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Archive for January, 2007

Pacific Internet (PCNTF) Receives a New Acquisition Offer

January 12th, 2007 by Yehuda Fruchter | No Comments

This morning Pacific Internet (PCNTF), a stock we’ve been holding since last February, finally received a new acquisition offer from Asia Netcom, for about $10.15 per share. Interestingly, this new offer is close to the valuation we suggested for the shares back in June, when MediaRing upped their offer. A full discussion of the valuation scenarios for PCNTF can be found by clicking here.

So what should you do with you shares of PCNTF given the new, higher offer? Well, we’re still holding on. Given the significant increased valuations for IP Service Providers worldwide over the last six months, we think that $10.15 per share is not a fair valuation for PCNTF. Therefore, we don’t expect management to favor this offer and it’s possible that additional bids for the company will come in.

Please Note: We first recommended Pacific Internet (PCNTF) at $7.60, and still hold a position in the stock. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise.

ActivIdentity (ACTI): Buying More On This Dip

January 10th, 2007 by Yehuda Fruchter | 4 Comments

An interesting compensation arrangement with senior executives, an upcoming first ever cash-flow positive quarter, a very low relative valuation to competitors, and a sector teeming with acquisition activity, has us excited more than ever about ActivIdentity (ACTI), and we’re buyers on this recent dip in the stock price.

Compensation Arrangement

First up the recent 8-K filing. In the filing executives were granted a set of restricted stock units based on the price of ACTI stock on January 9, 2007. Interestingly, these shares vest over three years and only if the company’s stock price is at least 130% above the grant date price for at least 60 days. Furthermore, as the filing states:

“The number of shares underlying each award will be increased by 50% if and the Company achieves a specific targeted level of earnings before interest, taxes, depreciation (“EBITDA”) and will be reduced by 25% if the Company’s fiscal 2007 EBITDA is below a specified target.”

If you’re a big follower of executive option grants, like us, the compensation agreement appears to imply a near-term floor on the stock price at near the close on January 9, 2007. The kicker here is the 50% increase in stock awarded if certain EBITDA targets are met, and a reduction in the grant if they are not. Management is obviously very incentivised in the coming year, and clearly must be be forecasting good EBITDA flows going forward to agree to this kind of incentive arrangement.

First Ever Cash-Flow Positive Quarter

And if this doesn’t make you bullish on ACTI, how does the fact that the company will report its first ever cash-flow positive quarter in the coming quarter? How do we know that? At the end of the company’s very impressive fourth quarter 2006 report, management states:

“The company expects first quarter 2007 revenue to be in the range of $13.5 million to $15.0 million with a loss of between $0.08 and $0.11 per basic and diluted share. Cash (including short term investments) are expected to increase to between $128 million and $130 million.“

As you may already know we believe, and think there is solid empirical evidence to support this, that the best time to get into these types turnarounds is when companies start throwing off cash for either the first time ever or the first time in many years of losses. Your odds of investment success, although never gauranteed, are very good under these types of circumstances, especially when the valuation of the company is depressed and there are few Wall Street analysts covering the company.

Valuation is Low

Which brings us to the valuation of ACTI. With $130 million in cash, and no debt, the company’s Enterprise Value is about $95 million. Security software still remains one of the hottest areas in software M&A with takeouts going at very high multiples of TTM revenue. We believe that on average, takeovers in the software industry as a whole are done at 2.5X EV/Sales. With an estimated $60 million in sales in the coming year, that would imply a takeout price for ACTI at a price of at least $6.10 per share or about 25% above the current stock price. This number may prove conservative given that sales estimates may come in well above expectations, as they did last quarter, and given the valuation of key competitor VASCO Data Security International Inc. (VDSI), which currently trades at over 7X EV/TTM Sales. We think that as ACTI begins to deliver consistent cash-flow over the coming quarters it’s share price will rise so as to eliminate this valuation gap.

Our only problem with ACTI: What’s the company doing sitting on all that cash now that the business is cash-flow positive? They need to either give some of that cash back to shareholders via some sort dividend or stock buyback. Another option is to look for some small add-on acquisitions to accelerate growth. Management needs to address the cash position in upcoming conference calls.

Please Note: We first recommended ActivIdentity (ACTI) at $4.37, and still hold a position in the stock.

