Why'd I sell DFS?

This was the question I got after my previous 2 posts, which was a simple disclosure that I sold my stake in DFS where I didn't really provide any rationale (my apologies)...

My guess is DFS is worth about $20 to $25 dollars, so I don't see a huge potential upside. Additionally, given the current state of the economy, there is a relatively large amount of uncertainty in my guess of DFS's fair value - who knows, maybe its fair value is $10, or maybe it's $30... only time will tell.

Also, the stock has basically tripled from its March 2009 lows, and this type of run-up always makes me a little nervous. This is similar to when I sold USG and SHLD after their run-ups, see my previous posts on those former holdings for details (you can click on the "zzClosed Position..." labels on the right to easily navigate there).

Anyway, someone said that when it comes to investing the science is buying and the art is selling... and someone else said there's no rule that says you have to get 100% of the upside. So maybe DFS will continue higher and I'll end up kicking myself, or maybe it'll go back down to the single digits and I'll buy more...

Transaction Alert: Sold DFS Part 2

Today I sold my remaining 475 shares of DFS at a price of $15.49.

After this transaction my cash balance has increased to almost $40K, which is a bit higher than I'd like. Hopefully some new investment opportunities will present themselves, but I also think several of my portfolio holdings are very cheap, so I could always just add to those...

Transaction Alert: Sold DFS

The portfolio churn continues...

Today I sold 475 shares of DFS at $15.25. This was only half my position, so I still have 475 remaining shares. I originally purchased DFS in late 2008 and early 2009 for an average price of $10.34.

Transaction Alert: Bought MYGN, Sold WTM

This is a two part post. Last week was a busy one for me - in addition to buying Seahawk Drilling (HAWK), I also sold White Mountain (WTM) and purchased Myriad Genetics (MYGN).

I purchased 30 shares of WTM on 2/24/2009 for $203.58 and sold on 7/9/2010 for $331.17. While the returns on this investment were good, they weren't significantly different than the broad market, so I can't really call it a win. I still think WTM is undervalued and has a top notch management team, HOWEVER I think there are better opportunities elsewhere. Despite selling my shares, I'm going to keep this one on my watch list.

I purchased 650 shares MYGN on 7/9/2010 for $15.05, and as with most purchases this position is now approximately 10% of my portfolio. MYGN hit its 5-year high in early 2009 in the low 40's, so it's really been quite a fall since then (in fact, the stock hit its 52-week low the same day I bought it). Anyway, Myriad essentially does 2 things:

• It's predictive medicine products help determine the likelihood that a patient will get breast/ovarian/colon/skin cancer.
• It's personalized medicine tests allow doctors to customize the treatment received by cancer patients for the best possible results.

This is pretty heavy stuff - predictive and personalized medicine. So why has the stock been hammered?

• It's not growing as fast as the market predicted and priced. Obviously lowering growth forecasts has a significant impact on valuation, and my guess is many "growth" investors are dumping their shares.
• There is significant uncertainty around the company's patents, and weaker patent protection could make MYGN vulnerable to increased competition.

My guess is the market is overreacting to these negatives, and as a result the stock has been punished too harshly. Here's my thesis - I think MYGN can grow in the mid-teens for at least the next 5 years, but really it has the potential to grow at this clip for next couple of decades. It's trading at less than 8x EV/EBITDA and a PE ratio of 12x for the ttm - this is VERY cheap for a company with this kind of growth profile. Also, since capital requirements are low, free cash flow is quite strong.

So what are the expected returns? Well, if MYGN grows in the mid-teens for the next 5 years before leveling off, I'd expect the stock to be worth somewhere in the high 20's. If it grows in the mid-teens for the next couple decades then the stock's worth significantly more. Finally, if I'm wrong and the market is right, then the stock is probably fairly valued at today's prices. So, I guess we'll see what happens...

On a side note, my portfolio is now about 25% cash. This feels OK, but I may look to increase my cash allocation in the near future. Afterall, there's a lot wrong with the world - municipal/state/sovereign defaults are all a possibility, deflation could be around the corner, with inflation around the corner after that... As PIMCO's Gross/El-Erian say - we're driving down a bumpy dirt road in the dark without a spare tire...

Transaction Alert: Bought HAWK

This post is a couple days late, so my apologies. On 7/7/2010 I purchased 1000 shares of Seahawk Drilling, symbol HAWK, for $9.10 a share. As with most purchases, this new holding makes up about 10% of my portfolio.

By way of background, HAWK is a shallow water offshore drilling company in the Gulf of Mexico. They became a public company in August 2009 after being spunoff from Pride International. In addition to the typical market inefficiencies that can accompany a spinoff, the BP Gulf disaster has contributed to make the price of HAWK shares very very cheap IMO.

