It has become a New Years tradition to combine forces with a few investment bloggers and put together some investment ideas for the coming year.  ZachStocks has bragging rights to the last place slot for 2009 as my recommendations for TBS International, TBSI (a dry bulk shipping company) and China Medical Technologies, CMED both faces significant challenges.  Shipping rates continued to be low throughout much of the year, and China Medical faced a surprise change in management and a heavy debt load.

Looking forward to 2010, I expect the ZachStocks recommendations to perform much more positively, while at the same time I want to caution against buying and simply leaving the positions unmonitored for the year.  We live in dynamic times where policy and economic trends are fluctuating very rapidly.  All investment decisions must be made with imperfect information, and then adjusted as new information comes to light.  Successful investors are able to allocate capital with purpose and confidence, but they are also able to switch gears and make new decisions when the situation warrants.

So with that said, here are my four recommendations for 2010 and as they become available you will see the additional recommendations from my competition at the bottom of the post:

The Blackstone Group LP (BX)

The private equity industry is set for a major rebound in the coming year.  Many of the funds that are managed by Blackstone are nearing their high water mark which means that the company will be able to participate in further gains in the alternative funds managed.  The market is offering ample liquidity which means that many of the companies owned by Blackstone’s private equity funds can be sold to the public in Initial Public Offerings (IPOs).  These transactions will allow the funds to book significant profits and lead to increasing shareholder value.  Finally, Blackstone continues to attract new capital with the most recent figure of $96.3 billion under management.  With these growth situations along with a healthy 9% dividend yield, I expect Blackstone to rally sharply this year.

Assured Guaranty (AGO)

Most financial insurance companies (which insure securities such as municipal bonds and Mortgage Backed Securities) have either gone out of business or are teetering on the edge.  Companies like Ambac Financial (ABK) and MBIA Inc. (MBI) may still be solvent, but they don’t have the capital available to go after new business.  But Assured Guaranty made some very smart, conservative decisions in the mania leading up to the housing crash, and now has the capital to write new business and capture market share.  Assured Guaranty recently made an acquisition that adds a significant amount of new revenue, and should be accretive to shareholders in the coming year.  While the stock has had a tremendous run since April, it still trades at an attractive level compared to its high quality assets and its prospective growth.  I expect the stock to continue to add to its gains as we enter this new decade.

IntercontinentalExchange (ICE)

As Congress works to overhaul the regulatory system for our financial markets, many of the banks and derivative dealers will face a new standard of disclosure and risk control.  OTC contracts which used to be private will be forced onto exchanges and the contracts will have to be cleared by a third party.  The CME Group (CME) and IntercontinentalExchange are the two primary clearinghouses which have the ability to clear derivative products and the additional business should add to profitability for both of these companies.  ICE has made several recent acquisitions to give the company a competitive edge and I expect the company to capitalize on the regulatory opportunities in the next several months.  The stock is not cheap, so there is a bit more risk in this opportunity, but investors should reward the company for its growth, driving the stock price higher.

iShares Silver Trust (SLV)

The fear of inflation could be a major trend for 2010 as most governments continue to utilize an accommodating monetary policy.  Printing presses continue to pump out more currency leaving more dollars (or euros) chasing fewer goods.  When inflation fears mount, the best investment strategy is to own “stuff” or hard assets because supplies are relatively stable (versus an increasing supply of currency).  Silver is unique in that it is both a precious metal (storage of value) as well as an industrial metal (there are real-world uses for it).  December has featured a sharp pullback in the shiny metal and that actually gives us an excellent entry point for silver heading into the new year.  I expect silver to be a solid place to store “real” value, and if inflation fears take off, silver could vault higher with a price that increases many-fold as investors look for an alternative to owning dollars.

Happy New year and I wish you the best of success in the coming year.  If you would like information on how to develop an appropriate investment program for your personal account, please email me and I would be happy to discuss ways to safely grow your capital.

Wishing you every success!

Other Bloggers 2010 Recommendations

The Financial Blogger

My Trader’s Journal

The Wild Investor

Four Pillars

Where Does All My Money Go

Intelligent Speculator

Dividend Growth Investor

Note: This is a recap of performance for the stocks picked at the beginning of 2009.  Picks for 2010 will be posted January first.

To paraphrase a hedge fund manager that I follow closely, “Nothing has happened this year the way I expected it to.”  While this statement does little to instill confidence in this money manager, William posted returns north of 20% for the year in his long-short fund which remains fairly neutral as far as market exposure is concerned.  The point is that although 2009 was a year of major shifts in market direction, policy decisions, and investment risk; it was still possible to adjust trading style along the way to account for the changes and book significant profits.

