The Wish List

Companies that I would like to own but don't, and why:

Citibank (C) -- seems like a terrific value, with great international exposure and a very solid payout. Hard to believe you can get a company this cheap with the level of growth they have and still get close to a 4% dividend. They aren't nearly as sensitive to increased interest rates or narrowing spreads as many other financials, so I think their stock is irrationally depressed. But I probably won't buy this one -- I like to leave most of the large-cap stock picking to the experts, since I don't think I can beat the market by buying big, well-followed companies the same way that I might by buying small caps, fast growers or misunderstood or irrationally mispriced companies. Bank of America comes close to Citibank in my book, too.

Costco Wholesale (COST) -- I love this business, and by all accounts the are some of the best merchandisers in the world. This is one of the few companies that beats the pants of Wal-Mart (Sam's Club will never have the success or cachet of Costco). Unfortunately, it's a little too steeply priced right now and while I'm sure they will continue to be successful I'm not convinced that the growth rate will make the current price a value going forward.

Motorola (MOT) -- I think their growth rate is going to surprise people, and that this company can get back to being an innovator with the next generation of cellular phones. The Razr proves that they have a good eye for design and for developing what people want, as they first showed with the breakthrough flip phones in the 90s. I think Motorola is getting unfairly tarnished for some management mistakes following the internet meltdown, and I think their focus on new phone design and partnerships going forward (will we really see an Ipod phone someday? If so, I think it'll come from Motorola) will put them in good stead. I like Nokia too, and think both of these companies have a chance to ride new designs to great success in the coming few years, but this is a similar situation to Citibank -- I'm trying to let Dodge & Cox manage the large cap portion of my portfolio since I don't think I can have much of a competitive advantage in that sector of the market.

Dampskibsselskabet Torm As (TRMD) -- This Danish shipping company was in my portfolio for a year or so, I sold my shares in December 2004 with a pretty substantial profit, but it has continued to go up. This is one I should have held long term, it is going to be much less boom and bust than the typical shipping company (and especially less so than the typical tanker company, which is a big portion of their business). They run tankers as well as other bulk ships, but their strength is in product tankers, not crude oil tankers, so they stand to benefit from worldwide shipment of other liquids -- from food products to refined fuels to chemicals, all of which are steadier than crude in my opinion, though crude tankers are still a great business if your stomach is strong enough. If the price drops by 20% or so, I'd like to buy back in, but I can't justify it at $50+. I'm holding out hope -- it's quite thinly traded on the Nasdaq and can be wildly irrationally priced at times, as it was when I first bought it at under $30 when, frankly, the business looked even better than it does today.

Affiliated Computer Services (ACS) -- I've been toying with buying this one for quite some time. I actually first heard about them as a municipal contractor for running red light and speeding cameras, which I think will turn out to be a huge growth business, but they are a very diversified computer services outsourcing company. I like the idea of it, and their growth looks pretty good to me and valuation seems fair -- but I must not understand the company well enough because the little voice in my head won't let me buy. After looking at this one on and off for nearly a year, I think it's going to take a sale price for me to buy in -- maybe I'll get lucky and they'll lose a high profile contract or report a bad quarter and I'll have another chance to take a close look and buy in.

Coffee Holding Company (JVA) -- This one hasn't been public for very long, but it looks very promising and I may well buy in once I have the opportunity to do some more research. They seem to be holding their cards pretty close to their vest, but the company sells coffee at wholesale both in their own brand names and to retailers to sell as store brands. I think this is a good business if they are indeed really capable of putting gourmet products out there at reduced prices, and building up their own brands, but I'm not convinced yet. I also don't understand the competition very well, or if they have an advantage in their relationships with producers or retailers or in the way they source, roast or package their coffees. Earnings look very good, so I think I'll let this one percolate and see how it looks once I've got more information on the business.

I'm sure there are more, those are just the ones that I keep coming back to recently -- I'll keep adding to this list as I remember or discover other candidates for the portfolio.

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Marvel Enterprises (MVL) and
Dreamworks Animation (DWA)




Marvel bought January 20, 2005 at $17.31 and
April 28, 2005 at 19.74

Dreamworks bought March 28, 2005 at $38.78 and
May 10, 2005 at $31


This seemed like an interesting pair to write up today, since the Fantastic Four opening weekend was such a nice surprise for many and the evil twin of Marvel lately, Dreamworks Animation, continues to plummet -- first on bad sales projections, then on the SEC investigation and inept guidance. The charts of these two companies appeared to be almost mirror images on Monday of this week (you can see what I mean on a comparison chart from Yahoo here). I'm also invested in a third company in this space, Lions Gate Films, but that one seems quite separate from the first two and is certainly following a different strategy and inhabiting a differerent space on the cultural landscape.

