Here is a round up of this weeks best articles I came across in no particular order.

• Q3 2008 13F Portfolio Holdings presented by The Enlightened American
• Analyzing Stock Valuations during Recession presented by The Peridot Capitalist
• Bail Out Capitalism, Not the Big Three presented by Forbes/Vitaliy N. Katsenelson
• Measuring Dividend Stocks Investment Risk Profile presented by Dividends 4 Life
• Pershing Square Q3 Letter to Investors presented by Stable Boy Selections
• The Retailers Poised to Survive, Then Thrive presented by The Div Guy
• How is Joel Greenblatt Performing In This Market? presented by Magic Diligence
• 10 by 10: A New Way to Look at Yield and Dividend Growth presented by Dividend Growth Investor
• New Position - CP Rail presented by the moneygardener
• Taking Stock in IGM Review presented by TMWTFS
• RCI a Wobbly Monopoly presented by Blogvesting
• Largest US Bankruptcy on Tap presented by Can Turtles Fly?
• Time to Make a Killing in GM, Ford Bonds? presented by Everyday Finance
• This BUDs for Me presented by Fat Pitch Financials
• BofA Out, AMEX In presented by my Value Idea
• Ben Graham Net Net Deep Value Stocks presented by The DIV-Net (me)
• The Art of Short Selling presented by Simoleon Sense (I ended up buying the book)

The DIV-Net Featured Articles

• Dividend Growth Investor - Why Should Companies Pay Out Dividends
  
• The Div Guy - Dividend Stocks The S&P Elite
• Disciplined Approach to Investing - Don’t Overreach for Dividend Yield
  
• Dividends4Life - Stock Analysis: Entertainment Properties Trust (EPR)
• The Dividend Guy - Dividends as Defensive Buffers
  
• the moneygardener - Mr Dividend, My Third Earner
• The Stock Market Prognosticator - Pershing Square Capital Letter

Thanks to Contrarian Value Investing for the notice.

Just out of curiosity, I was checking out the Morningstar fair values for my companies and surprisingly, they were all very close, minus AEO. So just for fun, here is a comparison of the intrinsic values between the companies I have written about on this blog. Small caps are not covered by Morningstar, so I have left them out.

(Morningstar fair value estimates as of Nov 19, 2008)

Morningstar vs Old School Value

ETN (published Nov 17, 2008)

Morningstar: $81 | OSV: $77

DPS (published Oct 28, 2008)

Morningstar: $28 | OSV:$25-$32

KSWS (published April 16, 2008)

Morningstar: $19 | OSV: $19.86

AEO (published March 11,2008)

Morningstar $22 | OSV: $37.37

So in the spirit of having some fun with intrinsic value, it doesn’t seem like I need to bother with a premium Morningstar membership. I get pretty much the same quantitative assumptions and you can too starting from only $6.95.

Technorati Tags: morningstar, intrinsic value, valuation, spreadsheet, ksws, aeo, dps, etn,  

Eaton is a company I briefly looked at in late 2007 when it was trading in the $80’s, I thought I’d take a quick review to see the status of the company today.

Business Summary

The company is a diversified industrial manufacturer and operates in 4 business segments.

1. Electrical - electrical systems and components for power quality, distribution and control
2. Hydraulics - fluid power systems and services for industrial, mobile and aircraft equipment
3. Aerospace - intelligent truck drivetrain systems for safety and fuel economy
4. Automotive - automotive engine air management systems, powertrain solutions and specialty controls for performance, fuel economy and safety.

The great thing about ETN is that it is a highly diversified company with business all over the world. Not just US dependent.

Valuation

From a numbers point of view, Eaton is a very solid company. Since 2001, ETN has improved and made progress in its operations.

• Gross, operating, net margins are stable at around 27%, 9%, 7% respectively
• Book value has been increasing at a good pace
• Throws off positive FCF for the past 10 years, although it has reduced during 2007 and 2008
• Cash is generated from its core business rather than other businesses
• The median CROIC for the past 10 years has been at 9%, ROE at constant 17%, ROA at 6%
• Excellent inventory turnover at 7.0

Take a look at the below images to see what I mean.

The numbers point to a capable management team who understand their business. The cash generation of the business can also support the current dividend yield of 4.7% along with a history of increasing dividends.

I’ve applied a 15% discount rate due to rising inflation and my strong preference for present day dollars as to future cash. This is ever more true in this environment. A growth rate of 6% yields a share value of around $77 with the buy price set at $38.

