NVE Corporation (NVEC)

Technology companies often face the prospect of years of negative cash flow while developing new ideas while hoping that one of these epiphanies will carry the company to profitability. Not so with NVE Corporation (NVEC). The company has had a longstanding agreement with the government to do contract research and development. This means the company gets paid for the R&D it performs while at the same time, most of the intellectual property it discovers along the way still belongs to the company.

Spintronics is short for Spin Electronics, and depicts what Craig Hallum has termed a "profound advance in microelectronic technology." The technology uses the electron spin instead of the electron charge to acquire, store or transmit data. Obviously with my financial background I can't dive deep into the ramifications of this technology, but suffice it to say the company is on the verge of revolutionary discoveries that could drastically impact electronics in the future.

Although most of the contract R&D was done for military purposes, the company has introduced its first products in the medical device area. Specifically, NVE has begun selling revolutionary technology relating to hearing aids and pacemakers. As applications from research begin hitting the market, NVE has seen its revenue stream shift from being heavy in government contracts to now being much more driven by sales of products. The expectation is that the company will soon enter the automotive and consumer electronic businesses.

NVE has done a good job of validating their technology by lining up some strong blue chip customers. Companies such as Honeywell, Cypress Semi and Motorola have come on board which strengthens the technology's credibility. One concern when bringing in partners is the protection of the intellectual property. NVE has more than 100 patents worldwide to cover its technology but there still arise questions as to how these patents cover specific uses of the technology.

The company is currently involved in litigation with Motorola as well as Freescale Semiconductor but it looks likely that negotiations will allow the relationship to remain and NVE to be paid a license fee for its technology. In fact, licensing is likely to be a significant revenue driver in the future as more companies want to implement spintronics into their products. International revenue is picking up as well allowing NVE to diversify its revenue base and take advantage of the strong global economy.

I am a bit concerned that the stock is expensive, but it is very unclear how quickly the company will grow its business. There is a strong possibility that sales will ramp as more applications come online. There is a significant amount of short selling in the stock which could provide buying pressure should any unexpected positive announcements happen. The prospects look good and I would look for a good low risk spot to become involved with this name.

FD: Author does not have a position in NVEC

Bare Escentuals (BARE)

I spend a good bit of time leafing through companies that have come public in the last 12 months as it is a wonderful area to find emerging companies with strong growth prospects and possibly overlooked stocks. Such may be the case with Bare Escentuals (BARE). The company markets makeup and other cosmetic products through its boutique shops as well as through wholesale channels that filter down into department stores. One of the differentiating factors for the company is that BARE was one of the first to make mineral based products so popular and this type of product is now becoming the industry standard.

After coming public in September 2006, the stock has been subject to two secondary pricings as major shareholders are cutting back on their positions. The most recent sale, along with a company pre-announcement that wasn't taken too well on the street has brought the price lower in the last month. The large shareholders are still out there which may cause a bit of an overhang in the stock, but they have significantly lightened their positions so it is unlikely they will add too much more pressure to the stock.

Concerns with the pre-announcement center around poor performance in the infomercial portion which accounted for 1/3 of 2006 revenue. A new format was used for the company's infomercial and it wasn't received well by customers. Management was quick to realize the campaign wasn't working and soon after, the program had been changed. Sales picked back up with the new format, but the damage for the quarter had already been done. The stock is obviously pricing in continued weakness in that area.

While that news is definitely negative, there is much to be excited about when viewing the company as a whole. There are three main areas the company is counting on to drive growth and each of these departments appear to be in good health.

First is the boutiques which directly sell BARE's products. There are 33 of these stores nationwide and they generally enjoy margins 10-15% higher than the other distribution channels. The company is planning for 15 new stores each of the next 2 years and some speculate there is a potential for 150 doors long-term.

Second is the wholesale channel which has had some exciting news lately. Sephora which has picked up BARE's products as its top selling brand, will now be included in many JC Penny stores. In addition, there are over 200 doors in France which allow the company good exposure in Europe.

This brings us to the third driver which is International. The company is concentrating on Europe right now as they are able to widen their footprint while relying on marketing efforts to drive sales in multiple countries. Japan is another key opportunity as the demographics and product use statistics are very encouraging.

While not cheap, this stock reflects the tremendous growth potential for the company. It appears we are seeing evidence of institutional buyers stepping in at this level which will likely provide some support for the stock price. I would be careful as the overall industry is not one of the leading groups in this market, but the individual company metrics warrant a close look.