My investment thesis for these two investments is basically this: ownership of great intellectual property in entertainment is a potential cash cow. Both of these companies stand to build great libraries of films and enjoy very high margin licensing deals with the next generation of entertainment products, whether it's video games, toys, television, or otherwise. This industry is inherently high risk, but I don't think it's as risky as the box office watchers would have you believe while they judge both of these companies by the performance of a single character in a single film on a single weekend.

Marvel, as most probably know, is a comic book company that has been through financial chaos and become reborn as an intellectual property and toy vendor that licenses its universe of characters out to films, video games, etc., and also sells comic books.

Dreamworks Animation is the stepchild of Dreamworks SKG, the powerhouse studio put together more than ten years ago with Spielberg, Katzenberg and Geffen and that has done well for itself in film and television. The animation division went public last fall, following the blockbuster Shrek 2 and trying to ride Pixar's stock market coattails, and it has seen some troubled times this year, to say the least. DWA also relies on its own intellectual property, creating films that hopefully inspire kids to bring their parents, buy the licensed toys, and take home the DVD a few months later to watch over and over and over again.

Marvel first.

I haven't seen F4 yet, but I'd like to and it sounds like the fun, squabbling, family angst came through nicely in this iteration of the film, along with lots of explosions and all that other good Summer movie stuff. But I would have been fine with holding this stock long term even if this one film was a disappointment on opening night.

Marvel is a personally interesting stock for me, as well as one that I think is a good long term financial holding. I grew up reading X-Men and Spiderman comics, and I am pleased to see these iconic characters finally being well managed and turned into entertainment franchises in films, DVD, television, toys and video games as well as the traditional comic book publishing that defined the company for much of its life during the past golden ages of comic books.

While I think the comic book as a mass market product will never be what it was in terms of a financial engine for the company or a culturally important media, I do think that the stories told visually in comic books translate very effectively into newer media forms, especially movies and interactive entertainment like video games, and I think Marvel's focus on creating a multimedia universe inhabited by its characters, both large and small, will lead to great success.

Marvel's recovery from the financial maelstrom of Ron Perelman et al is now complete, with a solid balance sheet and cash flow, and an increasingly well-managed revenue stream from licensing deals, publishing (which still makes good money from all the aging fans like me), and movies. The time to buy most recently was probably last summer when the stock remained in the low teens even after the success of Spiderman 2, but I think it's still a good buy at this price -- they had two iffy releases in the cineplexes in the last year in Blade 3 and Elektra, but they still made money on those movies.

Marvel has been very successful in recent years because of their ability to license out proprietary characters to Hollywood and collect a small portion of the proceeds at little or no risk. That makes them a good steady investment even if some of the movies are flops, as long as enough of them still do well enough to keep the movie studios interested in making more. But that's where the story gets interesting.

You see, this model -- which served them well, and gave me some comfort in holding the stock long term -- is being modified in the coming years. Marvel will still license out their characters and stories for films, games and other content, but they're also going to start participating in the riskier end of the business by financing and producing their own films.

As any good investor knows, one generally gets more rewards if you're willing to take on more risk. I think that's the case with Marvel's move into producing their own films, and in this case I think it's coming at the perfect time and their financing deals are structured brilliantly -- as I read the initial releases on this, the company doesn't go bust if they default on their financing deals due to failed films, they just lose the collateral. And the collateral is the characters themselves -- so you could argue that this is still fairly low risk. If Marvel makes a great movie with Captain America using this deal, they collect windfall profits from being the primary producers of the film. If the movie is a stupendous flop and all else is also going poorly for Marvel and they can't pay the bills, they lose the movie rights to Captain America as the collateral they put up for the financing. So in that case, the collateral they're losing -- future Captain America movies -- is already damaged goods, having been proven in the marketplace to be a flop. No great loss.

Of course, that's a simplification of the deal that Marvel has struck with Paramount and their backers who will fund the films, but the point basically stands: Marvel's creations are so valuable, even this second tier of Captain America, Nick Fury, Thor et al., that they are good enough to be their own guarantee of a movie's success. We don't know much in the way of details at the moment about how much the financing will cost Marvel, which is certainly an area for careful attention and concern because the last time MVL was circling the bowl it was due to financial mismanagement and a huge debt burden, but that information should be coming soon and I think Marvel is in a good position to get reasonable terms from its backers going forward.