Potential Warnings Signs

If it wasn’t for the recent acquisition spree and debt levels, I would probably have bought some shares already, but upon further analysis, the quality of earnings isn’t as high as I anticipated.

Within a 2 year timeframe starting Feb 2007, Eaton has made 14 acquisitions with the latest on Oct 2, 2008. I like growth, but not through so many acquisitions.

“Sales growth of 25% in the third quarter of 2008 over the third quarter of 2007 consisted of 19% from acquisitions of businesses within the last year, 4% from organic growth, and 2% from foreign exchange.”

The question is, will Eaton continue to eat companies in order to gain market share and keep up with earnings in the future?

Due to all the acquisitions, Eaton’s long term debt has ballooned to just under $3 billion along with $5.9 billion in goodwill and $1.9 billion in intangibles. Although Eaton should be able to meet its obligations, I’ll prefer to be cautious and wait to see how the acquisitions impact the business and whether they were worth overpaying for. With a “significant slowdown” expected over the coming year, watching for another quarter or two may be a good idea.

Although it is getting close to the buy price, I think I will just keep an eye on ETN for now.

Disclosure: No positions of any stocks held at time of writing.

Technorati Tags: berkshire, eaton, etn, valuation

My goal - go through each company and find the ones worthy of investment.

Since there are 200 companies to go through, the search process will have to be quite mechanical and quick in order to get through the list and to filter out the less than stellar companies.

1. Immediately exclude financials (don’t understand or know how to value them)
2. Run the companies through the intrinsic value spreadsheet with the PE as the growth rate, but capped at 15%. The selected companies shall exhibit;
   • Positive, consistent and growing cash flows.
   • Consistent margins. Fluctuating/decreasing margins over several years will not be accepted unless the other criterias are outstanding.
   • Above average returns from capital investments (CROIC, ROE, ROA)
   • Strong balance sheet
3. Companies should have at least 5 years of operating history
4. The companies that make the cut will then be reviewed individually

Going through the first 15 have already produced 7 candidates for further analysis. They are

• Quality Systems (QSII)
• PetMed Express (PETS)
• Deckers Outdoor (DECK)
• Hittite Microwave (HITT)
• K-Tron International (KTII)
• Dynamic Materials (BOOM)
• Middleby (MIDD)

Just by looking at the numbers I can see why they made the list.

Also, these companies have all been trading at a premium, some still are, until recently. See the table below.

If potentially good companies keep appearing at this rate, I’ll be very busy over the holiday season.

I’ll be posting updates as I continue down the list so check back soon.

Disclosure: I only own KTII as of this writing

Technorati Tags: QSII, PETS, DECK, HITT, KTII, BOOM, MIDD, small cap, stock analysis, forbes, intrinsic value

• 3 Things Investors Do To Get In Trouble presented by The Dividend Guy
• Its the Economy Stupid presented by Contrarian Value Investing
• The Future for US Stocks presented by Dividend Growth Investor
• IBM Dividend Stock Analysis presented by Dividends4Life
• Could GE be a Cheap Global Comeback Play presented by  The Div Guy
• The Folly of Forecasting: Ignore all Financial Experts presented by Simoleonsense
• Investing Carnival Remeberence Edition presented by the moneygardener
• Dialing for Dollars at Office Depot presented by Barel Karsan
• The DIY Journey presented by TMWTFS
• CTC Media: Big Gain Potential, Equally Big Risk presented by Magic Diligence
• More Tough Economic Times Ahead presented by College Analysts
• Options strategy with Google presented by Everyday Finance
• 114th Festival of Stocks presented by Fat Pitch Financials
• Northstar Business Model Re-evaluation presented by my Value Idea

The DIV-Net Featured Articles

• Dividend Growth Investor - Zecco Review
  
• The Div Guy - Dividend Stocks The S&P Elite
• Disciplined Approach to Investing - Newsletter Recommendation Falls Short of Market
  
• Dividends4Life - Stock Analysis: Canadian National Railway Company (CNI)
  
• The Dividend Guy - Main Broker to Questrade
  
• the moneygardener - Telus Hikes Dividend
• The Stock Market Prognosticator - A Cry In the Wilderness

This series is based on the book You can be a stock market genius! so for additional information, be sure to read it yourself.

New here? Catch up on the series.

Part 1: Odd Lot Tenders
Part 2: Book review on You can be a stock market genius!
Part 3: Spinoffs
Part 4: A Look at Dr Pepper Snapple

Quick Brush Up

There is no point in buying a stock speculating that the company will be taken over. Risk arbitrage, which I will just refer to as arbitrage, involves the purchase of a stock after the merger announcement.