FD: Author does not have a position in BARE

Research in Motion (RIMM)

"No one has ever gone broke taking profits." That is a popular saying in the circles I have been known to traffic in. It makes sense doesn't it? If you take winners off the table when you have a profit, you will always have more money than you did when you started. But there is another uglier side to this coin that few do a good job of covering.

I was on the beach with the family last week when the Research in Motion (RIMM) release came out and my associate called me to let me know that it was up big post-market. In speaking with a family member that is in a similar business, we were lamenting the fact that neither of us had adequate exposure to this name. Our fund has a small position because my associate was wise enough to get us on board, and I was cautious enough to keep the size small enough to ensure we didn't make any serious money on it.

My family member (we'll call him Fred), confessed that he covered his position in his IRA last year as he had already realized a 50% gain in the stock and thought the run was likely over. It reminded me of another more relevant adage that one should "let your winners run, and cut your losses quickly." Its so easy to take a quick profit when it is available and go looking for another great pick while many of us are so stubborn that we stick with positions that do not show an immediate profit because we're confident in our analysis and expect that position to eventually conform to our expectations.

Now this post is not supposed to be a ringing endorsement of RIMM encouraging everyone to go pick up the stock. It is extended here and is really a dangerous place to be initiating a position. However, if I held a position in RIMM (wait! I do! - its just small), I wouldn't be too quick to cover. The company is apparently starting to move into the vibrant Chinese economy, is introducing new products, and is likely to be a formidable competitor to Apple and the new I-phone that is getting so much press.

I guess the point that I am trying to make to those less seasoned investors is that in developing a strategy to successfully traverse these markets, one must be disciplined to stick with names that are conforming to your expectations because if you have done the work and taken the risk, you should stick around to be paid the best possible price for your efforts. Conversely, if a stock isn't behaving as you expected, there must be a pre-determined point at which you are going to ruthlessly cut it so as not to give up your profits from winners on picks that don't turn out.

For me, this means holding on to my long positions in Chipotle, Intercontinental, and FC Stone, as well as shorts in Resmed, Moody's and Las Vegas Sands until they give me a definite reason to close them out. Conversely, I need to be willing to close positions such as Under Armour and Carmax that are simply working against me. On my desk I have two words displayed over my computer monitors. they are "DISCIPLINE" and "FOCUS." I believe these are a traders two best friends and are necessary for success in this business.

Have a great Friday and enjoy the weekend!

FD: Author has a long position in RIMM

Mindray Medical (MR)

In the ever growing Chinese economy, healthcare has taken center stage as more and more of the population now has access to first class physician services. Mindray (MR) has been an integral part of this process through the three product lines it offers its customers. The company makes devices relating to 1) Patient monitoring, 2) Diagnostic lab instruments, and 3) Ultrasound imaging systems.

While the company has only been public on US markets for the last 9 months, It has a long profitable history dating back nearly a decade. New products are a vital part of this business and the company commits 10% of all revenue to research and development of these new ideas. Over the next few years, most of the growth will likely come from its color ultrasound machine which has only recently become available. Demand was so strong for this product upon launching that the company was briefly out of stock. It appears manufacturing has been able to catch up and the company was quickly back to selling the product which accounted for 50% of the sales growth last quarter.

While Mindray operates primarily in the China market, it has begun to diversify into other countries to increase revenue and diversify geographically. It is currently selling products in 120+ countries and has many of its products approved by the US FDA, or the European equivalent. For more developing countries, the company focuses on peddling its patient monitoring and diagnostic instruments, while more developed nations such as the US and many European countries, the company is able to sell its high tech new ultrasound machine with good success.

Looking at analyst expectations over the past year or so, it is easily noted that analysts typically underestimate the company's earnings power and constantly have to adjust future expectations higher. I expect this to continue for the next year or two at least as it appears a bit of conservatism is inherent in this industry. Even if the current consensus is correct, the stock is still not extremely expensive for the growth rate it is achieving. I would expect this growth to be fairly stable as the company is not relying on any one specific economy to drive business growth.

While I currently do not have a position in the company, I would look for a small pullback in the shares to buy stock. This is a disciplined approach that I use to minimize my risk in new positions and hopefully allow me to hold winning stocks longer without getting stopped out. I would not discourage someone from taking a position in this name as I believe the growth prospects are very appealing.

