Buying Blackstone (BX)

Steve Schwarzman spoke at the Merrill Lynch conference today, and I think some of what he said about his company, Blackstone, has been overlooked in the wash of John Thain rumors. I picked up a few shares of Blackstone today.

So what did he say that was interesting?

About the business:

He said that the alternative assset industry is a "marvelous place."

And that risk-adjusted returns are way above returns from traditional assets.

Importantly, he noted that institutional penetration is still low -- most big institutional pension plans have only 4 or 5% in alternative investments, and they are looking to increase that allocation.

(Personally, I think this increase in market share for private equity and alternative investments is a huge opportunity for Blackstone -- pension fund managers are going to be in a near panic to hit their numbers as the baby boomers retire, and they'll look longingly at the outsize returns achieved by David Swensen at Yale using allocations of more like 20-30% in various alternative assets like private equity, hedge funds, and real estate ... all areas of significant Blackstone strength).

Schwarzman also opined that Blackstone has been given a significantly lower multiple than traditional money managers, but has more than three times their growth rate.

Beyond that, he took a bit of a stab at the analysts who track the shares and noted that "We are not focused on quarters, we are focused on building value for the long term" -- which of course is something many people say, and I don't know whether Schwarzman is more or less believable in saying that than anyone else. They don't give quarterly earnings guidance, which is certainly one indication that they really believe this.

I like that management and employees are incentivized by the distributions and performance of the Limited Partnership Units. The existing partners, according to Schwarzman, are pushed out to an 8-year vesting schedule, significantly longer than average, which means they will be sitting on big embedded costs over the years that they vest these shares and that those people are very motivated to stick around -- the IPO wasn't a one-day gravy train for them. Those costs of vesting options are what surprised investors a little bit with the high costs during their last earnings release, but of course they have nothing to do with operating earnings.

Blackstone has separately stated that they more or less promise to have an ongoing distribution of 1.20 per year as a minimum through 2009 (close to a 5% yield), and Schwarzman reiterated that they will continue to distribute additional income as they make more. As befits a partnership, the reason for their existence is to funnel excess cash earnings to unitholders.

But what stood out for me in his comments was his hypothetical projection of Blackstone performance -- and of course, since they don't really give guidance this wasn't official guidance, but it was dramatically optimistic in comparison with current results. That specific kind of optimism is somewhat rare from CEOs in these post-SarbOx days, and it makes me wonder whether analysts really are lowballing Blackstone's long term potential right now.

Schwarzman said that the two keys for them will be the size of assets under management, and the rate of return on those assets. That's because they essentially make their money from the management fee, which is charged regardless of their performance, and the carried interest return, which is the percentage of gains that they charge.

Returns have historically been massive in comparison to the overall market, but also quite lumpy -- I think that if they can keep getting their average returns their income should be remarkable. (It's worth noting that many people consider the last five years to have been the "golden era" for private equity, and that those returns might be impossible in the future.)

So it's important to note that Blackstone is still raising record amounts of money, and still finding ways to invest it. Schwarzman said that "People fundamentally missed that we committed to invest 6.9 billion dollars in one quarter in private equity and real estate." That's $6.9 billion that they can start charging fees on.

If they have many future quarters like that, Shwarzman said that from just that one part of their business they could "theoretically make $8 billion in profit in a year."

And as part of that same hypothetical exercise, "estimates that show earnings in the $1-2 billion range could prove to be dramatically wrong."

I don't want to overstate this -- and Schwarzman tried to be quite politic about it, too, in emphasizing that the $8 billion potential assumes that everything goes their way, they get returns in line with their average, and they continue to attract a lot of money. But I am a little surprised at the lack of attention it got -- there was one Reuters story titled "Blackstone CEO sees earnings estimates way too low," but that was all I saw. You can, of course, listen to his presentation yourself if you like through the IR section of the Blackstone website.

They of course can't control their circumstances entirely, but clearly Schwarzman believes that there is potential for really dramatic outsize returns because of the power of carried interest and the massive amounts of money that the world is willing to give Blackstone to invest.