I've been following HAWK since it was spunoff almost a year ago, and as a result I stumbled upon an excellent blog, http://greenbackd.com/. Greenbackd's analysis of HAWK is perhaps the single best write up I've ever seen on a blog - this is serious stuff here, in fact it's more insightful and intelligent than just about any Wall Street report I've read (and I've read quite a few). So, rather than try to do my own write-up (which would pale in comparison), I'm just going to link to Greenback'd's.

• An introduction (September 2009): http://greenbackd.com/2009/09/08/guest-post-ben-bortner-on-seahawk-drilling-nasdaqhawk/
• Revisited (June 2010): http://greenbackd.com/2010/06/03/seahawk-drilling-nasdaqhawk-redux/
• Parallels between HAWK and Mohnish Pabrai's investment in FRO, very insightful (June 2010): http://greenbackd.com/2010/06/04/pabrai-on-frontline-ltd-usa-nysefro-hawk-template/
• HAWK liquidation value (June 2010): http://greenbackd.com/2010/06/30/hawk-liquidation-values/
• Rig value (July 2010): http://greenbackd.com/2010/07/06/hawk-rig-market-values/

The above links are a long read, so here is a summary of the most pertinent information I used to make my decision:

• HAWK is probably worth $154 MM in a forced liquidation scenario where it's rigs are sold as scrap. However, even in this type of scenario the rigs would probably be sold as operational, in which case the liquidation value is probably closer to $300 MM. (As of 7/9/2010, at a stock price of $10.71, HAWK had a market cap of $126.6 MM!!)
• In the good old days (2006 to 2008), HAWK generated a pro forma net income in the $150 MM range on an annual basis. It probably won't ever get back to those results, but given it's PE ratio is less than 1x peak earnings shows how cheap the stock has become.
• On July 29th, an 8K was filed that basically said the CEO and board members wouldn't receive a cash salary for the rest of 2010, but rather they would get an equivalent amount of restricted stock based on the June 25th closing price - so effectively they're "buying" a huge slug of stock. However, what's so interesting about this isn't the stock "purchase," but rather the timing - ALL of the stock is being awarded at the June 25th price (as opposed to a monthly price). If I were to read between the lines my guess would be management thinks the stock is CHEAP and it's NOT going to stay this cheap for long.

So, that's basically my investment thesis boiled down to a couple of bullet points. In a way, HAWK reminds me of my experience with USG. I purchased USG in March of 2009 when the outlook couldn't have been bleaker for the home builder supply industry. Things didn't get materially better, BUT the outlook went from bleak to slightly-less-bleak, and the stock went from a purchase price of <$5 to a selling price >$21 over my 13 month holding period. Will HAWK do the same? (Obviously I have no idea, but I've placed my bet!)

My Returns as of Q2 2010

I started 2010 with $107,514 in my portfolio and finished the quarter with $101,294. I didn't make any deposits or withdrawals, so the decrease in value was driven by a decline in aggregate of my stocks.

• On an absolute basis, my portfolio declined 5.8% during the first two quarters of 2010. Annualized, this rate of return is -11.3% (although negative, this is still slightly better than the S&P).
• I've been tracking my returns for 4 years and 6 months, during which time my annual rate of return is 13.4%. Over the same period the S&P returned -1.9% annually. In other words, over 4 and half years I've outperformed the S&P by over 15% annually.

Obviously, beating the S&P by 15% every year is quite good. HOWEVER, as I've said before, I have a very concentrated portfolio - a few good picks can make a huge difference in performance - so I still have no idea whether I'm just lucky or if I'm doing something right...

Sucker's Rally?

It's been awhile since my last post, so I apologize to my regular readers - I think there are 2 of you :)

Last week I read a fascinating article in the Huffington Post, entitled "Remember: In 1930, They Didn't Known It Was 'the Great Depression' Yet" (http://www.huffingtonpost.com/henry-blodget/remember-in-1930-they-did_b_605814.html). I highly recommend reading it in its entirety, but the basic gist is after the 1929 crash there was brief period defined by renewed optimism, speculation, IPO's, etc. which of course turned out to be a sucker's rally.

Basically, the market went from its 1929 peak of 381 to an initial bottom of 199. This was followed by a rally that pulled the market all the way to 294 over the next six months. Finally, after this "sucker's rally" the market once again turned negative and bottomed out at 42 eight months later (that's right, 42!).

The point of the article is to draw similarities between what's unfolding today and what happened back then - was it a sucker's rally when the DOW went from its March 2009 low of 6.5K to its May 2010 high of 11.2K? Should we expect the market to hit new lows over the coming months and years?

Obviously I have no clue.

