Berk Sure Has A Way

Is Demand Media (DMD) another case of great company but a terrible stock?

If you bought at the IPO or are otherwise able to sell your shares, I would recommend selling. It may go higher, but more likely it will go much lower.

Full Article here:

Demand Media – Overvalued?

Going forward I will be publishing my full articles at SeekingAlpha. My page there is: http://seekingalpha.com/author/kevin-berk/articles

Last week I attended the Value Investing Congress in New York.  The speakers were top notch and the presentations were very engaging.

I enjoyed hearing the speakers’ discuss their investment processes.  Lloyd Khaner’s talk on turnarounds was very well done.  Also, various presentations on the continued weak state of the housing market were very informative.  Overall, the tone was pretty bearish on the economy and the markets.  Many of the presenters professed concern about overvaluation but projected a sense of “the show must go on… so here are my stock picks.”

I agree that the markets feel stretched based on the woeful state of the consumer but some of the picks are worth watching.  Some longs do go up when markets go down.  Even better is to pick up great stocks on sale if the market does turn down again.  My favorites of the conference were:

Small Cap Long Ideas – Risky companies

IRDM – Whitney Tilson and Glenn Tongue presented an interesting pitch for Iridium (yes, the formerly bankrupt satellite phone company that used to be a punchline!).  According to Whitney and Glenn, Iridium has an unrivaled set of assets (satellites and services).  Iridium reaches 90+% of the globe has no cell towers (e.g. ocean, dessert, mountains).  The company was purchased by a SPAC a year ago on favorable terms.  Non-voice data services are growing dramatically and the voice business is growing nicely.   The bear case on IRDM is that they plan launch a new constellation of satellites starting in 2014.  Whitney and Glenn believe that IRDM might be about to launch it without borrowing funds.

CORE – Kian Ghazi provided a detailed bull case for Core Mark, a convenience store distribution player.  CORE is the number two operator behind Mclane (a Berkshire company).  Kian claims that while distribution may not be a sexy business, it can be a defensible one if the following conditions are met:  high route density for drop-offs, highly fragmented, high switching costs and small drops with lots of stops.  In his opinion, CORE
benefits from all of these.  His bullish case for them rests on an emerging part of their business:  fresh food (prepared fruit cups, sandwiches, etc).  This high margin, high growth business should more than offset the secular decline in low margin cigarette business which is a big part of CORE existing revenue.

Mid / Large Caps Long Ideas – Safer, less risk of massive downside

CXW – Bill Ackman sparked a rally in Corrections Corp when he revealed he owned a 9+% stake (which hadn’t been publicly disclosed yet).  His pitch was funny and well thought out:  CXW is largely an inexpensive, safe real estate play with extremely creditworthy tenants, secular growth and room for market share gains.  He claimed that private prisons operate more effectively than public ones on many levels and that the trend will be towards privatization (especially for new prisons).   The stock probably won’t double but he thinks it has upside to $40-50+.

LH – Zeke Ashton laid out the case for Labcorp, the number two provider of laboratory testing behind Quest Diagnostics.  The growth rate of the company is high, the industry pretty defensible.  The only issue is a biggie though – healthcare reform.  The lab testing business has been bandied about as a rich target for cost cutting, but Zeke thinks that the concerns here are overblown.  There may even be a scenario in which LH and Quest benefit from expanded coverage and testing.

Shorts – Proceed with caution

ITB – Whitney Tilson presented the housing stock ETF as a short based on an updated version of his voluminous housing “head fake” presentation.  It lays out a compelling story that housing has not yet bottomed because of shadow inventory (7 million homes in various stages of delinquency and foreclosure), option-ARM exposure peaking in 2011, a stretched consumer, removal of stimulus and the eventual rise in interest rates.  His take was that there are more than enough homes for those that can afford to buy them and that the housing companies should basically build nothing for years.

O – Bill Ackman spoke briefly about shorting Realty Income – the “monthly dividend company”.  This is a company he has previous criticized for having risky tenants who have done sale-leaseback transactions with Realty Income.  He expects that the company will have a radical valuation readjustment once the market realizes that the dividend is not safe.   The company does a lot of shareholder marketing focusing on the dividend and if (when, according to Ackman) O sustains credit losses in its weak portfolio they will need to cut the dividend.