So, the overhangs on Blackstone (and all other private equity firms, at least the public ones) remain -- lumpy earnings, a business that the analysts are going to have a really hard time projecting, and the threat of higher taxation on carried interest (which seems to me to be largely baked in to the stock at the current forward PE ratio of around 13), to say nothing of the possibility that tighter debt terms and higher interest rates might hurt the potential for really massive deals in the near future (though I think Blackstone has said that their average deal is a relatively modest $500 million, which certainly doesn't require massive debt financing when you're talking about investment funds of $20 billion or more).

This seems like a bit of a contrarian buy, as does anything financial these days, but I think the asset managers in general are going to be excellent investments over the next ten years, and as the leading light in a segment of that business that's well positioned to take market share from competitors, especially among the big pension managers that are the engine of private equity funding, I expect very good things from Blackstone over the long run ... and I think the downside is limited if performance of the company remains just average, especially in the near term with the backstop of that 5% dividend.

Full disclosure: I own both shares and options on BX.

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Cheap Gold in the Ground? (CELTF)

I'm not generally much of a "gold bug" -- I don't believe that the world economy is going to hell in a handbasket, and I don't think that paper currency is worthless. But I do believe that a little gold in your portfolio can be a nice buffer -- especially when prices are soaring, as they are lately.

But buying the gold ETF is so booooorring.

Kidding, sort of. Certainly if you like gold and silver the safe bet is the ETF for either.

But if you're going to dabble in minerals, not much beats the pop potential of a nice junior miner. I owned shares of Northern Orion a while back and enjoyed some nice returns there, then moved most of my commodities-related investing into Ambrian (AMNZF), which is the investment banker for many AIM listed exploration and mining companies (among other things). And though I'm not a mining expert and get sleepy-eyed reading the pages and pages of drilling assays, I can occasionally work up some enthusiasm for another miner.

This one, which I bought shares of a month or two ago after first hearing about them in June due to a fairly aggressive newsletter teaser ad campaign called "Gold of the Pharaohs," has been really fun to watch -- at least news-wise, if not stock price-wise.

Centamin Egypt is an Egyptian company, listed in Australia and Canada (CELTF on the pink sheets) that is aiming to rebuild the Egyptian gold mining industry. Egypt was a huge source of gold in the days of, you guessed it, the Pharaohs ... that's where all that gold came from that they found in King Tut's tomb, and that was so faithfully reproduced in the headdresses and jewelry of Yul Brynner (Rameses) in The Ten Commandments. Or maybe I'm mixing up my references a bit ... but the point is, Egypt and gold have been linked for a long time.

Until recently, however, there apparently hasn't been much modern gold mining in Egypt.

But this little company, Centamin, is on the verge of changing that. They bought a processing plant from Newmont that until last month was in Kori Kollo in the Bolivian boonies (it's now dismantled and is either in a warehouse in La Paz or on a boat, not sure of the precise details), and they're moving it to their mining site a few miles from the Red Sea.

A long way, I know ... and I hope they've got plenty of insurance for the sea voyage. This is an $11 million plant, not bad for some heavily used equipment half a world away from where you need it.

They're also building the infrastructure for the mining operation -- the roads, plumbing, electrical generation, housing, etc.

But that's not the exciting part -- it's nice to see that progress is being made, and they are good about alerting investors to how far they've gotten, including photos of the installations and updates on the progress of the plant dismantling, etc. I always like it when these little mining companies send out photos of their progress -- clearly they could still be lying or doctoring pictures, but at least they've made the effort to show that something real is happening on the ground, not just the churning of press releases.

The really nice part is that they're still exploring the property, even as mining operations are expected to begin by the end of the year, and the amount of gold they find keeps going up (up 25% or so in just the few months since I started paying attention).

Their mine looks to me (no expert) like it's going to essentially be strip mining away a few small hillocks called the Sukari Hill and what's underneath them, and they've still got several drilling rigs operating to help direct the first stages of the mining operations and further suss out their reserves.

Those drilling results are released more or less monthly, and they have been able to consistently say that they're finding or proving new veins of gold and that they are upping their reserves based on the results.

Every time.

And after close to ten years of drilling and exploring this site, the last month's release included the largest increase in the reserves that they've recorded so far. And they've so far drilled a fairly small portion of their potential minesite, though they do have nine drill rigs currently still looking.

