Another Revisit - MICC

About this time last year, I spoke about Millicom International (MICC) - the Luxembourg based emerging market wireless company that I heavily recommended (Check out the review post here). Back then, I had upped my price target for the mid-70's to approximately $90/share over the long-term.

Now, I am of the philosophy that you have to continuously revisit your investments and assess if they are still a good fit for your portfolio. Companies change, circumstances change and the reasons you bought a stock can get out of whack in a real hurry. As a wise man still says - 'Don't Buy and Hold, Buy and Homework!'.

Since that post, MICC has indeed risen in price and is now trading at right around $90. With my previous price target acheived, I dug into the numbers to see if it is still worth holding.

Still A Strong Business

For those that don't remember, MICC's primary business is selling prepaid wireless services in third world countries. This includes countries with little or no wireline infrastructure, making wireless the primary means of communication. The company operates in 3 regions - Central America, South America, and Africa with Central America being the largest segment in terms of revenue.

Looking at the last year, it's evident that MICC's business has recovered well with the global recovery. EBITDA for the last 12 months (LTM) came in at a healthy $1.59 Billion - a solid 19.5% increase over 2008 (which itself was a record). More importantly, EBITDA margin has held at a steady 44% which is on the high end for the last 4 years.

Looking Forward

But having a solid business thus far isn't the only factor we need to consider here. All that information does is justify the increase in the stock price, but it doesn't give us much insights into what we have looking forward.

Looking at the company's annual report presentation, one of the most promising numbers I see is the Customer penetration, specifically in data usage. I look at the emerging markets to somewhat mirror the developed countries in data usage growth patterns (the theory worked for voice mobile phone usage). According to the presentation, MICC's current data penetration for Latin America is 5.2%. Assuming that the number is similar for the MICC's other regions, and the average penetration growth rate for the company is 47%, I think there's a good deal of room for revenue growth for MICC. Therefore, I expect data penetration to be a solid source of revenue growth for the company resulting in total 2011 EBITDA of around $1.95 Billion (slightly higher than analyst estimates which MICC has done a good job of meeting over the last few years). Assuming the current Market Cap/EBITDA multiple of approximately 6X, we come to a expected price of $107 - an almost 20% jump to the current price.

Risks

As always, there are some risks associated with MICC, or any investment. Besides the ever-present political risk of doing business in third-world countries, I think another important risk to take into consideration is the decreasing Average Revenue Per User. This key metric in the wireless industry has been decreasing by an average of about 15% each quarter over the last year. Likely due to the economic conditions, decreasing ARPU can significantly impact the profitibality of any wireless company (just as Sprint). Nonetheless, I think this risk is somewhat mitigated by the data usage penetration mentioned above. This product will help MICC offset this decline by providing a new revenue source. Futhermore, even with penetration at only 5%, the rate of ARPU decline has decreased in the latest quarter to less than 10%.

Bottom Line

With the strong business model and a history of delivering to shareholders, I think MICC is a strong bet if you want to take advantage of early-cycle emerging market growth. Even with the runup in the share price, I think the company has a conservative upside of at least 10-15% over the next year, and therefore, I think it's a good buy.

Revisiting the Motorola Play

In November of 2009, I wrote about Motorola and its attempted resurgance into the cell phone market (check out the articles here and here). The company had gone from a dominant player in cell phones with the RAZR to an also-ran with unappealing products and shrinking market share (which also resulted in a shrinking stock price that went almost as low as $3/share). However, with the introduction of the Droid and the palpable sense of negativity surrounding the stock, I thought it would be fair to give the stock another chance.

However, as was discussed in last November's posts, after looking into the DROID (both financially and physically) and keeping a close tab on sales figures, I was left unimpressed and didn't feel the DROID was a compelling enough product to justify the recent run-up in the stock price.

That was when the stock was around $9 a share. Today it's around $8 - underperforming the S&P 500 by 18%

Time For A Revisit

Although I didn't back Motorola as a pick late last year, I have been keeping an eye on the stock since then - I already did all this research, might as well keep up in case the situation changes. And recently, I've been seeing some serious signs of life for the DROID, and my philosophy is so goes the DROID goes MOT. With the introduction of the DROID X, Motorola has been building up steam in its smartphone marketshare, and in the cell phone business, marketshare is everything. As you can see below, MOT has seen a best-in-industry 136.8% growth in smartphone marketshare in Q1 2010. Granted that the overall marketshare is still pretty low, but I think that's already reflected in the stock price and nobody is arguing that MOT is starting from a difficult position.

