Archive: December, 2007

PLT: Plantronics Turnaround May Present Value

The following is a reprint of my December 20, 2007 RealMoney column

I have long complained that Plantronics’ (PLT) increasing exposure to consumers was nothing but trouble. If lower margins and higher advertising costs weren’t enough, the fact that the consumer part of the business was dragging down overall growth was the icing on the cake.

The company was cleaning up its act earlier this year, and the shares rallied as a result. But an earnings miss in October and a downgrade by JPMorgan (JPM - Annual Report) have robbed stockholders of the entire year’s worth of gains.

Once again, the main culprit is the consumer business – specifically the Audio Entertainment Group (AEG), which was formed through the company’s ill-advised purchase of Altec Lansing. Through the six months ended September 30, that segment’s sales were just $43 million – down from $63 million in the same period last year.

In addition to the AEG, the company continues to struggle with more intense competition in the mobile headset business. One reason for the JPMorgan downgrade was that channel checks indicate the company is losing share of Bluetooth headsets to Motorola (MOT - Annual Report) and Nokia (NOK).

Finally, inventories continue to be far too high for my comfort. They have more than doubled over the past couple of years compared to a cumulative sales increase of just 42%. It isn’t the situation one wants to have in a slowing economy, especially in the face of competitive pressure.

The Good News

There are still a few reasons for optimism, though. For one thing, the drop in AEG revenues means it now accounts for less than 12% of the total business. Even if things continue to deteriorate, the incremental impact will be less likely to weigh on the total company.

Furthermore, the company took action to try and prevent such deterioration. Last month they announced a plan to close and/or consolidate a number of facilities as part of a strategic initiative to lower costs. They are also trying to design fresher products that consumers may actually want to buy, but those aren’t expected until next Christmas.

One good thing that could come of the restructuring in the short term would be a disruption in manufacturing. Though this doesn’t sound good at first blush, it would give the company a chance to work down those inventories.

Not a Bad Value

Shares are trading at less than 17x the consensus estimate for the fiscal year ending in March, and just 14x the estimate for March 2009. Unfortunately, given the recent news it is likely both sets of estimates will come down over the next few weeks.

The 9.9% consensus analyst estimate for 5-year growth is less than the company’s sustainable growth rate based on ROE. This means if growth is less than expected the company should be able to compensate by raising the dividend or buying back shares.   On a price to book basis, I think the current multiple of 2.2x could increase. Combined with the growth potential, a valuation expansion could lead to double-digit gains for the stock.

Over the last 12 months Plantronics generated $79 million in free cash flow. If anything, I think this could improve if the company gets a grip on its inventory levels and production capacity. The current FCF/EV yield is fairly attractive at 6.3%, which provides a decent margin of safety while waiting for the growth to materialize.

Although I like the valuation and believe there is cause for optimism, the stock has whipsawed lately due to numerous analyst upgrades and downgrades. Investors willing to take a chance on it would want to pick their price carefully.

Writing puts may also be an effective strategy here. As I write this, the February 25’s are trading at $1.10, offering a potential 4.5% 1-month return on the money risked and an effective purchase price of $23.90 in the event of further market declines.

Topics: Communications Equipment, JPMorgan Chase (JPM), Motorola (MOT), Nokia (NOK), Plantronics (PLT) | No Comments

My Picks for RealMoney are Off to a Good Start

This article is a reprint of my December 19, 2007 RealMoney column.

An Update of My September 2007 Stock Picks

  • My picks in September had winners and losers, but fortunately more of the former
  • Closing out my bearish stance on Office Depot (ODP)

I wrote six articles in September that included a bullish or bearish stock opinion, and with three months behind them I thought it was a good time to see how they performed and whether any changes were warranted. On the whole, the picks are playing out more or less as planned.

Motorola

On September 10, I wrote that if Motorola (MOT - Annual Report) could get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there Motorola shares would be worth nearly $23.

Instead, the cash flow position has continued to deteriorate, contributing to former CEO Ed Zander’s recent ouster. The stock is down 7.2% since the article was written, compared to just a 0.5% decline in the S&P 500.