Special thanks to Toby Shute for contributing content to this post.

Outlook for Oil Service Shares

January 9th, 2007 by Yehuda Fruchter | 1 Comment

As oil prices continue to be weak, and shares in oil service providers remain in the doldrums (i.e. check out the OIH performance over the last six months and year), we thought we’d share some interesting historical figures for those still bullish on the sector.

According to Simmons and Company, the leading independent investment bank in the energy industry (Note: Emphasis added by Envoy Global Research):

“During the 1970s, the oil service stocks realized stellar performance. For example, from 1970 through 1979, the stock price of SLB increased ten-fold. The ascent was dramatic in absolute terms as well as relative terms as SLB eclipsed the broad market (measured by the S&P 500) which rose a meager 16% over this period. Even so, the ascent was not a smooth climb. Oil service stocks enjoyed their most significant gains in the early 1970s and late 1970s due in large part to the Arab oil embargo of 1973 and the Iranian oil embargo of 1979. Our focus is on the less volatile stock price period from 1975 through 1978, a time when oil services experienced robust gains, but also hit a plateau for a 20-month stint during 1976 – 1978... The absolute returns on the oil service stocks were spectacular. The composite posted gains of nearly 300% between 1970 – 1973, 80% between 1975 – 1978 and 200% between 1979 – 1980…As shown below, the P/Es contracted meaningfully during the steady growth, lower volatility period from 1975 – 1978. Although a significant component of the contraction was driven by the broad market P/E retrenchment, the trend is clearly evident on a relative P/E basis as well. While one might argue that P/Es typically contract as up-cycles unfold and that the reduction in relative P/Es during this time was reflective of the maturation of the cycle, two pieces of data counter this position. First, relative P/Es were expanding during the explosive growth period of 1970 – 1973 and relative P/Es expanded rapidly in 1979 – 1980 as explosive growth and greater volatility returned.”

Source: Simmons and Company, Intl. 12/03, The More Things Change the More They Stay The Same

So what do we take away from all of this?

Well firstly, we’d caution like Simmons, that parallels between today’s environment and the 70′s are hardly perfect and it would be silly to simply extract findings from the 1970s and haphazardly apply them to today’s energy markets without an extensive comparative analysis. Nevertheless, on a simple level, and simplicity perhaps is the key to investment success, the above numbers suggest to us that if you missed the first big run in oil stocks earlier in the decade, not to worry, they’ll be another big run before the end of the decade. The culprit, sadly, will probably be some major geopolitical event. In the meantime, start gathering a list of the most attractive names in the energy sector for purchase during this period of price consolidation. We would expect that entry back into the sector will prove profitable late this year or in early 2008 after performance-chasing funds grow tired of the once hot sector.

Phoenix Technologies (PTEC): Activist Shareholders Still Pressing for Change

January 8th, 2007 by Yehuda Fruchter | 2 Comments

Last week, the major activist shareholders in Phoenix Technologies (PTEC), filed an amended 13-D with the SEC. We noticed several interesting tidbits in the filing, which support our continued optimism for this software turnaround play.

Notably, the filers stated:

“The Reporting Persons continue to believe that the Shares of
the Issuer are undervalued and in order to maximize shareholder value, Ramius Capital continues to be interested in acquiring the Issuer. “

As we mentioned in our initial write-up on PTEC, Ramius Capital and other major shareholders have already offered to buy PTEC for $5.05 per share. As the new SEC filing implies, this offer is still on the table. While we doubt that current management will accept this offer, given that their options are set at about the same price, the fact that PTEC’s stock is currently trading at a decent discount to the offer price implies limited downside at current prices.

In fact, PTEC reminds us somewhat of our successful foray into Stratos International (STLW), a fiber-optic turnaround play, which traded significantly beneath Steel Partners offer price for quite some time, offering investors an extremely low-risk investment opportunity in what is generally a high-risk sector. As you may already know, it didn’t take much to push STLW’s stock back up above the offer price.

Another point of interest from the amended PTEC 13-D filing, is that the activist shareholders who are now seeking board appointments, mostly bought into PTEC at much higher prices. Some major purchases were at well above $5, offering another indication that the risk in PTEC’s shares is limited at current prices.

