Friday, December 28, 2007

More on Moody's and MBIA

Interesting news lately on MBIA -- stock pops recently because the Davis funds bought more than 5% of the stock and then yesterday Buffett comes out and says he is going to start offering muni bond insurance.

That's the problem with the insurers -- now that everyone is questioning their ability to pay off on the bonds they already have insured, how many are lining up to get that same guarantee on new issues? Seems like some states and cities have called Buffett and asked them to insure their bonds. Berkshire Hathaway has a solid AAA with more capital than anyone else in the insurance market so they are taking advantage of the current panic to make a dime, while its available. If MBIA and Ambac return to solid footing and start pricing insurance like they recently did -- too cheap -- then Buffett will take his money and go home.

Could see others like AIG or GE Financial Services join in as well, while the big 2 are struggling.

That increased competition could take some of the better margin business away from the big 2 (mbi and ambac), which will hurt their ability to earn their way out of this problem.

So the big question is will the same thing happen to Moody's? A tough question for me to answer but I think there are subtle differences between them that make all the difference in the world.

The bond insurers are financially weak -- there are serious questions about their ability to pay claims -- this is tangible dollars and cents at stake. Moody's renders opinions that are often wrong -- have been in the past and likely will be in the future. The value of the opinions is for both regulators and institutional investors to have guidelines -- a frame of reference -- on the credit worthiness of fixed income securities. But Moody's reputation is not the same as dollars and cents. Is it possible that new raters will try to take advantage of the tarnished reputations of Moody's and S&P -- its possible but not as necessary as with the insurers.

Some unsophisticated investors who were greedy -- meaning they didn't understand risk and reward -- chose to bless the AAA rating on CDO's to be as true as the Gospels -- hasn't worked out that way. Moody's is learning and will adapt in terms of how they rate future structured product. dumb investors have lost their money -- not likely to trust the AAA rating as much but what about all the other fixed income investors? I suspect they will trust the AAA as much as they have in the past.

Oh and those Davis boys? They owned over 7% of Moody's as of the end of September so their exposure to Moody's is actually significantly greater than it is to MBI (5% of 2.5 bill vs. 7% of 10 bill).

about ready to buy my next round -- too bad I can't (out of the office so I can't access the ethics system to get employer approval).

Friday, December 21, 2007

Moody's vs. MBIA vs. Brokers vs. other financials

MBIA, brokers, banks, etc. have all fallen since the troubles during the summer started yet I pick MCO over all of them (possible exception of GS) because Moody's has no liabilities and no assets to worry about.

MBIA is on the hook for who knows how many billions from their insurance -- potentially enough to bankrupt them or require massive capital infusions. Thursday we learned there are $8 bill more CDO issues for MBIA then we thought yesterday. That's a good chunk of capital.

The brokers -- Merrill, Bear, Morgan Stanley, Citigroup or the banks -- WB, BAC, STI, WFC, etc. -- all have had writedowns and all are likely to keep writing down asset values. Their capital is at risk from all the writedowns, which may put the firm at risk unless they are able to get more capital like Morgan Stanley did today from the Chinese.

Moody's merely renders opinions on the creditworthiness of various securities -- they do not insure those securities; nor do they own any of them and unless they lose some litigation, they have no liabilities whatsoever related to the problems all these other financials are having. Yet the stock is still down 50% from its highs.

Moody's may not be a good stock from here, but I cannot imagine how it couldn't be a better risk reward then all of these other financials because its survival is no where near threatened -- they have no need to raise capital and in fact they have excess capital that can be used to buy back stock.


Stock is down several points from its recent earnings release yet so far the only change in fundamentals is estimates have stopped rising. They are meeting numbers and showing impressive metrics (subsrciber numbers) yet their guidance is around consensus to a shade below consensus. So the reaction by investors is to lower the multiple. Makes some sense although my thought is that the problems in the industry are in the fixed income area and that is a meaningless area to Factset.