Still, I think the issues at Motorola can be fixed by bringing the costs – particularly research, development and overhead – in line with the current revenue generation. Alternatively, activist shareholder Carl Icahn could push to break the company up into smaller pieces that might be acquired for a higher total than the current company is currently able to garner. Either way, I’m sticking to my guns on Motorola.

Yahoo

On September 11 I made a bearish call on Yahoo! (YHOO), saying I didn’t believe in the consensus growth estimates and that Yahoo isn’t generating enough cash flow today to make waiting for the recovery worthwhile — at least not for me.

Things haven’t gotten any better since then, and the stock has lost 1.1% – although that is a slightly better performance than the 1.7% loss in the S&P over the same period. I remain bearish on Yahoo.

Office Depot

On September 12, I made a bearish call on Office Depot (ODP), saying “things are likely to get worse before they get better.” Things got worse, and after the company missed earnings and delayed filing its required 10Q the stock has lost 23.3%, compared to a 1.7% decline in the S&P 500.

But I also said “it looks like a stock that will pay off in the end,” and I think the current downturn may have taken the worst out of the stock. I have written put options against the shares (a bet that has lost money) and I think there are more reasons to be positive than negative.

Think the worst of the housing downturn is over? Office Depot’s solid cash flow should make it a safer play than homebuilders or financials. Think small-business tech spending will rise? Office Depot’s P/E is a fraction of Dell’s (DELL).

Office Depot could still have some downside, and I don’t expect a quick recovery. But at current valuations I can no longer justify a bearish position, so I’m closing out that call.

Delta Airlines

On September 17 I made another bearish call, this time against Delta Airlines (DAL). Although the stock looked cheap, after I made some adjustments for earnings quality it looked more like a company recently emerged from bankruptcy (which it is.) The stock has lost 17.7% since that call, compared to a 2.1% decline in the S&P.

Short term, anything can happen as airlines have tons of leverage that can lead to wild swings in profitability in pricing. But long-term I don’t think the major airlines have any better prospects than they did before the previous 10 or so bankruptcies, and I remain bearish.

Apple

I weighed in favor of the bulls for Apple (AAPL) on September 17, and was rewarded with a 32.5% increase in the shares, compared to the 2.1% loss for the S&P 500. The share gains cut Apple’s 3.9% free cash flow yield down to 2.9%, so it isn’t the value it was then.

Still, the cash flow rose 250% from the prior year, and Apple’s market share remains small for most of its product lines. The company continues to make desirable products, and if I have to take a chance on a tech name surviving an economic downturn it might as well be Apple.

Adobe

My last September stock pick was a bullish call on Adobe (ADBE) on the 18th. The stock always seems to sell off after a major product introduction such as the Creative Suite launch in May of this year. Investors tend to sell on that news after buying up the shares in anticipation of it.

Although the sell-off wasn’t very pronounced this year, the shares did get stuck in neutral. My own call may have been a bit early, as the shares are down 6.3% since the article and the S&P is only down 4.9%.

On their earnings call, the company reiterated their guidance for next year. As the next product cycle moves closer, I think my bullishness will pay off.

Disclosure: William Trent owns shares of Adobe (ADBE) and has written naked put options against the shares of Office Depot (ODP).

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: Adobe Systems (ADBE), Advertising, Airline, Apple (AAPL), Communications Equipment, Computer Hardware, Delta Air Lines (DAL), Motorola (MOT), Office Depot (ODP), Retail (Specialty), Services, Technology, Transportation, Yahoo! (YHOO) | No Comments

Baa/Treasury Spread Continues to Widen

I often take the pulse of risk tolerance by looking at the corporate/treasury risk premium, which is calculated on a daily, weekly and monthly basis by the Federal Reserve. (Specifically, I compare the Baa Corporate bond rate to the 10 year Treasury Constant Maturity.)A lower spread is positive for the economy and for corporate earnings, as it means companies don’t have to pay as much (relative to riskless treasuries) to borrow money that can then be invested in profitable opportunities. In effect, it lowers the bar as to what makes for a worthwhile investment. A low spread has a mixed message for stock market investing – good for earnings/economy per above, but means investors are being paid less to take risks.