Finally, it is also important to note that the shareholder activists in PTEC have extensive experience in the software industry, particularly in turnaround situations, giving us further confidence in the underlying value of PTEC.

For reference the two major current activists in PTEC are:

JOHN MUTCH (AGE 50). In March 2003, Mr. Mutch was appointed to the Board of Directors of Peregrine Systems (NASD:PRGN.PK) (“Peregrine”), a global enterprise software provider, to assist Peregrine and its management in development of a plan of reorganization, which ultimately led to Peregrine’s emergence from bankruptcy. From August 2003 to December 2005, Mr. Mutch served as President and Chief Executive Officer of Peregrine, during which time he restructured and stabilized its business operations and led Peregrine through its acquisition by Hewlett-Packard.

PHILIP MOYER (AGE 41) is a private investor and entrepreneur. From
July 2003 to September 2005, Mr. Moyer served as General Manager, Professional Services Industry for Microsoft Corp. (NASD:MSFT) (“Microsoft”). From July 2002 to July 2005, Mr. Moyer also served as Microsoft’s General Manager of Global Customers, during which time he was responsible for managing worldwide sales and service teams for some of Microsoft’s largest multi-national customers. From July 1999 to July 2002, Mr. Moyer was General Manager of Microsoft’s Services Organizations (Consulting, Support, Technology Specialists, and Partners) in the U.S. East Region. From 1991 to July 1999, Mr. Moyer held a variety of executive and technical positions with Microsoft.

In sum, we still believe that PTEC has little risk at current prices, and significant upside, as management, all of whom also have excellent track records in software turnarounds, continues to restructure the company to leverage PTEC’s leading position in the BIOS market.

For our initial reports on PTEC, please click here.

Systematic Investing: The Basic Thought Process

January 4th, 2007 by Envoy Global Research | No Comments

In the book "Innovation and
Entrepreneurship", famed management guru, Peter Drucker, provides
a two-line description of the entrepreneurial process that we think can
be modified somewhat to provide an excellent summary of the investment process we, and many others, advocate.

Websense’s Acquisition of PortAuthority: Our Take

January 3rd, 2007 by Yehuda Fruchter | No Comments

Greg, a subscriber, asks: What are your thoughts about the recent purchase of PortAuthority for $90 million by WBSN? How do you think this affects the current price and long term value of WBSN?

Our Answer:

The analysis of Websense’s (WBSN) $90 million acquisition of PortAuthority is somewhat difficult particularly since as turnaround investors we rarely share the same view of risk or employ the same investment criteria as executive management.
Financial Valuation Seems Exorbitant

As an investor looking from the outside in, the purchase price for PortAuthority, clearly seems ludicrous based on the price paid relative to sales and profits (i.e. there weren’t any). In fact, if PortAuthority was a public company, we wouldn’t even bother to consider it for investment given the sky-high valuation. From our viewpoint, you’re generally better off allocating capital to a bet on already proven endeavors where a valuation gap seemingly exists, rather than gamble on the development of unproven businesses with negligible historical cash-flow.

Business Risk Appears Minimal

However, from an executive management standpoint, the purchase price for PortAuthority was probably fair and represented an excellent gamble. We presume that the thought process went as follows: WBSN itself generates between $80 million – $90 million a year in free cash-flow, so that in the worst case if the purchase does not work out we’ll get back the cash we spent in a year. No big loss. At the same time, if our prediction, based on extensive industry inside information, comes true that the data software leakage market becomes bigger than the URL filtering market over the next few years, we’ll easily make 10X our money. So the risk/reward seems excellent from an executive’s perspective.

Which side is correct? There is no answer to that question, as the truth is clearly relative to your position with the company.
Option Compensation and Incentives Imply a Margin of Safety
However, notwithstanding the above analysis, we still are holding onto our shares of WBSN and would consider buying more at current prices. The reason? WBSN’s stock is still trading at a significant discount to recently awarded options, particularly for the CEO of the company who option strike prices are above $30 per share.

We find it hard to believe that the WBSN’s executive management team would undertake this seemingly expensive acquisition of PortAuthority and risk losing money on their options, unless they felt very confident that their strategies for the base URL filtering business were succeeding and that the business was on its way back to decent growth. The next quarter should reveal the truth on this matter, so time will tell whether we are correct or not in our assessment.

