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Jeffrey Walkenhorst
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Summary: Portfolio Manager at Copeland Capital, formerly a Senior Research Analyst at international think tank, Wall Street Research Analyst, and Private Investor. Experience consulting to investment funds, financial services firms, global organizations, and high net worth individuals/families.... More
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Copeland Capital Management LLC
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  • Psychology Remains Fickle as The Big Bad Wolf Ignores Fundamentals
    We're sorry to keep coming back to the economy and general media headlines, yet we can't help but provide our two cents.

    We know there's much to worry about and have covered some of this before: weak job market, weak real estate market, uncertainty over government regulation, mounting fiscal debt and deficits, higher taxes that will squeeze citizens and corporations alike, and on, and on, and on.....

    With the possible exception of recent regulatory changes, ALL of these concerns aren't new news, but the Market wants to fixate on them at present and countless pundits perpetuate a wall of worry. The shifting sentiment reminds us of something Wilbur Ross said in Fortune interview back in March (note title: "Mr. Distress is Ready to Buy"):
    • "For example, people suddenly decide Greece is the problem, and whack, the market is down 10%. If weeks from now people decide California is the problem, markets will move again. Everyone has known for over a year that both places are troubled. Why do we care now? How do we know that the problems of Greece or rescuing that country will make a difference in the economic landscape one way or the other?"
    Ah, how fickle Market psychology can be. In discussing current conditions with a friend and former colleague who's now an equity analyst at a large corporate pension fund, he reminded us that "no one cares that second quarter results will be good, the market is a discounting mechanism -- everyone is worried about the outlook." Okay, fair point - higher equity valuations depend on a growing stream of forward earnings (more specifically, free cash flow).

    Let's explore this further with a simple sampling of earnings headlines from the WSJ. However, before looking at fundamental-oriented headlines, let's look at the current, number three headline (front and center) as of Friday 7:45pm EST:
    • Stocks Tumble as Optimism Fades - A double dose of discouraging numbers from corporate earnings and a consumer-sentiment gauge pushed the Dow down 261.41 points, or 2.5%, to 10097.90.
    Now, let's quickly review which companies are cited in this article as posting "discouraging numbers": Bank of America (BAC), Citigroup (C), General Electric (GE), and Google (GOOG).

    Alright, despite Citigroup beating earnings expectations, seeing fewer charge-offs, and reducing loss reserves (see this WSJ article), maybe the banks are wrestling with a slow/no growth environment (partially on more stringent, self-imposed lending practices = good thing). Actually sounds pretty positive; could be worse.

    As for Bank of America, we'll forget about the following Dow Jones headline from 7:42 am Friday morning:
    That said, we understand that new regulatory burdens may take a large bite of revenue and earnings.... NOT so good and possibly a meaningful cost not only on BofA but on Americans at large. On this topic, our friend noted the multiplier effect, as in lower revenue and earnings for an entire economic sector may result in reduced consumption (and investment) by a factor many times over the direct corporate expense. Higher taxes are also a culprit with regard to the multiplier effect.

    Next, it's true that GE's revenue was down slightly Y/Y, although we could note that this global conglomerate remains largely a cyclical, industrial company despite owning NBC Universal and GE Capital. THUS, we might expect GE to lag a recovery and investors should focus more on new orders rather than trailing sales figures. In this regard, here's what was relayed in the company's press release:
    • "GE's economic environment continues to improve," GE Chairman and CEO Jeff Immelt said, citing growth in orders, margins and earnings amid other encouraging signs in the quarter. "Equipment orders increased 17%, including 20% growth in the Energy Infrastructure segment and 14% at Technology Infrastructure. Oil & Gas and Healthcare orders were particular bright spots and helped hold total company orders backlog roughly flat, excluding the impact of foreign exchange.
    On the conference all, CEO Immelt opened with this (courtesy of SeekingAlpha):
    • Just at the outset, I'd say I think the GE team had a really great quarter. Our environment continues to improve, media buying was strong, rail loadings were positive, revenue passenger miles were positive, losses have declined and credit demand is up, and equipment orders were positive. But we are still cautious in a few areas. We are working through a difficult commercial real estate cycle. After many quarters of decline, demand for electricity finally rebounded in the second quarter and we think that's encouraging. And as many people have written, we think this is a multi-speed recovery. So it's going to – the economy is going to strengthen at different paces around the world.