My four picks for 2009 did not turn out to be very profitable despite a significant market rally from March through December.  Thankfully, portfolios managed for Sound Counsel Investment Advisers were able to trade actively throughout the year and performed much better than the 2009 recommendations.  As I choose growth opportunities for the portfolios I manage, I am careful to use stop points in order to exit losing trades, while letting winners continue to compound gains.  Often we use covered calls to manage some of the risk, and the advent of inverse ETFs has also been helpful in managing downside risks for entire markets as well as individual sectors.

So without further adieu, here is some commentary on the four picks for 2009.  Stay tuned for the 2010 picks which will be posted January 1.

1. JA Solar Holdings (JASO)
   While Alternative certainly received its fair share of headlines this year, the solar industry was plagued with rising inventory levels and falling prices for solar products.  On top of the supply dynamics, many countries which had implemented strong solar energy tax incentives had to pull back on the stimulus measures due to financial strain.  As a result, many solar companies experienced a difficult period and those with excessive leverage were especially hard hit.  At the time of writing, it looks like JASO will finish the year with a gain of 30.5% which is certainly healthy, but the majority of the gains came in the last few weeks of the year.  JASO could continue to post additional gains in the coming year, but there are still significant uncertainties surrounding the alternative energy market.
2. AECOM Technology Corp (ACM)
   AECOM is an international construction management company which is expected to benefit from global stimulus projects aimed at improving infrastructure projects such as bridges, roads, power plants and other developments.  Since AECOM has a well diversified client base, it was expected that the company would grow earnings (which occurred quite nicely) and see its stock price rise as a result (which unfortunately did not occur).  Much of the stimulus spending took longer than expected to reach the market, and investors have placed a lower multiple (paying a smaller price for every dollar that the company earns).  The lower multiple is likely due to a perception that the company will not continue to grow quickly after the stimulus projects are completed.  At this point AECOM still looks like a great investment with little debt and a low earnings multiple, but it has taken longer than expected for the stock to bounce.  Currently it looks like ACM will finish 2009 with a loss of 1.2% – not a very healthy showing considering the strength of the market.
3. TBS International (TBSI)
   At the end of 2008, it looked like shipping companies were primed for a significant rebound.  The financial crisis had sent many of the more leveraged players into the abyss, but companies with longer-term charters and reasonable debt levels were showing signs of improvement.  The wildcard in this industry was whether the day rates for dry bulk shipping would improve over the coming year.  Unfortunately, shipping has continued to be a challenging area for the economy, and since TBSI does not pay a dividend, it has been especially unattractive to investors.  The stock is down 27.2% for the year which is extremely disappointing.  Looking into the coming year, there is little evidence that this company will offer investors much hope of improving profits so I would not recommend an investment in this stock and have kept clients out of this name for some time.
4. China Medical Technologies (CMED)
   China Medical is another disappointing story as the stock is now down 30.2% for the year.  Midway through 2009, CMED had traded higher as the company’s rapid growth caught investor’s attention and the diagnostic company was expanding its base of customers.  However, a management change along with significant debt has caused investors to lose confidence.  At the current price, CMED is looking like a very solid value, but I am not invested right now because I want to know for sure that the business metrics are solid.  If management were to issue healthy guidance for the coming year (ending March 2011), I would consider working back into the stock, but for now it appears to hold excessive risk.

We have many risks and many opportunities in front of us as we enter this new decade.  Flexibility and damage control will be important skills to employ as the markets face the risk of inflation, mounting sovereign debt, and significant fluctuations in currency rates.  I would welcome the chance to help you develop a comprehensive plan for your investments in the coming year.  Please email me if you would like more information on Sound Counsel’s investment strategies.

Wishing you a happy New Year!

Other Bloggers 2009 Results

Intelligent Speculator

The Financial Blogger

My Trader’s Journal

The Wild Investor

Four Pillars

Where Does All My Money Go

Million Dollar Journey

If you are a musician for the money, it’s likely that your music is less appealing to the majority of your audience.  But what about the companies who make music their business?  The last few years has ushered in dramatic changes for the music industry and at this point most participants are struggling to survive.  Today, we’re going to take a look at Warner Music Group Corp (WMG) as a potential short candidate for the new year.

At first blush, you might think that WMG has a strong business which owns the rights to some very high profile artists.  Warner represents Fleetwood Mac, Linkin Park, Gnarls Barkley, Faith Hill, and many other up and coming stars.  Now my sense of pop culture is a bit deficient so these artists may not be a good representation of the talent Warner represents, but with the company pulling in more than $800 million dollars in revenue each quarter it is clear that they have at least a few products which resonate with the average music buyer.

But the technology changes in how music is distributed along with a sharp decline in the global economy has thrown WMG a one-two punch which has left profitability reeling.  Today, many listeners use free services such as YouTube, or Pandora to listen to music, and the revenue models for these services are primarily based on advertising rather than the purchase of music.  Warner has been scrambling to keep up with the changing world, but it currently appears that the company is falling behind from a business standpoint.