So now, before the actual mining operation begins, they stand with an exploration cost for the gold of about $5 an ounce. That's compared to well over $700 an ounce as a current market price, so we'll just have to separate out the mining costs (Egypt, as you can probably imagine, is a very low cost country, wage-wise), the royalties (they've got a good deal on royalties and taxes from the government, at least for their initial few years), and the transportation costs, and whatever's left will be lining their (and our) pockets. Let me clearly note that I have no idea what the average exploration cost is for gold miners, and I'm sure it varies widely, but with actual mining slated to begin in the very near term I really like this cost structure so far.

There's a decent overview of the company (which they essentially paid for, I believe) at Minesite.com, and the company website has a good number of informative presentations, announcements of resource upgrades, and updates on activities. Trading volume is pretty decent in Canada (at least in comparison to the pink sheets), where it trades under the symbol CEE.

So reserves continue to climb pretty dramatically, they've got a proven mining plant on its way to their site, the infrastructure is on its way, and this looks like it's going to be a real, profitable gold mine for years to come, with plenty of potential in the areas of the site that they've not yet drilled.

Of course, the bad part is that I'm buying a company that's already got a market cap of over $750 million that has spent ten years spending money, and hasn't yet sold an ounce of gold.

Still, I like the ongoing potential for this speculative investment. Over 10 million ounces of gold and counting are likely to be under those hills, all they've got to do is dig it up ...

Full disclosure: For those who haven't guessed, I do own shares of Centamin Egypt, bought on the pink sheets over the past few months at an average cost of $1.08.

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And ... back to the A Shares

Like a sloppy drunk returning to the roulette table, I've repurchased a position in the Morgan Stanley China A Share Closed End Fund (CAF).

Those who've been keeping up here (not so many of you, since I keep neglecting to post in a timely fashion), will remember that I bought these in the Spring because the discount was ridiculous, then sold when the discount shrunk to about 15% and the price was up well over 50%.

Well, I'm doing it again. I still see no fundamental reason for the decline in the A share market in the near future -- inflation is getting crazy in China, which should be good for stocks at least in comparison to bank deposits (and there isn't much else that the Chinese can do with their prodigious savings glut, even though they're beginning to loosen the restrictions a little bit and let some investors sample overseas fare).

And the discount is now back over 20% in this closed end fund.

So, I picked up some more shares today at an average of about $61.50.

This is, again, one of the few positions that I'm very cautious about -- I do have a trailing stop on these shares, which I almost never do with any other holdings, and I'm likely to sell if they continue to climb significantly and the NAV gets a little closer to the share price again.

But really, though I'm somewhat trepid about this position, I do think the A shares have quite a bit more potential in the short term of 6-12 months. Beyond being the most direct way of investing in the domestic Chinese economy, in my opinion, this is a play on supply and demand in two ways:

1) Chinese domestic investors have very few investments available to them, and they're mostly stocks on the domestic (Shenzen and Shanghai) A share market. So the A shares trade at a significant premium to the same company on the Hong Kong exchange, for example, in cases where companies have dual listings.

And 2) International investors have very little ability to invest directly in China. So this fund should trade at a premium to what foreign investors believe is the fair market value of the China A shares overall index.

The risk is that number 1 is moderated somewhat as the Chinese get the freedom to invest overseas -- but my bet is that this process will be extremely gradual, as most Chinese policy changes are, and that number 2 exposes the fact that most foreign investors believe the China A shares market is dramatically overvalued (due to number 1, mostly), so they may be paying a premium to what they believe the fair value is, but they believe, en masse, that the fair value is lower than the current net asset value.

So ... another gamble in a risky, isolated market. But frankly, in some ways I find the Chinese A share "bubble" companies to be somewhat more appealing than their US counterparts these days. If China can continue growing at 10% a year, as most believe they will come close to doing, especially as domestic consumption climbs in the Middle Kingdom, the valuations just aren't necessarily as crazy as they might look to jaundiced Western eyes that lived through the Nasdaq bubble.

We'll see, as usual ... I am leaving room to accept the fact that I'm wrong, and that an abrupt crash in the domestic markets in China is possible.

Full disclosure: I own CAF, and the China Fund CHN, as well as call options on the Hong Kong Index (EWH) and several individual positions in Chinese and asian stocks not directly mentioned here.

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Buying the Google Dip (GOOG)

Well, this is certainly not a contrarian assessment -- the web is achatter with people who are musing about this earnings shortfall as a buying opportunity in Google shares, including most analysts -- but sheep or no, I'm jumping in a little.