Risk/Reward for WBSN’s Shares Still Very Favorable

In closing, we remind investors that WBSN’s stock jumped nearly 50% after last quarters results surprised many bearish Wall Street analysts. Based on our understanding of the software market, we believe that these past results were not a fluke and that WBSN will continue to surprise investors in the coming year. And even in the worst case, you have a company generating $85 million per year in free cash-flow with a still pristine balance sheet. Where’s the risk here?

Disclosure: We hold shares in WBSN, and recommended them to subscribers at a price of $25.50. In addition, this report includes market analysis. All ideas, opinions, and/or forecasts, expressed or implied herein, are for informational purposes only and should not be construed as a recommendation to invest, trade, and/or speculate in the markets or in any particular stock. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. We maintain no legal responsibility to update this report or his holdings in the stock mentioned in this report.

A Powerful Emerging Market and Real Estate Combo

January 2nd, 2007 by Yehuda Fruchter | No Comments

Emerging market stocks did well in 2006 and expectations are for another solid year of performance in 2007. Since we’re not fans of chasing stocks, we were happy to find one emerging market that has yet to truly heat up and which we think could outperform significantly in the coming year.

Thankfully, we haven’t seen this market mentioned yet in any mainstream financial media, which gives us some degree of confidence that even though we’re not early, we’re definitely not late to the party here. In addition, in keeping with our turnaround/restructuring theme, this market is also one of the more impressive major macro-turnaround stories we’ve seen in quite some time.

So what’s the country we’re talking about and how do you play it?

Without further adieu, the emerging market that we think has the most upside potential over the next year is: Argentina.

Our preferred way of investing in Argentina is via Grupo Financiero Galicia S.A., the largest bank in Buenos Aires, the political and financial capital of Argentina. Grupo Financiero Galicia S.A. is member of Argentina’s Merval Index and its ADR’s trade on Nasdaq under the symbol: GGAL.

GGAL is currently trading at about $9.55. The stock is up quite significantly over the past few months, but we think it will continue to perform well in 2007. Importantly, we think the risk in GGAL is low over the next year given Argentina’s improving economic outlook, and the still relatively low participation by funds in an increasingly hot Argentinian stock market.

Cautionary Advice

Latin American Markets are Risky

It’s never been easy investing in Latin America, given the generally corrupt political system and unstable currency environment. In fact, a mere four years ago, Argentinian authorities devalued the Peso, precipitating one of the worst currency crises in modern history. Clearly, any investment in this region is very risky and you should expect a fair amount of volatility.

Financial Analysis of GGAL is Very Difficult

It is also important to note that our opinion is that individual stock analysis is a complete waste of time in most emerging markets and the only way to make serious money is to play certain leaders based on a believable macro-economic/social perspective. With Argentina and GGAL, in particular, it’s next to impossible to perform any serious valuation analysis since Argentinian GAAP is completely different than US GAAP, rendering GGAL’s financial statements incredibly confusing. Moreover, GGAL has a huge amount of government securities on its balance sheet which we’re not sure anyone knows how to truly value.

So in sum, it’s a mess out there, which is why you will not see any financial figures in this pick. In order to separate the forest from the trees, though, we suggest that you read thru GGAL’s Risk Factors in its 20-F SEC filings to get a good understanding of the qualitative investment factors in this situation. Briefly, all you really need to know is that the current economic growth of Argentina, especially in real estate and other lending markets, will clearly benefit GGAL, one of the leading financial institutions in Argentina.

In terms of specific reasons for our bullishness on Argentina, in general, and GGAL, in particular, we offer the following:

A Post-Bankruptcy Play on the Mend

As you probably already know, for various reasons we are big fans of post-bankruptcy/restructuring/recapitalization stocks. If there ever was a post-bankruptcy play, Argentina is it. Following the financial crisis in 2002, the entire country was basically bankrupt and the banks, including GGAL, for all intents and purposes were insolvent. However, fast forward four years, and Argentina is by all measures clearly recovering strongly from the past financial crisis. And yet, many investors still cringe at the thought of investing in Argentina, much as they feared Russia after that country’s debt debacle in the late 90’s. However, as investors increasingly forget Argentina’s past crisis and begin to focus again on its renewed growth, the Argentinian stock market should do well. Banks, like GGAL, in particular, should rise sharply, as financial institutions are always the prime beneficiaries of economic revivals, particularly when they are emerging from a period of insolvency.