FD: Author does not have position in MR

Acorn International Inc. (ATV)

As China's economy continues to expand, the amount of discretional spending and demand for consumer products ramps higher. Acorn International (ATV) has been meeting this demand through its TV shopping business which is aired on the country's four national channels as well as 40 smaller regional channels.

The company is somewhat similar to Focus Media in that it generates revenue through advertising to the general population, but ATV actually covers more of the process by not only delivering the advertising to the consumer, but also delivering the product to the consumer and collecting payment for the merchandise.

CIBC estimates that the market for TV shopping is roughly $1.4b in 2007 and sees the entire market growing by 20% through at least 2010. One of the reasons this market is so healthy is that China continues to struggle with its infrastructure. Since freight and transportation issues abound, it is easier for a consumer to purchase something over this television network than try to get to a city store that may or may not have been able to secure sufficient inventory of the desired item.

Retail sales in China are increasing at a robust rate due to the ever expanding GDP growth. While monetary policy is trying to put somewhat of a damper on this growth to keep the expansion sustainable and keep it from overheating, the Chinese economy should continue to grow and consumers are not likely to pull back their newfound demand for goods and services anytime soon. TV sales represent 0.1% of retail sales and that compares to 7.5% in the US. If this were to increase to just a small fraction of the US demographics one can imagine the increase in demand for ATV's business.

One of the issues that has the potential to impede ATV's growth is the working capital that is necessary to maintain the business. Currently, the company has to pay for the ad spots ahead of time on the television networks. It also keeps an inventory of the items it sells. When consumers purchase the products, the company usually delivers the product and receives cash on delivery (COD) which takes more time for the ATV to actually receive the revenue. If China begins to use more credit cards for these type purchases, ATV will receive its revenue much more quickly allowing it to reinvest that capital in larger marketing campaigns.

While the stock is not cheap, I believe the EPS growth justifies a premium multiple and would expect the stock to trade higher from here. There was a warm reception to the IPO back in May as the stock priced at $16 but hasn't traded below $22 since the first day of trading. The stock has pulled back over the last month as some of the hype from the IPO was likely digested. This pullback likely offers a good chance to pick up shares and I will be considering a purchase shortly.

FD: Author does not have a position in ATV

Trina Solar Ltd. (TSL)

The worldwide demand for energy continues to grow while at the same time, environmental concerns have put pressure on traditional sources such as fossil fuels. As governments and individuals alike strain to find a balance between these two conflicting needs, alternative energy companies are being brought into the spotlight.

One of the most popular energy sources for electricity will likely be solar power. Governments in many developed nations are pushing subsidies to stimulate demand as well as innovation in this field, and manufacturers of solar power equipment are taking advantage of these tailwinds.

Trina Solar (TSL) is one company taking advantage of the demand. The company is a supplier of components to make solar panels and has become increasingly vertically integrated. Analysts seem to agree that in order to remain competitive in the field, companies should control as much of the manufacturing process as possible from procuring the raw materials to producing the ingots, to manufacturing the wafers, to assembling the cells, and finally compiling the modules.

Trina has taken great strides to be involved in all parts of the process. The company has been able to manage the rising prices of silicon by purchasing recycled silicon at a significant discount. It already claims to have agreements for the purchase of half of its needs for 2008 which adds some stability to the process in the face of a volatile market for raw materials. In early June, the company raised $156m in a secondary offering of stock and will use most of the proceeds to beef up their production lines presumably adding functionality on the downstream side of the manufacturing chain.

Currently, the primary users of solar power are customers who are already on a public utility system, but want to supplement their consumption using solar energy. Trina noted in their prospectus that solar power production is expected to grow at a 44% compounded annual growth rate (CAGR) through 2010. The growth prospects are shared by the few analyst that follow the company as EPS are expected to grow from $0.52 in 2006 to $1.61 in 2007 and likely $3.72 in 2008. If these projections are relatively close, the stock is actually trading at a very reasonable level especially considering the robust long-term growth prospects.

While i currently do not have a position in TSL, I have participated in both the IPO and the recent secondary and am considering taking a longer-term position as the stock seems to be finding support after supply concerns begin to abate. The trading is likely to be a bit volatile as policy news can really affect the sector, but the risk to reward ratio appears very attractive and worth the time and effort to warrant deep research and possibly investment of capital.

