5 + 0.784x50M/2.8), expanding to 78M bushels/year (+56.5/2.8). That implies that they offset their corn costs by $1.11/bushel capacity ($60M/54M) through the selling of co-production products, which is substantial. That represents something like half the price of corn (in line with their numbers given in the Story section above), so we estimate that reduces their corn cost to something like 15-20% of ethanol revenue. But their actual OP margin is still 34%, meaning production costs eat up 2/3 of the ethanol sales price, so even with the co-product sales they are only performing at expectation, not better. It also implies that they generate $3.56 revenue/bushel corn ($192M/54M).

They seem to have a perfectly fine model. Their profit expansion depends on their ability to expand their ethanol production capacity, which with their new plant should expand something like 40% (56.5M/139.2M) in early 2007. And they are obviously subject to the vagaries of ethanol pricing and market demand. They seem Solid, but the commodities pricing ambiguity gives them a higher uncertainty than we usually allow in that category, so we'll hedge our rating by saying that they will probably trade like a Spectacular Story.

Stock: On 30 Dec 2005 they completed a private placement (to some former Morgan Stanley partners who formed Metalmark) of 21M shares at $13 for net proceeds of the company of $256M. They also have $160M in long-term debt. The IPO is a sale of those shares by the private investors, and not the company. No IPO proceeds will go to the company. That says that if you pay substantially more than $13/share, you're getting ripped off. It's not usually that easy to figure fair price, but they already did all the work for us. We'll have to wait to see how many shares they offer, and at what price, to know whether this deal is attractive long-term or not, but almost regardless, given the hoopla in the market recently, the IPO will probably pop. (BTW, they will trade under the symbol AVR).

Ethanol Plays - Green Plains Renewable Energy (GPRE)

2006-04-12T10:26:00.000-07:00

Background: For background on the ethanol market see here and here.

Story: Green Plains Renewable Energy is building a corn based ethanol refinery. That is exactly the same thing that Pacific Ethanol (with a correction here) is up to.

Company: Unlike Pacific Ethanol, GPRE has no other operations, nor any previous business (although they did just acquire Superior Ethanol, which as far as we can tell has similar intentions for a plant in Dickson County, Iowa). They are a pure play on their new plant. The plant is expected to produce 50M gal/year of ethanol, as well as both wet and dry Distillers Grains, near Shenandoah, Iowa. They do not indicate any plans to recapture CO2. The plant construction is in the the very early stages, with the main contractor expected to begin work approximately next week. They also have some additional land interests for future plant sites.

Their management team has some financing expertise, a lot of irrelevant expertise, and some farming knowledge. The only ethanol refinery expertise is as investors in previous ventures, although there is nothing to indicate that was anything other than passive. Other than the farming expertise, which is clearly relevant, we find the stated management team credentials unimpressive and largely unqualified. Where are the energy traders, the bankers, and the engineers? If they are all just hired help, what does the team actually bring to the table? So far this looks to us like a bunch of guys read the ethanol winds and set up their sails. They could easily run aground. We were skeptical of the Pacific Ethanol financial prospects, but at least their team seemed to have the expertise to have the possibility of pulling the venture off. Another way to put this issue is this: if any group of guys can get together, but land, and hire construction and process engineers, where is the competitive moat? Are ethanol plants really that easy to build and operate? It is just a big still, after all.

Maybe the financing will distinguish them. Nope. From their well-written recent quarterly report, they have about $30M in current assets. No revenues, and about $40K/month in operating expenses for the last year or so. Their current assets will not be sufficient to cover the expected $83M plant construction costs, but they have a $47M line of credit, contingent on the plant being in production by 1 May 2007 (i.e. construction beginning by then). They expect plant completion in approximately 2 years.

Stock: There are about 4.2M GPRE shares outstanding. There is no way to justify their stock price, as they are too early stage. Once constructed, their 50M gal ethanol/year plant will require 18M bushels of corn/year, and produce ca. 160K tons of dry distillers grains (also ca. 148K tons of financially irrelevant CO2). Some years from now, when the plant is in operation, we have no idea what the corn or ethanol prices will be. Nor do we have any idea if they will be able to operate the plant profitably under any circumstances, as they have no proven ability to do so (they also have no proven inability).

GPRE is pure speculation. There is room for that in a portfolio, but just be clear that that is what it is. Their stock price has just about doubled from it's low in March, so there are plenty of speculators on board already. We think there will be much better buying opportunities in the years ahead, but as a last-sucker-out play they seem to have some nice current momentum.

Pacific Ethanol (PEIX) Corrections and Additions

2006-04-08T16:34:00.000-07:00

These corrections relate to my earlier post.

Either I misinterpreted the information given by the construction contractor, or what they show is a typo, but the plant capacity should be 35M gallons/year of ethanol, not per day. That makes much more sense, and shows that their estimates of 12.5M bushels of corn will run the plant near capacity using the CBOT's conversion numbers.
The plant progress photos shown by the construction contractor are out of data, and more recent photos can be seen in a slide show on the lower left of the Pacific Ethanol website. Those photos show that the plant is further along, and that there might be a chance at it opening by late 2006.
In that same slide show is the only place that I have found two other key bits of information: from the annual ca. 12.5M bushels of corn, they expect to produce 35M gallons of ethanol, 290K tons of WDG, and 100K tons of CO2.

The stock still looks to me to have been considerably more compelling at $10/share, than at $28.

[Thanks to Himanshu Pandya at Financial Nirvana for the corrections]

Ethanol Plays - Pacific Ethanol (PEIX)

2006-04-07T15:40:00.000-07:00

Background: For background on the ethanol sector, please read this and this.

Himanshu Pandya over at FinancialNirvana.com has done a nice job on following Pacific Ethanol, and I would recommend reading his posts. [here, here, and here]. In particular he has pointed out that some of the speculation is likely due to a Bill Gates factor, which, along with some financing, may be in jeopardy.

Story: Pacific Ethanol is building a refinery in California for corn based ethanol production in the heart of the California agricultural and dairy land (the biggest agricultural and dairy producer in the country). The refinery is supposed to come on line in Q4 2006, and there are plans for 4 more subsequent refineries. As there is unlikely to be any increased ethanol demand in California (see background above), the supply capacity they are bringing online must be able to disrupt the current out-of-state supply and/or undercut the current prices. They are one of the biggest distributors of that alternate supply in the state, and that is their main business right now.

Byproducts of corn based ethanol production include Wet Distillers Grain (WDG), a dairy feed, and CO2, which they plan on capturing and selling to the beverage industry. The CO2 recapture is nice PR, but probably financially irrelevant. The WDG will likely help recoup some of the raw cost of their corn, although I don't have a good handle on estimating that, and they don't provide any financially relevant information. I can attest to the fact that their plant will be centrally located in one of the biggest agricultural centers in the country, particularly for dairy. For ADM, corn represents about 30% of the cost of ethanol, which right now has a spot price around $2.50/gal. So, we would like to see them recoup about $0.75 in WDG per gallon of ethanol produced. To figure that, we need the selling price of WDG, and mass of WDG/gallon of ethanol produced. We don't know either of those, so the advantage gained by their byproduct processing is unknown, and may be irrelevant.

From their prospectus:

PEI California [the refinery subsidiary] has, to date, not conducted any significant business operations other than the acquisition of real property located in Madera County on which we are constructing our first ethanol production facility.

That leaves open the possibility that all they have done is purchase the land, and construction hasn't even started, but that fear seems to be unfounded. It's a 35M gal/year plant.day (=ca. 13B gal/year) plant, so it alone could satisfy something like 80% of the California market. However, apparently they do not yet have all the necessary operational and construction permits (including water discharge) for the Madera plant (prospectus, pg. 14), which is supposed to start operations by the end of the year. Based on that alone, as well as what one would assume are recent pictures of the plant, I doubt the plant will begin operations this year, although more recent pictures (left hand side of their main web page) give them some hope.

Company: They have a complex corporate history - they used to be Accessity Corp, which as far as I can tell had absolutely nothing - medial billing recovery?, auto repair management? - to do with their current business, and was small and a money loser. Accessity was reincorporated as Pacific Ethanol. The have 3 remaining sub-entities, one that does ethanol marketing, one building the Madera plant, and one holding warrants and options on other land for future plants. The pro-forma results for their combined entities shows a slight increase in revenue Y/Y, from $83M for FY 2004, to annualized $100M ($75M for 9 months) in 2005, with a gross margin of ca. 3%, but losses after operating costs.

Some meat: they estimate 12.5M bushels/year of corn needed to operate their plant (prospectus, pg 15). Let's assume that allows for their maximum capacity of 35M gal/year of ethanol 12.7B gal/year of ethanol, which would give ca. 2.8 1000 gal of ethanol/bushel of corn. The CBOT says the ratio should be more like 2.6, only a factor of 380 difference. So that 12.5M bushels won't take them anywhere near capacity. With the CBOT's numbers, they have production capacity of 32.5M gal of ethanol/year (12.5Mx2.6). At a $2.50 spot price, that gives them $81M annual revenue, and at a corn bushel spot price of $2.40 that gives them a potential annual gross profit of $51M ($81M-$2.40x12.5M).

On the other hand, Barron's, in my background above, estimated corn is 30% of ethanol cost for ADM. which is consistent with the 2.6 factor between corn bushels and ethanol gallons with the price for a bushel of corn and a gallon of ethanol approximately equal. But the CBOT estimates corn cost is more like 70% of ethanol production cost, which would be in line with current corn prices and $1.30/gal for ethanol - it's historic average ($1.3x2.6/$2.4 = 0.7). So, if the increased ethanol production helps to moderate ethanol prices by increasing supply, their potential annual gross revenue could reduce to $12M. I would guess that they would have at least $12M in operating expenses for the plant.

You would think that as part of a prospectus, or at least on their web site, they would somewhere make the case for the financial viability of their ethanol plant. Their current ethanol trading business, even at record ethanol prices, is a loser, so the company's prospects depend on that plant. I've tried to get some handle on the possible economics of the plant. It doesn't look to me like they will lose money on it, but estimating the upside gives a wide range, and they provide no real guidance.

Stock: In order to complete their first ethanol plant, they just raised $34M, and will require an additional $60M, neither of which are assured. In March 2005, a significant private placement of stock was used to raise $21M for the company. For that private placement, the stock was valued between $3 and $5/share. Current PEIX quotes are 5 to 8 times higher. The latest private placement in Nov 2005 was for $8/share.