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The current spread is nearly as high as that of the 1998 Russia/LTCM crisis. The truly big investing opportunities (the telecom bust, the 1987 crash) usually offer spreads above 300 basis points.

Topics: Risk Premia | No Comments

DBD: Diebold and Diebeautiful? I Don’t Quite Think So

The following is a reprint of my December 13, 2007 RealMoney column.

Diebold (DBD), the maker of ATM machines and much-criticized automated voting machines, never seems far from controversy. It also has developed a habit over the last ten years or so of its share price swinging wildly back and forth between the $30’s and $50’s every couple of years. With the pendulum now back at the low end, traders may be tempted to hop on for the ride. Investors, however, should probably look elsewhere.

The Latest Controversy

Diebold topped out at $54.50 in late July, when it announced it would miss the deadline for filing its 10Q for the June quarter “while it seeks guidance from the Office of the Chief Accountant (the “OCA”) of the Securities and Exchange Commission with regard to its revenue recognition policy.”

After receiving said guidance, Diebold announced on October 2 that it would cease using the “bill and hold” method to record sales. The company helpfully added that:

The change in the company’s revenue recognition practice, and the potential amendment of prior financial statements, would only affect the timing of recognition of certain revenue. While the percentage of the company’s global bill and hold revenue varied from period to period, it represented 11 percent of Diebold’s total consolidated revenue in 2006. The company does not anticipate that the change in the timing of revenue recognition would impact previously reported cash provided by operating activities or the company’s net cash position.

Diebold will provide further information once it has completed an in-depth analysis of the most appropriate revenue recognition method and has reviewed it with its independent auditors and its audit committee. While the company cannot predict with certainty the length of time it will take to complete this analysis and review, it anticipates the process will take at least 30 days. Upon completing this process, Diebold will be in a position to provide updated revenue and earnings guidance for the full-year 2007.

At least 30 days later, the company announced its September quarter 10Q would also be delayed, as it is “in the process of determining the most appropriate method to replace its bill and hold practice, and has sought additional guidance from the OCA.”

Bill and Huh?

For the uninitiated, an SEC document describes what they are looking for:

Improper accounting for bill-and-hold transactions usually involves the recording of revenue from a sale, even though the customer has not taken title of the product and assumed the risks and rewards of ownership of the products specified in the customer’s purchase order or sales agreement. In a typical bill-and-hold transaction, the seller does not ship the product or ships it to a delivery site other than the customer’s site.

Diebold’s revenue growth rate in 2007 was 12.3%, and may have been mostly due to this questionable revenue recognition practice (as bill and hold sales were approximately 11% of total revenue in 2006.) Furthermore, since half the recorded revenue was service-related, the actual product sales may have even declined year/year.

Diebold’s chief rival, NCR (NCR) has noted that the upgrade cycle for ATM machines is in a lull. This is before any potential spending cutbacks by banks needing to conserve cash in the wake of the subprime crisis. It is hard to imagine the revenue growth getting much better.

Somebody Buy Them A Clue

As for “the most appropriate method to replace its bill and hold practice,” I don’t see why the company requires additional guidance from the OCA. They should recognize revenue when the customer accepts delivery of the product or service in question. In their own 10K they tell investors “for product sales, the company determines that the earnings process is complete when the customer has assumed risk of loss of the goods sold and all performance requirements are substantially complete.”

The fact that the company needs additional guidance when its own 10K describes the appropriate policy is troubling. Just as the previous CEO’s massive fund-raising activities for one political party cast doubt on the company’s objectivity when providing election equipment, the company appears to keep making mistakes that should be easily avoidable.

Shares are No Bargain

Now, just because the company keeps shooting itself in the foot doesn’t mean its stock is overpriced. Down 40% from the recent peak, it is worth asking whether the bad news is all priced in. Unfortunately, I don’t think it is.

For one thing, the stock is trading at 26x the 2006 earnings per share. Those are the most recent earnings figures available since the company is late filing its reports, and even they are likely to be revised lower following the restatements. The existing 2007 and 2008 consensus EPS estimates are most likely wishful thinking.

