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Neutral Tandem – Rebounding After Patent Pressure

Neutral Tandem – Rebounding After Patent Pressure

Neutral Tandem Inc. (TNDM)Shares of Neutral Tandem Inc. (TNDM) have been under pressure this year as the company struggles to maintain patent protection and fend off a significant competitor.  On March 30, Oppenheimer downgraded the stock to neutral after the United States Patent and Trademark Office agreed to reexamine a key patent which is been challenged by Peerless Network.

Newsletter AdIf the patent is overturned and Peerless is able to more directly compete with Neutral Tandem, the end result would likely cut into margins and pressure what has been a long history of sustained revenue and earnings growth.  Since Neutral Tandem began generating a profit in 2006, the company has grown earnings from 15 cents per share to an estimated $1.30 this year – quite an impressive feat for a period wrought with financial and business risk.

One of the reasons the company has performed so well is that management has approached the business from a fiscally conservative foundation.  The company currently has no debt and at the end of the fourth quarter boasted $161 million in cash.  As part of the fourth quarter earnings press release, the company announced a $25 million share repurchase program which, if traded correctly, could have reduced the share count significantly as the stock traded sharply lower during the first quarter.

TNDM announces earnings on May 5, before the market opens.  In addition to hearing information on the patent issue, I am curious to hear how much the company spent on repurchasing shares and how many shares they were actually able to retire.  I would love to see that the company acquired the shares at an average price between $15 and $16 although that may be a bit too aggressive.  The company did not set an expected period of time in which these shares would be repurchased, but one would think the opportunity in February and early March would allow the company to spend a large portion of the $25 million.


Last quarter, management guided 2010 revenue to be between $185 million and $200 million.  I can only assume that these levels will be decreased after the patent reconsideration, but the big question is whether the market has already priced in the disappointment.  The current earnings consensus (which should include adjustments made after the patent news was announced) still has the company earning $1.30 this year – representing 7% growth over last year.

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With a stock price of $17.36, investors are only paying a bit more than 13 times forward earnings.  If you back out the roughly $4.80 per share in cash, the multiple would actually be below 10 – one of the most attractive prices investors have been able to buy TNDM at for since the stock started trading in late 2007.

Today’s market has been rewarding small-cap growth companies regardless of valuation risk.  Neutral Tandem certainly has its share of risk, but at the same time that risk appears to be fully calculated into the market price.  At this point, any unexpectedly positive announcement out of the patent office could have a significant effect on the stock.  If it turns out that TNDM has to compete more directly with Peerless, that will not likely be a huge negative for the stock because analysts already expect this to happen.

Following the announcement, TNDM shares have begun to rebound, and today’s trading puts TNDM above the 50 day average and back in line with where the stock was trading before the March 30 downgrade.  I expect the risk to be muted in the stock, and the current positive momentum could be the result of a significant rebound.  Even if the stock recoups just half of the loss from $34.56 to a low of $14.50, it would represent a rebound to near $25 – a healthy return for investors today.

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So as we wait for the earnings announcement on May 5, I would recommend picking up a starter position in the stock and potentially adding more shares if the announcement is well received.  TNDM is a strong growth company with a talented management team.  Regardless of the patent issue, the company should be able to grow earnings and continue innovation, strong customer service, and maintain a healthy and growing customer base.

Neutral Tandem Inc. (TNDM)

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

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Financial Reform Boost Exchanges

Financial Reform Boost Exchanges

IntercontinentalExchange (ICE)Thursday was an important day for financial exchanges CME Group Inc. (CME) and IntercontinentalExchange (ICE).  The action was hot and heavy as traders bid ICE to a new high for the year and CME shares traded to levels not seen since January.  Investors were betting that regulatory reform would push more derivative volume onto their exchanges – boosting revenue and profits for years to come.

Newsletter AdUp the street in Manhattan, the action was just as intense.  After calling bank executives “fat cats” and pinning much of the blame for the financial crisis on the leaders of financial firms (that’s a discussion for another day) Obama tried to bridge the gap, asking the industry to call off lobbying campaigns to derail the financial reform bill.

The meeting appeared to be civil…  No one threw shoes, shouted in anger, or spouted off to the media afterwards.  But the environment was relatively tense as the president attempted to sell his plan to a group his administration has painted as villains and irresponsible citizens.

Tension was also the theme in Washington as democrats and republicans struggled to come to agreements on the details of the bill.  With so many moving parts, and a sharp divide between lobby interests and public outcry against Wall Street, the bill will no doubt face challenges and multiple changes along the way.

Clearance of OTC Contracts


While changes will be made and the final outcome is still not a complete certainty, there will almost undoubtedly be provisions in the bill which require major financial institutions to clear a much broader portion of Over The Counter (OTC) contracts.  These contracts represent derivative agreements between financial institutions and historically have been out of the view of most investors.