I also really like this deal because it gives creative control back to Marvel for the next wave of comic characters to enter the multiplex. That is, after all, their specialty, and they have reared these characters and stories from infancy into an entire universe of interacting heroes and villains -- since the early days of Stan Lee, Marvel has always known that it's not about cool suits and crazy superpowers, it's about effective storytelling and great characters. If Marvel can continue developing great stories instead of having to stand by and watch while their characters (a la Elektra) are mangled on film, even if to some profit, I think great films and future success are on the way.

And this way, even if the studios lose interest in superhero or comic book movies, Marvel can make them on their own and show that a good story and a great character can always find an audience. And hey, even if superhero movies go out of vogue for a brief time, there's more to comic books than superheros -- even after allowing for the broad range of stories from Batman (not Marvel) to Fantastic Four to Thor to the X-Men, there's more. Ghost Rider, most definitely not a superhero, will be riding into theaters with Nick Cage soon, and you never know what other great stories lurk in the vaults that spawned Men in Black (a Marvel property, though they acquired it by purchasing a small comic book company).

I am holding on to this one at least until they've released their first film on their own in 2007 (if all goes according to plan). I do have faith in management's performance at MVL, much more so than at Dreamworks, so I will consider adding to my position if one-time events -- like a bad opening weekend -- create buying opportunities.

There are other risks, too, that everyone should be aware of. Management could tire of the turnaround and quit ... people could lose interest in superheroes entirely ... they could have a string of mediocre marquee movies like the Hulk and Daredevil. I personally discount those risks, but they're worth investigating.

And one fear that many people note is that "all the good characters are taken" with Hulk, Spiderman, Fantastic Four and the X-Men all already out there and building libraries of sequels. I disagree -- even if the next wave of characters are less a part of the cultural landsape today than these big three are, success will come to many of them as good stories are told about the most promising of the other 5,000 characters in the library. Not every successful movie has to come with an audience that already knows the characters well from another media -- Shrek shows the lie in that (though it was a somewhat successful children's book, I doubt most most of the moviegoers knew that), as does the original Star Wars, or Raiders of the Lost Ark, Finding Nemo, Men in Black, the Incredibles, Ghostbusters or many other films that came to the screen unknown to their audiences and made the list of the top 100 grossing films of all time (as well as being, many of them, great merchandising successes, which is also key for Marvel).

and as for Dreamworks ...

Most people seem to agree that Dreamworks Animation stock is quite a dissapointment these days. This seems to be a story of merchandising inexperience more than anything else, since their actual films have been, with some missteps, strong successes since the first Shrek debuted a couple of years ago. They have proven that they can create mega-blockbuster films, but they haven't proven that they can effectively manage the DVD supply chain or Wall Street's expectations game.

The expectations management of DWA is something that should be easily fixed -- it is nearly a Wall Street mantra, and it's certainly a cliche, that companies must underpromise and overdeliver. Dreamworks has failed on three fronts lately with this, first predicting blockbuster results for the Shrek 2 DVD that failed to materialize (even though the DVD sales were huge), then predicting a blockbuster in the theaters with Madagascar (which was merely a big success, not a blowout blockbuster in theaters like Shrek 2), and finally revising their earnings downward yet again just a few days ago. Each of these problems would have been improved if conservative guidance had been given, an clearly Dreamworks management needs to learn the difference between creative promotion and hucksterism, which works great for the films, and honest and conservative information sharing, which works great for stocks.

In all fairness, the DVD concern is the same issue that's giving fits to all the movie studios lately. Pixar got a haircut a couple weeks back when they warned that Incredibles DVD's were likely to be returned from stores in greater numbers than expected, the same problem that hit Shrek 2 DVDs over the winter, and everywhere you turn there are articles about the demise of the DVD as Hollywood's cash cow.

I don't believe it. Some bad merchandising and poor demand estimates don't make for a sick industry. Home video and home entertainment are both growth industries -- what else are people going to do with their 85-inch plasma televisions? Watching quality films at home is the preference of most of the American public, and films that are aimed at kids, as all of Dreamworks' and much of Marvel's fare is, are destined to be watched multiple times by young eyes that crave repetition, which means purchases are likely.

The new efficiency in the retail marketplace, where retailers return unsold crates of DVDs if they haven't sold out in their first two weeks, is a wild swing away from past practice. I expect the experts are right on this, that it will depress some DVD sales of blockbusters, but that should be well within the power of DWA (and Pixar, for that matter), to manage. The problem was not that Shrek 2 didn't sell in DVD, the problem was that they shipped more than they could sell, and those returns ate all the

profits they might have otherwise seen from what were extremely strong sales by any other comparison. New techniques, stronger management, and marketing will evolve, and this stock market pummeling should scare DWA into making sure that they really get it right from here forward.