So how about cash flow? After all, as the company points out, changing from the bill-and-hold method shouldn’t affect the reported cash flow from operating activities. Measuring free cash flow as cash from operating activities less capital expenditures, the $206 million in 2006 free cash flow represents an 8% yield on the current enterprise value. I would normally consider such a yield worth pursuing.

The problem is, I don’t think that cash flow is sustainable. A good chunk of it was due to the company reducing working capital, a strategy that can be taken only so far. I peg the sustainable rate of cash from operations at about $90 million less than was reported, and I also have questions about the rise in “certain other assets.”

Making these adjustments, the free cash flow starts looking more like $80 million, for a yield of just 3.1%.

With the financial statements raising more questions than answers, likely slowing and the valuation mediocre at best, Diebold looks like a stock to avoid.

William Trent currently has a short position in put options related to Office Depot (ODP).

Topics: Computer Services, Diebold (DBD), NCR (NCR), Office Equipment | No Comments

LXK: Does Lexmark The Spot at Current Levels?

The following is a reprint of my December 12, 2007 RealMoney column

Printer manufacturer Lexmark, Inc. (LXK) started out this year at $73 and hasn’t looked back. Unfortunately, its motion has all been to the downside. Now less than half the stock it used to be, is it time to consider a nibble?

The stock is certainly cheap enough. Not only is it trading at a mere 12x expected earnings, $6.60 of the $34.50 current valuation is literally cash in the bank.

Over the last 12 months, Lexmark has brought in cash from operating activities totaling nearly $500 million and used less than $200 million for capital expenditures, resulting in free cash flow of $309 million and a FCF/Enterprise value yield of 11% – a very juicy premium to the current Treasury yield.

Of course, any juicy reward is bound to come with some risks, so let’s take a good hard look at those.

Second Fiddle

Even before Hewlett Packard’s (HPQ - Annual Report) recent resurgence, Lexmark was a distant runner-up in the printer business. Lexmark countered this position by forging an alliance with Dell (DELL) under which Lexmark makes all of the Dell-branded inkjet printers and half of their laser printers. Unfortunately for Lexmark, they inked that deal just in time for Dell to start its own tailspin.

Then, even if Hewlett Packard were to falter there are plenty of other competitors in the wings. First there are the traditional rivals like Seiko Epson (SEKE.Y) and Canon (CAJ), and Brother (BRTHY). Then, converging technologies have made competitors out of Ricoh (RICOY), Xerox (XRX), Samsung, and Kyocera Mita (KYO).

Declining Business

Everyone knows that obsolescence is a key risk for technology companies, and Lexmark is currently feeling the pain of the industry’s ongoing shift from inkjet to laser technology. I’ll let Lexmark explain it themselves (courtesy of the latest 10Q filing:)

Lexmark believes it is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. The Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales reflecting the Company’s decision to focus on more profitable printer placements, a mix shift between cartridges resulting in a higher percentage of moderate use cartridges and the weakness the Company is experiencing in its OEM business. Additionally, Lexmark expects to see continued declines in OEM unit sales, aggressive pricing and promotion activities in the inkjet and laser markets….

As the Company analyzes the situation, it sees the following:

  • Some of its unit sales are not generating adequate lifetime profitability due to lower prices, higher costs and supplies usage below its model.
  • Some markets and channels are on the low-end of the supplies generation distribution curve.
  • Its business is too skewed to the low-end versus the market, resulting in lower supplies generation per unit.

Cheap Enough?If the risks haven’t sent you running for the hills, you are probably wondering whether the current share price is cheap enough to justify taking those risks. With the prospects for a decline in sales, earnings and cash flow being more than a distinct possibility, any price paid is going to have to be justified for a declining business.

The traditional valuation model says that value is equal to the cash flow in the coming year, divided by the difference between the company’s cost of capital and its growth rate. The 11% free cash flow yield I calculated above is a version of this model, and it provides the denominator in the equation: lexmark’s return, less its growth rate, should equal 11%.

Since the growth rate is negative, the return will be something less than 11%. If the current declines of approximately 3%, the implied return works out to 8%. That probably doesn’t sound like a huge payoff for many investors, but it is still a nice premium to Treasuries. Depending on the outlook for the rest of the market, value investors might find it worth a shot.