Just before Christmas, Warner announced a new agreement with Hulu in which WMG will offer music videos and concert footage to Hulu viewers.  The agreement could help WMG capture some of the advertising revenue as they will likely operate under a revenue split agreement.  Both companies are already working together to determine what content will be available with Muse being the first artist featured.  Theoretically, as Warner exposes their artists to the broad audience which Hulu has assembled, sales of the artists records will pick up leading to stronger product revenue.  But the success of this model has yet to be proven.

Last month Warner announced results for its fiscal fourth quarter which ended September 30.  The company saw revenue of $861 million which was up 1% from last year.  Management seemed especially proud of the fact that digital revenue was $184 million which represents 21% of total revenue.  It stands to reason that in today’s technological world, media companies should see their digital revenue make up a larger portion of total revenue if they are to stay in business.

WMG had a strong quarter, increasing revenue, growing our cash balance to $384 million and raising digital revenue to 24% of total Recorded Music revenue. Over the fiscal year, even in the midst of difficult economic and industry trends, we grew our market share to 21% in the U.S. and continued progress on our key strategic goals: diversifying our revenue mix, improving our financial flexibility and maintaining our leadership in the industry’s digital transition. ~Edgar Bronfman Jr., CEO

To hear the CEO speak, you would think that this was a positive quarter for the music company.  But in actuality, WMG ended up losing 12 cents per share for the quarter and a full 64 cents per share for the year.  Also, while management may boast about their cash balance being a third of a billion dollars, you should note that long-term debt is stuck at $1.939 billion which dwarfs the company’s cash levels.

Warner’s balance sheet appears to carry a significant amount of risk.  Total assets are listed at $4.07 billion with total liabilities listed at $4.21 billion.  So the company actually has a negative book value.  The asset side of the equation is also a bit disturbing with $1.04 billion in goodwill and another $1.32 billion in “intangible assets subject to amortization.”  While I don’t necessarily doubt that these assets carry value, the math suggests that the company has a tangible book value that is more than $2 billion in the red!  As long as the company can continue to service the large debt load, they will stay in business.  But as we have seen in the past 18 months, there are times when debt service becomes nearly impossible even for strong companies.

Looking to 2010, analysts expect WMG to lose another 59 cents per share.  Now that’s better than the 64 cent loss of 2009, but it still represents losses for shareholders.  After rebounding from below $2.00 per share, the stock is now at $5.70 and appears very vulnerable.  There is a significant amount of volatility, but I wouldn’t be surprised if the stock tested or even broke below it’s March low in the next 12 months.

One caveat is that the company has some relatively easy hurdles to beat in 2010 when compared to 2009.  So it is not outlandish to think that the company could post revenue gains over last year, and profit losses that are less dramatic than we saw in 2009.  News releases will likely be skewed positively so while the company is posting a loss, management assumes that it is good news.  This positive spin could easily sent the stock higher – if only temporarily – which can cause losses if you are short.

So please use caution when trading WMG.  It may make sense to use option strategies that lower risk such as shorting the stock and then selling puts, or buying the puts with the understanding that the time decay could make the trade less profitable than shorting the stock outright.  But despite the volatility I expect the next year to favor short-sellers in this financially challenged stock.

FD: Author does not have a position in WMG

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As we wind down 2009 and look forward to the year ahead, I have been taking some time to read a few books relating to the financial crisis and how the events transpired.  The Greatest Trade Ever by Gregory Zuckerman details how John Paulson turned a profit of more than $15 billion by betting against the unrealistic housing and mortgage bubbles.  It’s inspiring to see how careful thought and methodical execution allowed this now legendary trader to vault from an “also ran” mediocre fund manager to one of the most respected investors of our time.

House of Cards by William D. Cohan is a bit of a darker read as it chronicles the collapse of Bear Stearns over a fateful spring week in early 2008.  The Bear Stearns failure is especially interesting to me as I personally worked on the same floor as Bear Stearns’ Atlanta office during the time that the firm went under.  It is quite sobering to see just how vulnerable our major financial institutions were (and many still are) due to the enormous leverage used as these companies aggressively pursued profits.  Many of the derivative tools which were used to drive trading gains (and eventually to bring down companies like Bear, Lehman, and AIG) are still actively traded and could potentially cause market chaos again.

As the political machine moves from emergency bailouts to the much more difficult process of making sure a similar financial catastrophe never happens again, new regulations are being put into practice which are expected to discourage institutions from taking similar excessive risks.  Now I could write a number of pages on why political regulation will likely fail at reigning in human greed and fear, but rather than dive into the intellectual side of that argument, let’s look at some investments which could profit from the additional regulation.