Zecco Forex Online Foreign Exchange TradingCausing these contracts to be cleared would help to reduce the systemic risk associated with the potential for default, but introducing a third party (ICE or CME) to “guarantee” the trades between institutions.  Essentially, ICE and CME would require the institutions to put up margin for each trade and the exchange would keep that money segregated for settlement of the trade.  As the OTC contract moves against one of the parties, the exchange would require additional margin to account for the increasing risk.

So the business model for CME and ICE requires strict risk control, and an accurate understanding of the terms for each of these detailed transactions.  On the other hand, while the risk management is intensive, the clearance fees can be extremely lucrative which is why investors are sending the stocks significantly higher.

Critical Mass and Nimble Growth

If I had to choose between CME and ICE to invest in, I would have to side with IntercontinentalExchange.  The company has about 1/3 the market cap of CME but as an 8 billion dollar company, they still have enough critical mass to compete in the industry.  Remember, to guarantee the huge trades these investment bankers are engaged in, the clearance firms must have significant capital reserves.

Both companies have grown their businesses through acquisitions in the past, buying rival exchanges and purchasing the rights to design futures contracts on specific indices followed by managers.  The clearance market is now primarily a duopoly with any rival firms struggling to present the critical mass necessary to garner the required confidence.

ICE has always been known for its energy markets although the company has increased its product offering tremendously in the past decade.  The company has a strong reputation and has continued to grow its revenue base even throughout the financial crisis.  In fact, the financial crisis may very well have benefited the firm as sharply increased trading volumes as well as the need for third party clearance actually drove business.  I wouldn’t be surprised if we saw a similar environment sometime in the next 12 months…

Being a smaller firm, ICE can more easily pursue deals that would make a material impact on its bottom line.  International expansion is already underway, but ICE could certainly increase its presence in Europe, Asia, and in other evolving economies.  Expertise in agricultural products will also be a benefit as inflationary concerns along with a ballooning population will drive commodity trading.

Investors have to pay a bit more for ICE – which is currently trading at 21.5 times expected 2010 earnings.  But the strong growth, a management team that has proven its ability and desire to complete large deals, and a political environment that drives more business to the exchange should make the premium price worthwhile.

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The recent breakout will likely be just the start of a strong run for both ICE and CME.  Pullbacks can likely be bought as there will no doubt be some uncertainty surrounding the finance bill.  But over the next 12 to 18 months I expect to see a robust return on this investment.

IntercontinentalExchange (ICE)

FD: Author has long positions in client accounts

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Education Gets an Upgrade

Education Gets an Upgrade

Newsletter AdWednesday, many of the for-profit educational companies got a lift after Credit Suisse (CS) upgraded Devry Inc. (DV) and ITT Educational Services (ESI). The report basically stated that regulation changes for the industry are not likely to be as severe as originally expected and investors can now purchase these companies with better visibility for future profits.

The Department of Education recently submitted “Gainful Employment” proposed language to the Office of Management and Budget to estimate the costs of the new proposed language.  Credit Suisse expects this language to be submitted to the public by mid-May or at the latest June 1.  From that point there would be a comment period followed by enforceable regulation likely to start November 1.

At question is the issue of federal student loans to pupils enrolled in for-profit institutions as they pursue undergrad or graduate degrees.  Since most student loan programs are federally insured, the government has a vested interest in making sure these education programs are up to standard quality, and that graduates are able to perform well in the workforce (and therefore pay off their student loans.)


There have been widely circulated reports (including a cover story in Barron’s Magazine titled Leveraging Up to Learn) which claim that students who graduate from for-profit institutions are less likely to find gainful employment and more likely to default on their loans.  The negative press has caused investors to think twice before committing capital to for-profit schools and by extension, what used to be lofty multiples on these growth stocks are now actually attractive compared to expected earnings.

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If Credit Suisse’s analysis is correct, and these institutions end up facing less regulatory pressure, we could quickly see multiples on stocks increase as investors focus on the growth aspect rather than the risk dynamics.  Since risk seems to be ignored in nearly every other sector right now, I don’t have a hard time believing that traders could quickly jump on the educational bandwagon.

