WU & NFLX

Western Union fell 5% yesterday on News that Verizon was letting customers transfer money with their phones. Western Union said they thought the technology was interesting and will be exploring the possibility of using it. I doubt this will have any lasting effect and it won't be long before Western Union partners with a cell phone company to do this. Even if they don't I doubt the majority of their current customers have phones or can afford them.

To see if this drop will finally allow me to average down I updated my valuation, using the intrinsic value model Pabrai writes about in Mosiac.

Current Excess Capital On Hand $1,749.0
Starting FCF $1,094.50
Next Year Growth 12%
Year 2 - 4       10%
Year 5 - 7       10%
Year 8 - 10       8%
Discount Rate     9%


Shares Outstanding in Year 1 768.00
Shares Compound Rate -0.50%
PV 10 Year Sale, Years 1-10 FCF,
and Excess Capital 24,895.99
Year 10 Shares Outstanding 730.45

Price/Share $34.08
Price/Share w/50% margin of safety $17.04

Year   FCF       PV of FCF
Start $1,094.50 $1,094.50
1 1,225.84       1,124.62
2 1,348.42       1,134.94
3 1,483.27       1,145.35
4 1,631.59       1,155.86
5 1,794.75       1,166.47
6 1,974.23       1,177.17
7 2,171.65       1,187.97
8 2,345.38       1,177.07
9 2,533.01       1,166.27
10 2,735.65      1,155.57
sale 27,356.54  11,555.70
fcf 19,243.80   11,591.29
Total 46,600.34 23,146.99

In this DCF I use assumptions of 12% growth next year,
then 10% every year before years 8-10 when I predict 8% growth.

I also assume Western Union will buy back .5% of its shares every year.

This puts the value at 34.08, not the 50% discount that Pabrai looks for but 40% discounted which is enough for me in a business I like and I've bought more today.

Netflix

Munger said checklists should be used in investing which is why once again I'm using Buffett's checklist according to Hagstrom to look at Netflix.

Business

Simple, Understandable

Yup. They are an online movie rental business. They have over 75,000 titles available to rent online and multiple different paying options depending on how many movies one would like to rent at once. They also have started with digital downloads of movies that customers can watch in their web browser.

Consistent History

Um, younger than me so not really long. But it is consistent.

Favorable Long-Term Prospects

Excuse my French, but Hell Yes! Uncertainty on this is what is depressing the price, but they did so well fending off Wal-Mart that Amazon.com decided to can its business renting DVDs. People also think Blockbuster will kill Netflix but so far its spent hundreds of millions of dollars on its Online Rental business only to get it not as good as Netflix and to have less then a third of the share of Netflix, still. Right now it is basically giving away movies Blockbuster will probably have to choose online or stores pretty soon, if not it will have to raise its price on Total Access which will allow Netflix to gain a lot of Blockbuster's subscribers.

Management

Rational

Yes. Netflix knows exactly what it's doing and what will happen to its business in the future.

Candid

They have the best IR Site I've seen. Even including Videos with the executives discussing the business.

Resist Institutional Imperative

Management appears to be more focused on finding shareholders for the long haul and not on short term results.

Financial

Return on Equity

Currently Netflix has an OK ROE of 16%, I believe in the future as its marketing expenses dip relative to revenue ROE will rise to a very god number reflecting its dominance in the industry.

Owner's Earnings

Income  49,082
+ D&A   88,204
- CapEx 15,720

=Owner's Earnings - $121,566

Profit Margins

Currently Owner's Earnings Margins are at 24%, very high and it will only rise in the future as marketing and technology expenses fall.

Value

Using the same method I used for WU with growth next year of 20%, and then growth of 18% until year 8 when it reduces to 10% and a discount rate of 12% I get a value of $48 per share, which is way above the current price, but also just a starting point.