I've been a GOogle shareholder for about two and a half years, but I did sell a portion of my holdings about 18 months ago -- taking profits after my one year holding period partly because I was nervous about short term pricing, and partly because Google had become by far my largest holding.

Now, after a little share hiccup, I'm buying back those shares (for more than I sold them for, unfortunately, but for a price that I think is fair). I sold shares right around $400, and bought them back last night at an average price of $508, which brings my average cost basis all the way up to $350.

Thanks to a portfolio that is much larger now, Google is not back to being my top holding, but it is now in the top five again.

Why did I buy?

Well, the short answer is that the earnings were too good not to at this price. I understand that the price run up to $550 was based on some probably irrational momentum enthusaism, but I didn't think $550 was such a crazy share price.

Here's how the numbers compare from the March 2006 earnings release, when I sold a few shares, to today's news:

Sales
March 2006: $1.92 billion
July 2007: $3.87 billion

Earnings:
March 2006: $372 million
July 2007: $925 million

That's right -- sales about doubled, earnings came close to tripling. Even though the margins are not what was hoped for in this latest release due to a hiring binge, that ain't bad long term performance.

Gross margins have been pretty steady over the past year at near 60%, though net margins are weaker. I'll take that over the opposite outcome (better net margins, worse gross margins) because it means Google's problems are cost-related, not that they're losing pricing power due to competition.

And that's really the key: here in the US, at least, there is precious little competition, and no sign that competition is niping at Google's heels despite Microsoft and Ask and Yahoo ALL launching improved services and much better ad systems in the past year or so. Overseas, even in places like China where Google has market share problems so far, there isn't a single market where Google couldn't buy their biggest competitor without breaking a sweat. ... and overall, Google's international growth continues to outpace even the very good US results.

The "law of large numbers" argument, that Google cannot sustain its growth rate, is somewhat compelling ... but it certainly hasn't impacted Google yet in a meaningful way. It's true that earnings growth has slowed somewhat due to investment, but we're still talking about near-60% sales growth and a company that, I believe, is likely to hit an inflection point with their recent achievement of "full" staffing levels that may enable them to increase margins in coming years.

So ... I can't argue with the market pushing GOOG shares down by a few percent today, as seems to be the final result. But the 8-9% hairdcut the shares got overnight and early this morning was a bit overdone, and I'm glad I picked up a few shares.

I like the fact that Google is investing in more people right now, especially because many of them are overseas hires or hires who can help build Google's next generation of services. Google even indicated that a good portion of that 1% earnings miss may have been caused by the one-time $60 million impact of a change in ther HR accounting policies.

But really, I just want to hold Google shares as a significant part of my portfolio, and this dip gave me a timely opportunity to restore that position when I happened to have cash on hand. Google beat analyst predictions for sales growth during a seasonally challenging quarter, and they're investing in the future with more engineers and salespeople. I think we continue to underestimate the long term growth potential here, though Google will likely look expensive on a trailing PE basis for many years. I'll try to ignore the quarter to quarter volatility and keep my eye on the prize: world advertising domination.

disclosure: I do own shares of Google, and am also a Google AdSense publisher.

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Switching Commodity Plays (NTO, AMNZF.PK)

I'm taking advantage of the Yamana offer for Northern Orion that boosted prices by close to 10% at one point, and selling my NTO shares in order to open a position in a very different kind of commodity investment.

Northern Orion (NTO) has been good to me -- I bought shares a couple years ago at around $2.20, and sold them yesterday morning at $5.90. I do think that their reserves are worth more than that, but they will be also very expensive to produce and/or take a long time top come to market, so I'll take the short term payout here and not hold on to Yamana shares.

Instead, I've decided to open a position in an investment bank that largely focuses on commodities -- a relatively new firm, now called Ambrian Capital, that's listed in the UK (AMBR in London, AMNZF on the pink sheets). I first heard about this when I saw it teased as the "best investment of 2007" by a newsletter publisher in my work over at stockgumshoe.com, but of course that recommendation and some other heavy buying (by Rick Rule and others, particularly US investors) made the price spike up significantly in April. It has since fallen back to more reasonable levels, so I've picked up some shares here at an average cost of about US$1.36.

Ambrian is an investment bank, asset manager, and adviser that focuses primarily on resource industries -- including underwriting and advising of commodity companies and trading of actual commodities, among them metals, energy and carbon credits.