77% of revenues are from buy side clients -- without a concentration in client or client type (long only vs. hedge fund, etc.). That leaves only 23% from sell side clients -- all on the equity or investment banking side so no fixed income to lose.

Stock's PE will fight an uphill battle as long as brokers are suffering losses and layoffs but I believe the business will not miss -- they will continue their growth streak.

From a stock perspective though, I find Moody's more attractive -- Moody's has fallen further, is cheaper and has even better profitability metrics vs. FDS. No reason to sell FDS but for now the incremental dollars will go to MCO. If FDS falls further, will have to reconsider and potentially buy more.

Thursday, December 20, 2007


Well the deal is back on and its structured in such a way that it doesn't need any additional approvals -- that way it can be wrapped up before the end of the year.

So the price is better -- $180 mill vs. $290 before. The number of shares is greater, which is a reflection of the price drop in DFR. Sellers note so we don't have to worry about some covenant from a bank or bond deal causing troubles.

3 Keys to why this deal is cool:

1. Internally managed REITs get higher valuations because there are less conflicts of interest and presummably the management team has more incentive to do well.

2. Income stream is now more diversified -- asset management fees are pretty steady and simple to model -- just a precentage of the assets. Incentive fees are harder but at least one analyst has already stripped them from his model for 2008. People will use conservative assumptions on incentive fees in this environment.

3. The management side gives them a path to growth -- not too many ways to grow a bond portfolio other than getting more capital. DFR had a plan to expand ROE by going into alternative assets from RMBS and that would have a one time boost to the income from the REIT (one time but spread over a couple of years of implementation) but once that is done how do you grow?

By growing assets under management, DFR now has an easy way to continue to grow after they have shifted their asset mix in the REIT portfolio. Big yield and growth story is a potent combination.

The deal is dilutive to 2008 and if you read carefully, you should have noticed that the company said that pool of 2007 earnings that had not been distributed yet would get paid out in either the December dividend or the next one. That suggests they might keep the dividend at 42 cents but the earnings will be less than that due to the dilution (hopefully, because otherwise that means they are earning less too.)

The spread they are earning in their RMBS portfolio has widened, which should help support their earnings so to me any decline in earnings power is dilution driven.

So let's say 1.50 in dividends going forward -- that's a high teens yield and they should be able to grow that over time thanks to the management side, which showed 4% asset growth since July -- quite impressive given the turmoil in the fixed income markets.

I think the stock would be closer to fair value in the low teens.

Monday, December 17, 2007

From GGG to MCO

Did it today -- sold some more of my GGG for Moody's (MCO) -- probably not a good price for the trade but at least I have some exposure which is what I wanted. My thinking is that I am not really increasing my exposure to housing/debt/financials but rather just shifting it from Graco which was about 40% exposed to housing. I expect Moody's to be faster growing than Graco over the next several years and its selling at a similar valuation despite Moody's having even better economics than Graco which is really hard to do.

I figured my loss exposure to MCO wasn't much greater than to GGG and it could be even better protection because Moody's has underperformed Graco significantly over the last couple of years -- prior to that MCO was a better stock.

Buying MCO at almost half off and I figure that the stock will not get truly cheap because Buffett owns 18% -- he will just buy more at the right price. So will the company -- figure on $500 mill in share buyback annually which should be enough to buy back between 10-15 mill shares (265 mill outstanding now). Between the company and Buffett, I figure the stock has some downside protection. If it falls further -- say to the low 30's I will buy more. If it just pulls back to the $35 area, then I will probably just buy some options in the stock. increase my exposure without risking a lot of capital. I just figure that this round of financial declines is done -- will there be further declines? quite possibly but this round is done. Think end of March 2001 as far as the tech stocks go.