From my perspective, Mr. Katzenberg needs some help on the management front (and they need to stop providing quarterly guidance at all, in my opinion, if they're to be so inept at guessing). I am confident that the big holders of DWA stock, including Paul Allen who would like to sell some of his holdings, will closely watch performance going forward, as will I.

I think the value folks who bought DWA based on their trailing PE of 6 or 7 (now down to 5) are likely to be selling now, even as I'm thinking that Dreamworks goes on sale and might now become more of a long-term value. I look forward to this fall's Wallace and Gromit feature and next year's Over the Hedge and Flushed Away, neither of which comes with much cachet and could provide some upside surprise, but the real blockbusters will follow as the Shrek franchise returns with Shrek 3 and Puss in Boots, and Seinfeld's first animated feature, Bees, comes to the theaters.

My holdings are underwater now on this one, and I'm not planning to buy more this fall as I think it may continue to trend lower without a blockbuster performance from Wallace and Gromit, but I'm going to continue to hold as long as I see signs of management improvement.

What would make me sell?

Continued inept management. I'll give them a year from now, which will include two theatrical releases. If they don't improve by then I'll consider selling -- and by improve I mean manage expectations better, and manage the DVD sales and licensing revenue to increase margins between now and next summer. The films don't have to be blockbusters for me to hold, but their releases and subsequent DVD releases and merchandising have to be successful to the extent that management can control that (with Marvel and DWA both, I consider one or two creative mistakes to be possible buying opportunities. Not so with management mistakes).

There are lots of folks who disagree with me, of course, and they may well be right. The DVD may be dead. Piracy may destroy the intellectual property that is these firms' primary asset. I think both risks are overstated, but that's just me. I expect it's just as likely that I'll be enjoying Spiderman 5 and Shrek 4 in a few years on my new HDTV with the next generation of High Def DVDs.



Technorati tags: Marvel, Dreamworks, DWA, MVL, DVD

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Portfolio change -- DWRI bought July 7, 2005 at $18.02.

This was a purchase made using some cash I had available, haven't sold anything to buy this one.

The brief argument? I hadn't realized Design Within Reach was a public company until I saw a Motley Fool article on them a week or so ago, and a quick perusal of their investor information made me want to open a small position as I research more.

DWR provides high quality, signature modern designer furniture at fairly reasonable prices (they target the top 10% of furniture buyers, so it's not that reasonable for all of us). They sell furniture designed by most of the big names in modern design -- Eames, Gehry, Le Corbusier, Starck, etc., and for many of these designers and their iconic designs they are by far the easiest and most affordable place to purchase (for some they are the only place -- about 20% of their designs are exlusive to DWR).

While the furniture is not cheap, it is reasonable when compared to other high quality furniture, and modern interior design is a very hot niche right now as far as I can tell -- shaping the offerings of Target, Pottery Barn and Crate and Barrel as well as the high end furniture companies. And the DWR experience is great, by all accounts -- they sell through the web catalogs, and their own galleries where you can try things out, and all furniture is delivered from their warehouses in Kentucky (or straight from the manufacturer) within a very short time. Virtually everything is perpetually in stock, thanks to a relatively small inventory of about 700 items. They are currently debt-free for all intents and purposes, and they are using their tremendous cash flow and IPO funding, and a credit line as well, to expand their galleries very quickly -- they have spots in some of the hippest (and most lucrative) areas in the country already, but at only about 50 studios today they have lots of room to expand.

Sales in studios (including the growth of new studios, which more than doubled) over the past year were up 92%, and direct sales grew at 24% (with web orders growing twice that fast). Studio growth is going to continue at a rapid pace, and their catalog distribution is expected to be ramped up as well. I see lots of growth ahead for this company, and even while they're in this hyper growth stage they're already making money -- they're guiding for .51 this year, which would put them at a high but reasonable PE of 35 or so for a fast-growing company (and I wouldn't be surprised to see them blow through these estimates).

There are definitely some risks, and we've seen some other furniture companies get clobbered this year (Hooker and the like), but I think this upper tier design-conscious retailing, with lots of flexibility and a consumer friendly experience (you can buy at our store, or online or via phone, and you don't have to carry it home -- everything's shipped right to your house) is a great idea and will continue to prove to be a great business going forward. I'll write more about this one as I have time and as I flesh out what is currently a very small position. And maybe someday I'll be able to buy a nice Le Corbusier lounge chair.