Let's take the best case possible: they make $51M gross revenue, and have no operating costs so that it all drops to thebottome line. After their ca. $5M (that's a 9-month loss, but were' trying to be generous here) loss from current operations that leaves them $46M. With 28M shares outstanding, that gives them projected EPS of $1.64. At a current share price of 28, that gives them a projected P/E of 17. That's perfectly reasonable. What if they have trouble completing the plant? What if ethanol goes back to $1.50/gal? What if they have $20M in plant operating expenses, and we annualize their current losses? That gives them projected earnings of $22M, for a projected EPS of $0.79, and a projected P/E of 36, for a company that may only be profitable in 2008.

At $10, where their price was in January, this gamble might have been worth it, but at current prices they seem uncompelling. More gambling than investing. Pass at current prices. I doubt their plant is coming on line in 2006, so there will likely be better buying opportunities in the future.

[Disclaimer: I'm a bit delirious with fever right now, so hopefully I haven't said anything too egregiously stupid.]
[Update 8Apr2006: PLEASE SEE THE CORRECTIONS POSTED HERE]
[Update 11Apr2006: Further corrections added.]

Sick Kids = Slow Blogging

2006-04-05T10:26:00.000-07:00

BTW, PMC Sierra bought Passave, so forget about that one.

California Ethanol Market

2006-04-04T13:13:00.000-07:00

Ethanol as a motor fuel background here.

California is the biggest automobile market in the country, and has phased out MTBE in favor of ethanol as a fuel oxygenate. What are the possibilities for the ethanol market in California? To get an idea, let's look at data from one of the last years of the use of MTBE in California. We'll use Q4 2002 data, since that is the most recent data before the phase-out began in earnest. From that data, we can see that MTBE represented about 10% of each gallon of gas, and the average price of MTBE ran something like 20% less than the actual gasoline cost (not pump cost, which has all sorts of taxes on it), and was very roughly ca. $1/gal. That same data shows California used ca. 0.9M barrels of gasoline/day, or 38M gallons/day (42gal/bbl), or 13.8B gal/year. That means that the California MTBE fuel market was something like a $1.4B annual business (13.8Bx0.10x$1.00).

Now, current California gasoline use 5.7% ethanol, current spot prices are about $2.50/gallon, and current gasoline use has increased to about 16B gal/year. That makes the California ethanol motor fuel market under current conditions something like a $2.3B annual market (16Bx0.057x$2.50), fully served by current out-of-state providers. Using just the 2004 consumption numbers, but the current ethanol spot prices, shows that the transition to ethanol could have caused about a $600M price disruption, or about $0.04/gallon ($600M/13.8B).

So, the key point here is that ethanol runs about double the price of MTBE, but current gasoline formulations use about half as much ethanol as MTBE, so there has been very little net price disruption to the end consumer. If a greater percentage of ethanol were used in each gallon of gasoline, or for any reason the price of ethanol were to continue to rise, there would be noticeable price disruption in the gasoline market.

On the other hand, the long term price of ethanol, particularly prior to the MTBE phase out, is more like $1.30/gallon, comparable to the price of MTBE and to the price of gasoline (remember, were not talking pump prices here, which have all sorts of taxes, etc. on them, and run about double the raw product cost). So, this is clearly a market in flux between supply and demand. A demand disruption due to MTBE phase-out has about doubled the ethanol price. Greater supply coming online may lower that price, but without new demand the overall size of the pie will stay the same.

Now, about that increased demand...It's based on the Federal Energy Policy Act of 2005, which in summary mandates 7.5B gallons annually by 2012. California's portion of that is basically what California uses now, so California has no legislatively increased ethanol demand. Nationally, mid-2005 production capacity was 3.9B gallons, so it seems that production capacity needs to about double by 2012. However, there is a special carve out for "cellulosic sources" (wood like products, not corn, but corn stalks ok), that gives them a 2.5:1 extra credit. That is, 1 gallon of cellulosic ethanol counts as 2.5 gallons against the mandate. So, for example, the 3.6B gal increased production needs could be met by 1B gallons of cellulosic production, and 1.1B increased corn based production.

Given all that, what we want, is an ethanol play that can make money even given the current pie size ($2.3B in California alone) plus natural growth (more people, more miles driven, etc.), but that would be poised to take advantage of any large increase in demand (in particular, a transition to E85 - an 85% ethanol motor fuel). And, of course we want them at the right price.

Ethanol Wildcatting

2006-04-03T11:41:00.000-07:00

US motor vehicle fuels usually have an additive to increase the efficiency of burning (i.e. an oxidant for anti-knocking). Formerly tetraethyl lead, the most recent one was MTBE, which has been phased out due to detection of leakage from underground storage tanks (MTBE lends a strong unpleasant flavor to drinking water). The replacement is ethanol (drinking alcohol). As a oxidant replacement, it will comprise a few percent of gasoline. That alone is a driver for the ethanol production industry. But in addition there is renewed talk about using ethanol as almost a gasoline replacement - up to 85% ethanol. Brazil has what seems to be a successful program on this front. Finally, the President, in the most recent State of the Union, indicated the possibility of enhanced ethanol usage as a motor fuel.

Some key points about ethanol as a fuel:

ethanol is both miscible (infinitely soluble) with water, and hydroscopic. The latter term means that if you have pure ethanol just sitting around, it will suck water out of the air or any other source and dissolve it, and the mixed water/ethanol combination has different physical properties (better martinis, not as good a fuel). Since water is everywhere, handling ethanol as a fuel is complicated.
ADM is the largest producer of ethanol in the US, and any competitor needs to have some viable competitive advantage against them.
Ethanol production is subsidized in the US, which makes predictions about market viability murky.
Growing motor fuels sounds great at first blush, but like with anything economic, the question is an allocation of competing scarce resources. Land is used for food crops, and is fertilized with petroleum-derived products. If corn production is significantly diverted to fuel production, what effect will that have on the market prices of corn - what sort of price change would it take to kill off the market viability of corn fuel production, and how subject is the price of corn to that amount of price change? Since fertilizer is a petroleum based product, that diminishes the incremental advantages of corn based fuel production against "oil independence," and affects the final price of the product (could go wither way).
There's politics in this - favoring farming lobbies over oil lobbies. Both those lobbies are big and powerful.
Kopin Tan in the 3Apr2006 Barron's had a write-up on ADM and ethanol (no link since I'm protesting their new online subscription policy - 2 subscription fees to them is enough). Some key points: ADM has 29% of the market, next largest player has 5%; Ethanol was at $1.35/gal, but may be going rapidly to $2.53/gal; the ethanol fuel subsidy is $0.51/gal; ethanol is now 3% of US fuel market; corn accounts for one third of ethanol production costs.
There is lots of speculation about advances in getting ethanol from cellulose, either by growing the cellulose more cheaply (switch grass? hemp in the US is probably the best bet, but that won't happen), or by inventing a new process (e.g. biological enzymes). Ideas are not businesses.

So, the big picture here is that understanding ethanol as an investment is complex. It's not nearly as simple as the main storylines, nor is it a sure thing, nor is it necessarily going to be successful. For example, if gas with ethanol shoots to $4.00/gal, this market will die overnight as legislation gets reversed. But given all the Middle East turmoil, the State of the Union, and the MTBE phase out, anything ethanol related is sure to be a Spectacular Story, almost regardless of the specifics.

With that background, we're going to look at a few of the new players in the next few posts.

[BTW, there's wildcatting going on in oil, too]

China Grentech (GRRF) IPO

2006-03-31T12:52:00.000-08:00

Story: China GrenTech makes wireless antennas, repeaters, and other parts for the sending and detection of wireless transmissions in the Chinese telecom market. Antennas are old technology (think Marconi), but since nobody quite yet understands the nature of electromagnetic frequency (EMF) radiation, we still end up with incremental improvements, and lot's of fun science. There is also constant work on the exploitation of EMFs through clever algorithms (think Qualcomm and CDMA, etc.), and more basic infrastructure work on just getting useful transmission and detection networks built. The research, detection, and exploitation of EMFs is a wide ranging and hugely important field (microwaves, lasers, cell phones, space travel, interaction of light and matter, quantum tunneling, and it just goes on and on...).

Given that big picture background, what is the likely play here? Are they likely to have some unique scientific advance that cements their moat? No. The play here is that the Chinese government has been sitting on a decision on what next generation wireless telecom technology to certify, and the rollout of that service by the big Chinese wireless companies is pending. All the big global wireless telecom players have been salivating over that for the last couple of years already. So the play here is on that pending buildout, and the tight relationship that China Grentech has to the Chinese Telecom players, as well as the fact that they likely have a pretty good cost structure (because they are Chinese). This is a regulatory play, not a technology play. Given their likely huge regulatory advantage, let's take a look at their prospectus:

Company: They filed their completed prospectus with the SEC today. China Unicom and China Mobile together accounted for 95.1%, 88.8%, and 78.9% of revenue for 2003, 2004, and 2005, respectively. In 2004 they added China Telecom and China Netcom as customers, accounting for 4.9% and 14.8% of revenue for 2004 and 2005. That gives a total revenue share due to the 4 big Chinese telecom companies for the last 3 years of 95.1%, 93.7%, and 93.7%. Like I said, they are a regulatory play.

They site expected ca. 10% growth in the Chinese telecom market (prospectus, page 4) for the next few years, so given their revenue sources they should have a maximum of 10% top line growth, all else being equal. In actuality, they have had Y/Y revenue growth of 57% (RMB 566.5M/RMB 360.8M) and 26%(RMB 716.3M/RMB 566.5M), and absolute growth of ca. 150-200M RMB Y/Y (ca. $22M). So, their growth is already slowing percentage-wise, and absolutely, and unless they gain some new market share or get higher margin products or otherwise somehow change their product and operating mix they are heading for 10% Y/Y growth.

Net income growth Y/Y has been -2% and 24% (RMB 146M/RMB 148M and RMB 181M/RMB 146M). Given that we are usually more distrustful of Chinese numbers, we think they did some window dressing on the most recent numbers to mask an otherwise uncompelling model. Given the regulatory shenanigans in China, and that we find neither a compelling model nor a smoking gun in their prospectus, we are not going to rate them one way or the other. But...

Stock: Chinese! Wireless! They have timed their listing to hopefully exploit that hype, and because of that they may trade for a bit like a Spectacular Story. In fact, GRRF listed at $18, above it's initial upper range of $16, and opened around $20. They are sort-of a monopoly play, so we don't want to call them a Dog, but given the capricious nature of Chinese regulatory uncertainty we really have no confidence in predicting how they will do. For that reason, we'll avoid them.

Himax (HIMX) Snack

2006-03-31T10:25:00.000-08:00

Himax Technologies priced today at $9/share. At our previous calculation of $0.38/share of 2005 operating earnings, that gives them a trailing operating P/E of 24 ($9.00/$0.38), which is only slightly above the tech market P/E, and seems low for a company with ca. 80% top line revenue growth, 100% operating revenue growth, and 50% OOP margins.