The book quickly gets to the point and tells the reader to avoid arbitrage because of the high levels of uncertainty involved in the process. However, I would like to add that by waiting and choosing wisely, you will be able to make very good gains off low risk.

The basics and overview can be found in an earlier post here. It covers topics such as why you should consider arbitrage in your investing strategy, the types of homework you should do, what to look for and the risk involved.

Previous Arbitrage

So far, I’ve gone through three arbitrage opportunities in this blog. Aquila, Jazz Technologies and currently Puget Energy. I eeked out a tiny profit with Aquila and documented a vital mistake with this transaction, successfully did not partake in the Jazz merger due to the illiquidity and stock for stock condition, and would like to see the Pugest Energy merger close out soon.

Keep Things Simple

There are also different forms of arbitrage.

• Cash only transactions where stock is paid for in cash
• Stock for stock where the shareholders are given stock of the other company
• Partial stock where a percentage of the share is converted to stock and cash
• Purchase merger securities (the Greenblatt recommends looking into warrants)

Focus On This Checklist (source: fwallstreet.com)

Before you invest any cash, you should be able answer all the items below.

1. Due diligence by both parties
2. Financing and regulator approval
3. Get preliminary shareholder sentiment (or controlling shareholder approval)
4. Obtain regulator (SEC, FCC, any and all) approval
5. Get final shareholder approval at a meeting called for that purpose
6. Insiders continually vesting or buying shares

Risks to Think About

• Calculate the potential upside and downside vs time. In the PSD merger, I’ve given the chance of success 90% with a gain of around 25% within 1 month. This is excellent odds.

• Unpredictability: Anything can happen in mergers. Financing can break down at the last minute, the market can go crazy and take everyone with them, earthquakes could ruin the operation of the business  etc etc.

• Allocate assets accordingly depending on your odds.

• Taxes will have to be paid because this is a short term strategy. Consider this when you calculate gains.

But most of all, stick to investing in solid companies if you are unsure or feel uneasy with the whole notion.

Disclosure: Long PSD

Technorati Tags: arbitrage, special situation, PSD

Achieving better returns is easy to say, but how are you supposed to achieve it? It won’t be by pouring your hard-earned savings into the day’s hottest investment (oil today, housing yesterday, tech stocks the day before). Participants in these “hot” markets overpay for these issues, and thereby incur downside risk. Better returns won’t come from mutual funds either, which are known to underperform the market thanks to their fees and short-term herd mentalities, as discussed here. Instead, you’re going to have to earn your returns just like you earn your salary from working and just like you earn your savings from cutting expenses.

To illustrate, let me use an example. If you knew of a company that was for sale for $25 million, but had inventory and accounts receivable worth over $80 million, and total liabilities of just $40 million, would you be interested? You would be buying $40 million of liquid assets for $25 million…but who has $25 million lying around? Fortunately, the stock market sells you much smaller chunks of these types of companies, but the ratio of what you’re going to own to what you have to pay is just the same!

In fact, the stock market contains a plethora of small cap companies that no analysts follow and that no institutions hold…these small stocks are just too tiny for paid analysts and large funds to pay attention to. As a result, for the prudent investor who is willing to look for the handful of gems among these issues (and finding these do take effort, for such blatant mispricings are few and far between), the promise of better investment returns along with downside risk protection holds true.

At Barel Karsan, we try to find companies worth $1 that sell for 50 cents (see here for one such example). We identify such companies, we discuss them, and we hold onto them until the market recognizes their true value. This investment strategy has been practiced by Warren Buffett, Ben Graham, and countless other value investors and has served them all well. It can do the same for you.

24hr home shopping - that’s the name of the game for ValueVision Media Inc (VVTV), so grab yourself a cuppa because this analysis is a loooong one.

(You can also skip the whole business part and go straight to the valuation)

Business Summary

VVTV operates in television home shopping, e-commerce, direct mail and online marketing. The company’s live 24 hour every day television programming is distributed primarily through cable and satellite affiliation agreements and the purchase of month to month full and part time lease agreements of cable and broadcast television time.

In addition, VVTV distributes its programming through a company owned full power television station in Boston, Massachusetts. It also markets and sells an array of merchandise through Internet retailing websites, www.shopnbc.com and www.shopnbc.tv.

The company has an exclusive license agreement with NBC Universal (NBCU), for the worldwide use of an NBC branded name and peacock image through May 2011.