Conclusion

The valuation model I used was set-up to be aggressive, because Mohnish was using it to show how overvalued some tech stocks were, which is why I used such conservative inputs with WU, but I also believe my Owner's Earnings estimates for Netflix may be high, I will continue looking at it, I definitely believe it is a value stock flying under the radar.

Portfolio Review

As promised I'll go over my current holdings before doing any 'serious' research on new holdings.

To start the total value of my portfolio is $4,841.92 (already up three freaking dollars since I started writing the article!) which is way down from the $5,380 that I have deposited into it. This is too depressing for me to calculate the returns on it right now, but last year it dipped below $4,500 so it is coming back. Maybe I should call this the stupid mistakes portfolio where I learned what not to do. Or on second thought that's a little too long and we'll keep it at ReaL Money - yeah like the soccer teams - at least for now.

Positions

K-Swiss 16.5%
Western Union 12.8%
Overstock.com 18.4%
Cryptologic 10.3%
Cant tell u Corp. 11.1%
CASH 30.9%

K-Swiss
Allocation: 16.5%
First Buy: 10/25/2004
Total Return: 15%

Initial Thesis K-Swiss was a magic formula stock before the book came out. The company had good growth, the best balance sheet and the best returns on capital in the industry and it was a small-cap stock. It did not possess a moat at all, but because 70% of sales came from its classic category, and this protected it from expenses and inventory loss on desiging new shoes. My initial valuation valued K-Swiss at >$45 per share.

Current Picture K-Swiss still has good returns and surprisingly good margins considering its revenue fell 40% domestically last year. But that's the problem its revenue fell 40% domestically last year. It has dealt with the cycles twice in the past and gotten through them so I'm confident it can get through it again, even if it doesn't - as mentioned on the conference call - it now has the ability to become a lot bigger in Europe and Asia then could ever be in the US in the future International Sales may be the driver behind K-Swiss. BUT, this domestic sales fall scares me - if it doesn't turn-it around this time then its overvalued.

Thoughts As usual I'm still debating within my brain what to do, I'm not 100% certain that it Will turn-around and if it does when. But I also believe it is a good company with able management and I already have 30% cash and am having trouble finding good opportunities.

Western Union
Allocation: 12.8%
First Buy: 10/17/2006
Total Return: 23%

Initial Thesis This one's easy I actually posted the whole write-up here. Suffice it to say it's a good company with a long history, good management, competitive advantages and undervalued. You know that usual value investing stuff.

Current Picture There hasn't been a lot of change. It's up over 20% which is pretty good.

Thoughts As you can see with the new position CRYP I usually buy more than once, I put about $500 in and then wait for it to fall - which it always did in the past - to buy more and get my basis up to around 15% of the portfolio. Unfortunately - a strange word for the situation I might add - WU shot up 20% almost immediately after I bought it and I never could do that second buy, I love it as a company but won't invest more now because it's not undervalued enough. That is why its allocation is only ~13%.

Overstock.com
Allocation: 18.4%
First Buy: 8/9/2006
Total Return: 13.6%

Initial Thesis I wrote about this one too. Suffice it to say it was a great business model but the stock price was depressed for two reasons: Wall St. thinks Byrne is crazy and it has yet to turn a profit. Amazon.com and Netflix each went up multiple 'bags' and neither were ever as undervalued sales-wise as Overstock.com is now.

Current Picture All the above plus they're getting positive results in the lawsuit and it randomly went up 5% the other day.

Thoughts This one is the opposite of Western Union and is my biggest position because I've been able to average down twice. But I'm also having seconds thoughts, if it is a no-brainer and its low-risk high-uncertainty then I should have backed up the truck and the position size is good. BUT if it's just high-uncertainty then I have too much in it and should probably reduce it to compensate for the risk.