They also own large or controlling interest in several mining and energy companies, including Jubilee Platinum, Centamin Egypt, Uruguay Mineral Exploration, Inc, and Anglesey Mining among many others.

At today's price in London they're trading at a PE on last year's earnings of just about 8 (8.6 pence in earnings, 67p share price.) -- that's substantially below most investment banks, and I assume it reflects some general pessimism that we're at the peak of the commodities cycle. I don't personally believe that, but even if we are, for these prices I'm willing to take a small chance that this is the peak earnings in the near term. Their yield is about 2.5% and growing, not bad for a very new operation.

But I think what I find most compelling about this investment, aside from what looks to me like clear progress in building an effective and focused investment bank in this sector, with rapid earnings growth, is the valuation of the shares if you consider their outside holdings.

Their principal investments group, which invests the firm's own money, holds investments worth roughly 50 million pounds (including those mining companies noted above). It's certainly true that those investments could all fall precipitously if commodities collapse, and about 10% of that money is in unlisted companies so it's even more illiquid than the rest, but the current market cap of Ambrian Capital is only about 72 million pounds. That means, if you want to do the math, that the value of the bank itself today, aside from its outside investments, is 22 million pounds.

If you then take out the realized gains from the income numbers as a "what if" exercise (the income for last year was roughly 60% realized gains/40% investment banking), you get income on investment banking of about 8 million pounds from a valuation of 22 million pounds. So that means if we ignore their assets, and they sold them off today for roughly book value (which may not be possible), as I read the numbers you'd then be dealing with a fast-growing investment bank trading at a PE of under 3.

[belated note: sorry folks, just realized my error here. I still like the valuation, but it's not a 3 PE unless you screw up the exercise, as I did. This fails to assign the majority of the administrative expenses to the investment bank. Admin expenses for the group were about 8 million pounds, and investment banking operating profit was about 8 million pounds -- so I think we need to assign probably at least 75% of the admin costs to the bank, since merchant banking is much more people-intensive than investment management. Ambrian doesn't break them out, since they have no good way to do so as all overhead is shared across the group. I still like the shares as much, since the whole is more important than the parts at this point and I expect dramatic earnings growth to continue, but my error in the exercise made the valuation look sillier than it is -- sorry!]

The group's general intention appears to be to realize gains on many of their portfolio companies or to use them to seed investment funds for various sectors (they currently manage one investment fund, Golden Prospect Precious Metals), and they recognize the need to diversify as much as they can given the volatile nature of commodities. They're also planning to start a small private equity fund that they hope will both make profitable investments and help steer firms to the investment bank for advising and IPO underwriting in the future.

Like many folks, Ambrian is also looking to the East -- they recently sold a small stake in the bank (about 9%) to Sun Hung Kai of Hong Kong, and they intend for this to be a pathway into the Chinese markets, both to advise Far Eastern commodities companies, and to help invest the cash that is pouring through many of those markets.

So ... although this is certainly a risky investment and a tiny company, I like the risk-reward profile, and I think that this is the best play I can make on commodities right now -- if the commodity markets remain at all robust, Ambrian should be well positioned to continue rapid earnings growth, and they are not nearly as leveraged to any one commodity or one project as most other investments I would consider.

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A little Crazy ... a Little China

In what might be a dumb move, I've picked up shares in a couple of China closed-end funds in the last few days.

I've tried to hedge my bets a little bit, however: I have acquired shares of both the China Fund (CFN) and the Morgan Stanly China A Shares fund (CAF). These are extremely different investments, which I'll explain briefly. Basically, the China Fund is a mutual fund that buys stable, perhaps less-well-known companies that generally trade on non-mainland exchanges. I'd consider this to be the more stable fund, and a good long term investment. The China A Shares fund represents an investment in the actual bubble -- the Shanghain and Shenzen traded A shares market that is dominated by Chinese retail investors. Both trade at stiff discounts to their net asset value -- something on the order of 20% discounts in both cases, though that fluctuates a lot on any given day.