The bottom line is that this is serious growth - the type MOT hasn't seen in a while. Furthermore, by parterning with Google's Android OS, MOT is building on what's arguably the best smartphone platform in the industry. In fact, in the first half of this year, Android smartphones outsold Apple's iPhone. Finally, keep in mind the numbers you see above are just for Q1 of 2010. Since then, the DROID X has been selling very well - a fact made apparent by the significant decrease in promotional by Verizon compared to the original DROID.

Translating that to Stock Price

The reason I'm focusing so much on this marketshare numbers is because MOT is aiming to make itself more of a smartphone maker and less of a 'run of the mill' handset maker. This translates to fatter margins that can be applied to the bottom line and a higher stock price. Right now the stock is around $8. It has had a pretty good fun with the good news coming out for DROID, but I think it can have at least another 10-15% upside with this continued momentum. Be careful, though. If you see any indication of market share momentum dropping, I would put a tight trailing stop. Coming back from the dead can be a slippery endeavour.

Jobs Jobs Jobs!

Over the last few months, when friends and family have asked me the all too common question on where I think the stock market is headed, I’ve had a pretty consistent answer – Jobs Jobs Jobs! Yes there are many other factors that come into play, including geopolitical uncertainties, economic growth from emerging markets, and housing prices. But to me, there’s one driving variable left in the market right now, and that’s the employment picture in the US.

Why I Think This

My reasoning behind this rationale is deceptively simple and can be summed up to a few bullet points:

• It’s the one area of the economy that hasn’t shown significant signs of recovery since the market bottomed in March 2009. The US unemployment rate has been stuck in the 9-10% range for a while now, while other indicators like productivity, household income, and manufacturing have improved at least modestly (yes, I know housing hasn’t improved significantly either, but I think the jobs is more the “cause” and the housing prices will be the “effect” in this scenario.
• This recession is markedly different than others because it’s the first time in many years that the US consumer has really cut back on spending. In past recessions, particularly the dot-com downturn in the early 2000’s, the consumer has been able to continue spending and, since this group makes up 2/3rds of economic activity, the recessions are able to be overcome fairly easily. With the unemployment rate being as stubbornly high as it is, the US consumer has severely cut back. Initially it was essentially all consumers that were cutting back. People were afraid of losing their jobs and cut back on non-essential spending. Although many of those consumers that didn’t lose their jobs have come back, there’s still a large contingent out there holding back on spending because they’re either unemployed, or have permanently adapted to a leaner lifestyle.
• Now that I’ve made the connection between employment and spending, let’s take it one step further to make the connection between employment and corporate spending. US corporations have a record amount of cash on hand. As the recession began, they also cut their own expenditure drastically. Corporations have refrained from spending most of this cash with the exception of increasing dividends to shareholders and buying back stock. However, real economic recovery requires that this capital be deployed and deployed effectively. To do this, companies need to see the biggest part of the economy come back to life – the consumer. And for that to happen, those consumers need to start working more. As you can see in the figure below, it’s a bit of a catch-22 – companies won’t hire until consumers start spending, and consumers won’t spend until companies hire them which requires those companies to spend that cash they’ve been hoarding. At the end of the day, once those people start getting hired, that’s when the real money will get back into the system and we can start seeing real GDP growth.
  

And Now the Bad News

Now that I’ve beaten the employment horse to death, here’s the problem. Last Friday, the government released it’s monthly employment figures which showed that companies hire surprisingly few people (83,000 vs. the expected 112,000). Keep in mind that this is the private sector employment number and that, overall, 125,000 employees LOST their jobs – mostly due to census workers being laid off as expected. Furthermore, the overall unemployment rate fell to 9.5% from 9.7%, but that’s likely due to the fact that fewer people are actively searching for jobs and, therefore, are no longer counted as unemployed.

But the real worrisome part here is that employment continues to be the nagging buzz-kill for the economic recovery. We still aren’t seeing the critical mass of hiring that is needed to spur some of the consumer spending increases and the subsequent capital deployment by private companies. The engine is sputtering and just not turning over.

Where to Invest Here

As you’ve probably noticed, the market has been down significantly the last few weeks. This is in large part due to pre-cursor signs of the economic troubles. Interestingly enough, when the actual employment numbers came out last Friday, the market was quiet and didn’t react either way. I think this was mostly due to the fact that investors already had an idea that this was coming as well as the upcoming long weekend. Therefore, I think this week will be a key indicator for the market on investor sentiment to the employment picture. It will either be perceived as a sign of more bad things to come and, hence, a longer term negative for the market (which I think is more likely) OR a buying opportunity since much of the downside may have already been priced in. It’s hard to say either way, but I’m watching the market like a hawk this week for clues on this enigma.