Friday, December 14, 2007


Did the trade today -- sold some GGG to buy some more FLIR. If you looked at it objectively, this is unlikely to be a good trade. I did it because I wanted to have more money in FLIR then I had in GGG and I didn't want to sell something else to buy more FLIR to make it bigger than GGG.

I am a huge believer in the growth potential of infrared imaging -- I expect them to keep growing at 20-30% in revenues and to see operating margins expand while producing lots of free cash flow. That's much faster than GGG -- the reason the trade may not work is that FLIR's PE is almost 2X GGG's so much of the faster growth in FLIR is embedded in the expectations of both stocks. I guess I hope its not the case -- that FLIR will grow even faster than many believe or if not faster then at a high rate for longer than most believe.

Been moving slowly with FLIR -- now finally around HALF my eventual position (I hope) which is around 4% -- similar in size to GOOG, CME, UEPS and TSRA. That's 2X most of my other positions such as TECH, FDS, MDT, ILMN, etc. I would love to own more of the others (ex. MDT) at the right prices but so far I have talked myself out of buying.


MCO was back below $38 for a time today -- it closed at $38.5. Been doing more thinking on the issues.

1994 -- the last year the company experienced a down revenue year is included in a slide on a presentation available at their website -- it shows a 9% compound annual growth rate in revenues from 1992 -- 1996. So that period includes the peak year of 93, a down year in 94, a rebound in 95 and more growth in 96. they don't provide specifics but they do provide a log based chart and it seems to me that in 95 they got close to 93 levels but didn't beat them and in 96 they went to new highs.

That translates to 2006 = 1992 with 2007 being the peak year followed by a decline in 2008 and rebound years in 2009 and 2010 so that they are at new levels of growth in 2010. If you follow these numbers and assume a similar 9% growth rate from 2006 to 2010, then revenues in 2010 are about $2.875 billion. That translates into EPS of roughly $3.25 to $3.50 in 2010. Assume a 20-22 PE on those numbers and the stock could be around $70 -- not bad vs. $38.50 today. That's only 2 years away (we are using 2008 EPS estimates for valuation purposes now so 2 years from now we will be looking at 2010 numbers) to double your money.

What is the downside?

a. business model changes because forced to abandon issuer pays model. Stock would get cut in half again because the business would shrink dramatically. low probability but 50% loss potential (guess).

b. litigation expenses and or potential losses if courts rule they don't just issue opinions but rather guarantees -- if they lose the court case see risk a. -- big loss because the business model would be broke. Higher expenses due to litigation is one thing -- it hurts but its not that big of a deal -- losing a case means potentially losing the franchise.

c. competition in structured products ratings due to loss of credibility -- this means somewhat lower margins -- say 40% instead of 50% and less revenue growth because they are sharing more with competitors. No idea on downside -- say 25%.

d. Growth in debt issuance world wide slows to the point that Moody's revenues are still flat with 07 numbers in 2010. The great deleveraging people talk about that would hurt their revenues. Its possible -- this is the highest probability risk, yet I still think its a low number. economic growth leads to growth in debt -- its that simple -- very highly correlated so either we end up with no GDP growth for awhile (next few years) or most developed economies change dramatically away from debt. This means a flat to down stock price -- probably somewhere in the mid 20's soon and maybe $40 in 2010.

So let's say the downside from thursday's close is 33% and the upside is somewhere between 50-150% over the next few years. Good chance I'm early to the story but that is why I will buy small to start. Will dip a toe and wait for more info -- most likely bad -- then buy more when the stock dips towards $30. That's my guess. Key for me is their franchise is in tact in my mind -- they will remain a toll keeper on the growth in debt. International markets will ensure that debt grows nicely.

Wednesday, December 12, 2007

Federal Reserve cuts 25

Ouch -- with friends like the Fed who needs enemies huh? Obviously the market traders who were setting prices today were hoping for 50bps and I can't blame them. My home equity line and my financial stock exposure was hoping for 50bps too. Grand scheme of things no big deal. We were primed for a breather after the recent rally and so now we have gotten it. I suspect we will be higher from here -- if not Wednesday, then soon after.