[Disclosure: As of a few minutes ago, long HIMX]

New Options on Cortex

2006-03-29T08:49:00.000-08:00

Cortex Pharmaceuticals (COR) has had an amazing run since I first wrote about them, until today, when they are tanking. The question is whether the run is over or not. The news is that their products have seen some promising results, and in the absence of any other news that I can find indicating a change to that, it seems that the advent of new options is driving abnormal pricing behavior.

So the price drop on huge volume is probably technical, and fundamentals will take over again after a few days. We're holding.

[Disclosure: As of writing, long COR]

Is GM Run by Monkeys?

2006-03-28T07:24:00.000-08:00

Hey we've got a new plan, better than the old one. We still can't sell our cars, but when we lowered the prices to at least get rid of them, we didn't make as much money as we needed from them. Here's our new plan: lets raise prices! Wheeeee! Then we'll make more money, and all will be good.

Rick Wagoner will be fired, and GM is still heading for bankruptcy. What hubris.

Note to GM: it's a market - you must meet market demand, not internal need. The latter adjusts to the former, not the other way around.

Jajah Phone Disruption

2006-03-27T12:30:00.000-08:00

I just became aware of Jajah.com from the San Jose Mercury News.

My first thought: Holy Crap this is disruptive - new life to the local landline market, a real problem for stand alone VoIP and computer based Skype-like services.

My second thought: But these guys, who I have been using for years, offer a very similar service and they haven't changed the world.

My third thought: I guess publicity is important, but the bigger question is: why, with the plethora of dial-around services available, should the subscription VoIP market ever stand a chance? It certainly does, but it seems odd. I'll have to noodle on that.

Himax Technologies (HIMX) IPO

2006-03-24T09:01:00.000-08:00

Story: Himax is a Taiwanese fabless designer of integrated circuits for the LCD industry. That's an enormous growth industry, with some parts of it pulling in handsome profits (large screen TV's), some parts rapidly becoming commoditized (17" monitors selling at cost), and some parts transitioning to yet newer technologies (cell phones going from LCDs to OLEDs). We like this industry. But On the other hand there are some very large fabless IC companies, and their stocks have all been struggling lately and for the past couple of years (for example), despite very high utilization rates. The reason is that the margins in the ICfab portion of the industry are very low. But the performance of fabless companies can be much more variable. Is there room for a new player who specializes in the display area?

Company: From their prospectus, they give full year numbers for 2003, 2004 and 2005, and they have had:

rapid Y/Y top line revenue growth of 128% and 80% ($300M/$131M and $540M/$300M), or absolute Y/Y revenue growth of $168M and $240M. That looks good, except that their cost of revenue is also high.
Subtracting that out, gives them annual operating revenue of $31.7M, $64.3M and $120.8M, and an operating revenue growth rate of 90-100% Y/Y.
That gives them a gross margin of 24%, 21%, and 22% ($31.7M/$131.8M, $64.3M/$300.3M, and $120.8M/$540.2M). That reflects some slight variation in their costs, but the variation is not significant, and the values imply that about 20% of their top line revenue is available to the company.
After other business expenses, they had operating income of $3.4M, $32.9M, and $68M.
That gives them an OP margin (operating income/revenue) of 2.6%, 11%, and 12.6% ($3.4M/$131M, $32.9M/$300M, and $68M/$540M). While those numbers are low, they are actually a bit higher than we expected since this is known to be a low margin business. It's also good that the OP margins are expanding, showing that they are getting slightly more efficient each year.
The more important OOP margin (operating income/operating revenue) of 11%, 51%, and 56% ($3.4M/$31.7M, $32.9/$64.3M, and $68M/$121M) shows that about half of the cash they get to keep drops to the bottom line, and they use the other half to run the business.
Fully diluted annual operating EPS were $0.03, $0.19, and $0.38.

So, they are doubling their operating revenue each year, and half of it drops to the bottom line, for an operating growth rate of about 50%. That's pretty darn good. In addition, these are not small numbers, and they have shown some nice Y/Y consistency. Solid.

Just shows that it always pays to check - I expected these guys to be weak, but they are not.

Stock: HIMX ADRs are not public yet, but at a 50% operating growth rate, and we'll say a 10% share dilution rate, for a roughly 40-50% operating EPS growth rate, they could probably get something like a 2x market multiple. We'll hold off to see what they price at, and then decide if they are worth picking up.

[Disclaimer: At writing, long AUO, LPL, GLW, EK, CAJ]
[Update 27Mar2006: Introductory story somewhat modified after an astute reader pointed out that TSM is the biggest fab on the planet.]

KB Home (KBH) Confirms Good Housing Sector

2006-03-22T18:12:00.000-08:00

KB Home reported Q1 2006 results today, and they were stellar. Q/Q stockholder equity increased 2%. Y/Y operating revenue increased 34% ($2.187B/$1.628B), operating income increased 40% ($274M/$195M), and net income increased 42% ($174M/$123M). Quarterly Y/Y EPS increased 43% ($2.02/$1.41), showing a small effect from their share buyback program. That gives them a pretty much flat OP margin of 12% ($196M/$1628M vs. $274M/$2187M).

Q1 is often the worst in the housing sector. Annualizing their results forward gives annual operating earnings of $8.08 ($2.02x4 - they are projecting $11.25), which at a current share price of about $65, gives them a conservative forward P/E of 8. Doing the same for Toll Brothers gives them a forward P/E of 8 also ($0.98x4, and a current price around $33).

Here's a summary for the Y/Y Q1 quarterly growth for the two:

Y/Y Quarterly Comparison	TOL	KBH
Stockholder Equity Increase	6%	2%
Revenue Increase	29%	34%
Operating Income Increase	36%	40%
Net Income Increase	49%	42%
Current OP Margin	19%	12%
Forward P/E	8	8

Boy, I wish all sectors that were falling apart were falling apart that well. Top line growth of about 30%, and bottom line growth of ca. 45%, with a P/E of 8 is a screaming buy, and that's just what we're likely to be doing. Unfounded rumors of a housing implosion have created some nice entry points.

[Some other relevant comments on a flat yield curve (and here and here), and housing trends (and here and here).]

Toll Brothers (TOL) vs. KB Home (KBH)

2006-03-22T10:13:00.000-08:00

Both Toll Brothers and KB Home are big house manufacturers. We talked about some of the housing market background earlier. Over the last five years, the stocks of these two companies have almost perfectly tracked each other, until late 2005 when KBH recovered somewhat and TOL continued to deteriorate. Since then the gap between them has once again narrowed, but has not completely filled. We'll bet that gap will close, so the question is whether the sector will go up, or drop. From a technical perspective, looking only at TOL indicates the most likely thing is a further price drop (head and shoulders formation). But looking only at KBH indicates something different - a long term trend that has met resistance and is now in a range bound pennant - it could just as well go up as down. Even if it stays range bound, that's a $20 possible price move.

So, from current housing stock patterns it is not at all clear that the sector is dead. Then the WSJ reports today on the pattern of UK housing stocks, ahead of us in the interest rate cycle, where fundamentals slowed but stocks recovered due to better management. KB Home reports quarterly results today after the market closes. Toll Brothers filed quarterly results on 10 Mar 2006 for the period ending 31 January 2006. Q/Q stockholder equity increased 6% despite some significant asset shifts and some minor liabilities changes. Y/Y revenue increased 29% ($1,278M/$989M), operating income increased 36% ($237M/$175M), and net income increased 49% ($163M/$110M). Quarterly Y/Y EPS increased 48% ($0.98/$0.66), showing a tiny bit of share dilution. That gives them a Y/Y slight OP margin increase from 18% to 19% (from $175M/$989M to $238M/$1278M).

The short story is that their model is better this year than last year - no sign of slowing - and their stock is half what it was. As far as we can tell, the stock decline is based on sentiment over the housing sector - fuzzy stories - rather than the cold hard numbers. We'll look for confirmation or contradiction of that from KB Home after today's close.

Nextest (NEXT) IPO

2006-03-21T11:17:00.000-08:00

Story: Along with oil wildcatters, there has been a recent space of semiconductor testing equipment IPO registrations. I guess that says the market expects tech to do well going forward. There are lots of big competitors in this field, and most of the new entrants usually have some sort of one-trick-pony advantage over the other players. If it's a good enough trick, everyone ends up amused, but more often it something that rapidly gets copied and/or commoditized, and the new players stay niche and small. Given the stiff competition, we look for stellar performance in these types of plays, as an indication of an actual, rather than chimerical, moat. Nextest Systems Corp. is just one example. We'll try to hammer through some others in the coming days.

BTW, these guys make IC testing equipment, and have sold about 1000 machines since formation in 1997.

Company: From their prospectus (page F-4), they had a profitable 2004, and lost money in 2005. Revenue increased Y/Y from $44M to $48M, but gross profit decreased a bit, indicating that their gross margin decreased. That's about as operational as it gets. At least these guys have some gross profit (unlike SunPower, which we dogged for that reason, although the market doesn't seem to care). So, they at least have some money left over after accounting for the expenses of manufacturing their tools, but then R&D and SG&A sucks up the rest of it. The difference between gain and loss between 2004 and 2005 is almost exclusively SG&A. Revenue increased a bit, but cost of revenue increased just as much. That makes them about as boring as it gets. Blah.

Stock: They'll probably price tonight after the market close, and open tomorrow. Given their financials, and their current loss, we really don't care what price they get.

Google Finance Launches

2006-03-21T07:49:00.000-08:00

Google just launched a major competitive front to Yahoo!, with the introduction of Google Finance. There are many many financial websites on the web, of differing quality and depth, and differing product positioning. Both Yahoo! Finance and Google Finance are straight database front ends - no useful commentary, etc. The Yahoo! product has been around for many years, the Google product is brand new. So, how do they stack up? The Yahoo! database is generally pretty good, but the front end is miserable. It takes many clicks to get what you want and none of it is pretty, but there is a lot there. I almost always have to go to other sources though. The Google front end is very pretty, with some innovative and well thought out features. The "Company Financials" on the main page give exactly what one needs for the most recent period. The charts on that same page are great. Comparing that to the Yahoo! main page makes the Yahoo! entry seem clumsy.

Some specific little differences: for the AUO listings used above, Google reports the numbers in Taiwan Dollars, Yahoo! has them converted to US dollars. On the one hand, the TWD could be misleading if you didn't notice it, on the other hand, there is no currency conversion (which varies over the years) polluting the numbers. Secondly, I checked a number of smaller companies, and the Google entries are either non-existent or limited, so the database is still being built. There is some inconsistency in the Yahoo! data, as it varies by date instead of all being for the same time period. That is not true, so far, for the same Google data.