One of the most recent regulatory reform bills which was debated in the House attempted to require all financial derivatives to be traded on exchanges and cleared.  The purpose was to provide both transparency and a sense of risk control.  As exchanges posted data on which derivative contracts were being traded, at what prices, and at what volume; investors would have a better sense of the liquidity of such vehicles and what price the market was willing to pay for exposure to particular investment and trading agreements. The risk control would come into play as the derivative agreements were “cleared” or guaranteed by a third party.  Companies like IntercontinentalExchange (ICE) and the CME Group (CME) act as intermediaries between trading counterparties, guaranteeing that the trades will be settled.  As the clearinghouses are taking on the counterparty risk associated with each trade, the market becomes less vulnerable to the risk that one of the parties will default on a major trade (or basket of trades).  The clearinghouse must manage its own risk and will therefore require each party to put up a certain level of margin or collateral depending on what is at risk with the particular trade. Clearinghouses must carefully manage their own risk, but if the business is handled appropriately the profits can be quite lucrative.  Not only does the clearinghouse get to charge fees for each trade cleared, but the firm holds a large amount of capital which it can invest while counterparties leave the trade on the books.  ICE and CME are both expected to be major beneficiaries of the push to have more derivative trades directed through the clearing function. Of course not everything goes according to plan in Washington (thank goodness), and it is unreasonable to expect that 100% of derivative trades will be forced onto exchanges.  Dealers and other market participants will still transact some business without a third party intermediary.  However, Morgan Stanley (MS) believes that the volume of derivatives cleared could increase from the its current portion of 20% to as high as 60% in 2012.  A tripling of market share could certainly boost the profits of the established players and potentially lead to sharp investment gains in 2010.

One of the benefits of operating a capital intensive business like a clearinghouse is that it is very difficult for new competition to enter the market.  With a clearing business, trust and reputation are the most important assets as traders do not want to clear unless they believe that the clearinghouse has the capital to truly absorb the risk if a counterparty defaults.  This reputation cannot be easily built without a significant amount of time in the business, and it is difficult to manufacture that experience without clearing major trades.  So there truly is a “chicken or egg first” difficulty in starting a new clearing franchise.  Also, large financial institutions are not likely to enter the clearance business because they would rather make their profits on the trading side.  So for now it appears that ICE and CME are the leaders and have a sustainable advantage in collecting profits from clearing derivative trades. Neither CME or ICE are trading at extremely cheap multiples.  That is because the market has begun to realize the strong potential for earnings growth.  However, as the political climate continues to drive banks and dealers toward greater disclosure and stronger risk controls, it is likely the earnings growth will be even greater than expected for CME and ICE.  The result will likely be a sustainable advance in the stock price of both clearinghouses and while there could be moderate volatility the trend should remain intact for months to come. FD: Long position in Sound Counsel Investment Advisers client portfolios Enjoy this article? Sign up for the ZachStocks Newsletter, Your source for Sound Market Commentary, Growth Stock Analysis and Successful Investment Strategies

After taking some time off to enjoy time with friends and family, I’m back at the desk combing through opportunities for 2010.  ZachStocks market and stock articles will be back up and running shortly, but in the meantime I wanted to post a sample of the free ZachStocks Newsletter.  The newlsetter is sent out twice a week with market commentary early in the week, and some insightful links heading into the weekend.  Sign up to receive your free subscription and I look forward to hearing your thoughts.

Below is a sample of the ZachStocks Newsletter which was sent on December 18th…

Dear Subscribers,

Strength in the US dollar has begun what could be a major market shift.  Up to this point, international stocks and domestic companies with significant international revenue have been the beneficiary of a weak dollar.  But as the economic picture turns “less bad” traders are beginning to price in the probability of a rate hike and the long-term consequences of inflation.  This could cause a major shift away from international exposure at a time when the domestic risks aren’t much better.  It’s unclear exactly where investors will be able to put their capital that offers attractive returns and acceptable risk.  So continue to keep the defense on the field and consider lining up some short ideas for when markets begin to crack.

Below are some of the articles I found most interesting this week:

Zero Hedge: Prepare for the Hyperinflationary Great Depression

While the debate between deflationists and (hyper)inflationists has been a long and painful one, numerous events set off in motion by the Bernanke Fed (as a direct legacy of the Greenspan multi-decade period of cheap and boundless credit) may have well cast America as the unwilling protagonist in the sequel of the failed monetary policy economic experiment better known as Zimbabwe.

Some of the charts showing currency expansion and government debt can be very concerning.  I’m not sure why the US would be any different than numerous other historical cases where printing of fiat currency caused devastation.  While it’s not fun to think about the long-term ramifications of our current policy decisions, I fear that if we can’t learn from history we will be doomed to repeat it.