FD: Author does not have a position in TSL

Metro PCS Communications (PCS)

Tired of unpleasant surprises when opening cell phone bills? Metro PCS (PCS) has the solution. The company offers only pre-paid unlimited calling and data plans so the monthly check is the same every time. PCS also benefits from the non-traditional format because all revenues are pre-paid and the company does not have to worry about allowing for bad debt or wondering if customers will pay for service they have already used.

The pre-paid service has another distinct advantage for the company because it can offer services to anyone without having to run a credit check or verify the customer's ability to maintain a contract. Bear Stearns has noted that the company's exposure to illegal immigrants is larger than most carriers because it doesn't have to do background checks on clients. This is also a factor of the company operating in markets where immigration is more prevalent.

Currently, PCS's footprint covers 7 of the top 25 US markets. Typically the company rolls out one city at a time keeping costs in check and allowing them to concentrate on bringing the new market up to speed quickly. The next few years should bring many notable cities online including NYC, Boston, Philadelphia, and Las Vegas. The rollout should allow the company to continue its trend of strong revenue growth that spans many quarters. Baird believes the company's IPO in April raised enough capital ($862.5m) to fund this growth without additional capital infusions. Thomas Weisel believes they may need to raise a bit more capital but is still bullish on the name.

At this point, the average Cost Per Gross Addition (CPGA or cost of adding a new subscriber) is lower than any competitor at roughly $100 and the operating costs per subscriber also remain below the industry norm. This allows the company to realize great profitability even though their churn rate (percentage of customers dropping their service) is significantly above the industry average. Keeping costs in line will be key as the company continues to roll out service in increasingly competitive markets.

Analysts site some concerns revolving around spectrum that the company will use in its expansion. The FCC auctioned off this spectrum but there could be some timing issues as to when PCS will be able to take advantage of this asset it purchased. New hardware will have to be installed and some current users of the spectrum will have to be removed. Any delay could be negative for the company so this will need to be monitored.

All in all, the future looks rosy for the company and with the stock only being available for the last 2-3 months, there is likely pent up demand for the company. Much of the stock was issued to private equity holders who agreed to a 180 day lockup. This may cause some overhang in supply of the stock but if the market is healthy and the company continues to execute, this will only have a muted effect on the shares. I have a long position and will likely add more in the future.

FD: Author has long position in PCS

Bear Stearns (BSC)

A successful investing strategy often flies in the face of conventional wisdom and puts the investor opposite the expectations of the general public. Such is the case with my recent purchase of Bear Stearns (BSC).

Bear has been in the news spotlight the last few weeks as two hedge funds it is affiliated with have come under intense pressure. The funds invest in Collateralized Debt Obligations (CDO) and are fairly leveraged vehicles. The more risky of the two reportedly raised $600 Million and then went out and used that to borrow an additional $6 Billion to invest. The company used the investments as collateral to secure the loans and now that the collateral is valued lower, lenders such as Merrill Lynch have threatened to pull the collateral, sell it in the market at drastically lower prices in order to get out of their predicament.

In steps BSC to save the day. The company has graciously offered to put up $1.6b (and possibly as much as $3.2b) as collateral to bail out the funds. The stock has been hit hard on the news and speculation is abundant that this could be a very damaging move for BSC. Some have even suggested that this could put Bear out of business and others speculate the stock will be pushed so low as to make Bear a sure take out by another brokerage.

If you look back at the history of Bear, you see a few key differences between the company and their counterparts across the street. Bear may not be as talented at attracting the individual assets like Merrill Lynch, they play a smaller role at incubating new funds than Goldman Sachs, and their investment banking doesn't do nearly the volume of Credit Suisse. However, the company does an Excellent job of managing and investing its own capital. The corporate culture still reverberates around making positive returns on assets and traders are meticulously trained to manage risk, and build the company's asset base by seizing opportunity.

This bailout is just that... An opportunity for the company to issue a loan (they are being compensated for the risk they are taking) and make a good return on their money. I picked up a position in BSC calls and expect this wave of selling to be just about over. I would not suggest putting too much capital at risk, but the chances of a rebound are good, and the size of the move is potentially very exciting.

FD: Author has long position in BSC

Fortress Investment Group (FIG)

There has been plenty of buzz surrounding the world of alternative investments lately. The first big story revolves around two hedge funds affiliated with Bear Stearns that are invested in Collateralized Debt Obligations (CDO's). From what I understand, one of these funds started with $600 million in capital and went out and borrowed $6 billion (with a B) to begin their investment program. This is often a recipe for disaster and in fact, the fund has lost assets and now the lenders are likely to recall the loans and foreclose on the collateral (which won't be worth much if everyone on the street knows they are trying to sell foreclosed property).