Topics: Brother (BRTHY), Canon (CAJ), Computer Hardware, Computer Peripherals, Dell (DELL), Hewlett Packard (HPQ), Kyocera Mita (KYO), Lexmark (LXK), Office Equipment, Ricoh (RICOY), Seiko Epson (SEKE.Y), Xerox (XRX) | 1 Comment

CRDN: Considering Options on Ceradyne Again

The following is a reprint of my December 11, 2007 RealMoney column.

Ceradyne (CRDN) develops, manufactures and markets products based on highly technical ceramic materials. It is best known for selling ballistic plates used for body armor and light-weight vehicle armor by the U.S. military. Such sales accounted for more than 75% of total revenue during the last several years.

Much of that time, shares of Ceradyne have appeared very cheap on a price/earnings basis. Persistent fears that the body armor market would peak have kept a lid on the price. As an example, in October provided guidance for next year’s earnings per share of $5.60 – $6.65. Such a wide range would normally not be much help, but in Ceradyne’s case it means the stock is trading somewhere between 7x and 8x next year’s earnings.

Although I like a cheap stock as much as anyone, I too have been concerned that the military orders would peak. Although the company is expanding into other areas, it will be several years before any of them is likely to offset a potential decline in military sales. As a result, I have taken a very cautious approach to Ceradyne over the last couple of years.

Because of my caution, I missed the run from $50 – $80 per share over the last 12 months. But I also missed the run from $80 back down below $50. In the meantime, I still managed to earn $16 per share on CRDN – after transaction costs – mostly by doing my best not to have a position in the stock.

The really good news is that I think investors can once again profit from a relatively low-risk approach to Ceradyne. Here’s how it would work today.

Selling Options

If you don’t own Ceradyne today, you would sell a put option forcing you to buy the shares at a specific price on a specific date if the shares are trading below that level. Essentially, you are selling downside insurance to someone who owns the shares, and they are willing to pay you a premium for that privilege.

Today, that premium depends on exactly what risk you will allow them to insure. You could get about $0.55 to insure a drop below $45 before December 22, or about $1.60 to insure the same price until January 19, 2008. In either case, you get a return of close to 2% per month for the $45 you put at risk.

Alternatively, you could sell put options at $50, especially if you are confident of the current valuation being cheap. Since these options are in the money, a January $50 would bring in about $4.00 – $1.60 because it is already in the hole, and the other $2.40 being a higher premium than the $1.60 you get (see previous paragraph) for insuring a less likely drop below $45.

So what happens if the stock does drop and your counterparty makes you buy it? Then I would sell a call option. To illustrate, let’s assume you write the put option for $50 and the price doesn’t change between now and January.

You write the put option for $4.00 and on January 19 Ceradyne is priced at $48. Your put option is exercised against you and you pay $50 per share to buy it. Your net purchase price is $50 less the $4.00 premium or $46, and you are $2.00 ahead of the game.

You immediately sell a $50 call option expiring in February. Judging from today’s option prices, you might get $1.50 for this option, bringing your total outlay to under $45 per share. If the stock rises to, say, $51 you get called and sell your shares for $50, for a net profit of more than $5 per share even though you bought and sold at the same price. You may even want to write a new $50 put option at that time and start the process over again.

If the stock isn’t above $50 when the option expires in February, sell another one expiring in March and collect another premium. Incidentally, this is also the way investors who currently own Ceradyne can play this game – instead of starting with a put option, you start with the call.

Risks are Real

I described this strategy as low risk, and I believe it is. But anyone interested in giving it a try should be aware that there are indeed risks, and potentially substantial ones.

Let’s say you write a January $45 put and get your $1.60 premium. In January, the stock trades at $44 and you end up with it, at a net cost of $43.60. You immediately sell a February $45 call option for something like $1.25, bringing your net investment down to $42.35.

Then the company announces that for some reason earnings will only be $3.00 per share in 2008 and the stock drops to $30. You’re down $12.35, or 27% of the money you put at risk. So much for low risk.