Sitka Pacific: November Letter to Clients

The US economy has indeed pulled back from the brink this year, as the positive Gross Domestic Product for the third quarter attests.  However, the question now is whether we have truly turned the corner, or whether this rebound has been just a lull in the storm… Unfortunately, the drop-off in mortgage resets seen in 2009 is only a temporary respite… The dollar amount of mortgages scheduled to reset in 2010 and 2011 is going right back up again, until finally dropping off in 2012.  Seen from this perspective, the conditions in 2009 appear to be more like the eye of the hurricane, not the end of it.

As more banks repay the TARP funds, the potential for further mortgage losses looms as an even larger threat.  If these banks which were bailed out by the government and then repaid the loans are forced to once again ask for assistance, you can bet that the public outcry will be fierce.  Many off-balance sheet assets (of the toxic sort) will be required to be put back on balance sheets in 2010 which could cause a weakening of capital ratios and lead to significant weakness.  I hope that these problems will remain contained, but for now I wouldn’t touch most major financial institutions.

Financial Times: Distressed Debt on the wane in US markets

Bonds trading at less than 50 cents on the dollar now account for only 1.1 per cent of the high-yield market, or $8.9bn in securities, down from 27.5 per cent, or $202bn in bonds, a year ago, according to JPMorgan data.  The intense demand for once-distressed bonds is stirring the debate about whether investors are acting wisely or piling into junk bonds because of a lack of opportunities elsewhere in the fixed-income markets.

Investment managers have become so intent on generating returns, that they are once again turning a blind eye to risk.  The quote above may appear to be a positive – after all, more bonds are trading close to their par value – but if the underlying fundamentals continue to be weak, and investors are just paying more for the debt, then we could be grossly mispricing risk.  A positive side to this coin is that small businesses are finding it somewhat easier to issue bonds and raise capital.  But is that really helpful if these bonds go into default in a few years?

WSJ: Spendthrift to Penny Pincher – A Vision of the New Consumer

Their (the consumer) value system is shifting from aspiring to material wealth to aspiring to a life better lived.  Businesses ranging from shoemakers to financial services to luxury hotels don’t expect American consumers to return to their spendthrift ways anytime soon. They see consumers emerging from the punishing downturn with a new mind-set: careful, practical, more socially conscious and embarrassed by flashy shows of wealth.

You can’t live through a decade like we are currently completing without having it affect you in some way.  A return to a grass-roots lifestyle is intuitively refreshing as there is nothing more obnoxious than a wealthy person trying to make sure that everyone knows he is doing well.  But a shift away from luxury goods also has a downside too.  Employees at retailing locations, manufacturing plants, and many other service industries will likely see hours cut and jobs eliminated.  Ultimately, a return to the basics will be good for the country, but in the meantime the pain can be quite difficult.

Sorry to be a Grinch this holiday season.  I truly am not a pessimist and despite the danger I see in the markets, I believe 2010 can be an incredibly profitable period.  We simply need to keep our eyes open and take advantage of the opportunities that present themselves.  This coming year, investors who embrace a conservative approach or who are willing to profit from declining profits will likely see their wealth increase.  But the simple buy and hold crowd will find it difficult to make money, much less outpace inflation.

Wishing you every success,

Zachary Scheidt
Chief Investment Strategist
Sound Counsel Investment Advisers
678-467-7064

As equity markets continue to trade higher, and economists have largely turned into cheerleaders for an unsubstantiated recovery, the junk bond market has begun to reflect a smaller degree of risk.  Not only have prices risen to the point where many poorly rated bonds are trading at levels that mirror their financially sound counterparts, but companies which real financial challenges have been able to issue more debt at attractive interest rates.

One of the largest junk bond issuances occurred last week when Clear Channel Outdoor Holdings (CCO) issued a full $2.5 billion which was significantly higher than the original plan to sell $750 million.  Clear Channel Outdoor is the spinoff child of the larger Clear Channel Communications which is privately held by Thomas H. Lee Partners and Bain Capital.  Investors have been bidding CCO higher as more capital would normally create a healthier company for investors.  However, the picture is a bit more complex and the bond offering may turn out to be little help for the leveraged advertising company.

As it turns out, nearly all of the capital raised will be used to repay the parent company which is privately owned and leveraged 14.4 times.  This means that  for every dollar of equity Clear Channel Communications has created, there is $14.40 in debt – a staggering level.  The heavy debt is largely a risk born by the private equity companies and Clear Channel Outdoor is simply the conduit that the private equity holders are using to borrow capital from public markets to reduce their own exposure.  Since CCO is a healthier entity (and that is a stretch because CCO is leveraged 4.6 to one), it is easier to use this vehicle to raise capital.