    AND, toward the end prepared remarks:

    • We have a very strong balance sheet with consolidated cash of $74 billion. You go down the walk, you see lots of free cash flow, which is a big part of the GE business model. It's just lots of cash available for capital allocation as we look at the year. So we continue to build the cash balance. We are on track for CFOA for the year. And I think the cash story and the balance sheet strengthening story is a very positive story for GE and our investors.

    Finally, on the European crisis:

    • As Keith said, we had a lot of chance to talk to people. I would say while governments are adjusting, the companies are partners that we work with across Europe are all continuing to invest. Lot of them has export franchises. And so there just seems to be a little bit of a disconnect between what has to happen broadly from a macro standpoint and where the individual companies are that we are working with. So as Keith said, we just don't see a big systemic issue coming out of Europe given what we see today.

    To summarize: (1) flat orders overall, but strong new orders in certain segments and mixed growth across various markets (to be expected as the whole world can't necessarily boom at once), (2) giant cash flow and cash on balance sheet (like the rest of corporate America and PE/VC funds), and (3) scary headlines related to Europe are disconnected from corporate investment/growth plans. All in all, not too bad.

    AND, what about Google (GOOG)? We know why the Market was upset: flat Q/Q revenue growth and a bottom-line miss on higher operating expenses. BUT, from a How's the Economy Doing standpoint, let's consider that revenue increased 24% Y/Y -- impressive for any company, especially now -- and that Google is hiring more employees. The company is using it's war chest of cash to fund new initiatives that may well lead to even more jobs and other innovations that spur the economy. As an aside, we tweeted
    an interesting perspective from Bill Gurley of Benchmark Capital (click for article) on why Google trades at less than 20 times forward earnings rather than 30 times: it's business model is simply "too good."

    WE ALMOST FORGOT: back to that simple sampling of earnings headlines from the WSJ (click to enlarge - also captured Friday evening):


    For what it's worth, we include 14 headlines exactly in the order we captured them from the WSJ Friday evening (starting with left column moving to right). Let's split three ways:

    • Positive bias: Gannett (GCI), Schwab (SCHW), Daimler, Sony Ericsson, Europe Earnings, J.P. Morgan (JPM), AMD (AMD), J.B. Hunt (JBHT), Novartis (NVS)
    • Mixed: Mattel (MAT), GE, banks (including J.P. Morgan), IBM (IBM - tbd Monday)
    • Negative bias: none.

    Count 'em. Nine positive, several mixed, and zero -- zippo -- in the negative category. We could even add several more positive headlines, including results and raised guidance from WW Grainger (GWW), a company that "offers over 900,000 products and sells almost everything from abrasives to refrigerants to vacuum valves" (as noted in Reuters article - link above).

    We understand that Market psychology is a significant factor to the extent that it can influence real economic behavior, but ARE WE MISSING SOMETHING? OR, are the front page headlines somehow fixated on the flavor of the day, week, or month, feeding into the negative frenzy?

    One thing is certain: from the above sampling of large companies, we truly don't see "discouraging numbers from corporate earnings." Stable to better results are a positive, in our book.

    We know the outlook remains critical, yet ample evidence of current momentum across multiple sectors -- including global transportation/trade that feeds the world economy -- suggests continued growth that should also benefit U.S. companies. More earnings reports next week will provide additional color, possibly providing a life line of support to fickle psychology.