  • Devry Inc. (DV)Devry Inc. – Over the last four quarters, Devry has seen its revenue increase between 28% and 43% for each of the quarterly reports.  Earnings per share has been even more impressive with growth of 40% to 69% using year-over-year comparisons.The stock is trading at less than 20 times earnings even though analysts expect 53% growth in fiscal 2010 (the company’s fiscal year ends June 30) and another 24% in 2011.  A strong balance sheet with no debt should help to inspire confidence, and the stock just broke out of a consolidation on strong volume.  Buying near $70 could turn out to be a very attractive trade over the next three to six months.
  • ITT Technical Institute (ESI)ITT Technical Institute – The company has similar growth characteristics to DV, but a bit more of a leveraged balance sheet.  The most recent report showed a debt to equity ratio of 96% which is manageable as long as cash flow continues to increase.ESI is trading at a much cheaper multiple of 11 times 2010 estimates which could either imply a better value proposition, or less growth potential than DV.  Tuesday’s trade broke the stock out of a relatively healthy looking consolidation, but in early trading Wednesday the stock was giving back much of the gains.  I would recommend keeping ESI on the watch list and potentially buying once the stock rallies above $118 again.
Other Articles of Interest
Value Investing Versus Technical Trading
Why Zumiez Should Survive the Downgrade
Mish: Debt for Diploma Schemes
Forbes: Studying the Education Stock Charts

There are plenty of other education companies in the sector to look at – a few of which may actually offer better trading opportunities.  I’m lining up one of these trades for readers of the free ZachStocks Newsletter so make sure you’re subscribed and looking for the trade in the morning.  As always, manage risk carefully and know where your stops will be.  The industry is likely to trade much higher, but if my analysis is premature or even dead wrong, you want to have an exit strategy if the positions head south.

Devry Inc. (DV)

ITT Technical Institute (ESI)

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

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Posted in Featured, Long IdeasComments (0)

Calix Networks – When Valuation Doesn’t Matter

Calix Networks – When Valuation Doesn’t Matter

Calix Networks Inc. (CALX)It’s 1999 all over again!  In late March Calix Networks Inc. (CALX) completed its IPO, selling 6.3 million shares to the public at $13.00 per share.  The deal helped the company to raise roughly $50 million dollars and also allowed private investors to cash in on a portion of their holdings and receive a $26 million dollar payday.  Best of all, the stock was in high demand on opening day with a quick gap higher to $18.00 and an eventual close near $15 for a 16% return on the day.

Newsletter AdCalix Networks is a provider of communications equipment to what the company calls CSPs or “Communication Service Providers.”  The equipment helps telecom companies make better use of their networks, be they copper or fiber.  In the offering prospectus, the company laid out several issues that the products are meant to assist with.

  • Service Offerings – Calix products are able to help telecom companies offer a broader array of services to their customers.  Many networks were originally designed to only provide voice or limited data to customers.  The products offered by Calix helps to increase the number of services telecom companies can provide.
  • Capacity and Efficiency – With the demand for data increasing an exponential rate (think streaming media, video conferencing and other feature rich applications) telecom companies are seeing their networks strain to handle the traffic.  Calix products can help with this – allowing customers to upgrade networks at a moderate pace when capital is available.
  • Technology Flexibility – There are many different protocols and technological means by which voice and data flow.  Calix products allow networks to efficiently communicate with each other even when different or conflicting technologies are being utilized.
  • Customer Value – The end goal is to provide a value for CSPs technology that will allow for flexibility, lower costs and better returns on their capital expenditures.

While the business model certainly sounds respectable (and the company has already shipped 6 million “ports” to roughly 500 customers) investors are being asked to take a leap of faith.  The fact that the company has yet to post a profitable year has raised concern and will likely be discussed more as CALX continues to trade above its offering price.


Typically, I would agree with this discussion except for the fact that CALX appears to have a good shot of generating strong earnings in the next two years – if management can grow its business responsibly.  On top of the potential for fundamental improvement, we are currently in a very speculative market where traders are looking past fundamental barriers.  So when speculative issues rise, expect CALX to be one of the go-to names for generating higher returns.

The Fundamental Picture

Looking at the financial data from 2009, the company generated a gross margin of 33%.  So before covering expenses like R&D, Sales and Marketing and the catch-all General and Administration category, CALX actually turned a $77 million dollar profit.

Why gold will not make new highs or lows this year

Why gold will not make new highs or lows this year

Now assuming the company is able to generate 30-35% annualized revenue growth over the next two years, maintain a 33% gross margin, and keep operating expenses at a stable level, the company could come very close to reporting $1.00 per share in EPS for 2011.  If this were the case, CALX would likely see its stock trade at a multiple north of $20 – good for a 50% increase from today’s price.

I understand that this scenario may not play out perfectly.  Sales growth could be much higher or much lower.  Management will almost certainly increase operating expenses as the company grows.  But the company is at a very dynamic point where earnings are just beginning to turn positive (forth quarter EPS was positive $0.08 per share) and the actual dollar earnings per share could ramp up significantly in the next few years.

Other Articles of Interest

Explosive Growth Opportunity in Latin American


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FMMF: Calix Networks Up 20%
24/7WallSt: 3 IPOs in One Day

The stock is now trading just above the $13.00 IPO price and the reputations of Goldman Sachs (GS) and Morgan Stanley (MS) are on the line.  Trades could be initiated here with a tight stop below the IPO price as the brokerages will likely step in to support the deal if the stock gets close to this level.  Initiating a trade with a relatively small amount of risk and potentially large returns is a good way to initiate small trades at this time, and one could quickly increase position size as the trade moves into positive territory.