Clear Channel Outdoor is the outdoor advertising division of the media conglomerate which was brought public in an IPO in 2005.  While the stock initially traded well, doubling in price during its first year as a public company, the last two years have been difficult for many advertising companies.  CCO has since dropped from a high just above $30 to a low of $2.14 during the financial crisis.   But like many speculative stocks, CCO has rallied sharply, and is now up 416% from the ultimate low.

2009 has been a very difficult year fundamentally for the company.  Revenues have been sharply lower each quarter, and despite the rising stock price, the company has reported a sharp loss for the year.  On June 30, the company announced that it would take a write down of $812 million to account for the lower value of many intangible balance sheet items and even in 2010, the company is expected to lose 17 cents per share.  It’s a bit baffling to see the stock trading with such strength when the actual company is under such duress.

One bullish case for the company is that the parent company – or more accurately the private equity owners – could take CCO private, buying out the public shareholders at a premium.  The parent company already owns 89% of the company and if things got bad enough, the private equity team could simply buy the remainder of the company and wait for a better opportunity to re-issue the company to the market.  However, if the private equity holders were up for this type of transaction, I believe they would have taken advantage of the opportunity when the stock price was much lower.

More likely, the private equity holders will look for an opportunistic time to begin selling their 89% ownership stake and thus reducing their risk.  Liquidating their holding into a market that is now willing to take on risk could be a very wise move – especially if a weakened consumer leads to a continued weak environment for advertising.  A sell of CCO stock would likely cause pressure and drive the price lower, so the private holders will have to be careful how they initiate the transaction.

The bottom line is that there is significant risk in CCO shares at this price.  The firm is under a significant debt burden, and the recent junk bond issuance does little to relieve that burden.  The equity and bond markets may be extremely forgiving today, but if and when the environment turns south, CCO equity holders and debt holders could be left holding a lot of risk and very little in the way of profitable assets.

FD: Author does not have a position in CCO

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Talecris Biotherapeutics (TLCR) is one of the more recent successful IPO stories as the company raised capital and began trading on October 1.  The IPO was priced at $19.00 per share and underwritten by an all-star cast of investment bankers including Morgan Stanley (MS), Goldman Sachs (GS), Citigroup (C) and JPMorgan Chase (JPM).  On the first day of trading, investors were rewarded with an 11% return as the stock bolted out of the gate.

Over the next month, the stock began to cool off as is often the case with new issues.  In early December, TLCR breached the all important IPO price of $19, but within two weeks the stock began to mount a recovery.  This is a perfect example of how underwriters and IPO investors can often be counted on to support a new issue very close to the IPO price.  It’s important for the underwriters to have the issues trade above the offering price, because it makes their job easier when peddling the next IPO to investors.  So often for quality IPOs, it is a good strategy to buy additional shares when the stock tests the initial price point.

The business model for Talecris appears to be very sound, as the company is experiencing strong revenue growth and generating impressive strength in earnings.  The company is a world leader in plasma based therapies and has strong command over its niche of the medical business.  One concern could be that the company receives 70% of its revenue from its two main products (Gamunex IVIG and Prolastin A1PI).  I’m not extremely experienced when it comes to the medical industry, but it appears based on market share and revenue trends that the company is very successful in its product lines. The third quarter was a strong period for TLCR with revenue growth of 12.9% and EPS of $0.38 which represents an increase of 72.7% over last year.  It appears that the company has been able to reduce expenses through vertically integrating its supply chain which has led to stronger gross margins.  The IPO transaction allowed the company to pay down a portion of its debt leading to lower interest expense which further helps to bolster earnings.

Our third quarter results reflect the continued demand for Gamunex, our brand of IGIV, as well our success in building a vertically integrated plasma supply chain to ensure a continual supply of Gamunex. ~Lawrence D. Stern, CEO

As far as debt is concerned, the company still has long-term liabilities north of $1 billion.  The liabilities are offset by $630 million in inventory and a healthy balance of accounts receivables, but the high level of debt could still become a concern should there be any unexpected changes in the revenue stream.  While it is still too soon after the IPO, I would not be surprised if the company issued additional equity in the first few quarters of 2010 in order to pay down debt.  This would dilute current shareholders, but would also lead to a more stable capital structure.

Analysts are expecting the company to earn $1.52 per share in 2010 which is probably reasonable given the strong management team, growing revenue base, and cost cutting initiatives.  At the current price near $21, the stock is trading at a multiple of 14 which seems a bit conservative considering the earnings growth.  Some caution is in order due to the debt level, but a multiple of 20 would not be unreasonable.  If we see medical stocks rebound in the aftermath of health care reform (as I expect we will), TLCR could ride the trend and see a much higher multiple.

So at this point it looks like the risk/reward ratio is very good.  $19.00 remains an important level to watch as a breach of this level would cause me to stop out my position.  On the other hand, the stock has the potential to trade through $30 and yield a 40% plus return.  The next six months should be a positive period for TLCR and its investors and I look forward to seeing what kind of growth management can generate.