Speed is key. I want to be able to make a few clicks, and get everything I need, and trust it. It looks to me like the Google product is superior to the Yahoo! offering. Yahoo! also serves as a data service for historical data downloads - I don't know if Google plans to offer that as well. I also don't know what sort of revenue stream Yahoo! gets from it's financial data services, although the pages are cluttered with ads. Any revenue from page viewing is going to come under pressure.

On the other hand, they both still suck on some fronts. For example, they are both wrong on who they list as competitors for AUO (for the record, a short list would include: LG Phillips LCD, Chi Mei Optoelectronics, Sharp, and Samsung. Yahoo! gets Sharp, Google gets LPL, both miss the other two). Still, the Google offering is a first rate product, and with the greater ease of use will likely climb quickly to wide adoption.

Ben, Feel Free to Quote Me Next Time

2006-03-20T18:11:00.000-08:00

Except for some unnecessary goblygook about different interest rate tranches, Bernanke just said pretty much exactly what I said, but it took him more words.

Tootin' my horn.

Tim Hortons (THI) IPO

2006-03-20T14:02:00.000-08:00

Story: Tim Hortons is a Canadian and US coffee shop being spun out from Wendy's. Food industry IPO's over the last year (CMG, CBOU, KONA, MRT, RUTH), as can be seen in the table, have not done too well.

The headline you will see everywhere else is probably the opposite, since it will be based on the recent impression left by Chipotle, and based on comparing the list price to the recent price. Even then, most were flops, and using our standard IPO methodology, all but 1 were flops. We were unimpressed with Caribou Coffee, but we think each of these plays is better examined individually. For example, CMG serves an Americanized Mexican food palette, which has relatively less competition than the coffeehouse sector. A McDonald's spin out is also obviously a differentiating factor, although Wendy's Stock has done better recently.

Tim Horton's is part of a trifecta of burger flip IPO's - first was CMG spun out of McDonald's, now comes this one, and announced and expected is Burger King. Why all the sudden burger action? We don't know, and we don't really care. It would be nice to get another Starbucks, but the odds are very very slim. So we don't really care, but we'll take a quick look.

Company: Their prospectus shows operating income about flat over the last 3 years ($280M, $320M, $290M), with some fluctuation. They run about 6% sales growth (flutters up and down depending on year and country and exact type of store). We're bored. Blah.

Stock: Wendy's (WEN), The parent of Tim Hortons, has made a little run in anticipation of the spin out, but had been doing ok even without it. WEN might be the play rather than THI, but we will probably pass.

Thanks, Eliot, For the Shakedown

2006-03-17T12:44:00.000-08:00

We've been hoping that Eliot Spitzer would provide us some more buying opportunities by baselessly shaking down some new company. We've made good money off of the AIG opportunity, but I missed the free money offered by Renaissance Re. We would have never considered H&R Block (HRB), except that Eliot's $30-60M shakedown attempts have failed so far, so now he's filed a big fat $250M suit. It's highly likely that he has nothing other than power (e.g. a factual basis for a winning case), since he hasn't won anything in court. HRB doesn't look so hot anyhow, and the Spitzer shakedown seems to have only provided a temporary $2 opportunity, but there will probably be some more coming. If he does manage to cause a nice gap, we may take it after looking into them more thoroughly. Thanks Eliot!

[Disclosure: Currently Long AIG and RNRPRC]

[Update 24Mar2006: The WSJ rips Spitzer apart.]

The New Program Trading Target

2006-03-17T07:54:00.000-08:00

First the market took out 11,000 on the DJIA (INDU). Then 1290 on the S&P 500 (SPX) became the target. Both of those have now been passed, at least for the time being. Yesterday's sell-off action was triggered by the NASDAQ 100 (NDX) hitting the 1700 mark, and almost all the negative action was in the NASDAQ, with the NYSE positive. That sort of bifurcation is another sign of program trading. So, it looks like the new target is the NDX at 1700.

A Little Bit of Paranoia

2006-03-16T14:30:00.000-08:00

1) There are rumours (via Instapundit) that terrorist chatter is at pre-9/11 levels.

2) There was a recent threat of a coming big nasty attack.

3) As of December 2005, the head of Israeli Military Intelligence had a March 2006 timeline for some progress on Iran's nukes.

4) The Saudi bourse and other Middle Eastern stock markets are off about 30% over the last couple of weeks.

Now, the Middle Eastern markets may be off for all sorts of legitimate reasons, including US tensions with Iran, the signal sent from the failure of the ports deal, coming oil-market corrections, or just normal gyrations (they are up hugely over the last couple of years). But what if the Middle Eastern markets know something? The idea that markets are the best mechanism of predicting impending attacks, while not politically correct, is not unique.

Update:
1) March 20 is the 3 year anniversary of the invasion of Iraq.
2) Kudlow's list of Middle East market selloffs here.

NightHawk Radiology (NHWK) Snack

2006-03-16T12:36:00.000-08:00

NightHawk - a teleradiology company with a recent IPO we discussed - just posted 2005 Q4 and FY numbers on 9 Mar 2006. For Q4, they had $18.5M revenue, $13.3M operating expenses, for $5.2M operating income, which at 24.4M diluted shares gives quarterly operating earnings of $0.21/share. Assuming there is no seasonality in the radiological services industry and that there is no further stock dilution, annualizing that number gives forward projected FY operating EPS of $0.84 ($0.21x4), which at a current price for NHWK of ca. $25/shares gives a forward operating P/E of 28. That's a premium to the market, but isn't crazy. They are showing some improved profitability from operations, but we'll maintain our Blah rating until there is a bit more clarity on the consistency of their forward operations and/or there is a more compelling entry point.

Note that on a GAAP basis they showed a $9.1M Q4 loss, due almost solely to a "Change in fair value of redeemable preferred stock conversion feature."

Is XsunX (XSNX) Being Manipulated?

2006-03-15T18:03:00.000-08:00

I've received a number of comments about XsunX, all from the same person. I decided to look into them. They are working on transparent solar cells, have a weird history, and a weird structure. The only technological information I can find on them is all paid advertising (from IPODesktop and others) masquerading as research. Each of their press releases is misleading. They offer one key statement, and then go on about intentions. For example, the latest one has the phrase "...has begun the construction of a mass production system...". That seems to imply, and is likely intended to give the impression, that commercialization and mass production is around the corner. But all that it really says is that they broke ground on a new building or something. They made some statements in 2004 about technological developments (4% conversion efficiency), but nothing technological since then. By the way, what they claim to mean by "4% efficiency" is "4...Watts of direct current...per square foot of PowerGlass film" [here, page 5], which is not the definition of efficiency, which is always a measure of power out versus power in.

I've looked through their entire web site, and their entire FY 2005 report. A few things become clear. They are no where near having a product, have never generated any revenue, and don't know when they will. They provide no detail on their technology other than links to patents, which they have licensed. Otherwise it's almost all marketing. They are a single person company, with a single office, rented for $750/month. Any actual research or other development work could only be performed at MVSystems.com, with whom they have a tight relationship (patent licensing, President of one is Chairman of the other). They claim 15 "technologists and support staff" [here, page 14] available to them, but show no salary or other costs associated with them. They do have $0.5M in R&D expenditures for Fiscal Year 2005, but don't detail what that bought.

They cut a $5-10M deal with an early stage investment fund, such that that fund basically owns them, and needs the shares to stay above $0.38.

As of 30 Sept 2005 they were thinking "that their workforce is likely to increase to 8". That means 7 new hires, with 3 of those in admin, and 4 in marketing and sales. Since they don't have anything to sell, that means 4 in marketing.

A Google blogsearch on them returns 274 hits, with nearly every one based on one of their press releases, or at a disreputable site sponsored by a PR agency, or a stock quote reference, or otherwise either suspect or without depth. A general Google search on them returns 85,700 hits, most of similar quality.

About the only legitimizer they have going for them is that they won an award in 2005 from The World Technology Network (WTN), which is sort of half-way between the Nobel committee and a PR firm. For instance, they put out newsletters comprised of information written by their members - that's PR. Corporations can influence their possible membership by sponsorship. I learned a while ago from a business advisor (although I never paid him for the advice), that if you want someone to come to your function, offer them an award. With that in mind, everyone involved in the WTN may be there either through sponsorship or awards bribery. On the other hand, they have a list of first rate names of members, which if they really are all active participants lend the organization quite a bit of legitimacy. So, is the WTN a PR firm, or a true science validator, and how did XsunX get their endorsement? As near as I can figure, they were an exhibitor at the 2005 conference, which automatically makes them a member and eligible for votes for 2005, which they then won. And it's possible that they bought their way in.

So, if they are as small and illegitimate as their SEC filing indicates, they have no business getting a big award, unless that awards agency didn't do their homework, or isn't really all that respectable, or just flubbed it. Or they are a really great investment, and I'm just missing it. Even then, they are only story, since they have no products or revenue. And stories are not businesses.

So, I think they've got nothing, they hoodwinked the WTN, they hired all those promised PR people and they are doing a damn fine job, because XSNX has moved absurdly, from about a dime, to $2.25, just like or better than the private investors need them too. The money is at Cornell Capital, the technology is at MVSystems, and XsunX is just a guy. He's probably a really nice guy.

From what I read in their SEC filing, they are a perfectly fine development stage company. They are small and just struggling like any small company to get along, and I don't mean to kick them. I don't think they are a fraud. They are a perfectly fine penny stock, provided they have no exposure. But they are not a legitimate investment in the leagues of STP or even SunPower. It looks to me like the stock is being manipulated. Playing in manipulated penny shares with no products is just not our game. Avoid.

[Note: I realize that by even talking about these guys I've fed into the PR machine (even bad PR is better than nothing), but I made the mistake of mentioning them once earlier, only in the context of stating that I won't talk about them, and now I feel the need to correct that. This is the best I can do.]

[Disclosure: Currently Long STP]

OpenTV (OPTV) IP TV Middleware

2006-03-15T11:38:00.000-08:00

Story: The television market is undergoing some upheaval, coupled to the changes in the telecom market, and both caused by the advent of the internet. The big change that has occurred, and is continuing, is the unification of all transmissions into one basic protocol method (IP - internet protocol). Differing hardware will all implement or enable that same protocol. Built on top of that are various different functions, enabled via software. That is very different from the past, where each specific communication or transmission method was implemented via unique hardware and methods. The transition is far from complete (really just beginning), but that is where it is going. There are still many different technologies used (think Cable DOCSIS, cell phones, WiMax, Satellite TV, Telecom, etc.).

The reasons for this transition are that 1) we can, 2) system maintenance is easier and cheaper, 3) system utilization and exploitation is more thorough, 4) introduction of new products is faster and cheaper. The transition is hindered by 1) legacy systems, 2) anachronistic regulatory systems, 3) clinging to competitive moats that are drying up, 4) technological difficulties, 5) transition costs.