The products sold through the company’s electronic media segment is made up of jewelry, watches, computers and other electronics, housewares, apparel, health and beauty aids, fitness products, giftware, collectibles, seasonal items and other merchandise.

Growth Strategy

Congratulations, you’ve made it past the boring business summary. The way you felt as you read that first section pretty much sums up the business. Frustrating, boring, no growth.

The truth is, home shopping is just so…. 80’s. No wonder the company has been operating at a loss for the past 6 years and that probably won’t change anytime soon.

Although the company is undergoing a restructuring, I don’t believe the amount of fat trimming will be enough to produce a consistent yearly profit. The company has reduced its workforce by 10%, consolidated its distribution and fulfillment operations into a single warehouse and closed a retail outlet store.

“The company’s organization structure was simplified and streamlined(??) to focus on profitability.”

I don’t see this as anything more than just cost cutting from external pressures.

But surely there must be a company or growth strategy, right?. Here is what the quarterly report had to say:

• optimize mix of product categories offered on television and the internet in order to appeal to a broader population of potential customers
• continue the growth of the internet business through the innovative use of technology and marketing efforts
• obtain cost-effective distribution agreements for our television programming with cable and satellite operators, as well as pursuing other means of reaching customers such as through webcasting, internet videos and internet-based broadcasting networks
• increase the productivity of each hour of television programming by focusing on ways to maximize margin dollars per hour and increase the number of customers within the households
• enhance our television broadcast quality, programming, website features and customer support
• leverage the strong recognition of the NBC brand name
• change the product mix to focus on the female, repeat-purchaser core customer. Reduce high ticket items such as electronics that drives one time customers, but not repeat business.

Of the six strategies, I am dismissing all of them but the last one. I could be blind, but I don’t see anything that Amazon, Google, Home Shopping Network or any other retailer hasn’t already done.

Competitive Moat

If VVTV was a true retailing business, it’s competitive advantage and moat would be nil. However, VVTV is also a broadcaster with its network as its main assets. Nevertheless, competition is a nightmare. It may have the assets of a broadcaster, but the market in which it competes consists of brick and mortar stores, discount stores, warehouse stores, other television home shopping networks, internet retailers, infomercial companies, catalog and mail order retailer and other direct sellers.

Its main competitor however is QVC Network and Home Shopping Network. Both these competitors are much larger in terms of revenue and customers and reaches a broader range of households. VVTV reaches 72 million households.

The average selling price, or ASP, per unit was $224 in the 2008 second quarter and $233 in fiscal 2007. This is about 4x higer than its bigger rivals, but it also means there are more high ticket one time purchasers than repeat customers.

Bottom line - No moat in retailing. Narrow moat in the network business due to the high costs of startup.

Risks

• A majority of VVTV’s cable and satellite distribution agreements are due to expire at the end of 2008

If VVTV is unable to get favorable terms for a new distribution agreement, extra contract fees could eat away at the cash supply.

• History of losses and high fixed cost operating base.

With this company, a loss is more likely than a profit. However, if a majority of their customers switch to digital, operating costs should go down.

• The company may be required to issue warrants to purchase a substantial number of shares of NBCU in 2008 and 2009 for renewals or extensions of cable and satellite distribution agreements.

A specific number on the warrants is not provided, but if does happen, shareholder dilution will be high.

• GE Equity and NBCU hold the largest stake and controls a lot of what goes on

• VVTV has to pay in cash, the class A redeemable convertible preferred stock issued to GE Equity which has a redemption price of $8.29 per share.

Since the current stock price is 50c, there is no chance that these preferred stock will be converted to common stock. If GE Equity redeems it for cash on March 8, 2009, the cost of all the preferred stock is $44 million. Bye bye cash, hello debt.

Management

From the current state of the company, I can only deduce that management is not in touch with the operations of the business. To get to the point where the company is worth less than its office building is just astonishing.

Insider ownership is at around 5% which is a decent number but it is mostly all through stock options. Even at such fire sale prices, no one seems to be interested in buying.

In fiscal 2007, the company bought back 3.6 million shares amounting to $27 million at an average price of $7.46. I like that management is spending the money to repurchase shares rather than squander it on useless attempts to gain profits.

On Sept 11, 2008, the board of directors announced it had appointed a special committee of independent directors to review strategic alternatives to maximize stockholder value. The key words here are “announced” and “review”. This implies talk without action for the time being.

My views seem to be correct as expressed through this letter by J. Carlos Cannell to the board. In the Oct 27, 2008 letter, Cannell asked that the board declare a $1.20 special dividend to shareholders so that he could liquidate his position rather than live with the current board.