FD: Author does not have a position in TLCR

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It’s not easy being a bank these days.  Oh sure, it’s nice to still be alive.  After all, last year at this time it was uncertain exactly how many financial institutions were actually going to stay in business.  But after begging for taxpayer money to keep them alive and kicking, banks are now finding that the strings attached are more like giant anchor chains and regardless of whether an individual firm has paid back the funds or not (and really it doesn’t matter whether the institution received any funds or not), banks are now being held to a standard that requires them to focus on the public good more than the pursuit of profits.

This week, Barack Obama delivered a very pointed address to US banks, declaring that he didn’t run for office to help a bunch of “fat cats” get rich.  With many high profile banks repaying TARP liabilities and removing themselves from the compensation restrictions imposed by the government, Obama is sending the message loud and clear that banks are still required to be good stewards of their capital.  This implies that the president believes that US banks should significantly increase lending in order to supply liquidity to businesses and consumers in need of financing.

Currently, banks are enjoying one of the best rate environments possible due to the low short-term borrowing costs these institutions can take advantage of.  With the Fed Funds target rate at zero to 0.25%, banks can borrow for quite literally no interest expense (or marginal expense at worst) and invest that capital in nearly anything paying a nominal yield.  Of course Bernanke would like to see this capital lent to businesses and individuals for higher rates of return but also to prime the pump for additional economic growth.  But most recently, banks have been taking the capital they can borrow at low rates and investing in treasuries which carry a smaller profit but much more stability.

The process of borrowing cheap and investing “just a bit less cheap” does very little to stimulate our economy.  In fact, the only good it really does is to help the bank report stable profits and show a balance sheet with an improving risk picture.  (Now I’m well aware that most major banks have plenty of legacy risk associated with assets already on their books – but new lending is following the path of zero risk tolerance).  If banks continue on this path, they will likely face even more harsh criticism from an administration who believes that the financial institutions owe it to the taxpayers to be offering more liquidity.

As it turns out, the choices for banks are not pretty regardless of which angle you take.  If banks are more free with their lending, the amount of risk taken could turn out to be devastating.  This is actually a major part of the problem that got us into our difficult position in the first place.  Credit flowing freely to consumers and businesses who are not good credit risks is certainly not a good idea for the banks, or for the taxpayers.  Imagine the public backlash if these new loans turned to losses and the government had to bail out the banks again! You can bet the heads would start to roll.

But on the other hand, if the lending institutions decide not to extend credit to businesses and instead use the low borrowing rates to fortify their balance sheets, they will likely face the ire of an administration desperate to manufacture economic growth.  As it stands now, rates for borrowers are extremely low – definitely an attractive point for businesses.  But the credit standards required are extremely high.  Even showing a rock solid balance sheet, business plan, and collateral does not ensure that a business will be able to raise capital.

My personal fear is that banks are buttressing their capital base because of the off-balance sheet exposure that many still have to weak assets and structured products.  As these products are moved back on the balance sheet due to regulations imposed next year, the capital picture could turn much uglier.  With this in mind, I would recommend steering clear of major banks as an investment in the first half of 2010 while regulation continues to unfold and the picture becomes clearer.

As for the banking industry, the government should certainly continue to monitor the risk associated with these institutions, but should refrain from pushing these companies toward making loans.  Once the risk picture is cleaned up and transparency returns, competition will cause the banks to naturally lend at fair market rates.  But forcing these institutions to lend regardless of credit quality will ultimately lead to higher risk and systemic failure.

FD: Author does not have a position in stocks mentioned in this article.

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For-Profit schools have been getting a lot of attention over the last few weeks – and not much of it has been good.  While managers of these institutions often argue that the industry offers an efficient and cost effective opportunity for students to better their education, the track record of many of these companies when it comes to the career mobility or the financial improvement of students, does not exactly garner high marks.

This morning, an article buried on page A7 of the Wall Street Journal outlines the results of government data which discloses default rates for students who have enjoyed government loans for various forms of education.  The information appears to point to a much higher default rate for students who were enrolled in for-profit programs versus community college and state funded not-for-profit schools.  Of the 316 schools whose students had default rates above 30%, three quarters of the institutions were for-profit institutions.

The information is likely to cause a serious black eye to these for-profit educators, many of whom rely on government grants and loans to students in order to maintain enrollment levels.  The public backlash could come on two fronts.  First, students will likely think twice about enrolling in a public school if the data points to fewer of their classmates having the ability to repay government loans for the program.  The second source of backlash could come from taxpayers who are disappointed to see their government funding education programs which are failing to provide students with the earnings power necessary to repay the government for the education.