Calix Networks Inc. (CALX)

FD: Author does not have a position in CALX

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Posted in Featured, IPO, Long IdeasComments (8)

Why Zumiez Should Survive the Downgrade

Why Zumiez Should Survive the Downgrade

Zumiez Inc. (ZUMZ)There’s nothing more frustrating than holding a winning position only to have a Wall Street analyst downgrade the stock and cut your profits.  Subscribers to the ZachStocks Newsletter recently purchased Zumiez Inc. (ZUMZ) as it broke out to a new 52 week high, clearing a four week consolidation.  The trade was profitable until Thursday when the stock gave up ground due to a downgrade from two second tier research outfits.

Newsletter AdThe downgrades came on the heels of March same-store-sales which were released by many key retailers after the close on Wednesday.  The figures showed revenues for ZUMZ stores open over a year to be up 13.2% year-over-year.  The numbers were ahead of the published expectations as analysts had been projecting growth of 11.8%.  For the firm as a whole, sales were up 20% to 35.8 million – quite an impressive showing for a purely discretional apparel and sports equipment store.

I don’t necessarily disagree with the downgrades from a fundamental standpoint.  ZUMZ is currently trading at nearly 40 times expected earnings for 2010 – a premium price even given the attractive growth rate of the stock.  But despite the high multiple and the weakness of shares today, ZUMZ should quickly retake its bullish stance.  The reason rests with the current market climate and the power of momentum and speculative buyers.


Today’s investor is primarily interested in high beta names which are most likely to achieve oversized growth.  Individual investors whose accounts are still underwater from the peak value of two years ago, and mutual fund managers with a mandate to beat the S&P 500 are much less concerned with safety and anxious to capture as much exposure as possible.

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This type of trading environment usually favors the high-growth speculative names.  Since the retail and finance sectors have captured a good portion of the momentum trades, I expect these sectors to take a significant amount of bad news before they give up their relative strength.  Many investors watching the strength in these areas have been waiting for pullbacks in order to deploy more capital.  So with these buyers “waiting in the wings” the first pullback for strong retail and finance names will likely be bought.

Zumiez is likely to benefit from the phenomenon of Strategic Defaults.  As homeowners give up the burden of paying mortgages on properties that are worth much less than the liabilities, money is freed from constrained budgets and more likely to be spent on discretionary items.  So it would not surprise me to see Zumiez and other niche retailers post strong revenue trends in April and into the beginning of the year.

Only after the boost from strategic defaults has been fully accounted for will we start to see retail stock prices decline and in turn the fundamentals of the companies in question begin to wither.  (remember, the stock price nearly always precedes the fundamental change.)

Other Articles of Interest
Strategic Defaults Fuel Spending
Explosive Growth Opportunity in Latin American
24/7WallSt: Retail Business Daily
Forbes: Mall Stores Post Same Store Sales

The ZachStocks Newlsetter has a stop of $19.80 for our long position in ZUMZ.  If this level is hit, we will exit our position in the interest of risk control and save our capital for a better opportunity down the road.  But for the time being, ZUMZ continues to look healthy and I expect a quick rebound in the shares as investors support the discretionary retail sector.

Zumiez Inc. (ZUMZ)

FD: Author does not have a position in ZUMZ

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Explosive Growth Opportunity in Latin American

Explosive Growth Opportunity in Latin American

NII Holdings (NIHD)While the US economy stages what could be considered a “timid” or even “manufactured” economic recovery, Latin American economies appear to be in aggressive growth mode.  As a large portion of the population integrates technology into their daily lives, the demand for wireless service is growing.  And several healthy companies are hard at work building out these services.


Today we’re going to look at NII Holdings Inc. (NIHD) which is one of the smaller wireless carriers in South America.  With a subscriber base of 7.4 million, NIHD is dwarfed by rivals America Movil (AMX) and Telefonica (TEF).  But unlike its rivals, NIHD concentrates on a specific profitable niche of the wireless market – small businesses and corporate accounts.  So while AMX and TEF are appealing to the masses and collecting an average monthly revenue per user near $11.50, NIHD recently reported revenue of $45 per account – quite a difference.

Newsletter AdAs the Latin American demand for service grows, NIHD has made aggressive expansion plans and is actively increasing its rollout of 3G coverage.  Over the next year, the company expects to spend between $850 and $950 million to build out its network – the majority of this capital being deployed in Chile and Peru.  Analysts also expect the company to be an active bidder this spring when a large portion of wireless spectrum in Mexico is auctioned.