On the other hand, if you compare the same transactions to buying the stocks today for $48.30 you would be $6 ahead of the game if you used the option strategy. So, while the risks are real, I still consider the strategy to have less risk than either owning or shorting Ceradyne outright.

Pick Your Value

I did a sensitivity analysis on Ceradyne earnings more than a year ago, and would highly suggest doing a similar one today. Given the range of estimates the company provided (and the possibility that future earnings could be lower) it is a good idea to get a feel for the worst-case scenario.

Once you get comfortable with the worst outcome, you can decide at what price you would be willing to have exposure, and can use options to limit your risk around that level. Small price swings can have a large impact on option prices, so you need to be aware of the market and I often use limit orders for this type of strategy.

Topics: Capital Goods, Ceradyne (CRDN) | 1 Comment

TPX: Can Tempur Pedic Investors Rest Easy?

This is a reprint of my December 10, 2007 RealMoney article.

Despite an impressive recent history of earnings surprises and a string of analyst upgrades in the last few months, shares of Tempur Pedic (TPX) have been stuck in a trading range for much of 2007.

The slowdown in the housing market has investors skittish over anything related to homes, including furnishings. But earlier this year Tempur Pedic was selling more mattresses than it could make.

By April the company had caught up with demand and was ready to start driving demand again. And in both the June and September quarters earnings per share came in $0.04 ahead of estimates.

So, with the stock now trading at just 14x the consensus earnings estimate for 2008 (and history suggesting that the consensus estimate is too low), is it time for investors to overcome their skittishness and buy Tempur Pedic? I turned to the latest 10Q to look for answers.

Financial Engineering

So far this year, the company has borrowed $200 million and used those proceeds (plus most of the cash flow it generated) buying back shares. The 8% reduction in share count accounted for a nickel’s worth of the EPS in the third quarter.

The downside to this move is that adding debt to reduce equity has caused some odd consequences. The book value has been virtually wiped out, and there is now $556 million in long-term debt against just $28 million in shareholders’ equity on the books.

Of course, debt financing is not necessarily a bad thing. As long as the company can make payments on the debt, the tax advantages and lower capital costs can make it a favorable alternative to equity. And why let private equity buyers reap the advantages if management and shareholders can do it themselves?

Tempur Pedic generated $130 million in cash from operations in the first nine months of 2007 and spent just $14 million on capital expenditures and acquisitions. The remaining $116 million (remember – that was just nine months worth) would have been enough to repay a quarter of the debt. So for now it doesn’t look like the company is overly stretched.

Cash Flow Concerns?

Prudence, however, dictates a careful examination of that cash flow to see whether it is sustainable. After all, cash flows can be volatile, and debt won’t just disappear if the cash flow starts falling.

That $130 million in cash flow from operations was a decline from $133 million in the first nine months last year, even though net income was $20 million higher. Net income rising while cash flows are falling is a signal that more of the net income is attributable to accruals (estimates) rather than actual cash changing hands. Many consider such relationships to be a warning sign that net income is overstated.

For Tempur Pedic, the culprit is a $33 million swing in inventory investment. Last year the company drew down $18.5 million in inventory, whereas this year it added $14.2 million to inventory.

I’m not too concerned about that, for the reasons mentioned earlier – at the beginning of this year (and much of last year) the company didn’t have enough manufacturing capacity to meet demand. As a result, it drew down inventory. This year the capacity has been increased enough to meet demand and build back some of the inventory. Since the sales are growing, it is also appropriate for the inventory to keep growing (as long as the growth is more or less in line with the growth in sales.)

Valuation

As noted earlier, Tempur Pedic is starting to look attractive on a P/E basis, particularly given the 23% earnings growth expected next year and the 17% five-year consensus growth forecast.

The company still gets two thirds of its sales in the United States, which suggests that some concern is still warranted given the declining housing market and other signs that the economy may be slowing.

Still, with the company on track to generate $100 million in free cash flow this year, the 3.6% FCF/EV yield is at least comparable to the yield on Treasuries. The consensus growth estimate clearly offers investors an enticing risk premium, provided they believe it will materialize.