Given that overall background, the specific issue here is the transition of TV to IP, appropriately called IPTV. This is what Verizon is trying to roll out with it's FIOS network. It is the reason that Cisco bought Scientific Atlanta. OpenTV is a software company positioned right in the middle of this transition. They make the middleware software that enables the end-user products (like TV watching via set-top boxes) to function with various hardware over an IP (or otherwise) based network. That is just a great market position to be in, provided that you have the right direction, and superior products. It's a very competitive field right now (Microsoft is providing the service for Verizon's FIOS, but there have been problems).

In terms of market success, we'll get to that in the next section, but I want to make one point on where OpenTV's story is off. They, like some of the other players, are pushing or enabling interactive advertising. That is different than targeted advertising, where different users are shown different ads or other content based on collected demographics. We think that has a bright (and inevitable) future. Interactive advertising is more like showing an ad and providing links for the viewer to click on to get more information and possibly make a purchase. That idea fundamentally misunderstands the marketplace. If there is one thing these guys need to learn, before burning more money in this 10 year cash sinkhole, it's that:

TV is passive, computing is active.

If I want to pursue something, I'll sit at my desk. If I want mindless, passive entertainment, I'll sit in the living room. Interactive TV is an advertiser's dream, but it's a pipe dream; there is no demonstrated demand, and previous attempts have been big fat flops. Give it up. OpenTV pays lip service to this being a boost for them down the road - hopefully they are not wasting too much money on it. Let's see.

Company: They just posted Q4 and FY 2005 results yesterday. They are happy to be showing their first EBITDA profitable quarter, and "positive operating cash flow for the full year." Yeah, but top line quarterly revenue declined 4% Y/Y ($23.2M/$24.1M), although for the full year it grew 12% Y/Y ($86.4M/$77.2M). This is a dynamic and changing industry, with major developments in 2005 over 2004, and yet their top line only grew 12%. That's pretty close to flat, especially for a supposedly global company with product wins in India and the UK. All their improvements in performance numbers have come from the ITDA part - Interest, Taxes, Depreciation and Amortization. Nothing operational. For operations they show a FY operating loss of $8.677M for 2005, versus $24.827M for 2004. That looks like an improvement, but really they just went from being a piece of junk to being bad. It would make sense if the losses were all attributable to R&D or some other justifiable start-up expenses, but it's not. There's just no way to see from their numbers that they have a profitable business model. Maybe if they hugely ramped up revenue and kept expenses fixed, but they sure haven't demonstrated an ability to do that.

Based on the story, their position, and the PR, we expected these guys to look good. Based on the numbers, they're a Dog.

Stock: OPTV flips around between $2 and $3, and took a bit of a pop on yesterday's press release and today's presentation, but there is just nothing there. Talk is cheap. Top line growth isn't. We'll pass. We're surprised they have not had more success, but we always let the marketplace guide our calls, since we figure their potential and actual customers will always know more relevant details about them than we can. Unfortunately, those customers are just not increasing their buying.

Synchronoss Technologies (SNCR) IPO

2006-03-14T09:05:00.000-08:00

Story: Synchronoss Technologies does billing and provisioning for all the major US wireless carriers (although 75% of their revenue comes from Cingular), some of the cable companies, and a number of VoIP players. They have a great customer list. Their provisioning product targets customers acquired via web services, which is a good product position to be in. So, they provide bedrock services to the fastest growing segment of the telecom sector - a sector undergoing rapid evolution - and they have successfully captured most of the big players as customers. From that success story alone, my main question is why on earth would they want or need to come public? They have some expansion plans for deeper customer penetration, expanding VoIP penetration, and new customers in cable and WiMax .They seem to be a picks-and-shovels play on web-based customer acquisition in the telecom sector. Just a great story. Exactly the kind of story that we look for. Let's hope they actually deliver a business based on that story:

Company: Their prospectus gives FY data for 2003, 2004, and 2005. Revenue growth of 64% and 99% Y/Y ($27.2M/$16.55M & $54.2M/$27.2M), and in absolute terms, $10.6M & $27M Y/Y. So their top line is ramping up nicely. Gross revenue (Net Revenue - Cost of Services) of $8.895M, $9.503M and $24.013M, for Y/Y growth of 7% and 152%, and absolute growth Y/Y of $0.6M and $14.5M. So for 2003 and 2004 they were still sort of getting their model in place, as they had no gross margin growth, but it clicked in 2005, when their top line growth expanded much faster than their expenses, and their gross margin took off. That so far is a nicely functioning model. Now let's check operations. For operating expenses we'll include R&D and SG&A. Backing those out gives operating earnings of $1.682M, $1.839M, and $10.780M, for an OP margin (operating earnings/revenue) of 10%, 7%, and 20% ($1.682M/$16.55M, $1.839M/$27.191M, and $10.780M/54.218M), and the more important OOP margin (operating earnings/gross revenue) of 19%, 19%, and 45% ($1.682M/$8.895M, $1.839M/$9.503M, and $10.780M/$24.013M). So, of the money they get to keep, about 45% of it is left over after paying for operations. That's great. They are still small, but they have ramped their business up to a profitable (even GAAP-wise) size, and they show no signs of doing anything other than managing their growth very well. Solid.

Stock: They are not public yet, and they didn't give pricing details in the first version of their prospectus, so it's possible that this deal will end up unattractive, but we think it more likely to be the opposite, and we very well may be buying.

SED Snack

2006-03-08T12:18:00.000-08:00

CNet reports that Canon and Toshiba are delaying their SED TV commercialization.

[Previous SED comments here, here and here]

[Disclosure: currently long CAJ]

A Financing Question I Don't Get

2006-03-08T11:17:00.000-08:00

As a company, you have the choice between debt and equity to finance your growth or operations. Debt is great if you can borrow it, because you don't have to be public to get it, and you don't have to deal with shareholders and all the concomitant laws. On the other hand, you have to pay interest on the debt, so you have to have some stability in your operations, and if you miss those payments you might lose your company to the lenders. On the other hand, going public and issuing shares is sort of free money, if you can convince people to give it to you. The price you pay is compliance with all the securities regulations, and giving up some ownership.

But once you have that compliance in place, from a company perspective, stock seems much preferable to debt. Now there are always special cases, usually demanded by the market. For example, there may be no more market interest in a company's stock, but they are able to sell debt instruments to investors looking for income. There are also reasons to take stock off the market. The usual big two are 1) to either compensate for management giving away the company to employees or their buddies as options or stock compensation (essentially printing money, which they then must take an equal amount out of circulation to prevent inflation - for stocks, that's the price dropping); or 2) as a preamble to, or the act of, taking the company private.

Here's my question: what legitimate corporate purpose could possibly be served by a troubled company taking on debt to by back stock? That move deteriorates the financial integrity of the company, for almost no gain. It sort of smells of double-dealing for some ulterior motive other than the benefit of the company. Buying back stock is great. Taking on debt to do it isn't.

The WSJ reports that AutoNation (AN) will issue $1.2B in new debt to buy back 50M shares at $23/share. In other words, the company is shafting itself to benefit shareholders. All the debt rating agencies have them below investment grade already or will now lower their rating. It makes no sense until you read the last few lines of the WSJ article:

The company's largest individual shareholder, ESL Investments Inc., supports the buyback-and-debt plan.

Mr. Lampert's fund owns 77 million shares, a 29% stake, in AutoNation. Two members of ESL's management team are on AutoNation's board, including Mr. Lampert.

That debt is going to have pay one sweet interest rate to attract any buyers.

Here's another way to put it: A company can very plausibly structure its business to have little operational reason to care about it's stock price. The stock can drop to almost nothing, and the company can still sell widgets. The stock price is a reflection of operations, not the other way around (except where it is used as a proxy for cash). On the other hand, debt is a constant operational burden, as servicing the debt requires cash flow. A company can not choose, during hard times, to ignore debt holders, but they can choose to ignore stockholders. So for a troubled company, debt is an operational burden, and stock is not. Yet AutoNation is choosing to take on an operational burden for no intrinsic operational benefit. Smells fishy to me.

Ford Hybrid SUV Sadness

2006-03-07T10:41:00.000-08:00

Ford has no hope until it's CEO grows a brain. That's harsh, but here's the story. As a consumer/potential customer, I don't give a rat's ass about your company and your problems, I only care that you offer a competitive product - on both features and price. The WSJ has a write up on Ford's Escape Hybrid SUV strategy. The hybrid version is $27K, the regular version is $17K, and "...the company has no plans to cut sticker prices...on hybrids." Say we want a payback in 7 years, so we need to save $1400/year ($10K/7) on gas, which at $3.00/gal is 476 gallons. If we're driving 15K miles per year, we need to do it with 476 fewer gallons, so we need a change of 31.5 mpg. That's the delta, not the actual mileage. So, if the normal vehicle gets, 20 mpg, the hybrid vehicle must get 51 mpg to pay back a $10K premium over 7 years at $3.00 gas. If gas is cheaper, or the desired payback shorter, the difference must be even larger. (BTW, the actual difference is something like 10 mpg, which is great, and makes it all the more tragic that they have killed it with bad pricing.)

In a word, that's crazy. Apparently Ford's customers know it, since they are not buying very well. But Ford's not going to lower the premium. Instead they are starting an advertising campaign, thus raising their fixed costs. On 17K Ford hybrids sold last year, at a $10K premium each, that's $170M. They had about $5B in automotive advertising expenses in 2005 (Annual Report, page FS-9). So, if they took 3.4% of their advertising budget, they could completely eliminate the hybrid SUV price premium. They would then own the marketplace.

Which do you think is a better use of their money - to try to convince me they are green but then rip me off, or offer me a cheap and superior product? Like I always say (with credits to Michael Phillips at Gods of Commerce), advertising is almost always a croc. Ford is doing an increased big push right now on their green potential, but they've been saying the same thing for the last 5 years, and it's been all sound-and-fury, signifying nothing, that entire time. Only now are they finally rolling out hybrids, and they are pricing them out of the market.

Ford's potential customers have the brains to figure this out. Unfortunately, their management doesn't.

Interest Rates

2006-03-07T08:44:00.000-08:00

Interest rates are in the market. We're having a bit of trouble with the 11,000 range on the Dow (Jones Industrial Average) and the 1290 range on the S&P 500 index. Both those levels trigger programmed trading. Outside of that automatic sell or buy signal, the biggest immediate worry in the market over the last week or so is interest rates - will they go up significantly? The Bank of Japan has indicated they will raise domestic interest rates, and perhaps start buying fewer foreign (US) securities, meaning that to attract their capitol the US long bond rate will have to go up. The employment rate is at full employment in the US - 4.7% - and much lower in some locals - and since labor is generally the biggest cost of business, and the labor market is getting competitive, salaries may have to go up to attract new employees. One way to keep wages down under full employment is to increase productivity, but today's report that productivity slowed in the 4th quarter (-0.5% growth) indicates that that solution may not be adequate.