Opportunities with 3G spectrum encompass more than just the handheld phone market.  There is speculation that NIHD will eventually begin selling connections for laptops and even desktops as its business clientele begin to demand the ability to access data on more devices.  The potential for lucrative contracts for business data could provide additional revenue growth for the company – and for existing markets this would require little additional expense.

The metrics surrounding subscriber growth appear to be very healthy.  Over 2009, the company added roughly 1.2 million new subscribers and did this at an average “cost per gross add” of $271.  Since average revenue is $45 monthly per account, it only takes six months for the revenue to make up for the cost to acquire each new customer.  And NIHD’s churn rate is relatively attractive at 2.0% in 2009.  The trend actually looks favorable as the fourth quarter experienced only a 1.85% churn rate.  Satisfied customers lead to better margins – and it appears NIHD is keeping customers very happy.

Steve Dussek, CEO, NII Holdings (NIHD)We expanded our network to about 15 million additional people during the year, with most of that expansion in Brazil. We believe these investments will continue to enhance our brand and visibility, positioning NII to generate more profitable growth in the future. ~Steve Dussek, CEO

One of the biggest challenges for smaller wireless customers is the capital expense necessary to increase coverage.  On February 15th, the company announced that Grupo Televisia will invest $1.44 billion in cash to acquire a 30% stake in NIHD.  The additional capital will be instrumental as NIHD heads to the auction table for the Mexican spectrum.

Even before this capital injection, NIHD had a very attractive balance sheet with $2.5 billion in cash.  The debt level is high (at $3.49 billion) but with plenty of cash on hand, this is not a significant problem (especially considering the attractive cash flow from existing subscribers).

Other Articles of Interest
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IBD: NII Holdings Holding Its Own as 3G Looms
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In 2010, management is guiding investors to expect revenues of $5.2 to 5.4 billion.  NIHD is also expecting to add 1.275 million to 1.375 million net new subscribers.  Assuming these expectation are correct (and they are most likely conservative) shareholders could see NIHD continue its positive trend for months to come.

At $42.25, the stock is just off its 52 week high, but has a long way to go before reaching its 2008 peak of $57.05 or the all-time high above $92 logged in 2007.  And yet the company has higher earnings than during these speculative price periods.  Waiting for a pullback may be the wisest way to accumulate shares of this Latin America growth opportunity, but don’t expect the stock to pull back too much given the growth opportunities and management’s strong track record.

NII Holdings (NIHD)

FD: Author does not have a position in NIHD

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Posted in Featured, Long IdeasComments (6)

Chimera Raises Capital for RMBS Purchases

Chimera Raises Capital for RMBS Purchases

Chimera Investment Corp (CIM)It was a quick transaction and while investors were momentarily stunned, it appears that Credit Suisse (CS) pulled it off without a hitch!  Last week, Chimera Investment Corp (CIM) announced that it would sell 85 million shares of stock to the public and named Credit Suisse as the sole underwriter for the transaction.  Initially the stock traded sharply lower as investors feared dilution to their ownership of the REIT.  After all, CIM sold the shares at a price of $3.61 which was roughly 7% below the closing price Wednesday afternoon when the announcement was made.

ZachStocks NewsletterBut the current market is quite resilient and CIM managed to rally throughout the day and actually close higher – a strong sign of demand for the stock.  Investors obviously believe that CIM will be able to put the capital to work effectively and generate a profit on this new capital.  While management certainly could have borrowed the money and used its available leverage to purchase these securities, I am pleased that management opted for permanent capital rather than leverage which can wreak havoc when economic periods are difficult.

Investors in CIM are currently counting on the high dividend rate as their primary return for owning the stock.  Dividend payments are largely variable as they are linked directly to the operating earnings for each particular quarter.  But with a very low cost of capital, and meaningful cash flow from mortgage securities, CIM has been able to pay a dividend yield north of 15%.


While management states that their primary goal is to produce attractive dividends with capital gains as a secondary objective, I am much more interested in the potential for the stock to trade significantly higher.  As investors realize that the dividend payment is safe (which will likely happen as a function of the company continuing stable payouts), investors will be willing to pay more for this stable cash-flow security.


As demand rises, the price of the stock should trade significantly higher.  In this market, a yield of 6% or 8% is still very attractive, and if CIM traded up to a place where the yield was 8%, the price would be roughly $7.50 per share – good for a 92% increase (all the while, investors are still receiving the dividend payments)

I should note that the ZachStocks Newsletter has a pending position in CIM to buy once the stock breaks out of its current range.

The attractive dividend yield also functions to implement a floor under the shares because as the stock trades lower, the dividend yield only becomes more attractive.  Fund managers looking for attractive value will quickly zero in on the strong dividend yield and likely begin to place large buy orders.