But this is unlikely as

“pursuant to the shareholder agreement we have with GE Equity, we are prohibited from paying dividends in excess of 5% of our market capitalization in any quarter.” - quarterly report.

Valuation

On November 2, 2007, a fund manager by the name of Jaime Lester of Soundpost Partners wrote a letter to management in which he concluded that the current share price of $4.68 was underpricing the company and he believed the value to be around $6.

On September 24, 2008, fund manager J. Carlo Cannell of Cannell Capital LLC also submitted a letter stating that the current share price of $2.20 was severely underpriced. Cannell also believes the company to be worth closer to $6.

So let’s take a look at a couple of metrics on which we can valuate the company. Keep in mind, with these broadcasting companies, it’s important to calculate their cash flows and assets rather than earnings.

1. Sales from Full Time Equivalent households (FTE; households receiving 24hr programming)
2. Net Net Working Capital and tangible assets

Sales Per FTE

A quick way to look at VVTV is by their net sales per FTE. VVTV reaches 72 million households with the average net sales being $7.92 per household. But since people are not spending much nowadays, I’ll assume a low ball net sales of $4 per household. Even this low figure gives a value of $288 million (4×72=288) to the network, which is still 16 times more than its current $18 million market cap.

Net Net Working Capital and Tangible Assets

Net Net Working Capital = Cash and short-term investments + (0.75 * accounts receivable) + (0.5 * inventory) - total liabilities

The following numbers are from the latest quarterly report on August 2nd with adjustments to fit the above formula.

ValueVision is currently being sold for 30% of its cash holdings and 32% of its NNWC value which satisfies Ben Graham’s huge 66% margin of safety. This is rarely achieved. The NNWC per share value is $1.65 compared to the stock price of $0.53.

However, the NNWC does not include ValueVision’s main assets which is its FCC license, NBC license and its owned property.

Let’s assume the property of ValueVision was affected by the housing crisis by 20%. Reduce the $25 million quoted by Mr Jaime Lester in his letter by 20% to give the office real estate in Minnesota a value of $20 million. Add in the FCC, NBC license and property to NNWC to get the following;

The current market cap is currently only 15% of its low end value. Unbelievable.

Opinion

The company’s fundamentals and its industry is unattractive, growth isn’t something to rely on, its moat is very narrow, it is risky in the short term due to its obligations, and management seems slow to react. However, all this bad news has already been heavily factored in. The current market cap is worth less than its property or licensing or network or cash. From the market’s point of view, VVTV is doomed to fail.

With no long term debt, this is a true asset play with a potentially huge upside if given enough time. But even if it doesn’t, current valuations and prices indicate a fire sale even if the company was to go bankrupt.

A company being mispriced for 15c to the dollar, you don’t see this very often.

I see a big, fat, straight pitch coming my way.

Disclosure

No positions in any stocks as of this writing.

Technorati Tags: VVTV, valuevision, stock analysis

• Taking stock in MFC by TMWTFS
• Walmart Vs Target by Stock Pursuit
• All Aboard, The Contrarian Train by OSV
• Local Election Results Impacting Puget Energy by Fat Pitch Financials
• Have we reached a bottom? by Dividend Growth Investor
• Investment winners and losers in the Obama administration by D4L
• What Credit Crisis? by Stock Market Prognosticator
• George Weston Stable, but cheap? by Barel Karsen
• Money Manager Stock Selections for 2009 by The Div Guy
• It’s Not Different This Time by The Dividend Guy
• more Yellow Pages by The Moneygardener
• Video: Founder of Paypal and Nassim Taleb up 50% by Simoleon Sense

The DIV-Net Featured Articles

• Dividend Growth Investor - Warren Buffett - The Ultimate Dividend Investor
  
• The Div Guy - New Dividend Stock Buys: Abbott Labs (ABT)
• Disciplined Approach to Investing - Attractive Stock Valuations Being Created In This Bear Market
• Dividends4Life - Stock Analysis: CenturyTel Inc (CTL)
• The Dividend Guy - What Are Covered Calls?
  
• the moneygardener - Currency and Canadian Investors
• The Stock Market Prognosticator - Words of Wisdom II

Thank you for all the submissions in this weeks Investing Carnival. Unfortunately I had to leave out the personal and general finance articles.

If anyone is interested in hosting the Investing Carnival on their site, please contact dividendgrowthinvestor@gmail.com. It is a great way to attract new visitors and exposure to your blog.