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Exelixis (EXEL)



Bought June 17, 2005 at $7.66


Since this stock had a big pop on Friday, it seemed like a good one to write up now. It looks like the reason for the 12% rise on Friday was a brokerage upgrade as Banc of America started coverage at "buy." (Incidentally, they also just started coverage of Vertex Pharmaceuticals, one of my other holdings, at "neutral" ... i suppose they must have just hired a new biotech analyst.)

Exelexis is a pretty small biotech with a promising pipeline of cancer drugs that appear to have better than average chances of eventual FDA approval (nothing revolutionary in terms of targets or in terms of the technology applied -- sometimes "revolutionary" is a bad word if it means trying to get the FDA to approve a whole new way of treating a disease instead of an improved drug that does something similar to existing treatments, only better).

Some of my other biotech holdings, including both Vertex and CV Therapeutics, have had much more coverage in the press and seem to be more fully hyped. That isn't necessarily a bad thing, but I think that these smaller companies with somewhat less attention might be priced at discounted levels in comparison to their more widley understood compatriots.

Biotech has certainly been in the news a lot over the past six months or so, with Genentech blasting off thanks to lots of good drug news -- including lots of coverage of Avastin, which looks like it might be the most important cancer drug in the world (and on which one of my other holdings, Protein Design Labs, makes a nice royalty for use of their proprietary antibodies). That has led to some good price climbs for a number of stocks, but I don't really have much interest in the huge biotechs like Genentech and Amgen -- I think those ships have sailed, for the most part, and that the explosive growth and exciting potential lie with the smaller biotechs with promising but mostly early-stage drug programs. Biotech is a relatively small proportion of my portfolio, and I treat these investments as very long term holds. Ideally, I like to pick companies that I think have the potential for long term growth into powerhouse companies -- the Genentechs and Amgens of a decade from now.

That kind of growth and future generally is built first on one or a few very successful drugs, but also on very deep pipelines and strong science going forward -- I'm not interested in investing in the one trick ponies of the biotech world, the companies that have one booming drug to make money for a few years, but nothing in the pipeline behind that the help them grow into a significant company.

Biotech is also an area I don't personally understand very well, so I rely on reading the advice and analysis of people who do understand the science and who can explain it in terms that a non-scientist can understand. The first person I found like that is Charly Travers over at the Motley Fool, though there are certainly others. Charly and his colleague, Karl Thiel, have both done some nice writeups of biotech companies and Charly writes a monthly biotech column in the Rule Breakers newsletter that I find provides a great education. This coverage alone is largely the reason I subscribe to Rule Breakers -- while the other recommendations they make and the analysis they do in general is compelling, it's the biotech stuff that I couldn't do on my own.

This article on the Motley Fool site is very useful in summing up reasons for investing in Exelixis.

Exelixis has a very promising mid-stage pipeline of primarily cancer drugs, including one currently involved in stage 3 trials for bile duct cancer (and which has orphan drug status, which provides extended exclusivity rights and some tax credits). Their full pipeline of drugs is explained on their website, and they have had a busy year -- aside from the ongoing stage three trials they have several drugs in or just beginning phase 1 trials, and three applications pending with the FDA as of this summer to begin additional clinical trials.

Exelixis is unlikely to be one of the biotech takeovers, in my opinion, because they have followed a strategy of partnering and licensing their drug programs in order to offset the cost of research and development and, indeed, the high costs of the clinical trials themselves. I see them as a separate company going forward, and I trust the analysis of Travers and others that the drug programs themselves seem very promising and are aimed at known cancer targets. This strategy is both good and bad, in that it helps to keep the company from going boom or bust with each FDA approval or denial, but also moderates the impact of a blockbuster. I'm pleased to see with their XL119, the drug closest to market, that they have partnered with Helsinn for a good amount of upfront money and ongoing milestone and royalty payments, but that they have retained the rights to repurchase the North American rights from Helsinn if the drugs performance warrants.

This one is going to be a wild ride, as it has been already from its IPO at nearly twice this price until now, but I think the solid science, low profile and good pipeline that includes several promising programs but also one drug that's in the final stages of approval make for a worthy bet.

This, like most of my biotech investments that have very long time horizons, is a "set it and forget it" stock that I'm not going to sell for the next ten years unless they receive a huge buyout offer, which I do not expect, or unless their proprietary science is discredited (in which case, I wouldn't likely sell anyway, since the stock would then be all but worthless). And for those interested in investing in biotech who aren't doctors or pharmacologists, I strongly recommend finding advisors who you trust who understand the science and the investing theses for these companies -- in my opinion, Motley Fool's Rule Breakers is a great and affordable resource, but there are certainly others as well.


Technorati tags: Exelixis, exel, biotech, Motley Fool

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