Playing the devil’s advocate, Chimera could potentially come under pressure if mortgage securities take a nose dive. According to this Financial Times article, BlackRock Recently warned that banks would have to take losses on distressed mortgages.  There is speculation that now that the Fed has wrapped up its monumental program to buy mortgage securities, that the market for these assets could dry up.  And then there is the danger of write-downs as homeowners either cannot or will not (see the weekend piece on strategic defaults) pay mortgages on houses where they owe more than the home is worth.

Other Articles of Interest
Strategic Defaults Fuel Spending
Healchare Issues with Robust Growth
FT: BlackRock Warns on Distressed Mortgages
Ritholtz: Put Down Trade Spats

But even with these risks in play, CIM has already taken significant write downs on its existing non-agency mortgages and is carrying them at nearly 50 cents on the dollar.  It would take a very nasty economic reversal for these securities to be re-priced lower, and the potential for actual appreciation in the mortgage portfolio is good.  Now that CIM has additional capital to put to work buying attractive opportunities, the returns on existing and new mortgage holdings has the potential to even increase the dividend payment which makes the buying argument even stronger.

With such positive trading after what could have been perceived as a dilutive transaction, I have more confidence in this position.  Continue to look for opportunities to accumulate shares as management effectively invests and generates strong operating earnings.

Chimera Investment Corp (CIM)

FD: Author has a long position in Sound Counsel portfolios

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Profits Are EZ For This Lender

Profits Are EZ For This Lender

Ezcorp Inc. (EZPW)Times are hard for a large number of US consumers.  And Ezcorp Inc. (EZPW) is betting that there is difficulty in Mexico, Canada, the UK and Australia as well.  The company is a leader in the pawn shop / cash advance / payday loan market and is quickly expanding internationally.  With revenue growth between 34% and 44% for the last four quarters, it appears consumer demand is increasing as well.

Newsletter AdThe “collateralized and short-term non-collateralized loan business” as it is now being called has come under scrutiny as many consumer advocacy groups have issues with the business model.  And while I don’t condone predatory lending practices, there are certainly legitimate arguments that some of these businesses offer access to capital that would not be available to consumers otherwise.  I’ll leave the social issues up to the more qualified and instead look carefully at the investment merit for the business.

Currently, the expansion into Mexico and Canada appear to be generating strong revenue growth and time will tell whether partnerships to gain access to the UK and Australian marketplaces will pay off.  EZPW is showing impressive earnings growth especially considering the fact that the additional stores in Mexico are not actually contributing to earnings growth.  The new stores are profitable, but the expansion campaign is capital intensive with new store opening costs offsetting any existing store earnings growth.


It’s basically a story of reinvestment where the existing store profits have been paying for expansion plans – but once a material base has been built, the expectation is for Mexico to contribute substantially to EZPWs growth.  And after the first quarter announcement (EZPW operates with a Sept 30 fiscal year end) it looked like that growth was on track:

Joe Rotunda, CEO, Ezcorp Inc. (EZPW)In all segments of our business, we saw strong loan demand.  It appears that our broadened range of loan offerings provides solutions to customers’ cash needs…  With these strong ending loan portfolio balances, we are well positioned for a solid fiscal year. ~Joe Rotunda, CEO

Ezcorp is expected to earn $1.83 per share this year which represents 27% earnings growth over 2009.  Analysts expect 2011 to feature an additional 11% growth although it’s difficult to predict earnings that far in advance.  But looking at the fundamental landscape in North America, I would venture to guess that the consumer will continue to need the financial services and access to cash.

Currently the stock is near $21 which represents a multiple of 11.5 – hardly an expensive price for a company with so much growth.  The low price is likely a reflection of the regulatory risk as many expect the current administration to increase its oversight.  The risk is certainly real, but EZPW is doing a good job of diversifying geographically so that it won’t be devastated if it becomes much more expensive to operate in the US.

The upside of this risk is that if we get to a point in the near future where it becomes clear that regulation will NOT materially hamper profits, the stock could quickly trade to a multiple of 20 or 25 times earnings as investors expect substantially higher growth.

Other Articles of Interest
MaxLinear Off to a Positive Start
A Retail Powerhouse Falls Behind
ZeroHedge: Dodd’s Financial Reform Bill
FMMF: Pawn Shops Continue to Impress

With the stock having pulled back for a few weeks, and holding firmly above the 50 day average, it could easily become a target for momentum players who would want to see the stock break to new highs and maintain its positive trend.  The current consolidation gives us a good area of support and swing traders could place their stops just below $20 to manage risk.  With the potential to run $5, $10 or $15 higher and risk of just over $1.00, EZPW looks like an attractive setup to pursue after the long weekend.

Ezcorp Inc. (EZPW)

FD: Author does not have a position in EZPW

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2010 ZachStocks Recommendations – Q1 Update

2010 ZachStocks Recommendations – Q1 Update

Newsletter AdAt the beginning of the year I entered “round two” of a friendly stock competition with a few other financial websites.  The rules were simple:  Pick four stocks or ETFs which should do well in 2010.  Of course it’s difficult to buy anything December 31 and hold through the full year – especially in such a dynamic period with regulatory changes, shifting economic trends, and global imbalances.