Darn TECH -- up over $70 now!!!! had the chance to buy more around $63 and didn't because of other options that I am now wary of. ugh!!

FLIR -- a sell rating has led to some profit taking -- should have bought more today especially if I think the market will rally from here but I didn't -- always hoping for more of course. Still at the equivalent of $62 that it closed near today, its still trading at high 20's multiple -- not much room for error. Mr. Am Tech puts out a sell saying all the good news is in the stock. Quite likely right but he was just talking about 2008. Maybe some upside but most likely he is right. On the other hand is the stock already discounting the strong secular growth of the next 3-7 years? not as convinced -- think the upside is still huge over time.

MCF -- bought some yesterday -- got a lousy price but those are the breaks. I listened to a couple of their conference calls tonight and the story is very interesting -- the guy said something fascinating about their value add --- they just discovered a 600bcf (billion cubic feet) natural gas find in the gulf of mexico -- probably the largest find in 15 years yet the 3D seismic on the area had been done in 1993 -- hundreds had looked at the very same data and seen nothing but they looked at it and found a huge store of gas. they won't and can't repeat that level of success but they can find several 50bcf reservoirs, which will be quite additive to the company's value given its small size.

Anyway, I plan on buying some more -- they have a $850 or so million market cap but CEO thought they were worth over 1 billion back in april when that 600bcf find was only 430bcf -- here we are with better fundamentals and the stock STILL isn't at 1 billion. I wouldn't normally take a CEO's word on valuation but this story is a little different.

that's about it for now.

Sunday, December 9, 2007

odds and ends

CME -- an analyst report recently included charts that showed compound growth rates of 25% or more for the volume traded of each of the major contracts that are traded on CME's exchange. This year the growth is even faster thanks to the higher volatility. I have expected $20 in 08 EPS for some time but now the stock is at 35x those estimates. either the stock will settle in here or the estimates are going to have to go higher. not sure what volume estimates people are assuming now but I don't think we are up to 25% volume growth yet. I will have to double check and report back.

MCF -- Contango Oil and Gas. Fascinating company. They determined that exploration is the point where most of the value is created in the natural gas industry so they outsource everything else and focus just on that. They partner with top geologists and others in the industry to carry out operations. They construct their contracts to provide the right incentives to encourage the best from people. They have taken a small amount of capital and created enormous amount of value from it in just several years -- say $60 mill to $850 mill in just 8 years. The beauty is that they are still small and the value is asset based rather than revenues and earnings so I think there are fewer limits to how big they can get. I am not an oil and gas value expert but I understand a good strategy and management team when I see one -- these people know how to add value and generate returns for shareholders. this is old -- from dec 06 but check this link out:,dwp_uuid=d8e9ac2a-30dc-11da-ac1b-00000e2511c8.html

TSRA -- they just signed a license with Toshiba -- another feather in their cap. good news in terms of their ability to get the consumer business up and running.

For those of you inclined to buy large cap stocks -- I think CSCO is pretty attractive right here -- I expect once they report again the stock will be back into the 30's. No way they are struggling while the rest of tech is doing well. they are just too well positioned. If I somehow had lots of cash, I would add this one but for now I have MSFT, GOOG, plus FLIR, TSRA, UEPS and FDS. plenty of tech exposure already. I would gladly trade MSFT for CSCO but tax costs make that impossible.

Thumb Sucking can be painful!

Thumb sucking. That's what I have been doing rather than decided to buy or not a couple of stocks. Thought about FDS and TECH each near their recent lows at $60 and $63 but was debating other stocks (MCO and QGEN, LMNX, etc). Next thing you know FDS is $65 and TECH is $69 not to mention MCO has jumped over 10%. not huge moves but a lot for just a few days.