Today, credit availability has tightened and it has become more difficult for students to find financing in order to further their education.  To a large degree, the government has stepped in to fill the gap with an assortment of available plans to students.  Up to this point, there has been plenty of capital available for students to borrow and spend on for-profit education programs, but that trend may be set to decline.  With these schools representing a majority of the defaulting borrowers, the government must take a close, hard look at whether these programs are beneficial or not, and whether public money should be spent to allow students to enroll in these programs.  If public funding is pulled or even just rationed, that could mean slumping profits for many of these schools.

Despite the relatively negative tone of the article, for-profit education stocks are rallying today as it appears investors were expecting the data to be even worse.  Most publicly traded educators are trading with relatively low multiples due to concern which has been growing in the sector.  The stocks have traditionally traded in a volatile pattern with 20% and 30% swings the norm more than the exception.  The Wall Street Journal cited Corinthian Colleges Inc. (COCO), and ITT Educational Services (ESI).  Both of these companies trade at single digit multiples to next year’s earnings (or very close) which may accurately reflect the risk in the industry.

Strayer Education (STRA), however, may be the exception which presents an attractive short opportunity.  The stock is trading at nearly $210 per share while analysts expect earnings of $9.51 per share in 2010.  If funding becomes more difficult for students to obtain, that $9.51 in earnings could quickly be in jeopardy.  While the stock is rallying sharply today and should probably not be shorted until it shows some weakness, shorting STRA could yield hefty profits in the coming year.  Assuming a modest 10% disappointment in earnings, and a still above average multiple of 14, the stock could trade down to $120 – down 43% from current levels.  When shorting, be sure to have proper risk controls in place and know how much you are willing to risk.

FD: Author does not have a position in STRA

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Shares of Fortress Investment Group (FIG) are trading higher today after comments made at the Goldman Sachs (GS) US Financial Services conference. The private equity company has benefited from the equity market rebound and the return of liquidity to the global investment universe. As I write, the stock is up more than 7% after CEO Daniel Mudd spoke at the conference this morning and told investors that they are seeing more demand for their private investment funds.

Fortress has seen its stock plummet over the past year as funds that the company managed took on losses while at the same time, investors pulled capital out due to the poor returns. This is the nature of private equity – it can often be a boom and bust business model even though funds are usually structured to be absolute return vehicles. When a fund or family of funds are performing well, the company recognizes very attractive incentive allocations (FIG gets to keep a portion of it’s investor’s profits) and at the same time, new capital comes pouring in.

However, when these funds face a few months of poor performance, investors pull capital out resulting in a smaller pool of capital available to generate gains. At the same time, the poor performance puts the funds below their “high water mark” and that level must be reached again before the fund can charge any incentive fees on investors who are simply making their money back. So even in a rebounding market environment, companies like FIG will see their profitability lag because it takes time to make up past losses on their investments.

But we are likely in the early stages of another boom in the private equity market and for Fortress particularly. There are two factors feeding this new wave of profitability which could quickly lead to a sharply higher stock price. First, the company isseeing new investment capital come in the door. Keep in mind that this capital does not have a high water mark. Gains on these new investments will immediately lead to FIG taking a portion of the returns as their own profit. In the past few months, FIG raised $500 million in a portfolio designed to invest in the Japanese real estate market. Other new fund launches will likely allow the company to substantially increase their Assets Under Management (AUM)

The second factor is that existing funds are nearing their high water marks. So while the funds have been struggling to make up past losses, these assets have basically been adding very little to FIG’s profits. But once the magical high water mark is hit, immediately new gains will tie directly to increased profits. As expectations ramp higher, the stock price will likely get a lift and potentially run several hundred percent higher.

Currently, analysts are expecting FIG to earn 28 cents in 2009 and 45 cents in 2010. This means that the stock is currently trading below 10 times next year’s expected earnings. To be fair, these earnings estimates are not very reliable. It’s extremely difficult to handicap exactly how well the company’s funds will do and what type of incentive allocations will be generated. But I do think that the Wall-Street analysts are excessively conservative given the difficulty we have experienced over the last year.

FIG is not an investment that you should make with your “safe” capital. In many ways, this is a risky bet that could go bust, or could pay off big. If the market experiences another decline (which I think is possible) its likely that the funds will be better prepared to handle the turbulence. But there’s no guarantee that they won’t lose money in the funds resulting in much lower revenue. However, there is a good chance that FIG will have some of its funds make wise investment decisions (short or long) which will yield significant profits and push earnings up significantly. A little confidence could go a long way and if FIG realized a multiple of 20 on earnings of 75 cents we would have a return of roughly 275%.

So consider taking a shot at FIG – buy a few speculative shares and tuck them away for 6 to 12 months. The potential is great and you are only risking roughly $4.20 per share.

FD: Author does not have a position in FIG

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