But the exercise is always helpful in identifying investment themes and then following those expectations throughout the year to determine what adjustments need to be made, and which situations turned out as expected.  As I write a bit before the close on March 31, it appears that all four of my positions are up on the year (thank God for small victories) but at the same time, there are definitely some shifting themes that give me a different perspective on at least one of my recommendations.

So let’s take a look at the status of these four investment opportunities, and then consider following the links at the bottom to see how we stacked up against the competition…

The Blackstone Group L.P. (BX)The Blackstone Group LP (BX) – Liquidity has been increasing during the first quarter, simply meaning that investors are willing to make more speculative purchases and banks are slowly increasing the amount of capital they will lend out.  This is an improving environment for BX for two primary reasons.

  1. The appetite for new stocks allows private equity firms to issue IPOs to a market that is demanding speculative investment vehicles.  Every time BX turns out stock at a profit, it is able to realize a gain in one of its investment funds – usually initiating an incentive allocation (BX is often eligible to receive part of profits from funds it manages as payment for overseeing the investments)
  2. Blackstone is finding it easier to raise new capital (either from investors or debt capital) to pursue investment opportunities.  Rising AUM creates the potential for much higher incentive allocations down the road when those investments increase in value.

Blackstone currently pays a hefty dividend of 30 cents per share each quarter so our return for Q1 should reflect the additional capital investors received.  The dividend yield (roughly 8.5% annualized) is helpful in stabilizing the price of the stock because investors are likely to pick up shares for income – and the increased demand holds the price above a theoretical threshold.

So while the stock is only up about 7% from the 12/31 initial contest price (9.7% if you include the dividend), I expect gains to accumulate throughout the year with a reasonable chance that BX could eclipse $20 before the end of December.

Assured Guaranty (AGO)Assured Guaranty (AGO) – As we mentioned on 12/31, this financial insurer is the only major competitor with enough capital to continue to underwrite new business.  Management has proven their ability to navigate turbulent waters by staying away from dangerous mortgage securities that were the downfall of stocks like Ambac Financial Group (ABK) and MBIA Inc. (MBI).

In early March, AGO passed a significant test with the stock holding up well even though a large shareholder dumped several million shares onto the market.  This was not totally unexpected – the shareholder was Dexia which had received a large block of stock as AGO acquired Financial Security Assurance from the firm.  Now that Dexia is out of its stock, I expect AGO to trade sharply higher both due to its strong financial foundation along with the growth from new underwriting.

While it didn’t make sense for the company to participate in the mortgage mania during the boom years of 2007, the purchase of Financial Security Assurance now allows AGO to underwrite mortgage insurance in an environment where premiums are much more reasonable given the amount of risk taken.

Currently our position is only up 2.3% from the 12/31 close, but sometime during Q3 or Q4 I expect to tack on another 18% as traders test the 52 week high posted in November of 2009.  AGO is actually a pending trade in the ZachStocks Newsletter which has been revised to offer timely stock recommendations twice a week for active traders and investors.

IntercontinentalExchange (ICE) IntercontinentalExchange (ICE) – When we looked at ICE at the beginning of the year, it was expected that increased regulation in the financial industry would require futures trading to be “cleared” which means that a third party must manage the risk and guarantee the trade.  ICE and CME Group Inc. (CME) are the two primary exchanges with clearing functions and the capital to manage risk.

During the first quarter, the administrations focus has shifted to health care reform along with other policy issues.  Financial reform is still on the table, but media attention has waned and it is unclear just how much business ICE could gain as a result of the current political environment.

On the other hand, ICE is trading in a very healthy pattern, and on Wednesday it appeared to break out of a “cup and handle” base with the potential to move quickly towards the 2009 highs near $120.  A healthy market appears to be bringing in many participants who are trading ICE’s products although a bit more volatility might actually spur volume increases.

The stock is currently trading at what I would consider a “fair” value.  Without the regulatory reform, there is not too much that gets me excited about ICE for a short-term trade, but as a long-time follower of the company, I believe ICE is an excellent investment with a talented management team.  So to sum it up – I am leaning towards a luke warm opinion of ICE today and if you don’t currently own it, there may not be a strong argument for picking up shares at this juncture.

iShares Silver Trust (SLV)iShares Silver Trust (SLV) – While I am thankful to be sitting with a small profit on this trade, I am becoming less convinced that silver will be an excellent trade for 2010.

We have experienced a strong market run which indicates investors are willing to take risk and provide liquidity.  The government statistics (flawed as they may be) lead us to believe that an economic rebound is occurring.  And yet with all the government spending, we are not seeing large moves in gold and silver.  Inflation seems to be temporarily at bay.