The China Fund is a more typical China mutual fund, with a long history, that happens to trade as a CEF. They have a couple of advisors, and they focus on buying non-state-controlled entities (this approach is common to many China stock advisors, including the newsletter editor Robert Hsu, who think the state owned enterprises are too bureaucratic and corrupt). I like this one because I appreciate the focus on smaller and unknown stocks that it would be difficult for me to buy personally -- they don't invest much on the A share market in Shanghai, but buy primarily Taiwanese and Hong Kong and other regionally traded shares that represent Chinese companies, or companies that primarily do business with China.

As of the end of April, their top holdings were:

Shanghai International Airport
Chaoda Modern Agriculture
China Merchants Bank
Daqin Railway
Shanghai Zhenhua Port Machinery
Golden Meditech
Financial Street
Xinjiang Tebian Electric
China Yangtze Power
Baoding Tianwei Baobian Electric
Powertech Technology
Cathay Financial
Merry Electronics
Formosa Petrochemical
China Oilfield Services

So I consider CHN to be a long term hold, which could obviously change. The expense ratio is a relatively reasonable 1.26%. CHN is now near a 20% discount to net asset value, which is nearly as high as the discount has ever been -- in contrast, the premium has occasionally gone as high as 60%, though I don't expect we'll see those numbers again. I don't think this fund deserves to trade at the same high discount as CAF, below, because of their relative lack of exposure to Chinese retail investors.

The China A Shares fund from Morgan Stanley (CAF) is more of a short-term bet for me. I think that it's entirely possible that the Shanghai markets will continue to climb for the rest of the next 12 months, on balance, even following the remarkable returns they've already had over the past year. There are definitely a lot more negatives with this fund, including massively higher expected volatility, but I think it's worth a gamble. With the shares trading at something like a 20% discount after being at almost as much of a premium as recently as December, and as the Chinese A share markets have continued to set new records despite all the talk of bubbles and state imposed control. This is essentially a small bet that at some point in the next few months -- before the Olympics next year, certainly -- US enthusiasm for the China A shares will return and that the markets will not have a crash. I could easily be wrong.

The top holdings of CAF, as of the end of March, were:
Huaxia Bank Co. Ltd
China Merchants Bank Co. Ltd
Shanghai Pudong Development BA
Daqin Railway Co. Ltd
Wuhan Iron & Steel Co. Ltd
Air China Ltd
Shenzhen Chiwan Wharf Holdings
Zhengzhou Yutong Bus Co.
China Coal Energy Co.
Maanshan Iron & Steel

As you can see, fairly limited overlap -- Dagin Railway and China Merchants Bank are in both funds, though I expect the CMB holdings in CHN are Hong Kong shares, not Shanghai (many companies list in both exchanges, at often different valuations). I've actually looked at China Merchants Bank as an independent investment idea before (in Hong Kong), because of their strong credit card business developing on the mainland, so I'm happy to have those shares doubled up in these positions.

The expense ratio is a relatively high 2%, thanks to the uniqueness of their portfolio in US markets, which is part of the reason I won't plan to hold this one for a very long time -- perhaps as much as a year or so, depending, of course, on how the market changes. I will likely keep a stop loss order on this one, which I almost never do for any investment.

So ... a couple Chinese investments. One long term because I like the investment strategy, one short term because I think the panic about A shares might be overdone ... and that short term one is on a much shorter leash, too. The CHN shares I purchased at $35.08, the CAF shares at $36.11.

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Another Buy From the Conviction List (ASEI)

Well, in the month or so since I posted my four-company "conviction buy" list, I've had the opportunity to buy two of those companies at even lower prices. The first was Gol Linhas Aereas a few weeks ago, and the second is American Science and Engineering (ASEI), which I picked up additional shares of this morning.

While I have been considering adding to my ASEI holdings for several months, today was the first time that I saw a stock price that I couldn't refuse. On no significant news that I'm aware of, the shares dipped by close to 5% today, and I picked up my additional shares at $48.09. This brings my average cost up to $46.55 (though I actually made my first of many purchases of ASEI shares above today's level, at $52 last year).

So why is the share price going down today? I have no real idea. It could just be a reaction to the fact that the order they announced, for $2 million worth of ZBVs, was pretty puny in the grand scheme of things ... or maybe there's some big institutional selling that I haven't seen yet.

As regards the ongoing announcement of contract wins -- their backlog of orders is still in the neighborhood of $100 million, so I don't much care what rules they follow to determine which orders to announce in press releases (they noted on a conference call a while back that they no longer announce all contracts, but will announce "more significant" ones). Generally, the ones they announce are larger than this of late, or are for "new" business with different countries or agencies, but I won't read too much into the tea leaves here.