    One other topic: we're always amazed why the Market frets so much over a reduction in China's GDP growth to 10% from 11-12%. No matter what the figure was, is, or will be, China has the political drive and balance sheet to keep funding long-tailed projects well into this decade and probably beyond. As this continues, Chinese consumption grows and the country imports more from the U.S., Europe, et al. As our friend says, "China wants to be number one," which -- admittedly -- has positive and potentially negative ramifications for us. Fortunately, we've much to contribute to China's growth engine. What did GE say about China during call Q&A?

    • Jeff Immelt: I showed a chart at EPG on China, which I think really reflects our perspective, which is it’s a extremely big and strategic market. We’ve got a big footprint of about $6 billion and we plan to grow at double-digits, that our strategy will be multifaceted, we will have businesses that will completely grow in a significant way like health care.

    Here's the slide from the 5/19/10 Electrical Products Group (EPG) Conference:


    Bottom-line from all of the above: to lose sleep and increase blood pressure, focus on the front page. To rest well (or at least easier), focus on fundamental results highlighted on the side/back page. Fundamentals are what matter most and, ultimately, drive the economy and shareholder value.


    Disclosure: None.
    Jul 17 9:47 AM | Link | Comment!
  • Fear Back in Vogue and Mr. Market is Schizophrenic, YET Focus on Fundamentals
    As we expected (noted in our 5/8 post with a brief warning to watch for DOW 5000 prognosticators), the doomsday crowd is back and fear/panic is taking control of the Market. For evidence, please see this Forbes article from Wednesday The Crash Camp Takes Over - OR - one of today's Yahoo! Finance (YHOO) headlines: Dow Slumps 3.6%: "We Are On Schedule for a Very, Very Long Bear Market," Prechter Says. We mentioned Mr. Prechter in our "Time to Go to Cash or is It?" post last November and acknowledge that he has a seasoned perspective with well argued points.

    In this regard, we're not naive or ignorant of mixed macroeconomic conditions and current events:
    • unsettling ecological disaster thanks to a horrific accident (lack of safety controls or oversight? mistakes? freak event drilling so deep? modern dependence on "black gold"?);
    • social unrest (Greece/Europe/Thailand/elsewhere?) underpinned by class warfare and/or necessary reductions in government expenditures (could be good thing over time if private enterprise can pick up slack);
    • high debt levels and seemingly irreversible deficit spending by most developed countries;
    • likely unsustainable entitlement programs (aging demographics might make earlier promises untenable though politically difficult to change);
    • higher taxes in many countries that may squeeze both consumption and investment, the latter of which is critical for economic growth and new job creation;
    • more jobs lost through corporate streamlining, mergers/acquisitions, or creative destruction (e.g. old media struggles);
    • and, even volcanic eruptions and earthquakes.
    • [fill in the blank on our non-exclusive list - you can probably think of other things].
    Aside on volcano - this is well worth a listen for those interested in geological perspective on the Icelandic eruption: The Heat is on - Volcanic Activity in Iceland by Andy Hooper at collegerama.tudelft.nl (captured by Sonic Foundry's/SOFO Mediasite).

    Yet, in addition to awareness of overall conditions, we must consider underlying fundamentals, which ultimately drive shareholder value (and share prices). While some companies/sectors continue to post mixed results with cautious outlooks, please give a look at a smattering of earnings related headlines from the WSJ Thursday evening (in addition to the good shipping/transportation news we highlighted the other week):

    • Children's Place and Buckle said earnings rose, beating forecasts, as the clothing retailers continued to focus on online sales growth.

    • Subscriber Content Read Preview

      Staples Profit Rises 32%

      Staples earnings rose 32% as the office-products retailer posted better-than-expected sales growth.

    • Subscriber Content Read Preview

      GameStop Profit Rises 6.7%

      GameStop said its earnings rose 6.7% in the company's fiscal first quarter, as revenue increased amid strong sales of new videogames.