As a libertarian free market type, I find the government intervention plan to "save" the mortgage industry and consequently the financial industry morally offensive. Nothing like violating the sanctity of contract and the mortgage holder's property rights by deciding that adjustable rates won't rise. If the private parties involved choose to modify the terms that's ok because its their decision -- the government getting involved just distorts everything.

As an investor and employee in the financial industry, I like the idea of stability and an end to the snowballing effect of foreclosures. The question is whether this marks the end or just a pause in the decline -- i.e. are we around March/April of 2001 (pause) or October of 2002 (end).

If its the end, then paying up a bit for MCO or FDS or TECH isn't so bad but if this is just a pause then we need to show some patience.

One thing is for sure -- sentiment is very bad right now. Hedge fund exposure to stocks is low and a lot of stocks -- financials are oversold. That means the market is going up.

Met with a wall street strategist recently who made the case that investors are crowded into stocks in certain sectors -- those with high international exposure like energy, materials and industrials. Its all a play on the secular theme of china driving demand and setting prices for all kinds of materials and infrastructure products. China is likely to see a slowdown in 2008 or in 2009 (post olympics) due to the monetary policy that China has in place. A slowdown in China will coincide with a pickup in US growth thanks to the fed's cutting rates. He argued that financials and consumer discretionary would be the best performing areas. I can certainly see that happening but I would point out he is a secular bear on financials -- he merely sees a cyclical rebound next year in the midst of long term struggle.

He also argued that emerging markets stocks would pull back next year -- performance has been too good and too many are too complacent about it continuing. My asian fund managers -- Matthews agrees -- they are conservatively positioned in undervalued securities -- that is hurting performance on the upside but will protect capital on the downside. I think everything the strategist said is likely to happen -- not sure when but I suspect it gets started around May of next year -- just seems like that is when the market has made changes the last couple of years. Not sure what actions I am going to take in my portfolio.

If financials do well next year, I think FDS's multiple will expand again and I think the pressure on DFR could loosen but that's very little exposure for me relative to what I have in energy and asia. might need to take some profits in the asian funds. I think health care -- especially LH could do better next year if attention shifts back to the US and so that could help me too.

not a big fan of any consumer discretionary stocks --own none right now. MCO could be my financials play.

more later.

Wednesday, December 5, 2007


The other choice I have been thinking about is adding to TECH or buying a new position in either QGEN or LMNX or something else. TECH is a great story but its a stock that has struggled and given the valuation and the relatively slow growth rate (but very consistent) I'm not sure the sluggish stock price is going to change.

QGEN has been a stronger performer in a related field -- they sell sample prep technologies that help automate lab processes when dealing wth nucleic acids (DNA/RNA). QGEN is also branching out into molecular diagnostics or testing based on DNA type stuff. I looked at the huge debt and the large goodwill on the balance sheet of QGEN and decided no thanks -- I realize they are a good franchise but I'm just not willing to bet on them -- if their franchise is so great why do they need to go out and spend a huge amount on buying Digene as a transformational deal that might move them more into diagnostics but will also change them from many products to a big concentration is just one -- HPV testing (cervical cancer).

LMNX provides DNA and protein analysis tools that can handle multiple tests on a single sample. Their business model is to partner or license their tech to others including TECH and QGEN. They have 4700 boxes in the field and they earn revenues for the systems (wholesale price, which is marked up to customer by their partners), for the consummables used in testing and royalties on total sales by their partners. its been a decent story though its never panned out as well as expected. If that's all there was, I might be more interested but ILMN's new Bead Xpress device is a competing instrument -- I have heard demand for the Bead Xpress is pretty strong for a new product so I am wary of buying into a competitor in LMNX. Now the good news for LMNX is that they are selling 600-800 new boxes per year and so far ILMN has sold maybe 40-80 so it will take awhile for ILMN to catch up if they ever do.