Brazil’s Looking Good and Provides a Model for What to Expect

The recent re-election of Lula in Brazil, means that we’re likely to see a fairly stable and predictable political and economic environment in Brazil over the next few years. As the economic powerhouse of Latin America, and a major economic partner for Argentina, the strength of Brazil should spill over to Argentina.Importantly, in recent years, Brazil’s strong growth has attracted a large amount of foreign investment igniting heavy investor/fund interest in the region. We think it’s only a matter of time before this enthusiasm for Brazil spills over into Argentina. We would note that following Brazil’s recovery from its own currency crisis earlier in the decade, shares of the country’s leading banks soared. For example, Unibanco (UBB) appreciated nearly 15X since just 2003. GGAL’s market value, despite it’s stature in Argentina, is tiny compared to these more well-known, Brazilian banks, lending support to our upside thesis for GGAL shares.

Peso Seems Undervalued

The Peso, Argentina’s currency, is currently very weak relative to the Real, Brazil’s currency. In fact, the Real continues to strengthen against the dollar, making trips to Brazil relatively expensive right now, especially for Latin Americans. It’s the exact opposite for Argentina.Currently, when you travel to Buenos Aires in Argentina, you inevitably run into tons of Brazilians who are taking advantage of the once-in-a-lifetime currency gap to go on shopping sprees in Buenos Aires’s chicest areas. In the past, Buenos Aires was as expensive as New York City, but it’s now one of the cheapest cities in the world even four years after the currency crisis.
In fact, Brazilian businesses have taken advantage of the currency situation by buying up some major Argentinian corporations.

In truth, we are not really qualified to speak of currency values, but given the history of the region and after witnessing the current economic activity, we can’t imagine that the Peso can stay this cheap for much longer. Either prices will need to rise rapidly in Argentina, and/or the Argentinian government will need to relax some currency controls and allow the Peso to strengthen somewhat. In either case, investors in Argentinian bank stocks, like GGAL, will benefit.

Buenos Aires Real Estate Market is Booming, but Mortgage Volumes Are Still Very Low

While the US is facing a real estate correction, Argentina is in the midst of a tremendous real estate boom. We witnessed this first hand when we traveled to Buenos Aires. It also appears as if the real estate boom could go on for several more years because almost all deals are still being done with cash, implying that there is absolutely no bubble scenario yet. Compare the situation with the US where cheap credit from banks has been the primary driver of the real estate bubble for more than five years.

The reason for the lack of loans in Argentina is that the depth of the crisis in 2002 caused tremendous harm to depositors’ confidence in the financial system. Without deposit growth, you have no lending capacity and without lending capacity you cut off the primary profit center for banks and main credit line for consumers.

Despite the fact that loan origination has resumed since 2004, credit activity in Argentina still remains low and a return to its pre-crisis levels still remains uncertain. Deposits in the financial system have resumed growth, but since most new deposits are short-term time in nature, it is still difficult for banks to lend money on a long-term basis.

However, our belief is that above situation merely presents an opportunity. As economic prosperity continues in the region and money is made in real estate transactions, confidence in the financial system will slowly recover enabling a substantial part of the country’s savings to be channeled back into the financial system on a long-term basis. When this happens (and it’s actually happening now), lending volumes will increase, particularly in the real estate/mortgage market, and the income generating capacity of Argentine financial institutions, like GGAL, will improve dramatically.

Foreign Funds Still Have Not Discovered Argentina

Interestingly, despite the positive environment in Argentina, the country’s capital markets have yet to really experience a major influx of “hot” fund money. In fact, despite the size of the economy, there are only a handful of Argentinian ADR’s to choose from and there are few if any financial pundits pushing Argentina as a sound emerging market investment. The same can’t be said of the Brazil, India, and China trio. This lack of overweighting by funds, supports our notion that the risk in the Argentinian stocks, in general, and GGAL in particular shares, is low over the coming year. At the same time, as other investors discover the exciting growth prospects in Argentina, the shares could appreciate significantly.