    • Subscriber Content Read Preview

      Dollar Tree Reports Higher Profit

      Dollar Tree posted a 5.3% rise in fiscal first-quarter earnings, as same-store sales increased and new stores added to the retailer's revenue.

     

    We pulled this directly from the WSJ site Thursday evening and even left in a few negative headlines toward the bottom. Most are positive.

    Volatility is a fact of the markets and psychology is a significant influence on market direction. Our hope is that positive fundamentals in many areas check the current trading bias toward negative psychology, stabilize market sentiment and provide confidence to businesses and consumers alike that the sky is not falling, as some might lead us to believe. Many things in the world are on track.

    We don't know what the Market will do near-term, but continue to hang our hat on fundamentals of specific companies trading at sensible (or even inexpensive) valuations, including eBay (EBAY), PetMed Express (PETS), Seaspan (SSW), and Weight Watchers (WTW). All the while, we never forget Ben Graham's guiding parable that Mr. Market is invariably schizophrenic and subject to wild swings.



    Disclosure: long YHOO, SOFO, EBAY, PETS, SSW, WTW.
    May 21 8:43 PM | Link | Comment!
  • Sonic Foundry: Buying Into the Mediasite Franchise as Large Deals Become Reality
    After Sonic Foundry's (SOFO) fiscal 2009 report last November, our post was "To Believe or Not to Believe (in the Mediasite Franchise)?" (link here). Readers probably know by now that our research provides ample evidence to believe in the franchise. We included more support for the franchise thesis earlier this week (here). Still, ultimately the financial results must confirm the presence and durability of a franchise.

    We think fiscal 1Q 2010 results released Thursday are another step in the right direction and -- importantly -- forward guidance for a "tipping point" (as coined by author Malcolm Gladwell) this year remains intact. In fact, management said we'll begin to see "large deal impact" during the March quarter (fiscal 2Q 2010). This is ahead of prior guidance calling for large deals to hit late spring and summer (June/September quarters). We recommend watching the half hour presentation - link here.

    An interesting sidebar (pointed out by someone on the Yahoo! Finance Message Board here) is to watch Sonic Foundry's earnings Webcast and compare the Mediasite delivery to that of video conferencing giant Polycom's recent earnings Webcast (PLCM) - link here. Polycom uses a pop-up window with video playback via user selected Windows Media or Real Player that has a slide window to the right. Yet, the slides didn't move for us. Instead, to share/show each new slide, a new browser window is launched each time (!!!), which -- to put frankly -- we find cumbersome and suboptimal. We suspect Polycom management would not only agree but likely prefer to use Mediasite to deliver their quarterly message (and other corporate events). Thus, as discussed in our "Get the Memo" post on 1/03/09, Polycom provides us with yet another example of an organization that needs Mediasite, albeit one sitting squarely in the video arena. Other video-related companies that could benefit include Thomson Reuters (TRI), Nasdaq OMX's (NDAQ) Shareholder.com unit, and even Cisco Systems (CSCO).

    Back to results. For the quarter, revenue of $4.5 million (+12% Y/Y) was better than implied guidance for only $4.0 million and the company's GAAP net loss was only $320 thousand compared to $1.3 million (revised) in the year ago period.

    Sonic's trailing twelve month income statement is as follows:
    • Billings of $19.5 million were up 1% Y/Y (expect acceleration in coming quarters)
    • Revenue of $19.1 was up 12% (catching up to TTM billings)
    • Gross profit of $14.6 million was up 16% (margin expansion)
    • GAAP operating expenses of $16.1 million were down 10% (expense reduction)
    • Cash operating income of approximately negative $150 thousand (a $900 thousand Y/Y improvement)
    Looking at the balance sheet: deferred revenue at 12/31/09 increased 10% Y/Y to $5.04 million, total debt increased to $1.01 million from $529 thousand a year ago, and net cash declined by $1.6 million to approximately $1.27M (total cash was $2.4 million). Net cash was down only $157 thousand Q/Q as positive working capital helped offset the company's modest operating loss. Management again noted that debt will increase to fund anticipated working capital needs to support large deals expected in coming months that should drive rapid top-line growth. Then, meaningful positive cash flow should arrive, improving the company's net cash position.