Overall, the conference was very interesting.  The slides from all the presentations were available after the conference as well.

Disclosure:  I do not
have positions in any of the stocks mentioned in this article.

Silicom (SILC) makes components for specialized servers and application appliances.  Part of their business serves the still growing WAN optimization market (see RVBD and BCSI), part of their business provides commodity products and an emerging part is providing new products to move SILC up the value chain.

Margin of safety.  Normally, a micro cap provider of commodity electronics would not excite me… but check out these financial stats:  Market cap of $49.1 million ($7.22 a share), $40 million in cash in the bank ($5.88 a share), enterprise value of $9.1 million ($1.40 a share), TTM earnings of $3.7 million ($0.56 a share).  EV/Earnings – 2.5!   Compared to the potential (e.g. $1.02 a share in 2007), it is conceivable that SILC could earn more than its EV in a single year (e.g. 2010 or 2011).

Profitable during the crisis.  While many companies have been taking big hits to earnings during the ongoing crisis, SILC has remained profitable.   Admittedly, visibility is very low and revenue has suffered but they continue to sign up new customers — including a tier 1 manufacturer.

Catalysts.  The SILC Q2 earnings report is on Monday July 27th – a positive report would be a catalyst for the stock.  Downside is mitigated by the $6 a share in cash, and upside could be quite large if the company shows revenue and earnings growth in the quarter.  Other potential catalysts include new analyst coverage, potential for share buybacks, new customer announcements and new products.  Lastly, the company’s founders, the Zisapel brothers, currently own almost 30%of the company.  They may continue to buy more stock or buy out the company completely.

Risks:

• Q2 could be a disaster – the economic environment has been bad, bad, bad

• Commodity producer – may need to lower prices or risk losing customers

• SILC would be a victim of US Dollar weakness or Shekel strength

• Micro cap stock – extremely low liquidity – don’t invest if you need the money

Bottom Line.  SILC is a very speculative investment with a good risk to reward profile.  It could dive below $6 (as it did in October of last year), but should recover to cash in the bank quickly.   I would not expect to hold this for the long term, but rather until the price becomes more in line with the company’s assets and performance.

Disclosure:  I am long SILC at the time of this writing – 7/22/09

Research In Motion, the makers of the Blackberry, has lowered guidance on Q4 subscribers not once, but twice.  The main explanation was that uncertainty around the NTP patent has delayed purchases.  I am gonna have to call bullsh*t on that excuse.  I am sure some corporations and government agencies did put off purchasing, but I doubt it was the whole source of the shortfall.  I think that companies are increasingly looking at Blackberry competitors for viable alternatives: Good Technology, Microsoft, Visto, etc.  Also, it is problematic that over two thirds of RIMM’s revenue comes from hardware sales – would Palm be a better play in that arena?

Interestingly, even with the huge Q4 miss RIMM pre-announced this month (slyly done the same day as the NTP patent resolution),  analysts have not lowered expectations for the May Quarter for RIMM.  I suspect RIMM is going to lower subscriber, revenue and earnings guidance for Q1 2007 (May) when they report on April 6th.  I’ve been burned shorting RIMM before, so this time I purchased in-the-money puts that expire in April.

BTW, I use a Treo 650 with Chatteremail and push-IMAP.  I used to use Good Tech when I worked at a corporation.  Both are better (and cheaper) than Blackberry.

I own puts on RIMM shares and calls on PALM.

[Post updated to add external links, my phone preference, PALM disclosure]

Intel is unloved right now.  AMD is kicking its butt on the low end and making inroads in high end chips.  Inventory is building up in the channel, margins are compressing, and analysts are downgrading the stock.  Intel’s stock has made very little progress in the last nine years.   However, on a PE basis INTC is cheaper than it has been since 1996. It is trading at below a 15 PE – even less if you back out its cash.  INTC has over $10 billion in net cash and is actively buying $25 billion of its own stock.  The dividend is 2%.  Apple is using Intel chips (and gaining share).  Windows Vista is about to be released which could drive a new upgrade cycle in PCs.  Intel’s competitive troubles with AMD may take longer to sort out, but INTC has the resources and infrastructure to out-innovate AMD.  AMD may be ahead on performance, but Intel is pulling ahead in price-performance, power consumption, and smaller chip-making infrastructure.  Intel is expanding via consumer electronics (with VIIV), NAND memory (a JV with Micron), and mobile chips (with XScale).