Long-term, though, I really think that an improving jobs picture is going to signal the next leg up in the stock market and the opposite picture will signal the next leg down. Like I said, many of the other economic indicators have been positive (although the factory orders number also came in with poor results which is cause for concern), so there is hope for a recovery here. We just need to get this employment engine revved up!

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

A Not So Electric IPO

In case you guys haven't heard, something happened in the stock market today that hasn't happened in a very long time. An auto company went public and listed itself on the NASDAQ exchange (in stark contrast to the auto companies that have be DE-listing themselves over the last couple of years). Tesla, the name that has become synonymous with rich and famous movie stars driving around $100+ all-electric cars is trying to raise money through an IPO to take its business to the next level. But before you begin clamoring for one of the most high profile IPO's since Chipotle, you need to look before you leap. All is not well with Tesla, and some things are weirder than other...

The Small Kid on a Very Big Block

The first and foremost concern I have about Tesla (TSLA) is the fact that it's in such an early stage in an incredibly competitive industry. The company has sold no more than 1,000 cars in it's history, and since its inception in 2004, it hasn't had a single profitable quarter. Now this may not be a huge deal for a company with a novel new technology that his incredible promise and can potentially landscape-changing for its industry (think Google or Dell back in its heydey). But, despite what you may think, Tesla's technology is hardly novel and far from promising. Several other, more established, names like Nissan and Chevy are vying to enter the electric car in the next 1-2 years. With their well-established supply chains, engineering muscle, and instant market credibility, they have the potential of pushing Tesla to the side and eliminating any first-mover advantage the California based company may have.

A Little Shadiness Thrown in There Too

Now I'm not the gossipy type, but when it's related to stocks, I think I can justify it. The founder of Tesla is Elon Musk - an entrepreneur whose claim to fame include founding Paypal and the X Prize. Now, you would think the founder of Paypal is a pretty wealthy guy. After all, Ebay paid $1.5 Billion for the online payment processor in 2002. But, there's a twist in the story. Mr. Musk is currently going through a messy divorce, and in recent filings, he states that he has spent his entire fortune on Tesla. As you may already know, issuing an IPO is a great way for the partners in a company to cash in the value of the company. Who's to say Mr. Musk isn't going forward with the IPO for more personal reasons to the detriment of his investors.

Tesla motors is a pretty hot commodity on Wall St. right now. It even had a great opening day - up 40%. But I do see some storm clouds on the horizon and would be weary of investing. The business model - assets made of promises and ideas rather than actual revenue and profits - smells faintly of the dot-com bubble. The fact that it is in one of the most volatile and competitive industries only exasperates the risk. On the other hand, if I'm wrong, there may be huge upside in the company. It is after all working on a sedan for approximately $50k to make the name more mainstream. Also, I even think it may be a good aquisition target for an automaker looking to jump start its electric vehicle program (Toyota has already invested a small amount in the name). But like I said, tread carefully.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

It's About Time!!

It’s finally happened. Since the beginning of the financial crisis, there have been victims, criminals, and all around blame scattering. The reasons for this are obvious, and, in some cases, I agreed with the pundits, professors, and politicians (yes…even politicians…I did say ‘some cases’ after all) on where this blame was being placed. However, there was one sub-industry on Wall St. that was conspicuously missing from the scrutiny that the big banks and insurance companies were facing. Since the day I began understanding the mechanisms that caused the near collapse of Wall St., I wondered why this group was not at the center of it all.

Well, I’ll stop the teasing and tell you that the group is the Credit Agencies. I’ve always felt that these agencies, of which there are three major ones (Moody’s, Fitch, and Standard & Poors), played an integral role in the mistakes that allowed the financial crisis to occur. If you recall from previous posts, one of the root causes of the crisis were Mortgage Back Securities that were created by banks and sold to investors. Eventually, the quality of the mortgages that were being put in the securities dwindled drastically. However, investors continued purchasing them. Well, the credit agency’s role is to notify these investors of the quality of the mortgages. They put a credit rating to the security (much like the credit ratings you and I have), and that, in turn, allowed buyers to assess the riskiness of what they’re buying.

However, somewhere along the way, the credit agencies seemed to have gotten short-sighted because the poor quality mortgages that were put into the MBS’s were, in many cases, given good credit ratings, thereby providing investors with a false sense of confidence in what they’re buying.