    A few slide highlights - new customers:

    Guidance:
    More on the outlook and market position:
    In Crossing the Chasm: Marketing and Selling Disruptive Products to Mainstream Customers by Geoffrey Moore (included in our reading list here), Mr. Moore shares his view of the technology adoption life cycle and strategies for making the jump -- i.e. "crossing the chasm" -- from "Early Adopters" to "Early Majority" and then to the "Late Majority". Mr. Moore's advisory firm, TCG Advisors, includes several related presentations on its Web site (link here).

    In one deck,
    Dealing With Darwin - Innovation Vectors TCG Advisors Deck, he illustrates the life cycle with a "bowling alley" and "tornado" in the "Early Majority" phase as adoption accelerates on the way to "Main Street" adoption. Given Sonic Foundry's guidance and apparent confidence that the large deals are in process (i.e. a reality), we think Mediasite is currently making the leap to mainstream adoption. Of course, execution is critical during this stage and, along with IT budget pressures, represents a primary risk factor.

    Let's briefly consider two scenarios:
    • (1) The best case scenario for investors: earnings power finally becomes material in calendar 2010, although the Market (today) may not believe the future promise until micro-cap Sonic truly shows it the money (within next six months). At that point, interest in "the story" suddenly perks up and valuation expands along with investor/media interest. We've seen it before with other companies. If quarterly revenue can scale to the mid-$6 million range, we estimate quarterly earnings of around $0.25, or approximately one dollar annualized. At that level, even a conservative P/E multiple puts shares meaningfully higher.
    • (2) The worst case scenario: large deals fail to materialize and the business trends flat and/or erodes and funding is a problem in a still fragile economy. The stock languishes and declines.
    Which scenario is most likely? Per our "Which Way from Here" presentation, we quickly admit that short-term forecasting is a fool's game. Also, traditional value investors might pass over Sonic Foundry given a history of operating losses and a small net cash position (limited margin of safety, at first blush). We acknowledge that our ownership stake falls into the speculative camp and, as noted in the past, we consider our investment somewhat akin to late stage venture capital.

    However, we find comfort through our extensive technology industry experience and Mediasite franchise analysis.
    Notably, we see and hear increasing, consistent, and favorable feedback from customers -- for the latest, please see the Big Bend Webinar this week:

    Getting the Buy-In and Budget to Launch Hybrid Courses Right Now
    Getting the Buy-In and Budget to Launch Hybrid Courses Right Now Russell Beard of Big Bend Community College shows you how one of the smallest community colleges in the state of Washington with one of the largest service districts – 4,000 students across 4,500 square miles – found the money, time and political will to launch a webcasting program.


    While acknowledging risk factors, we can now feel even better with our November conclusion on the back of reiterated guidance -- given the company's expanding customer roster and forthcoming campus-wide adoptions, we continue to believe our initial thesis: competitive advantages point to a powerful, sustainable franchise -- Sonic Foundry is (1) far along the learning curve with (2) intellectual property protection, and (3) very satisfied, captive customers that face high switching and search costs. Points (1) – (3) are both related to and strengthened by (4) economies of scale and (5) leading market share.

    Furthermore, our intrinsic value estimate of $20-27 is supported by an estimate of reproduction cost as well as the probable private market value that would be awarded by an informed strategic buyer based on trailing financial results (without the benefit of insights into Sonic's pipeline that might support a higher "PMV", 2009 M&A comps provide support).

    We will follow-up in February with a bit more on how to interpret forward guidance.

    Disclosure: Long SOFO.
    Jan 29 9:42 PM | Link | Comment!
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