In short, Intel is a contrarian play.  Sure, it could get worse before it gets better as AMD continues to steal share and the inventory backlog gets worked out.  But with INTC buying back shares, you should rejoice if the price keeps declining – you and Intel can buy more for less.

Is Asia the Fountain of Youth?  My take is that Asia presents the greatest opportunity for Intel. Intel CEO described China as the fountain of youth for computing. China, India and the rest of Asia comprise an opportunity more than twice the size of the current developed world over the coming 20 years.  With less than 10% of each country online and likely less than 5% with computers, the long term opportunity is huge.  It is my belief that almost every household in the world will have a computer at some point (just like TV’s in the US today). Heck, even Russia has a computer penetration of only 20% according to BusinessWeek.

Will Desktop Linux and OpenOffice remove the Microsoft software tax?  In more price sensitive foreign countries, a computer fully loaded with Microsoft software could be prohibitively expensive.  As free open-source alternatives to Microsoft’s products become viable for third world consumers, prices of computers with pre-installed software will drop (Microsoft will likely drop their prices in these countries too).  Fortunately for Intel, every computer still needs a processor!  Admittedly, many of these processors may be on the low end, but there will be a spectrum of demand.

Currency play? Asia’s share of Intel’s sales is now 60% and growing – they are selling to the manufacturers.  Given that Asian currencies are expected to strengthen over the next decade as China’s currency policy allows for floating, Intel’s stock could be a very smart bet on strengthening Asian currencies.  As Asian currencies strengthen, Intel will get a boost to dollar denominated revenue and profits. Intel does hedge currency fluctuations for 12 months forward, but over the medium to long term, they should benefit tremendously.

Disclosure: I am long INTC and MSFT.  I also own calls on MSFT.  I was recently long AMD but have almost sold out of my position (all I have left is spoken for via in-the-money covered calls).

I’ve been silent on MCHX for a while (been busy with a new baby), but I have another interesting post coming up soon!   In recent news, however, Marchex released earnings last week and have seemingly continued to convince investors that they are a growth business.  While their direct navigation top-line growth was intriguing (see marketing analysis below), I still contend that Marchex is overvalued and their stock price will correct.  Below are some of the red flags from the press release and conference call.

• 117% or 35%?The press release (and the business press too) proclaims that revenue was up 117% for the year.  However, if you look deeper, you can see that pro forma revenue (including all the acquisitions) was only up 35% for the year and a even smaller 27% Q4 over Q4.  Revenue growth is not robust and is decelerating.  For the businesses MCHX started the year with (Enhance, Goclick and Trafficleader) revenue was up only 9% Q4 over Q4 – going from $15.1 million in Q4 2004 to $16.4 million in 2005.  The Q4 over Q3 was a paltry 2% in those businesses – what happened to the famous Q4 bump? See my posts on their slow growing old businesses and lack of overall organic growth.

• High PE with modest growth?  Pro forma revenue is projected to grow 19-27% from 2005 to 2006 ($105 mil growing to $125-133 mil).  That is pretty low growth rate for a company trading at EV/FCF ratio above 50.  If you take Q4 on a run rate basis (4x 29.8 mil = $119.2 million), growth will be in the 5-12% range – hardly the growth rate of Google or Yahoo.  Theoretically, it should be easier to grow a business off the smaller revenue base that MCHX has.  See my post on their cash flow ratios.

• One million shares of dilution!  Another quarter and another million shares in dilution.  Shares outstanding went from 38.3 to 39.3 million from Q3 to Q4.  That is over $20 million in value dilution.  Marchex didn’t even have $30 million in revenue yet shareholders suffered over $20 million in dilution.

• Eye-popping marketing growth!  Q4 sales and marketing expenditure skyrocketed by 261% year over year and 59% over Q3.  Marketing as a percentage of reported revenue has doubled from a recent 7.3% to 14.7%.  If you look at the businesses they acquired this year, the numbers are even more dramatic with marketing as a percent going from basically nothing to 22.4% of revenue from new businesses.  Management has indicated that they have been purchasing sponsored listings to drive traffic to their direct navigation domains.  This arbitrage window should close as CPCs rise on the terms MCHX is buying.   Is MCHX basically buying short term revenue growth?

I own puts on Marchex shares at various prices.