Interesting part of LMNX story is these partners -- 50 deals so far with 32 partners actually selling equipment and generating revenues. But only 4 account for about 47% of revenues so the rest of the partnerships haven't gotten too far yet. It takes time to take LMNX's technology and use it to develop new tests and get them into customer hands and change scientist behavior. My understanding is these partners are going to introduce several new products next year, which should accelerate growth. Don't know for sure. LMNX is also developing their own tests and they have some due to be introduced next year so that is another source of growth for 2008 and beyond. need to do some more research before deciding on this one.

finally a new post

Well its almost been a week since the last post -- man that sucks. I keep hoping I will find the time but then too many other issues pop up.

Interesting times to say the least. My thumb sucking on BOOM has led that stock into the 60's last I checked -- nice move. Oh well. I also thumb sucked on FDS -- a stock I own and hoped to buy more of but kept waiting for a lower price then $60 -- today it was around $65. TECH is another stock I have been watching and waiting to buy more of -- a week ago it was in the $62-63 range but I still didn't buy and by the end of today it was near $67.

In the case of FDS and TECH there are 2 reasons why I held off buying more -- MCO and LMNX/QGEN.

MCO or Moody's is a great franchise -- they own a toll on the issuance of debt. The issuer pays a fee to have Moody's rate the debt and then publish their ratings for all to see for free -- interesting model. Most pick on them for conflicts of interest and everyone rails against their horrible ability to predict the future -- yet they are a valuable tool for fixed income investors just like I believe equity sell side research is a valuable tool for investors when used properly (unlike how they were used in 1999-2000). Anyway, MCO has 50% operating margins and no real capital requirements so the business has enormous returns on capital and thanks to the constant growth in debt throughout the world -- they have demonstrated consistent growth in revenues over the last 20 years (1994 the one exception). Right now the low end of estimates says next year they will earn around $2.10, which equates to an 17 or so PE using $36 price. That said, don't forget that estimates have been dropping and the idea the stock is cheap can only be based upon the idea that future earnings power is near these numbers -- take EPS down to $1.50 and the stock is expensive.

The stock is down 50% from its highs -- so right away my interest perks up because this HAS BEEN an incredible secular growth stock that is now at a half off sale. But that's just a starting point -- questions to be answered: what about lawsuits and all the other regulatory talk? what about conflicts of interest -- will business model change? Will there be any new competition or any other reason for margins to decline? What will growth be like in the future -- has there been well above normal growth that will need to normalize i.e. experience a slow period? At what point is the stock low enough to buy?

I would love to be able to talk to the sell side analysts at this point to find out what investors believe -- what are they asking about -- if they are questioning the franchise because of concerns about rating agencies conflicts and how their ratings have been wrong, then I want to buy with both hands. If they are dispassionately noting that debt issuance is likely to grow much slower for a few years and that 2008 will see sharp declines in structured products that will drag down estimates below $2, then I might nibble. If they remain too bullish because they refuse to give up on the wonderful story Moody's has been, then I want to stay away.

A reasonable case is that 2008 stinks but after that debt issuance picks up again and in 3-5 years the company is able to earn $2.7 to 3 bill in revenues, which translates into $1.3 to 1.5 bill in operating profit or about $3.40 in EPS assuming they continue to use their free cash flow to buyback stock. I could easily make the case that the stock will double from here in the next 3-5 years. I could also make the case that the stock will continue to fall into the 20's as issuance continues to drop and they face margin pressure -- this is an industry not used to competing on price but also not used to facing declining revenues either. I could make a best case and assume they reach more like $4 bill in revenues in 3-5 years. That could drive a stock price over $100 or a triple from here.

still thinking about this one but its not often someone holds a half off sale on a business with this kind of profitability. Still to circle back to my original point -- to me exposure to MCO is exposure to capital markets which FDS also provides in a certain way so I would rather not add to FDS AND buy MCO -- need to decide on MCO and if its a No then there is no reason not to add to FDS.