Cryptologic
Allocation: 10.3%
First Buy: 5/10/2007
Total Return: -8.5%

Thesis Cryptologic is down way too far because of uncertainty that it will not be able to survive without US sales because of legislation that made its business in US illegal. Huuuhhh (me breathing in after that run-on sentence). But only 30% of its business came from the US a number that's down from recent years. Plus its management has a history of outperforming its own estimates and its growing very fast internationally. Plus, there's new legislation being introduced that would repeal the first legislation - that's a pretty good word btw - and allow it to do business in the US. Oh yeah and don't forget that Pabrai owns it.

Thoughts Evidently I'm not very good at timing my purchases 7% of the 8.5% it's down since I bought it happened the DAY I put in the order. Will probably average down soon.

Can't Tell You

The last stock I own is a special situation - specifically a going private transaction. I found it through a paid service, so I won't name it here, if you're interested subscribe to the service - well worth the price - and I'll send you a link to it.

Top 5 I Don't Own
Here are five companies I don't own, but am interested in and have initiated research.

Netflix

I saw this on the 52-week low list the other day, it just didn't seem like it belonged there. I know Netflix has a good model but has been effected by Blockbuster's increasing competition online. I also believe that Netflix can survive and thrive even with Blockbuster competing and the negativity may be overblown. I've also read about 39.5 articles about Netflix being a buy-out target in the past few weeks.

Starbux

I also found this one on the low list I don't know why it's there - remember I went about three months without paying much attention to investing - but I'm interested why it is. Morningstar raised it to a wide-moat rating today which pique's my interest.

Chesapeake Energy

I've been reading a lot about Longleaf and listened to a speech of there's where they mentioned this. I also read a post on it somewhere that interested me. Plus, I got the annual report in the mail on Friday.

Western Sizzlin

'Nuff said. But, also Friendly's announced it's getting bought out which takes a lot of risk out of my valuation.

Pinnacle

The more I look at this the more I like, plus Pabrai owns it!

Mas Libros

Buffett: The Making of an American Capitalist

The Sleuth Investor

The General Theory of Employment, Interest, and Money (Great Minds Series)

Western Sizzlin

OK this is just going to be a quick note on a company I've been researching. It's 2 AM and I want to finish my book tonight but also wanted to do a post on my day off this week.

Value

It's rare to start a post with the valuation but for a company competing in a fragmented industry with no competitve advtanges, earnings decay and trading at 45x earnings I need to keep your interest.

This initial valuation is by no means meant to recommend the stock, it extreme back-of-the-envelope. I'm using $200,000 for net income, down from last year's ~275k and depreciation of $1 mil which is about in line with its trend and keeps the valaution simple. The CapEx number comes from the Chairman Letter.

Net Income    $200,000

+ D & A     $1,000,000

-CapEx         $40,000

= Owners Earnings

  $1,160,000 *13 = 15,080,000

So if Owner's Earnings is $1,160,000 next year and we give that a 13x multiple - which is less than half of restaurant Applebees - the restaurant's value is $15 million which isn't exciting when looking at WSZL's market cap of $25 million....

But when we add cash of $2.7 million and an $8.3 million investment in Friendly's we get a value for the company of $26 million, which puts it at a 7% discount currently.

Still not very exciting, but that means that we are getting all the potential of Sardar Biglari's future cash compounding ability for free.

Also this valuation does not add in any value for the potential fees earned from the new LP created by Biglari to invest the company's cash.

The letter is here and I'll post more of my reserach as soon I get it written-up.

Buenos Noches

Superinvestor Review: Pabrai

I've decided to, hopefully, go over the holdings of some superinvestors in the next few months to try to find some good opportunities.

I'll start with the superinvestor I'm most familiar with - Mohnish Pabrai.

I'll be using the data on his holdings from Guru Focus and go over the invetsments he is currently adding to or has not changed his position in. I may try to do post-mortem reverse engineering with the investments he has reduced or sold-out of later on.