These are sending short term worries through the market that long term interest rates may be going up. That would have far reaching consequences, some good, some bad. Remember, just a short time ago, the big market fear was the inverted yield curve, that is, long term interest rates were too low. Any move by Japan is likely to be measured, and unless you are involved in Forex and the Yen carry trade, its unlikely to have any real impact on you. Finally, economic numbers have a lot of slop in them. The 3rd quarter productivity number was 4.2% - too high. The 4th quarter number was -0.5% - too low. Average those, and the number is just right. Again, it's not a real worry.

We see this is as the normal piddling around. It's what makes a market. These are all relatively small shifts that have been well telegraphed, and promise at most modest moves. It's an excuse to worry, more than an actual worry. There are some real things to worry about, but interest rates are not it at this point.

Wahhhh! I want a monopoly again!

2006-03-02T08:24:00.000-08:00

Just when you begin to think that old players in a new market might get it, they do something to show you that they hate their customers, think of them as entitlements, and their strategic managers are either from the monopoly era or spreadsheet thinkers.

There is a concerted push on right now for bandwidth providers to try and pull more revenue from their services, regardless of the long term consequences of that change. In Europe, internet access lagged the US by years and years, because internet usage was charged as a measured rate, rather than a flat rate. That is, the more you download, the more you pay. It killed the business. The same was true in the US for cell phone service, where adoption rates were much higher in Europe and Japan for the same reason (bucket plans, i.e. flat rate pricing). But measured service is what some telecom players are trying to adopt here, both with broadband access (BellSouth is the fool here), and e-mail (Yahoo! and AOL are the fools here). From Bellsouth, it is just what you would expect from a company that used to charge absurd fees for long distance service. They are still thinking the same way, but they are no longer monopolists. Companies with such retrograde managements should probably be avoided. We've talked before about how Bellsouth missed the FTTH oportunity provided by Katrina. First they missed the train, now they're trying to shoot themselves in the foot. Safest if the strategic managers were just sacked.

But what is up with Yahoo! and AOL and two-tiered email service? They too are starting to look like spreadsheet management rather than strategic management. It's akin to what happens in Congress with static versus dynamic scoring. Take a snapshot of revenue sources on a spreadsheet, decide to increase one of them, make a projection on final revenue, based on the implemented change. The difference between the two approaches is between how you make that projection. In spreadsheet management (and static scoring) you assume that the change you just implemented will have absolutely no unintended consequence or any other sort of effect to your business outside of the line item you targeted. In strategic management (and dynamic scoring) you assume that the change you implemented will have some effect on the remaining aspects of your business, and you trickle that effect throughout. That is a much harder exercise to do, as it requires some intimate knowledge of your business and customers. Hired talent often doesn't have the necessary vision. For small changes, static spreadsheet management can be fine. But for big changes, it can be radically wrong, and dynamic strategic management is needed. Uhhh, pricing of one of your core services? I would call that a big change.

Both AOL and Yahoo! are making strategic moves (e.g. forcing a shift from dial-up customers to DSL, buying Web 2.0 companies, respectively), so it's not that they completely lack vision. What they miss is the intimate relationship between the desirability of their products and pricing. No matter how good your product, you can kill it by mispricing it. And once you make one of your core services undesirable, customers look elsewhere for your package of services. Look at the cell-phone business before bucket plans in the US, or the current problems with data plan doption rates, or the VoIP adoption rates. The market clearly likes flat-rate fees. It's why the US has a robust internet sector.

Tiered pricing is retrograde, foolish, anti-empirical, and a bad idea.

[Disclosure: currently long BLS]

Some Online Advertising Players

2006-02-28T10:34:00.000-08:00

There are many more players than these three, some quite large (Yahoo!, Microsoft), and other's not, but these are on our radar, and merit an update. We've discussed them previously, so we will just do an update here:

Google (GOOG)- stock price target upgraded to between $450-$2000 by investment bank analysts, followed promptly by disappointing numbers and a ca. $80 price drop, followed by speculators filling the gap, followed by today's announcement by the CFO that their easy growth is done. The romance phase is over. We don't see anything that they have done other than AdSense as being financially meaningful, so we think they may be beginning a major downturn.
ValueClick (VCLK) - presented Q4 and FY 2005 numbers yesterday, and a compelling IR pdf today. Q4: revenue up 43% Q/Q ($116.6M/$81.4M), operating earnings up 30% Q/Q ($23.1M/$17.8M), for an OP margin of 20% ($23.1M/$116.6M). Gross profit of $77.3M, giving an OOP margin of 30%($23.1/$77.3M). Net income up 23% Q/Q ($13.5M/$11.0M), but flat on an EPS basis due to dilution. For 2005 they have a trailing P/E of 40 ($17.50/$0.44), and an annual top line growth rate of about 80%, which seems to have accelerated in the fourth quarter. Their growth model is still linear, with high margins, and high top line growth.The stock has been flat for a bit now, which we have taken as a buying opportunity.
aQuantive (AQNT) - Q4 & FY 2005 numbers two weeks ago. Q4: revenue up 11% Q/Q ($87.5M/$78.7M), operating earnings up 33% Q/Q ($20.9M/$15.7M) for an OP margin of 24% ($20.9M/$87.5M). Gross profit of $38.6M, giving an OOP margin of 54% ($20.9M/$38.6M). For 2005 they had an operating EPS of $0.80 ($60.981M/76.516M shares), which at a current share price of $27.00 gives a trailing operating P/E of 34, which is nearly unchanged from our previous calculation. With FY top line growth of about 95% ($308M/$158M), steady gross margins of about 42%, and OP margins increasing from 17% to 20% ($26.5M/$158M and $60.98M/$308M), and OOP margins increasing from 39% to 47%($26.5M/$68.45M and $60.98M/$129.6M), they had a great 2005. We're still ambivalent, since their model still does not strike us as particularly unique, although they are executing well.

[Disclosure: as of this writing, long VCLK]

Today's Fun

2006-02-28T08:07:00.000-08:00

Google tanked the market, when their CFO basically said their growth is over. The selling pulled the Dow Industrials below 11K, triggering more programmed selling. The S&P 500 had already been struggling with the 1290 barrier for a few days. This will either right itself immediately (later today) or it will take a week or so. We would like some buying opportunities, and this may provide them.

Luna Innovations (LUNA) IPO

2006-02-24T13:06:00.000-08:00

Story: Luna Innovations filed for an IPO on 10 Feb 2006 and the descriptive tagline I saw was "molecular technology and sensing solutions." That caught my attention, given my background, in particular for how nebulous a description it is. They deserve some snarky comment here about how every business plan uses molecules, etc. I think what they mean is they've hired a bunch of chemists. Put another snarky comment here.

Ok, based on the unfocussed nature of their research and specialties, I'm guessing that they are a materials science combinatorix company, similar to Symyx, that is doing random chemistry and hoping to find a useful property to exploit. Did I guess correctly? No, so they need to rethink their blurb. They are doing some nanotech, which may be combinatorix based but more likely is not. They also build tools for characterizing optical properties, and build sensors that use optics to measure other physical properties. So they have a focus on optics, and a subdivision in nanotechnology.

Nanotech gets a lot of hype, and optics is very competitive (Newport, NewFocus, and many, many others). On the one hand, there is a huge difference between science and a business. On the other hand, there is nothing like good science to establish competitive moats for a business. As always, without a vast market direction at their heels, the question here is performance.

Company: Luna filed their initial prospectus on 10 Feb 2006. I can't help myself - here comes a snark:

We research, develop and commercialize innovative technologies in two primary areas: molecular technology solutions and sensing solutions. We have a disciplined and integrated business model that is designed to accelerate the process of bringing new and innovative products to market. We identify disruptive technology that can fulfill identified market needs and then take this technology from the applied research stage through commercialization in our two areas of focus

What in the hell does that say? We invent stuff? Maybe it will become as famous as the Razorfish statements to 60-Minutes. I think what the statement really says is that their Ph.D.'s can't write, and their marketing people have no clue what they really do. I just find it funny. It goes on like that:

Focus on developing and commercializing a growing portfolio of innovative products.
Transition our mix of revenues to a higher percentage of product sales and license revenues
Continue to strengthen our Contract Research Group.
Expand our intellectual property portfolio in our areas of focus.

Uhh, we wish we had some products and could sell them? To belabor it just a bit more, except for the "molecular technology...solutions" part of those two sets of statements, every word of it is true for almost every business ever created.</snark>

Maybe the numbers won't be so funny. We'll use the 9 month numbers ending 30 Sep 2005. Uhh, they had $6.2M in product revenue in the 2004 period and none in 2005? Contract research revenue increased 10% Y/Y ($11.1M/10.1M), but overall revenue decreased 32% Y/Y ($11.1M/$16.4M), since they have no products. Gross profits on contract research increased 4% Y/Y ($2.572M/$2.477M), slower than the revenue increase from that segment, so on the only business they have remaining, they aren't even controlling expenses. They were profitable in the 2004 period ($2.5M), but have a loss for the 2005 period (-$0.27M)

What are they thinking trying to come public? Dog. And a funny one at that.

Stock: I bet this offer gets pulled before ever making it to market. I would like nothing better than to invest in a Ph.D. heavy, optics research outfit, but wow have these guys not made the case.

[Disclosure: As of this writing, Long SMMX and NEWP. BTW, I've built low-femtosecond lasers in a past life.]

Scopus Video Networks (SCOP) Recent IPO

2006-02-24T11:32:00.000-08:00

Story: The communications field is in upheaval (that's good). Part of that upheaval includes broadband distribution services, and part of that includes video distribution. I put it that way, because the cable companies, which one used to think of as video distribution companies, are becoming fat pipe companies with video distribution as just one of their services. The same is true for wired and wireless phone companies. There are a couple of major developments on this front:

IP based networks - the Telco circuit-switched networks are dying and being replaced with all IP based networks, principally because network management is so much easier. The Telcos are also pushing into video distribution. So far, there have been reports of difficulties with the IP based video distribution systems under testing, but we expect those difficulties to be rapidly mollified.
Video on Demand - one virtue of an IP based system is the two-way information direction, so viewers do not have to passively watch whatever is on. All broadband video distributors are pushing forward with video-on-demand efforts, as are DVD rental firms, and a number of other types of companies.

Scopus is at the nexus of those two trends. They make hardware and accompanying software to manage and enable the distribution of video by Telco, cable, and satellite companies. That is just a great market cusp to ride right now, provided that they actually have customers, etc. They are an Israeli company, with worldwide initiatives, so they also provide some non-US diversification.