The second high profile story dealing with alternative investments may or may not make headlines this evening. Blackstone is expected to price their much anticipated IPO tonight and become one of the few publicly traded hedge fund managers (ok I know the company is a bit more complicated but that's part of what they do in a nutshell). Many have criticized the deal because the CEO Stephen Schwartzman will reap windfall profits from the deal (roughly 7 billion - again with a "B") and because the company will be taxed favorably. Congress is weighing in on the deal with Rep. Henry Waxman asking the SEC to refrain from allowing the IPO until congress has had a chance to look at it (since when does congress say who can and can't list stock?).

Keeping a relatively low profile in the midst of the turmoil is Fortress Investment Group (FIG). The company was the first asset management firm dealing with hedge funds and private equity to come public and the shares have done relatively well. The IPO was priced at $19 and immediately the stock traded up well over 60%. With such a big move in the first day, it is natural the stock would have to take some time to consolidate those gains, but even currently, it is trading above 25 or 35% above the IPO price.

Diving into the fundamentals to this company is more challenging than most companies I have worked with. Earnings per share is not a very good measurement of economic value because of the non-traditional business and the way unrealized gains are not included in that GAAP number. However, the company appears to be doing an excellent job of increasing their assets under management and investing these new assets in various diversified programs that have the potential for very attractive gains.

Investment programs offered by Fortress are divided up into 3 groups. Private equity represents $17.8 B of the assets and the capital is invested in companies and ventures that are not traded on public markets. Hedge funds represent $13.5 B and are invested in various strategic programs dealing with currency fluctuations, yield spreads, macro directional strategies etc. The third category is termed "Castles" by the company and relates to their closed end REIT that invests in real estate and properties. This is much smaller with $4.7 B in assets.

At the present time, the company does not have a significant amount of leverage which is important given the volatility of the current market, and alternative investment vehicles in particular. There appear to be a healthy level of investments in the private equity area that are available to bring public and capture significant incentive fees as well as profits that the company will make from its own capital invested in these deals. Finally, the company is having no trouble raising additional assets to put to work as their track record and talented management is gaining good exposure and investors are willing to take additional perceived risk in these non-traditional investments.

I recently purchased a position in FIG taking advantage of the weakness in the stock. I think when the Bear Stearns funds either get their act together, or go ahead and close down, it will take the negative spotlight off this area and result in an increased valuation for FIG. Also, the Blackstone IPO should bring good publicity to the sector and likely be a catalyst for FIG to trade higher.

Sell Ad Space

FD: author has a long position in FIG

CB Richard Ellis Group (CBG)

Lately strong employment numbers have caused market economists to worry about inflation federal reserve policy. These same employment statistics are music to the ears of CB Richard Ellis (CBG). The company is a commercial real estate operator that leases buildings, manages properties, and provides many different services surrounding this industry.

Recently, the company made a big acquisition, purchasing Trammel Crow in December fro $2.2 billion. While the company is no stranger to mergers, this most recent acquisition is a big step as it opens up many new opportunities for the company to expand its services offered. CBG has estimated that the acquisition will save $65 million in costs by second half of 2007 and during their first quarter release, it announced that these cost savings are ahead of schedule. However, the biggest benefit of merging the two companies revolves around the possibility of cross-selling the new Trammell customers many of the services CBG has already been offering. Trammell boasts many strong blue chip companies such as American Express and Bank of America so this adds stability and opportunity to the marriage.

In the past, much of CBG’s business has been on the transaction side. This means when the company assists in the sale of a large property, there is a significant boost to revenue and income. However, this is a non-recurring revenue stream so it is important to keep a pipeline full of these transactions in process. The other side of the business relates to what the company calls “outsourcing business” or managing properties for outside clients. This type of business usually revolves around a long-term contract so the revenue is a recurring stream that is predictable and adds stability to the business. While this management business was only 8% of revenue pre-merger, the addition of Trammell will bump this up to 18% of revenue and give the company opportunity to increase that as it cross sells opportunities to other clients.

Another interesting area of operation for the company is “CBRE Investors,” the money management portion of the business. The company sets up and manages real estate investment programs for clients either managing the accounts separately or setting up limited partnerships to make these investments. While the company is able to charge a fee for its $30 billion under management, it is also eligible to participate in incentive fees if it outperforms certain targets and benchmarks. This can be a very lucrative business and has been a fast growing portion of the company over the last few years.