Interestingly enough, George Soros recently gave a speech in which he elaborated on this very subject (http://www.gurufocus.com/forum/read.php?1,97265,97464#msg-97464). During this speech, he said such warm and fussy things like:

• The current situation in the world economy is “eerily” reminiscent of the 1930's with governments under pressure to narrow their budget deficits at a time when the economic recovery is weak.
• “The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama.” (Act I is defined by replacing private debt with public debt, "thereby reinforce[ing] the excess credit and leverage that had caused the crisis in the first place." Act II began "when financial markets started losing confidence in the credibility of sovereign debt," with Greece and the Euro taking center stage.

So if the bear case I described above does indeed come to pass it could mean very bad news for the average Joe who invests in common stocks (i.e. me). The question is how should one position their portfolio if they believe there's a 10% chance it'll play out (or 25%, or 5%, etc.)? Remember, there's always a chance that we make it through this mess unscathed, and if you hold too much cash you could miss out on significant upside...

Personally, I've got about a third of my portfolio in cash. Not only does this act as a safety blanket should things head south, but it will also give me the opportunity to snatch up some bargains in this scenario. Conversely, the other 2/3rds of my portfolio is spread over a small handful of stocks that I feel are undervalued in aggregate, so should the market rally I feel these securities will do quite well.

Transaction Alert: Bought AHS

When I sold SandRidge Energy (SD) last Friday I used the proceeds to immediately buy AMN Healthcare Services (AHS). I purchased 1200 shares, for a total outlay of about $9,600. The stock is currently at $8 a share, but I think it's worth about $15 to $20.

AHS is a staffing company for nurses and other healthcare workers. They are somewhat economically sensitive, and as a result their revenue fell from $1.2B in 2008 to $760MM in 2009. However, AHS generally produces pretty stable EBITDA margins in the high single digits, for 2008 their margin was 7.9% and for 2009 it was 7.5%.

I expect their revenue to rebound to about $1B within a year or two and probably grow at 5% to 10% thereafter. At $1B in revenue I conservatively expect them to generate about $70MM of EBITDA. With this type of margin/growth profile I think a EV/EBITDA ratio of 10x is quite reasonable, which implies an EV (enterprise value) of $700MM. Their current EV is just over $300MM, so it's really not much of a leap to get to my fair value range of $15 to $20 a share.

From a high-level perspective this new purchase did not alter my portfolio very significantly. I made the AHS purchase with cash from the sale of SD, so I'm still about 30% cash.

Transaction Alert: Sold SD

On Friday (May 21st) I made the tough decision to sell my shares of SandRidge Energy. I still think the stock is significantly undervalued BUT I'm also concerned there's a lot of downside risk, specifically:

1. A lower outlook for oil prices.
2. High leverage and a diluted shareholder base due to an ill-timed acquisition.
3. My portfolio already has significant exposure to the energy sector.

The SandRidge acquisition of Arena Resources will shift the company's focus to oil and away from natural gas in a significant way. Unfortunately, SandRidge made its bid when the price and outlook for oil was significantly higher - if the price of oil stays at its current level there's a very real possibility this merger will destroy shareholder value. If the price of oil falls further SandRidge could experience financial distress.

SandRidge is a very hard company to value - when I initially purchased the stock my estimate of the fair value was somewhere from $10 to $20 per share. Currently I think it's more like $5 to $15, but there's also a very real chance it could be worth even less. Ultimately, the risk/reward isn't as attractive as it used to be, but I'm going to keep an eye on SD b/c there are still a number of attributes that could make it a good investment.

Random Musings

A little over a month ago I wrote a post entitled "Feeling Fearful" (which can be found here http://mevsemt.blogspot.com/2010/04/feeling-fearful.html). During this time I sold several stocks (SHLD and USG) and allocated about 30% of my portfolio to cash - in retrospect, it looks like my timing couldn't have been more lucky. Since then, the market has turned decidedly more fearful as the Eurozone mess has drawn an increasing amount of investor attention and oil gushes into the gulf.

Ironically, the oil spill disaster could prove beneficial for some of the stocks I own. A likely consequence of this mess is increased government regulation and decreased offshore drilling in the short to medium term. This in turn could lead to an increase in the price of oil and natural gas (natural gas in particular, b/c it can't be imported from overseas nearly as easily). IF this does indeed play out I'd expect SD, GMXR, and EXC to reap the benefit (SD and GMXR have onshore operations and EXC would benefit from an environment with higher energy prices in general).

On a negative note I expect the call options for FAF to expire worthless. In my initial post I wrote that a broad market sell off could cause this, and of course within a couple days the market began selling off...

HOWEVER, I think any further market sell off could present an attractive buying opportunity. So, with about 30% (about $34K) of my portfolio in cash, I am constantly refining and evaluating my watch list. Current stocks that I find interesting include BAX, APOL, CNX, GENZ, AHS as well as existing holdings SD, GMXR, and EXC.

As always I'll post about any transactions.