Company: They released Q4 and FY 2005 results on 16 Feb 2006. Revenue for Q4 up 7% Y/Y ($11.9M/$11.1M) and FY up 28% Y/Y ($44.8M/$35.1M). They claim they turned profitable in the latter half of 2005, so we would like to see Q/Q numbers, so we will have to turn to their prospectus as well.

Revenue flat Q/Q ($11.9M/$11.6M), gross profit flat Q/Q ($6.4M/$6.3M), operating income up Q/Q, but tiny ($0.211M/$0.137M). They are struggling to stay at break even, with no top line or bottom line growth. Blah. Based on the Story we had higher hopes for these guys.

Stock: SCOP came public on 9 Dec 2005 at $7 (below their original range of $10-$12), and opened at the same price. They have ticked around +/- $1 since then, and we see no reason for them to do anything other than that (except perhaps go down), until they show some rapid top and bottom line growth. Pass.

Some Recent IPO Listings

2006-02-24T09:58:00.000-08:00

There have been a few IPO's over the past few days, but we have found nothing too compelling. Here's a rundown on some of them, and why we're ignoring them, based on their stories:

Liquidity Services - (LQDT, initial range $9-$11, listed $10, opened $10.10) - specialized online auctioneer for "wholesale, surplus and salvage assets" with DoD contracts, and some tiny profits. Auctions are very efficient pricing mechanisms provided that they are big enough to bring in enough buyers. Getting big enough for that requires lot's of sellers, or very specialized products. With efficiency comes more buyers and sellers, in a nice feedback loop that leads to accelerating profits. Small auctions with unspecialized products do not price well. This is one of the few areas where being a first mover is actually an advantage rather than a disadvantage. LDQT's specialized niche gives them the possibility of efficiency, but their existence since 2000 and their tiny profits ($1.5M Q4 2005 on $32M revenue, $0.618M Q4 2004 on $19.8M revenue) squashes that hope. The story play is that the DoD may have an increasing amount of junk to auction off.
Pacific Airport Group - (PAC, initial range $18-$20, listed $21, opened $28) - they operate 12 Mexican airports. The supposed story here is that they will profit from increasing Mexican air traffic, and past Mexican ADR's have done well. This is a big deal, raising $872M, and I think that is the real story. It's big enough for big money to pile in, which is what is happening, but we don't expect much growth in air traffic overall outside of Asia.
Burger King - a big ($400M) deal based on venture capital turn around story. How much more growth is possible in the burger-flip industry? This would be exciting in 1950. Let the VC's get their money back from profits.
Morgans Hotel Group - (MHGC, initial range $19-$21, priced $20, opened $19.65) - we have no particular insights or expertise pertaining to the hospitality industry.
NEG Inc - a big ($460M) deal - more energy wildcatting. Will merge with National Energy Group. A Carl Icahn play.
Merrill Corp - a medium ($253M) sized deal. Business services - document and data management, litigation support, imaging, printing. Service+, low margin, boring.

We may revisit some of these as some point, if our initial impressions change.

Mind (MNDO) Wireless Back Office Snack

2006-02-23T12:02:00.000-08:00

Story: MIND CTI is a small Israeli company providing back office billing infrastructure to wireless phone companies. They have some first tier (China Unicom) and a lot of second tier customers (Vietnam Data Communication Company, etc.). There is nothing special about them except that they are an infrastructure play on the wireless sector.

Company: They just reported Q4 2005 numbers with 17% Y/Y operating earning growth on flat Y/Y revenue growth. Blah.

Stock: Recently at about $3, on $0.19 net income gives a P/E of about 16. Boring.

Earthlink (ELNK) in All the Right Places?

2006-02-23T10:24:00.000-08:00

Story: Earthlink was an early national ISP, providing service mostly through dialup, but also DSL. I used them for many years, and had quite problematical service from them. They had a bit of a strange place in the market - they provide a service overlaid on the backbone owned by others (in this case the baby bells). Their infrastructure providers also turned out to be their competitors, and because of this attributing the quality of service problems was difficult (both sides blamed the other). Earthlink did not have complete control over their service, and the baby bells purposefully deteriorated their service in an attempt to get users to switch to their own competing service (they would tell me things like '...your line isn't provisioned for DSL because of blah blah blah, so Earthlink can't provide you the service, but we could...' when if their provisioning claim was true then they couldn't, and Earthlink was in fact providing service, showing that the provisioning claim was false. In a word, they were a bunch of liars.) As a result of those manipulations, neither of those companies have had me as a customer for many years now.

I bring this anecdote up because, on the one hand, Earthlink is firing on all cylinders with some interesting product offerings. On the other hand, for most of those offerings they are resellers, and/or agreement based, rather than owned by Earthlink. That leaves the possibility that their quality of service could once again be out of their own control. Perhaps they learned something from the past, and perhaps their new partners are true partners rather than back-stabbers, but there is certainly a risk there.

Now, on to their actual service offerings, which are each somewhat unique:

MuniFi - many municipalities nationwide have taken it upon themselves to build out an urban WiFi network, with the contracts bid out to providers. San Franisco, for example, will offer a two tier service with free, slow, advertiser supported service provided by Google, and a somewhat faster, paid service provided by Earthlink.
SK Telecom Wireless - They are forming an MVNO (a mobile virtual network operator) with SK Telecom. We've discussed that aspect already.
Covad VoIP - They are rolling out a line-powered VoIP service provided by Covad, that differs somewhat from other services in that no equipment is necessary on the user' premises, and the service stays active even if power goes out to the customer. It's a good add-on for their DSL service, but I don't find their pricing compelling, and it is unclear to me whether their service is a true replacement for Bell provided POTS phone service (Earthlink does not own the phone lines going to the home). DSL service still has severe range limits, with the higher speeds only available to a small fraction of the serviceable households, unlike cable or FTTH.

So, they are positioning themselves somewhat uniquely in the marketplace. Each of those services has special features that distinguish them, but they each also operate in a competitive milieu. Pricing is important, and on that front the services are not yet overly attractive. Whether the marketplace calls them a winner or not remains to be seen.

Company: They just released Q1 2006 numbers. Operating earnings are about flat Y/Y for 2005 at $214M, out of $1.3B operating revenue, for an OP margin of 16.6%. For 2006 they expect to be somewhere between flat and a $45M loss. They give a lot of information in their recent presentation, but most of it is Story. What it comes down to is that their traditional dial-up business is about to be dead, and they are transitioning to a completely new company. So far, they are managing that transition well (they have operating profits). Whether the new offerings rake in the profits or turn out to be big advertising and operations sink holes is just plain unknown at this time. So, we think of them as a turnaround with a possibly Spectacular Story.

Stock: ELNK has been around a long time. The play here is really based on Story, since the numbers are not firm enough to tell us anything. 2006 is, in management's words and in our opinion, a transitional year for them. I find their story interesting, but that is a long distance form actually profitably operating all the new programs. Fiber-to-the-home and VoIP will come on strong in 2006 and forward, WiMax will come on in 2007 or later, WiFi and Cell Phones are merging, etc. It's a sector in upheaval, which is good if you are on the right side. ELNK may be worth a bet, but that is what it would be.

Google has Copyright Problems

2006-02-23T09:25:00.000-08:00

Google just lost a preliminary ruling over indexing of stolen copyrighted material. They were clearly on the wrong side of the law on this one - the images were the property of the Perfect 10, and just because Google grabbed them from a third party does not excuse their trafficking in stolen property. Fixing this issue will be a pretty good technical challenge, but worse, they seem to have a philosophical problem with respect for others copyrighted intellectual property, as their initial library project showed.

I suspect we are going to see bigger cases, with greater damages, on this front. The argument that information dissemination helps all parties is only valid if all parties agree. What this means is that the search index business has yet another issue driving new algorithm development (there's more, but that's enough).

Toll Brothers (TOL)

2006-02-22T11:13:00.000-08:00

Story: Toll Brothers makes McMansions, and they make lots of them, and they make them on land that they buy pretty cheap, usually through options rather than direct purchase. That means their land purchases are low risk (they have the right, but not the obligation, to purchases and/or develop the land). The big picture here is the overall housing market in the US. Many think it is about to tank. Many of those same pundits have thought that the housing market was on the verge of tanking for each of the last 8 years. The housing boom has been stimulated by demographics, interest rates, and wealth conversion (stock market profits going into real estate):

Demographics - the American Dream is to own a home in the suburbs, once you are old enough to have kids. Has that changed with the current generation? No. Are there more Americans today? Yes. Look around. Are any serious population centers that you know of dying? I'm betting on the continued need for new homes.
Interest Rates - they were very low, and have now come back up, but mortgage rates over that span only shifted about 2% since the long bond has held steady. Mortgage risk is not like it used to be, due to mortgage backed securities and various risk derivatives based on them. That means lenders are not as scared of you, don't demand to be paid richly for their alleviated fears, and hence keep their rates down. Greenspan was trying to kill off the housing market, but he's gone. Could high interest rates kill the sector? You bet. Will they? They are just about topping right now, and there has been no serious signs of a mortgage default wave. Borrowers are still servicing their debt, so the market seems to be saying that the current levels are sustainable. Historically, too, the current mortgage rates are perfectly reasonable. This is not the 1970's with 17% inflation.
Wealth Conversion - If the stock market tanks, real estate is a refuge. If the market soars, people pull money out and buy houses. The truth of house prices is that the median never goes down (at least from the 1960's - as far back as I've looked). A curve of the median house price in any area (that I've checked) over time looks like a staircase. It shoots up for a few years, then plateaus for a few years, and then repeats. It does not drop. During the up phase, both low and high priced houses go up. During the plateau phase, low priced houses still go up toward the median, and high priced houses go down. So, the only place to fear the housing sector is at the top end in a stagnant market.

By top end, we mean prices greater than about twice the median price. The true mansions. From what we can tell from looking at the listed prices of homes offered by Toll Brother's in areas where we know something about prices, they offer homes for a good premium above the median, but not into the danger zone of crazy prices. And the homes they do offer are lavish for those dollars. So, the story as I see it, is that the trends are in Toll Brother's favor, and their products are top notch in the market but not extreme. They definitely have vulnerability, but the story is nevertheless, good.

As an aside, we would note that much of the housing market scare mongering has been propagated by the NYTimes, which we use as a contra-indicator.

As another aside, most of the headline housing economic numbers get reported as seasonally adjusted, and those adjustments tend to be noisy. It's better to just look at the actual numbers, averaged over a few months or the last year.