As you can probably see, the credit ratings were really the checkpoint to make sure that the MBS market didn’t get out of whack like it did. I’ve been wondering for the last 2 years why their feet weren’t being held to the fire. But it finally looks like all that is going to change…

Finally – Some Scrutiny

I’m not going to get into the details of what scrutiny the agencies are now receiving. Although this may seem odd, there’s two simple reasons I do this: 1) I think the investigations are more politically motivated than anything and, therefore, it’s hard to say if there’s going to be any real changes coming out from them and, 2) This post is already long enough.

Nonetheless, if you’d like to learn about the investigations, take a look here

Where Things Should Change

Now that the ratings agencies are being combed over for their role in the crisis, I’m hoping there will be some wholesale changes in how they’re allowed to do business. The most obvious change that NEEDS to happen is their revenue structure. Right now, the agencies are hired by banks to provide ratings to the securities those banks are creating. The banks then generally take the best ratings and advertise those to investors. Well there’s obviously a gap here – the same people you’re supposed scrutinize are paying your bills! I think there needs to be some regulations put in place for how these credit ratings operate to eliminate these ovbvious conflicts of interest. Here’s my top 3 changes:

1. Create a pool to which banks will be required to contribute. This pool will then be used to pay credit agencies for their work and, knowing that their money is coming from the pool and not directly from the bank requesting the rating, the credit agencies is less likely to artificially inflate ratings.

2. Along with the first change, you also have to change disclosure rules so that ALL ratings for the security must be disclosed to investors so investors can have a full picture of the security’s risk assessment. To offset this, you can have the requestors of the credit ratings pay for each of the ratings.

3. Create a government regulatory group (probably within the SEC) whose sole function is to audit the Credit Agencies and ensure that they’re ratings processes are consistent and accurate.

I’m glad to see the credit ratings agencies being scrutinized for their role in the crisis. I find it surprising that a business model so entangled with conflicts of interest has been allowed to exist. The changes I’ve suggested, although fairly drastic, I think would be a great way to eliminate the conflicts inherent in the current system.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

The Goldman Debacle - Part II

In my last post I used a casino analogy to describe the background of the SEC case against Goldman Sachs. Hopefully the analogy made the fundamental issue at hand a little clearer without the Wall Street jargon that confuses most of us common folk. But now that you understand the circumstances, you may notice the holes in the case and the somewhat flawed logic that the SEC is using to build what I think is a house of cards case.

It Can’t Be That Easy

First, let me tell you where I think the SEC’s case has merit. Basically, what the SEC is saying is that GS did not live up to its fiduciary duties by notifying investors that John Paulsen was shorting the mortgages in the CDO that it sold its investors. In a general sense, I think they’re right. GS, as the broker, should disclose as much relevant information as possible to its investors to ensure they’re interests are being served. And if it is apparent that GS violated this responsibility, they should certainly be punished for it.

That’s it. That’s the only area where I think this case has merit. Now, with that out of the way, let’s discuss where it doesn’t have merit. I think the biggest flaw in the SEC’s logic is that they’re saying that GS should have disclosed the person on the other side of the trade (i.e. Paulsen).

Stop right there and think about that. Say you were the casino in my example. When you see those gamblers come and bet money, isn’t there an assumption that those gamblers know that there’s someone on the other side betting against them. In any gamble, whether in a casino or Wall Street, there are two sides to every gamble. In the casino, we call that the ‘house’. On wall street, it could be anyone that feels the opposite of what your bet is.

In other words, every time you bet on an asset, whether it’s a CDO or a stock or you double down on a hand of Texas Hold ‘Em, there is an implicit counter-bet. If everybody felt that the mortgages in the CDO would go up like the investors that bought them did, why would anyone sell them? Furthermore, does it provide any additional value to the buyer if they were explicitly told who the counter-party on the CDO is? I don’t think so. When I buy a stock, I know someone is selling it to me. Will it change my decision if I knew who is selling the stock I’m buying? If I’ve done my proper due diligence, it shouldn’t

The bottom line here is that I feel that Goldman did not have a fiduciary responsibility in not disclosing that John Paulsen is betting against those mortgages because it wasn’t relevant information that the buyers needed to know – it’s just not common practice on Wall St. to do that. Furthermore, the fact that the actual buyers of the CDO were banks who are sophisticated enough investors to perform the necessary due diligence only reinforces this notion.

Where Do We Go From Here?

Honestly, I think the SEC’s case against GS is a witch-hunt to a large extent. The SEC has come under a great deal of scrutiny lately for allowing the financial collapse to occur under their watch, and, unfortunately, I think this case is them trying to pander to the public and Washington that they are still relevant. Hopefully, in time this case will be dropped. However, I think the more likely scenario is they’ll settle with GS out of court and we can move on.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.