Topics: Furniture and Fixtures, Tempur-Pedic (TPX) | No Comments

JBLU: Market Quickly Found the Right Price for JetBlue

Germay’s Lufthansa has agreed to buy 19% of JetBlue (JBLU) for $300 million. 300/0.19 = 1.578 billion in implied market value following the transaction. 1,578 – 300, therefore, would be the current value.

And that is pretty much exactly where JetBlue ended trading.

Topics: JetBlue (JBLU) | No Comments

TPX: Two Bits of Positive News on Tempur Pedic

In a recent RealMoney column, I wrote that Tempur-Pedic (TPX) is starting to look attractive on a P/E basis, particularly given the 23% earnings growth expected next year and the 17% five-year consensus growth forecast. However, the company still gets two thirds of its sales in the United States, which suggests that some concern is still warranted given the declining housing market and other signs that the economy may be slowing.

The stock is down today after competitor Select Comfort (SCSS) lowered guidance. But I also saw two positive bits of news on the company.

First, the judge dismissed an anti-trust case against Tempur Pedic.

Second, Zacks ranked it highly and wrote a detailed analysis on their site.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: Furniture and Fixtures, Select Comfort (SCSS), Tempur-Pedic (TPX) | No Comments

CSGS: The Long Case for CSG Systems

My RealMoney article from December 7, 2007:

CSG Systems (CSGS) is a leading provider of customer care and billing services for cable operators, including Comcast (CMCSA), Echostar (DISH - Annual Report), and Time Warner Cable (TWC). Since July, when the company announced in a shortfall in cash flow from operations, the shares are down more than a third. The current price may be a good opportunity for investors to buy a stable cash flow generator.

The cash flow shortfall in the second quarter was “due to unexpected changes in certain operating assets and liabilities at quarter end” as was largely made up in the third quarter. But don’t get me wrong – there are plenty of good reasons to explain the recent share price decline.

Let’s start with customers – the relationship with Comcast has been touchy at times, stemming from lawsuits related to Comcast’s 2002 acquisition of AT&T (AT&T’s former cable assets). That relationship seems stable now, but things could always get dicey again.

Then there is all the talk about Echostar being taken over. A merger with a company like AT&T (T - Annual Report) that does not use CSG’s services could mean CSG loses its number two client.

Next, even without any mergers and acquisitions activity going on CSG stands to lose when its customers have fewer bills to send out. Increased competition from telephone companies like AT&T and Verizon (VZ - Annual Report), along with trouble related to the housing market, have led both Echostar and Comcast to cut customer growth estimates recently.

So, suffice to say there are plenty of reasons to be concerned about CSG’s prospects in the near term. Now we have to figure out whether today’s one-third-off sale fully reflects those potential concerns. I think it does.

The Positive Side

If there is one thing to like about CSG Systems, it is that the earnings are predictable. Consider the last 12 quarters, which I charted below.

csgs-net-income.jpg

Source: Zacks Research Wizard

The knock against predictability, of course, is that the earnings are going nowhere. They have been stuck in neutral at $14-$16 million per quarter for much of the last three years. On the other hand, the company generates tons of cash – $105 million worth of free cash flow (cash from operations less capital expenditures) over the last 12 months.

And it uses most of that cash flow to buy back stock. In the third quarter of 2007 there were 17.5% fewer shares than there were in the same quarter last year. As a result, the earnings per share are far from stagnant. In fact, the last 12 months of EPS were 16.1% higher than the preceding 12 months.

Now that the share price has come down, the buybacks are having a bigger impact than ever. At the current pace, the company could take itself private within six years.

Free Cash Flow Yield

With $95 million in free cash flow and a current enterprise value of $638 million, CSG is sporting a free cash flow yield of more than 16%. Even if the $65 million they spent on acquisitions this year is deducted, the free cash flow yield would still be a healthy 6.2%, offering a solid risk premium over Treasuries.

With that kind of risk premium, investors look to be well compensated for the risks I outlined.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: AT&T (T), Broadcasting & Cable TV, Business Services, CSG Systems (CSGS), Comcast (CMCSA), Echostar (DISH), Services, Time Warner (TWX), Time Warner Cable (TWC), Verizon (VZ) | No Comments