Looking at the valuation of the stock, I am encouraged by the valuation (18.7x 2007 consensus EPS) especially when taking into account the projected growth in the company. I’m also comfortable with the financial statements as it appears the company is very conservative in the way it accounts for revenue and expenses which gives it a higher earnings quality. The economic picture continues to look stronger than we anticipated at the end of the year and as the company diversifies outside of the US to be a key European and Asian player, the risks associated with the US economy become more manageable.





CBG Notes

FD: Author has long position in CBG

Focus Media (FMCN)

Focus Media is a direct beneficiary of the economic boom in China. The company owns a network of flat screen TV’s set up in prominent places within the countries top tier cities. These screens continually broadcast advertisements to the masses who are waiting for busses, standing in lines, riding the elevators, or shopping. In Q1, the company was able to sell 90% of their available time slots in the tier 1 cities versus only 77% for Q1 last year. Furthermore the average ad price was roughly $12,000 up 2.5% from last year.

Acquisitions have allowed the company to grow into additional areas. A purchase of Allyes cemented their foothold in the internet market where more and more middle class Chinese citizens are spending time. Secondly, the company bought Framedia which places poster ads in public places much like the TV screens that Focus has mastered. Over the next year, the company plans to revamp many of Framedia’s posters to be digital posters able to change multiple advertisements in the same poster area. Analysts expect revenue to triple from these posters and it is expected that these posters will contribute $12m in revenue for Q2. For a company that brought in revenue of $68.2m in Q1, this is a significant increase.

Synergies with the Allyes acquisition should drive additional revenue as well. Formerly Allyes had access to roughly 300-400 clients who would purchase ads. Now Allyes has access to Focus’s 2,900 potential clients allowing the company to both sell more ads and increase the potential price as more customers are bidding for the same spots.

While the company has been very successful in the tier 1 cities of China, there is still plenty of opportunity in tier 2 cities that still have significant numbers of affluent citizens. In Q1, the company sold roughly 39.3% of all ads. After backing out its 90% rate in Tier 1 cities, it is clear there are many slots left to sell for the Tier 2 cities they have targeted. Average prices for these cities has increased as advertisers are seeing the benefit of reaching these additional cities, and selling rates will continue to pick up. Q1 was a seasonally weak time according to the Chinese calendar, so Q2 numbers will have a much more important effect on the stock and give us a better idea of just how fast this company is growing.

I was impressed to see that the company has no debt so they are not very constrained as to how much capital they can plow into new markets. The company typically partners with an affiliate in a new city until it has enough critical mass to then move into the city completely with more certainty of the market. While there is much room to grow, the management appears to be cautious and strategic with their growth decision making sure they do not over expand.

In a market that is ever expanding and growing, Focus Media seems to have a good handle on the economic environment and is a strong potential candidate for the international investors portfolio.



Monetize Your Site

FMCN Notes

FD: Author has long position in FMCN

F C Stone Group Inc. (FCSX)

One of the benefits of being a small investor is that one can take advantage of small or more thinly traded stocks that would not be available or efficient for a large institutional investor to be involved in. Such is the case to some degree with F C Stone Group (FCSX) which provides risk management consulting and transaction execution to commodity users and producers.

Although the company has only been public a few months, a few of its clients have been with the firm for over 30 years. As volatility has increased in commodities markets, the company’s business has picked up quickly and the future continues to look bright. The company benefits from increases in volatility and also increases in interest rates. Arguably these are two forces that should be around for the months and years ahead.

Producers of commodities such as farmers, miners, and energy producers have finding it more and more difficult to determine the current and future demand for their product which makes planning, investing and running their business more and more risky. The same is true for end users such as food producers, utilities, construction companies and any number of other industries. F C Stones customers typically have $5 million or more of commodity exposure a year and prefer to outsource the management of this exposure to risk. As volatility increases, more companies are becoming aware of their exposure to price swings and are willing to hire an outside consultant.

The barriers to entry are not extremely high in this business, but FCSX is able to compete through its highly trained consultants. The company has years of experience and is constantly researching new ways to help their clients avoid or even benefit from the volatility. Furthermore, the company has trading and clearing services available so clients are able to use FCSX as a one stop shop developing the strategy and executing each portion of that plan through the company’s infrastructure. FCSX makes a profit on the consulting, execution, clearing, and financing; the full process of mitigating customer risk.

