Sunday, February 25, 2007

Another Day, Another buyout... for those not keeping track at home, Florida Rock and Hydril have both been bought out at massive premiums versus my recommendations (to buy) that were made within the past six months in this blog. FRK is trading at $68 (up 58% from my $43 reco. price in Oct. 2006 and 78% from my buy-in price) and HYDL is trading at $95 (up 86% from my $51 buy-in price). They have been bought at heavy premiums above what the public market value would have reached, but reflective of the control premium that a private owner would be willing to pay to acquire these high quality franchises. Unfortunately, I unloaded most of my stock in both names after I had made 25% and 41% in the respective names. I have had more annoying problems in my life than selling at a 40% gain within a one month period though!

I continue to like $2-5Bln market cap companies, but have lately been looking at some slightly larger entities that also represent high quality businesses with strong brands and franchise quality. Several of these names are trading just above levels where I would consider them to be cheap. For instance, SAIC(federal IT/professional-services contractor-$18.50) and MRH(Bermuda reinsurance-$17.70) are names that I like. SAIC's main business risk is political, in the form of potential Democratic meddling with Federal outsourcing.... MRH's is hurricanes and nonsense like Florida's restructuring of its excess-of-loss reinsurance pricing.

In spite of these risks, MRH is increasing its book value by 15-20%/year and trades at 1.1x book value, with one of the best underwriters as its CEO and a more conservative risk policy (which is why book value isnt going up even faster). SAIC is not "cheap" per se, on an earnings basis, given its nearly 20x forward earnings, but this is one of those beauties that earns more in free-cashflow than it reports in earnings, due to the amortization of fixed-contract costs that are incurred up-front. Given that nearly 22,000 of their 45,000 employees have high-level security clearances (tough to acquire), this gives them a reasonable barrier to entry. On a FCF basis SAI earns above a 5% yield and should improve this figure now that it is a public company. On both companies I have bought a small amount of stock and sold out of the money calls. In addition, I have sold $17.50 puts going out to April for a 3% implied yield-to-put (22% annualized return, assuming I am not put any stock). If either SAI/MRH falls below $17.50 I would be okay owning these entities for the long-term, based on my current view of management and the companies.

I do not think either of these companies will be acquired by private equity, although SAI would be extremely attractive in an LBO if it were to fall much below $ I am not expecting a grand slam like FRK/HYDL to occur. The market appears frothy with too many things hitting 52 week highs, companies that people were shunning back in July. (PS- If I am not "put" any MRH/SAI, would look to roll and sell forward additional contracts, although MRH should carry a huge premium through the summer if you think hurricane season migh pick up).

Wednesday, February 07, 2007

Site of the Month- Check out

They had a pretty good writeup several days ago on MMM. From what I can tell, this company generates nearly $4.5Bln in normalized cashflow from operations, approximately $3.5Bln actual cashflow (due to working capital expenses) and nets out to $2.5Bln actual free cashflow per year. This assumes continued R&D and growth expenditures, however on lower growth assumptions this company trades at 16x free-cashflow in a low growth scenario, for a 6.25% free cashflow yield. While not the sexiest yield in the world, people have historically paid a lot more for this company's earnings...which have continued to increase in the face of a flattish/declining stock price over the past few years. The chart below tracks the company's stock price (white line) vs. its P/E (green line). MMM is under-levered ("AA" credit rating) and appears to be somewhat cheap on an absolute basis, but very cheap on a relative basis (versus its historical trading range). It is difficult to gauge competitive threats and how much LCD pricing will hurt some of their film divisions, so I am just buying a half position and watching it. This is more of a long-term IRA stock.