Berkshire Hathaway

I believe he sees this as the safest possible stock he could buy. But, becuase of some comments he made - about how he would sell this immediately if he could find a better opportunity - I do not believe he still thinks this is a compelling opportunity for future return. At his meeting he talked about 'placeholders' safe stocks that are discounted and/or pay a big dividend with basically no downside that have a better return then cash for when he can't find a better investment.

He wrote it up on ValueInvestorclub, here.

Currently Pabrai Funds has 6.29% of its assets in Berkshire Hathaway - as it will be with all of the stocks discussed here, this number is high because he does not have to report his cash position in filings.

FreightCar America

RAIL was first mentioned to me by Joe Koster a few weeks ago when I mentioned I was looking for ideas.

RAIL quickly looks like something that would interest Pabrai. After one-minute on Morningstar I see a P/E under five, P/S under .5, ROE almost at 90% (!), good margins at 14%, high growth and >$55 million more in cash than short-term debt. Now my question is why the heck is it still undervalued?

Joe recommended the Valueinvestorclub write-up. The first thing I see here is 80% market share which almost made me open another tab to go to Scottrade right now.

Currently this looks like a good way for Pabrai to get on the railroad bandwagon that Buffett started while maintaining his GARP style.

Pabrai has .4% invested in RAIL, but is likely buying more as you read this.

Delta Financial

I don't have much experience with financials, but recommend this thread from the Motley Fool for some analysis of his buy.

Here is the VIC write-up.

DFC currently represents 9.66% of Pabrai Funds.

Cryptologic

Cryptologic is an Internet gaming stock that is trading very low because of recent legislation that takes away it US business, and because it missed earnings last quarter. However only 30% of its business was done in the US.

Pabrai wrote-up Cryptologic for VIC, and its easy to see throughout the article its low-risk and high uncertainty.

Cryptologic is next on my list for research and it will be interesting to reverse-engineer a company Pabrai loves, especially since they missed his guide for earnings in the last quarter.

Pabrai has 10.92% in CRYP.

Harvest Natural Resources

Another hard stock with a great thread on Motley Fool.

HNR is a great company with focused management, that would probably be trading at a premium if it were not in Venezuela.

Pabrai Funds has 12.14% in HNR, but has made several buys recently.

ABX Air

This is a magic formula stock trading at less than 5x earnings - and less than a third of sales - with an ROE of ~70%.

ABX is a cargo airline with 99 planes, it also has hubs where it sorts packages, etc. It does most of this for DHL.

This looks kind of boring until you see the headline on how its profit fell 47% because of less business with DHL, the company said that Asian business should bring its profit back to normal, and normalized earnings could make this already cheap stock look a lot cheaper.

Pabrai has 8.9% in ABX.

Fairfax Financial

I don't have a lot of experience with insurance companies, but know of the debate among value investors on this company.

Prem Watsa was called the Warren Buffett of the north by a journalist and this was part of the reasoning behind Chanos - who shorted Moody's and said that Buffett is wrong on it, so it may not be a stretch to call him kind of loony - saying it was worth $0.

Pabrai wrote-it-up and I'd also recommend MSN BRK Board posts on it.

He's held it for a while and has 13% in it.

Ipsco

Ipsco is his biggest position at 18.35%, probably due to the fact that it's up almost 300% in less than two years.

Ipsco is a North American Steel Maker, that I would not doubt Pabrai starts selling in the coming months to make room for more RAIL... but those are just my thoughts it may not have reached 90% of his estimate intrinsic value yet.

Pinnacle

Pinnacle - a magic formula stock, surprisingly; Pabrai has bought a number of these recently... - is a regional airline that gets all of its revenue from Northwest, which means it would conceivably not have any revenue if Northwest killed their contract, this is what's depressing the price.

But, it wouldn't fall very far right now it has cash of $348 million and a market cap of $407 million.

Northwest renewing the contract and the north of 100% ROE that PNCL has made with it would provide a catalyst for a large price jump, but it would not drop an extreme amount if the contract is not renewed - classic Pabrai low risk, high uncertainty.