The stock is not a cheap name (as very few stocks with good growth prospects are). It trades at a 32 multiple to 2007 estimates (Year ending August), and 29 times 08 expectations. However, the expectations should not be thought of as concrete numbers. If we continue to see rates rising, inflation concerns, and volatility in prices, one can assume the company will land many new profitable clients and those expectations will likely be proved conservative. There is some speculation that the company will be added to one of the Russell indexes but I would not trade on such rumors. It is clear that institutions are beginning to take notice as volume has picked up on some strong days in the stock which helps me know that I have some deep pockets betting with me. The future looks bright and I’m anxious to see the long-term prospects for this quality company.

Buy Links

FCSX Notes

FD: Author has long position in FCSX

PS.Valueplays has an interesting article on FCSX that is worth the read.

CBOT Holdings (BOT)

CBOT Holdings is a derivatives exchange that operates both electronic exchanges as well as open outcry trading floors. BOT makes most of its revenue from trading of futures and options based on US treasuries. After pricing its IPO in late 2005, the stock has had an impressive run and is currently hovering around $200 after reporting EPS at $3.44 for 2006.


The stock is currently being courted by both the Chicago Mercantile Exchange (CME) as well as the Intercontinental Exchange (ICE). The bidding has been fast and furious as each company desperately wants to have access to BOT's valuable business. According to the current market value of all participants, the bid by ICE is a bit higher. ICE is offering 1.42 shares for every BOT shares - with ICE's 4:00 close of 149.19, the value for each share of BOT is $211.85. CME is offering 0.35 shares for each BOT share. CME closed at 557.07 implying a value of $194.97 for BOT. BOT closed at a premium to CME's bid and a discount to ICE's bid. From the sidelines, it looks as if the market is expecting CME to acquire BOT but it is likely that CME will increase their offer for the company.

After my previous post on Intercontinental Exchange, I was informed by CBOE management that I had some factual misunderstandings regarding their agreement with the CBOE and BOT. In an effort to sweeten their bid for BOT, ICE offered to solve a dispute that has been simmering between BOT and CBOE for years. I erroneously believed that this agreement involved ICE acquiring the CBOE after completing their proposed acquisition of BOT. The actual agreement is much different.

When CBOE was spun off from BOT, every full BOT member had rights to trade on the CBOE. This right included voting rights for CBOE matters but one could not exercise that right and still have privileges at the BOT. However, a BOT member that exercised his right to trade / vote on the CBOE could subsequently revert back to being a BOT member. If BOT merges with CME, the CBOE believes that these rights will be terminated according to the original legal agreement. This obviously is not acceptable to BOT members who consider these rights to have value. ICE in its desire to complete the deal with BOT members has agreed to compensate BOT members for their loss of this right to the tune of $500,000 per member. This offer is contingent on BOT merging with ICE and would leave ICE and CBOE separate and distinct entities.

Now for those BOT members reading this, I am sure that is an oversimplification of the details but it should hit the high points and still be relatively understandable to us who are not members of either firm. My apologies for my earlier misconception.

At any rate, it should be exciting to see who ends up purchasing BOT, who is left without a partner (CME or ICE) and what will happen to each company after a deal is inked. I have a feeling that BOT will end up agreeing to be bought by CME for a higher price than the 0.35 shares, and ICE will receive an offer from NYX or possibly another player hoping to pick up a futures exchange to add to their portfolio. There is significant value for these companies in consolidating and cutting back on expenses while still benefiting from the global increases in trading and liquidity that is so prevalent.



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FD: Author has a long position in BOT and ICE, and a short position in CME

Chipotle Mexican Grill (CMG)

Chipotle Mexican Grill seems to be firing on all cylinders. The company opened 28 new restaurants in the last quarter and increased their full year guidance to 110-120 new stores. Average restaurant sales were up significantly despite a broad market perception that the consumer is less likely to increase spending. When the quarter was announced the stock soared on the good news breaking to an all time high.

The fundamentals behind the company are truly inspiring. Corporate culture is a very integral part of the business as the company prides itself on its natural wholesome ingredients, responsible farming, community stewardship, and stimulating work place. This culture is passed on to customers who are more likely to go out of their way to stop at Chipotle instead of a competitor because of the values they share with the company.