The Goldman Debacle - Part I

Well folks, here we go. The fallout from the housing crisis is beginning to hit the biggest players in the industry. A few days ago, the SEC (the government organization tasked with policing the financial industry) formally filed a civil lawsuit against what was until then perceived to be the proverbial Iron Man on Wall Street – Goldman Sachs. In the lawsuit, the SEC basically accuses GS of intentionally misleading clients who invested in a product that the bank sold them. The ramifications of this can potentially be huge, and this is likely only the first shoe to drop in a series of lawsuits. But I wanted to take a look at exactly what’s going on, how I think it’ll play out, and, in true InvestingDecoded fashion, how you can potentially profit from it.

Place Your Bets

Exactly what events allegedly transpired to put GS in this situation is kind of tricky to explain. What I’d like to do is set up the scenario without using financial jargon that’ll just end up confusing most people. Let’s set up a real world scenario that parallels the SEC allegations:

Say you own a casino, and a man, let’s call him Mr. Paulsen, comes to your casino and asks you to put a specific model slot machine into this casino. The slot machine Mr. Paulsen is asking to put in the casino is well known to gamblers at the casino as it has historically given healthy pay-outs. Basically everyone who plays on that model slot machine has been winning money. But Mr. Paulsen thinks differently – he thinks that the slot machines are overrated and will eventually stop paying out healthy gains and gamblers will lose money. So he asks you to put the slot machine into your casino so he can get as many gamblers possible playing on it and make money once it stops paying out the cash.

Well, you as the casino owner agree to do it. But before you do that, you want to make sure the slot machine isn’t broken or tampered with. You hire an outside contractor to come inspect the casino to make sure it’s OK. But the vendor, NOT knowing that Mr. Paulsen is convinced the machine will stop paying out, OK’s the slot machine assuming there’s no conflict of interest between Mr. Paulsen and the players.

So you put the slot machine on your casino floor and gamblers clamor to play on it. But you don’t tell them something key – the person who asked you to put the machine there is convinced that you’re going to lose money. Now, as a gambler if the guy who had the clout to get that slot machine on the floor is convinced that the slot machine is overrated an will eventually stop paying out, wouldn’t you think twice about playing on the machine? However, as the casino owner, you don’t disclose this fact to the players. All you do is put a sign on the slot machine saying it was inspected by a third party and it works fine.

Low and behold, the machine stops paying out. Gamblers keep playing and keep losing money and walk away empty-handed. In the mean time, Mr. Paulsen reaps in the rewards from the gambler’s money, on the order of $1 Billion, and you the casino owner keep a share for your services.

This, in a very small nutshell, is what happened in this case. But the casino is Goldman Sachs, the slot machine is Collatorized Debt Obligation (basically a package of mortgages that investors can buy/sell, see past posts for more details) and the gamblers are investors. Furthermore, Mr. Paulsen is actually John Paulsen, a hedge fund manager who correctly bet against the housing market in 2007 and made billions of dollars. What Mr. Paulsen did was ask GS to create a CDO with mortgages that he thought were not as strong as they were perceived to be. He did this by analyzing the quality of these mortgages and comparing them to the credit rating given to them by the big credit rating agencies. The ones that the thought were literally overrated he wanted GS to put in the CDO. GS then hired ACA Management as an independent reviewer of the assets in the CDO (i.e. the independent contractor in the analogy). ACA was tasked to review the mortgages Mr. Paulsen requested to be put in the CDO. But what ACA didn’t know was that Paulsen was holding a short position on those very mortgages.

GS then took the CDO and sold it to investors (mostly foreign governments and banks). But GS didn’t disclose the fact that the person who selected the mortgages in the CDO thinks they’re going to collapse. Do you see the issue here? The bottom line, the SEC is accusing GS of creating a product and selling it to investors while not disclosing the entire story.

You might be thinking that this is a grey area of disclosure, and you’d be correct in thinking this. In my next post, we’ll discuss the holes in the SEC’s case, and how I think the story will play out.

What are your thoughts?

Questions/Comments/Feedback?
Please don’t hesitate to let me know of any questions or comments you have about this post or any other. If you want me to write about something else investing related, do let me know!

The Standard Disclaimer:

The stuff I just wrote above is my opinion and my opinion only. Please do not take it as fact. Perform all necessary research and analysis prior to acting on anything I've said above. This includes consulting with a financial advisor.