Company: The big news is that the inventory of new homes is up, and Toll Brothers' signed contracts are down. That is off of record numbers, and may suffer from the seasonal adjustment issue. A thorough analysis would require looking at which geographic areas they derive their profits from in conjunction with the market supply overhang in those markets, discounting demographic and other economic trends in those areas that may soak up that extra supply. That analysis is more than we want to do, and it is likely to be fraught with errors. We'll just note that they are operating at near record levels. They report quarterly numbers tomorrow, but we think of them more as a multi-year play.

We think they are Solid, but we have not really made the case here.

Stock: This is the real reason to be interested in TOL. They are down about 50% (to ~$30) from their 2005 peak (~$60), up about 50% from their 2004 levels (~$20), and up about 200% from their 2001-2002 levels (~$10). Their long term trend is up. They definitely went through a speculative excess in late 2004 and 2005 as hedge funds piled on, and have now been dumping. Also, from a chartist's technical standpoint they show a head-and-shoulders top, indicating a possible further drop. We view most charting techniques as unscientific pattern matching with no real criteria most of the time, but if enough people believe in it it can nevertheless become self-fulfilling. Thus there is definite further downside risk, but at a current P/E of about 6 (but housing stocks are always at low P/E's), we're thinking of dabbling, particularly if there is some froth regarding their earnings on Feb 23.

Dogbert the Economist

2006-02-21T12:24:00.000-08:00

It's usually a bad sign when you are aligned with Dogbert, but he's sort of right.

Today was all Technical

2006-02-21T12:22:00.000-08:00

The S&P 500 opened above 1290, it's near term resistance point, triggering all the automatic programmed sell orders, and the ensuing decline. It's all being reported as oil, but that's not it. It's purely technical today. All of today's volume is on the NASDAQ; the Dow Jones Industrials (NYSE) are almost ignored. The next few days will be fun.

Secular or Cyclical?

2006-02-21T08:59:00.000-08:00

According to some, we are in a Secular Bear market and a Cyclical Bull market. If you believe that, then you expect the market is about to drop. A Secular trend is a long term trend, that from it's name, ought to mean that a particular sector of the economy is changing. The disappearance of the horse-and-buggy with the advent of the automobile was a Secular change. Cyclical trends refer to the business cycle, where a business opportunity generates new companies or products that reap good profits, those profits bring in copy-cat competitors that kill off the profits, a bunch of the companies then go under, consequently reducing supply, and then the cycle repeats. The DRAM market is cyclical.

Secular and Cyclical make perfect sense in fundamental analysis of companies, and they are important tools for being on the right side of a trend. In fact, they are just another way of saying "the trend," and they differ in long or short term. But that's not how they are used in the popular press these days. Most of the references one sees these days use them in a technical sense, meaning an analysis of the stock market direction, not of companies. That is mostly hogwash. The best I can determine is that the adherents believe that the stock market goes in 18 year secular cycles, we just had a big upward push from the 1980's, so we're overdue for a contraction. So any upward stock market push is just cyclical in the overall secular down trend.

Here are just a few things that are different: Globalization; an effective Federal Reserve from the 1980's onward for the first time in the history of the world; no Gold Standard. Just looking at a chart of the DOW and saying '18 years up, then 18 years down or flat' based on past performance is, well, sort of stupid.

Here's the opposite of what everyone else is saying:

The energy market is in a cyclical, upswing, not a secular change to higher energy consumption. Energy consumption per-capita is dropping, population growth is slowing, GDP dependence on energy has dropped. We have some current short term supply disruptions, that are going to be over-compensated for with new technological and supply competition, sooner rather than later. That is the definition of cyclical, not secular. There is no long term energy shortage.
The technology market is in a secular upswing, with cyclical ups and downs. Can you honestly think of a single market space that is not somehow effected by microchips? RFID and bar-code scanning of canned fruit. Computerized calculation of maximum board feet from timber prior to cutting, etc. And of course all the obvious changes - fewer secretaries and more computers, etc. That is the definition of a secular change, and it shows no sign of abating.

Which is Better - XM (XMSR) or Sirius (SIRI) Satellite?

2006-02-17T12:47:00.000-08:00

It's hard to enthused about slogging through the just released Q4 and FY 2005 numbers for XM Satellite and Sirius, wondering which will be better, since 1) they both seem pretty bad, and 2) the whole world is already talking about their communal headline failings. Perhaps we can still find something unique though, since everyone seems to think XMSR is the better buy, and we, so far, have disagreed (here vs. here).

We're not investment bankers attempting a takeover, so enterprise value doesn't mean much to us. Rather, we just want a small cut of a big pie, so the main thing we're interested in is path-to-profitability. Both companies had unrepresentative activities in Q4: Sirius brought on Howard Stern and as a consequence had a big bump in subscriber growth, and XM spent like crazy on advertising to try to counter that move by Sirius. As a consequence, projecting from the latest quarterly numbers is likely to be even less accurate than a normally inaccurate extrapolation. On the other hand, we view the new developments as moving both companies to a somewhat new competitive plateau. We're skeptical that XM will have an easy time ratcheting down their increased spending. Long term we expect there is ample room in the marketplace for both companies. Both have compelling product line-ups.

We'll use FY 2005 data as the best forward representation. Their pricing plans are now essentially identical.

XM Satellite:

5.9M subscribers, 2.7M added in 2005.
$558M revenue, for $94.5/subscriber at $7.88/month (that is $2.69 less than what they are trying to report).
Hard to believe, but they do not give a churn rate in their press release.
Only 54% of OEM users convert to paying customers.
Operating revenue of $163M, for $27.62/subscriber at $2.30/month. (they put $10.058M of advertising under "cost of revenue" - we don't know why, so we backed it out).
Operating expenses of $573M (G&A of $43.864M, Marketing of $497.614, R&D of $31.281M)
Holding operating expenses fixed, they need 20.7M subscribers to break even ($573M/$27.62/subscriber), which will take 8 years at current addition rates.

Sirius Satellite:

3.3M subscribers, 2.2M added in 2005.
$242M revenue, for $73.33/subscriber at $6.11/month.
18% of people drop the service.
They do not give the OEM user's conversion rate in their press release.
Operating revenue of $57.3M, for $17.36/subscriber at $1.45/month.
Operating expenses of $625M (SG&A, Marketing, "subscriber acquisition costs", and R&D)
Holding operating expenses fixed, they need 36M subscribers to break even ($625M/$17.36/subscriber), which will take 16 years at current addition rates.

The above model breaks expenses into two categories, gross revenue expenses (used in (5)) that are inherent in providing their service and that are expected to scale with their service, and operating expenses, that may or may not scale and are more discretionary. Operating revenue is essentially "gross revenue" and is what they get to keep from their overall revenue. Operating expenses are how they use that left over revenue to try and generate new business, etc. That is why we view it as fair to look at the ratios provided in (7).

With 8 years vs. 16 years to break even, I guess it is fair to say that XM looks "better" than Sirius (I was wrong), but given both these companies' 2005 performance, all the directors should resign, and they are both heading to bankruptcy. They have paid modest lip service to improving prospects, but the way they are running their businesses is so phenomenally out of line with their profit model, that they can't make it without a serious slash-and-burn. Their projections for cash flow positive by end of 2006 look like fantasy to me. Yikes!

Note: Shorting them is another matter - we've only talked Company and Story here, not Stock.

[Disclosure: As of this writing, I am very regretfully long SIRI]

Public Health Procedure Pricing

2006-02-17T09:24:00.000-08:00

The WSJ today published a commentary from Dr. Scott W. Atlas calling for doctors to publicly post their pricing. I whole-heartedly endorse this market driven health pricing solution, since, well, I said the same thing. He cites whole -body CT scanning prices dropping 75% after pricing became public, which is just about the margin that I provided as the "absurd pricing" premium.

ClearFish Research

Corzine rehypothecation perjury

Appropriate for Today - Guy Fawkes Day

Pandora has a Broken Business Model

Inadvertent Admission that Keynes Multiplier is <<1, etc.

Electric Car Fuel Shock

CDS Bear Raid - it's all a Hoax?

Notes on Causes of Crises

Multipliers

General Market Thoughts

A Bit of Geopolitics - North Korean Positive Developments

1 Year Anniversary

Public Storage (PSA)

No Matter What You Do, You're Wrong

Housing Market

Google's new Pay-for-Performance program

Cortex Pharmaceuticals (COR) Reports Negative Results

Premium Cell Phone Services Not Selling Well

Recent Comments and IPO Developments

Old World Rate Thinking

Continental Resources (CXP) IPO Snack

Some Fishy Delphi Numbers

InnerWorkings (INWK) IPO

Bidz.com (BIDZ) IPO Snack

Burger King (BKC) IPO Snack

More Ethanol News

Ethanol News

Alien Technology (RFID) IPO Snack

Riverbed Technology (RVBD) IPO Snack

MasterCard (MA) IPO

Wintegra (WNTG) IPO

Cellulosic Ethanol Players

SunOpta (STKL) has the Cellulosic Ethanol Glow

CPI International (CPII) IPO Snack

Cellulosic Ethanol Background

Houston Wire (HWCC) IPO

American MoldGuard IPO?

Goodman Global (GGL) IPO

Couldn't Help But Notice the Similarity

Genetically Targeting Medications - Perlegen (PERL) IPO

Dirty Rotten Coal

Bausch & Lomb (BOL) Distress an Opportunity?

Google (GOOG) Snack

Basin Water (BWTR) IPO

Ethanol Plays - Xethanol (XTHN)

EarthLink's (ELNK) Amazing Churn

Local Matters (LOCL) IPO

Visicu (EICU) IPO

Ethanol Plays - MGP Ingredients (MGPI)

Ethanol Plays - VeraSun Energy (VSE) IPO

Ethanol Plays - Aventine Renewable Energy (AVR) IPO

Ethanol Plays - Green Plains Renewable Energy (GPRE)

Pacific Ethanol (PEIX) Corrections and Additions

Ethanol Plays - Pacific Ethanol (PEIX)

Sick Kids = Slow Blogging

California Ethanol Market

Ethanol Wildcatting

China Grentech (GRRF) IPO

Himax (HIMX) Snack

New Options on Cortex

Is GM Run by Monkeys?

Jajah Phone Disruption

Himax Technologies (HIMX) IPO

KB Home (KBH) Confirms Good Housing Sector

Toll Brothers (TOL) vs. KB Home (KBH)

Nextest (NEXT) IPO

Google Finance Launches

Ben, Feel Free to Quote Me Next Time

Tim Hortons (THI) IPO

Thanks, Eliot, For the Shakedown

The New Program Trading Target

A Little Bit of Paranoia

NightHawk Radiology (NHWK) Snack

Is XsunX (XSNX) Being Manipulated?

OpenTV (OPTV) IP TV Middleware

Synchronoss Technologies (SNCR) IPO

SED Snack

A Financing Question I Don't Get

Ford Hybrid SUV Sadness

Interest Rates