These values are not always easy to implement and the company has struggled to find enough hormone free meat to supply their entire corporation, but they have been able to at least roll out organic beef market by market and have a goal of completing this rollout in the next few years. All of their chicken is considered organic and fruits and vegetables also are organically grown by select farmers. While this fanaticism about quality results in higher food costs, customers are willing to pay a premium, knowing they are getting a good healthy value. (an interesting question is whether this will remain true if the economy enters a recessionary period in the next year).

Workforce values are also key to the company and this category actually saves them money in the long run. Over the past year, CMG has implemented a “hire from within” campaign that has allowed them to promote line employees to be store managers for the new locations. This results in lower training costs and improves morale and productivity on the line. I applaud the company for the publicity surrounding this strategy as it has a tangible effect on the way customers are treated by more responsible aspiring employees.

The stock is trading at a fairly high multiple assuming the consensus is correct at $1.71 per share for 2007. However, the growth the company has shown has been superb, and it looks as if the opportunity remains for several more years of exciting expansion. Not only are more stores being planned and opened, but the throughput in existing stores is picking up as people become more aware of the concept. Nearly 400 change machines have been installed in stores which help speed up the line in high volume stores during peak periods. This can have a profound impact on number of customers served, and the management is constantly tweaking ideas for how to cut down on line time so customers are served quickly and store capacity is increased.

I expect the stock to continue to trade well and think weakness we are seeing this week (corresponding to a market consolidation) gives investors a chance to pick up what they may have missed after the stock got moving following the quarterly announcement. For those a bit nervous about the multiple, one could sell calls against a long position as the premiums are high and the added layer of protection reduces some of the risk. I should add that I am long the stock in our fund and continue to look for ways to responsibly increase my position.



CMG notes

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FD: I have a long position in CMG

Intercontenental Exchange (ICE)

Intercontinental is an exchange specializing in the trading of derivative contracts and Over the Counter (OTC) contracts relating to energy products. Historically OTC contracts were particularly risky for traders because each party had to trust that the counter party (one taking the opposite side of the trade) was able to deliver on the agreement. ICE has created a new proprietary system where they are able to clear these contracts or essentially vouch for the credit-worthiness of each party. This clearing function has served to increase trader's confidence and has therefore increased the volume in such transactions resulting in more revenue for ICE.

The technology and platform that ICE uses is extremely sophisticated and scalable. As the company adds volume both on the clearing side as well as the execution (transaction) side, their ability to handle the trades has not been impeded. The company expects to be able to continue to ramp volume for the foreseeable future without having to make substantial improvements in their technology. Currently the platform appears to be faster and more robust than the platform used by the NASDAQ.

Consolidation is rampant in this industry. The ICE has recently purchased the New York Board of Trade (NYBOT) which trades futures and options on the US Dollar index (USDX) as well as contracts on the Russell 2,000 and 1,000 indices. The NASDAQ is currently recovering from a failed bid to buy the London Stock Exchange, and just last week announced they will be buying the OMX which is the Nordic exchange operating in Northern Europe. NYSE (ticker NYX) has mostly completed its purchase of Arca allowing it a foothold in the electronic trading of equities.

The most important deal to ICE right now revolves around the Chicago Board of Trade (ticker BOT). BOT has agreed to be acquired by the Chicago Mercantile Exchange (CME) but ICE has thrown its hat in the ring as a potential competing buyer of BOT. Most analysts agree that CME will likely win the battle to acquire BOT, but ICE has been busy working out ways to make its proposal more attractive. Most recently this week, ICE inked an agreement with the CBOE (former subsidiary of BOT) to acquire all of CBOE pending its ability to close the deal with BOT. This would be beneficial to BOT because there has been a long-standing argument with the CBOE as to certain ownership rights that the BOT still feels it is entitled to after it spun off the CBOE. This matter is still pending in court and could be a costly battle long-term.

All of this consolidation has an effect on the way the stocks for these companies trade. At this time, it seems that ICE's shares are under pressure as investors fear the company will pay too much for BOT. At the same time, ICE stock has performed very well due to the company's growth and innovation and I assume that once this uncertainty surrounding the BOT is settled, the stock will continue its run as the underlying business has wonderful prospects both as a stand-alone business or in conjunction with the BOT. One final wild card is that another player (some speculate the NYSE or a European exchange) may step in and make a bid for ICE which would have a profoundly positive effect on ICE's stock. At any rate, i believe the prospects for ICE are very good and I am maintaining a significant investment in the firm.



ICE notes

NOTE!
I have become aware of some discrepencies in this post. Please see my post on Chicago Board of Trade for a better understanding of the ICE / CBOE agreement.