Pabrai has 9% of the funds in PNCL.

I would recommend Pabrai's write-ups to understand how he analyzes companies. I would also extremely recommend his new book, The Dhandho Investor: The Low - Risk Value Method to High Returns.

Best Buy

So I had this lengthly post written out with detailed analysis on ten years of Best Buy annual reports, and at least three pages of valuation scenarios but then blogger deleted it all... OK maybe not, but I did I have an actual write-up written that got deleted, I don't have a lot of time now because I need to mow the lawn before I go to work so I'm just gonna put it through the The Warren Buffett Way, Second Edition list and if it passes I'll do some more extensive crap later.

Business

Simple and Understandable

Pretty much. Best Buy is the number one, basically the top dog, technology retailer. It's mainly Best Buy and Geek Squad, but other brands are listed here.

Circuit City is its only direct competitor - the only competitor who like it focuses on technology. It also competes with Wal Mart, Target, Costco, Sears, etc.

Consistent Operating History

Yes. Only one year that wasn't consistent in the past ten. Every other year showed ROE over 19% usually over 20.

Favorable Long-Term Prospects

Definitely. Management has shown ability to keep up its good profitability. Also it has no direct competitors that offer any sort of threat at all. Circuit City is kind of a joke comparatively, and I doubt Costco or Wal-Mart is going to randomly decide put Best Buy out of business tomorrow. Also its knowledgeable employees and Geek Squad are a massive help in buying decisions and later troubles and should be added as an intangible asset.

Of course I would not predict terminal growth of more than 1.5 or 2% simply because there aren't very many retailers still earning good returns on capital from 30 years ago.

Management

Rational?

From the annual report it seems like management is rational and knows what they're doing.

Candid?

The letter was very informative.

Resist Institutional Imperative?

Though the annual report had a lot of glossy pictures and looked like a marketing campaign, and some press releases had almost sleazy headlines, I'd say overall they resist the institutional imperative.

Financial

Return on Equity

Currently Best Buy has an ROE of 24%, and as previously noted only one time has it been lower than 19% in the past ten years. Add that to the fact that they devoted a page in the annual report to computing the return on capital and explaining it and I believe this is a company which focuses on ROE and will maintain a pretty high one.

Also Best Buy is short on debt with a D/E of .1.

Owner's Earnings

Income                  1377

+Depreciation           509

-CapEx                  733

=Owners Earnings        1153

Profit Margins

Though inherently low because it is a retailer its profit margins have been higher than the industry average in each of the last five years.

One Dollar of Market Value for Each of Retained Earnings

According to Quicken it has created $3 in market value for each in retained earnings easily passing this test.

Value

Best Buy is definitely more undervalued now that it has been in a few years, it trades for only 2/3 of sales and at a PE of only 16, which is lower than any average PE over the past ten years.

But according to Quciken it would need to grow earnings 11% annually over the next ten years to justify the current price. This does not leave a lot of room for error...

In my DCF I'll use a discount of 11%, growth of 10% over the next ten years, which is short of analysts expectations of 16%, and then 2% terminal after that, this gives me a value of $22.9 billion, add in cash of $3.8 billion and we get a value of $26.7 billion not much higher than today's market cap of 23.5 Billion, in fact only 9% higher and more than all of that is cash, not really much of a margin of safety.

In conclusion Best Buy may be relatively undervalued today, but slower prospective growth in coming years puts it at just around fair value when looking from a DCF perspective. My assumptions are conservative, though basically align with Morningstar who predicted one year of 16% growth before ten percent, I want companies to be at least 30% undervalued with conservative estimates, which bake in two layers of safety, before I decide to spend a lot of time researching it to find out where the value really is.

But, Best Buy is a good company, and a lot more experienced investor may be able to justify higher growth predictions, or may have found some hidden real estate value but my analysis says wait for it to fall about 10% before putting more work in.