Wednesday, May 14, 2008

more on UEPS but first......

MCO -- yes I know this is one of the few non-energy stocks out there that is going up consistently and yet I've sold away my upside through the calls I wrote. oh well. I still have till June so no telling what kind of pull back we might see between now and then. Reality is that AFTER I sold my calls I realized that about 25% of the non-Buffett owned float was short the stock. that pretty much limits the downside. business is picking up but its still pretty slow and it has to pick up some just to make current estimates. so now we are around 21-22X estimates, which would seem to be the high end in this environment but who knows -- fundies are improving so should the valuation.

DFR -- key question -- what is forward earnings potential given all the changes to the company? some argue its 40 cents per year. that is possible but unlikely that too many others believe it given the $1 stock price. certain aspects worse than I thought so that is a little worrisome.

FLIR -- just saw a commercial about franklin resources (mutual funds) and they claimed to have made money owning an infrared supplier -- most likely FLIR. DRS Tech was a competitor too so the deal should help support FLIR's stock too.

I have owned UEPS for about 2 years now and so far the stock has done nothing. The business has continued to get more valuable and that is key but this is testing my patience. The stock has bounced since the earnings report but is still relatively flat with the last few years around $28.

When MA pulled back towards $100 some time in the last couple of years I wondered if I should buy some. I decided not to primarily because I thought UEPS had far more opportunity. Well the market has its own thoughts on opportunities.

This is an important lesson -- one which I continually relearn. Expanding margins and increasing returns on capital are key drivers of big returns in stock prices. MA's margins and returns have soared since they came public (Visa is working on similar improvements). MA has enjoyed strong earnings relative to expectations driven by higher margins. Revenues have been good too but they are not growing at the rates that UEPS has the potential to produce over the next couple of years. Between wage payment in SA, Nigeria, Ghana, Iraq, etc. UEPS has huge opportunities that should triple the earnings in 5 years. Margins though are already above 40%.

But the main issue for UEPS is timing -- it takes a long time to negotiate a contract and then to implement the process/strategy and then have enough new cards with people choosing to use them at merchants (rather than just getting cash). But once the cards are in place and people are using them for their shopping and their bill paying and other services, those cards are likely to be in place for many many years.

no reason for most to switch so UEPS ends up with a long term annuity on the growth and usage of their cards -- same business model as Visa and Mastercard although because UEPS is a smart card there are many more services that can be performed on these cards than on regular credit cards. More services per card offsets at least somewhat the disadvantage that UEPS is at from a spending per card basis -- obviously first world consumers spend more on their cards than third world types.

Once the SA contract is resolved and some of their current countries reach critical mass (i.e. enough cards and merchants that people that don't have one feel a pull to get one) the business will be very profitable (little incremental costs post set up) with high free cash flow and still pretty good growth potential. They will have a long term annuity from all their existing cards that will make this business very valuable -- I find it hard to believe they won't have a 20's PE.

The hard part is the wait -- a new country announcement is very exciting and everyone's first instinct is to ask how much is that going to help EPS -- that's a good question but don't forget the timing -- it may take 5 years for a country to be up and running and have a critical mass of users. When I first bought the stock in the summer of 2006, analysts were already talking about wage payment in SA and Nigeria as big catalysts. Here we are almost 2 years later and those are only now starting to build customers. Iraq is just finalizing the contract so it could take quite awhile to build out the infrastructure and start really having an impact on the overall P&L.

But Iraq could double the size of the company as it stands now -- so could wage payment and nigeria. Ghana continues to get bigger and they are trying to add more countries all the time -- especially because of what Ghana is doing. With all the catalysts I am comfortable they will be earning $4-5 per share in 4-5 years and receiving a 20PE on those earnings for a stock price close to $100.

This is without a doubt my biggest opportunity-- in terms of cash cost basis its one of my largest bets in the portfolio too -- I have larger positions but that is because those stocks have gained in value after I bought them. I would have bought even more of UEPS but I realize the timing of the business means catalysts can always take longer to play out. its hard in other words even though I have a lot of patience and enthusiasm for the story but in 2 years to have not much happen -- that's hard. I am confident the patience will pay off.

Bought some more CLB on Monday to get close to a full position. Thankfully I timed it well -- $123.50 so I enjoyed yesterday's pop to $133.

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