Now I have to tell you that I don’t totally buy the “no inflation” argument.  There are just too many fundamental factors that should ignite an inflationary environment at some point along the way.  But if we were going to have a hyper-inflationary move, it likely would have occurred during the first quarter – in fact, we didn’t see any alarming statistical or market based evidence of this trend.

To be honest, I’m sitting back and scratching my head at this a little.  It’s not that I don’t understand how the argument against inflation, it’s just that I don’t agree with it!  But until the market actually begins to indicate that inflation is an issue, there will be more productive places for our capital.

So if you’re reading this today and you have a large position in SLV as a result of my recommendation, you should certainly do your own homework, but my recommendation is to close the position until we once again see signs that the market is focused on the demise of currency and the importance of hard assets.

That just about does it for this quarter.  Be sure to check back and view the other participants links.  We will review the picks again at the end of Q2.

FD: Author has long positions in stocks mentioned in Sound Counsel Investment Advisers portfolios

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Posted in Featured, Long Ideas, MarketsComments (4)

Healthcare Issue With Robust Growth

Healthcare Issue With Robust Growth

Intuitive Surgical (ISRG)Medical stocks have received more than their fair share of attention in the past few weeks as congress passed the health care reform bill.  While I see the bill as a major impediment to free commerce – Note AT&T Inc. (T) $1 billion dollar charge related to healthcare – there are still many medical companies which will continue to experience growth and opportunity in the coming years.  Best of all, some of these investments are trading at discounts to a “fair market value” due to concern over what healthcare reform will look like.

Newsletter AdIntuitive Surgical (ISRG) has put in a very strong performance with the stock up more than 250% since this time last year.  The company makes robotic equipment for Minimally Invasive Surgery (MIS) procedures and has expanded the number of procedures and the quality of service that physicians can offer patients.  The daVinci Surgical System employs cutting-edge (no pun intended) technology which is assisting surgeons around the world.

According to the company, the technology is changing surgery in three primary ways:

  1. The technology simplifies existing MIS procedures
  2. The technology makes difficult MIS operations routine
  3. The technology allows new MIS procedures to be possible

These changes have led to adoption of the system around the globe, and ISRG recently announced that Japan has approved the da Vinci system for use.  During the fourth quarter the number of procedures completed with the system rose by 44%.

Gary Guthart, CEO, Intuitive Surgical (ISRG)

Led by outstanding patient outcomes, robotic surgery adoption with patients and the medical community at large continues to grow. ~Gary Guthart, CEO


The primary case against investing in ISRG is the premium multiple.  Currently the stock is trading near $345 per share, while the company reported earnings of $5.93 in 2009.  This nets out to a historical PE of 58, certainly an expensive proposition.  But with the company expected to grow earnings by 31% this year and another  20% next year, the numbers start looking a bit more reasonable.

Is The US Dollar Reversing Again?

Is The US Dollar Reversing Again?

I expect that the current estimates for earnings growth may be light as analysts are rightfully concerned that ISRG will face pricing pressures as a result of the healthcare reform act.  But with growing international exposure and the expanding necessity of the company’s products, volume should more than make up for the potential pressure on margins.

While Intuitive has been successful in expanding its footprint and selling a large number of systems quarter by quarter, it’s even more impressive to see the stable base of renewable revenue the company is creating.  In the fourth quarter, instruments and accessories accounted for $113.3 million in revenue which was up 39% from a year ago.  On top of this, service revenue accounted for $47.8 million in revenue – and the two categories combined make up for roughly 50% of total revenue.

So as the installed base of systems grows, ISRG’s long-term revenue stream should continue to be healthy.  The additional revenue more than cover additional expense items associated with growth such as overhead issues like medical billing employees.

ISRG finished 2009 with cash of $1.172 billion and no debt.  The financial soundness allows for flexibility in pursuing additional growth strategies.  Intuitive could easily purchase an ancillary business with attractive products it could cross-sell to its growing client base of surgeons and facilities.  The capital can be used for R&D to develop a new line of complementary products.  Or the capital could be returned to investors through dividends or stock repurchases (although I would prefer for management not to buy stock at the current high price)

Other Articles of Interest
Home-Based Healthcare is Good Business
Tenet Healthcare – Potential Breakout
Barron’s: Healthy Outlook for Synovis
WSJ: Surgical-Device Firms Walk Fine Line

 

So with the broad equity market still showing strength, it makes sense to buy strong growth companies with the potential to continue to generate improving numbers.  The recent pullback offers a good entry point where traders could set a stop point near $330 or so and risk $15 with the potential for much higher gains.  If stopped out, investors may want to keep this name on their radar as the fundamental strength of the company should eventually lead to another strong run in the stock.

Intuitive Surgical (ISRG)

FD: Author does not have a position in ISRG

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