I see no reason to doubt the long term performance of the company going forward -- their earnings will undoubtedly remain very lumpy, but in the big picture I expect that lumpiness to average out to continued significant growth. Not always year over year growth for any given quarter, since they occasionally have blowout quarters with big orders that won't be replicated 12 months later, as we've seen recently, but certainly growth writ large.

And the shares reflect some severe pessimism that is largely due, I think, to the lumpiness of earnings and the fact that management doesn't give much in the way of guidance and gets somewhat bristly on the conference calls when asked to do so (largely because they don't necessarily know what quarters will bring which business). Some good articles have been published on Seeking Alpha regarding ASEI, including a note about a positive analyst note last month and a more recent detailed analysis of their conference calls.

The PE ratio of 18 going forward is based on what I think are pessimistic numbers, but the PE of 20 for the trailing year could certainly be interpreted as a bargain given the company's growth potential.

I focus on a few things:

1, the big CAARS program for detecting nuclear contraband at US ports is in its infancy, and ASEI stands to potentially open up a new very lucrative line of business if it is successful. There is $2.5 billion in contracts to fight for in this business, and I expect ASEI to get at least a strong portion of that.

2, on a related front, the Omniview Gantry is the poster child for container scanning at ports -- if political pressure can continue to push for scanning more of the cargo that enters US ports, this product is the logical candidate to be rolled out.

3, the death knell for the Z-Backscatter Van, ASEI's core product, has been sounded multiple times -- but the orders keep coming in. I am encouraged by the ongoing development of the "ruggedized" ZBV for harsh conditions, and by the ongoing domestic adoption of this tool at border crossings and other security checkpoints.

and 4, there exist plenty of upside opportunities where expectations are fairly low -- including drive-through scanners, package scanners and personnel scanners. They had an order earlier this year for the Z-Portal system that can be used at drive-through checkpoints, and it's possible that this could build into a larger business. The package scanning products are in use in some government buildings and might be a more reliable product than the ones used in most airports and similar secure areas, and the personnel scanning, which is being tested by the FAA at one airport, is another potential piece of business. I expect to see some eventual success from the package scanning product line and perhaps from the portal drive-through line, but would guess that the personal scanners probably won't get a wide rollout due to time and privacy concerns (the scan takes a short time, and it reveals a lot about the human body, even in "privatized" mode).

So I still see plenty of long-term upside for this reasonably-priced technology leader that feeds a growing need for port, building and mobile security scanning -- especially as budgets for Iraq and Homeland Security remain on a growth trend. It should also be noted that as of last month there was a big short position -- close to 20% of the float -- so that might mean either I'm misinterpreting the company's future or there's a possibility of a nice short squeeze. I could certainly be wrong, but I want to stick with this one for a few years and see if my guesses play out.

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Bear Stearns Downgrades, Time to Buy (GOL)

I picked up a few more shares of Gol Linhas Aereas Inteligentes (GOL) yesterday, after a nice dip that was precipitated by a Bear Stearns downgrade and some very pessimistic comments by their analyst.

I've written many times about GOL in the past year or two, including a recent note that they were going on my "Conviction Buy" list ... but I haven't bought any shares in a while.

The prices we're getting now can't be ignored, however, and I've now bought just about all the GOL I can handle for my portfolio ... I picked up shares yesterday at $25.89, just a couple percentage points above the lowest price these shares have seen in over a year.

So what was the downgrade concern? Primarily, it's a fare war between GOL and TAM, the two dominant domestic carriers. The analyst sees this slashing profits, particularly in the fourth quarter when a lot of additional capacity comes online with new plane deliveries to both of these companies.

It's possible that Bear Stearns will be right in the short term (meaning, the next year or so), but I have my doubts. This company is so much leaner and so much better run than TAM (which is not a discount airline), that I think a fare war is probably not such a bad thing in the very long run.

GOL's goal, above all else, is to build a vibrant consumer air travel economy in Brazil -- something that is just in its first stages. And to bring people into the air and pull them off the buses that rattle along Brazil's unfortunate roadways, they use low fares.

A low fare airline depends on reducing costs and cutting fares to drive traffic, and on opening up a whole new market of people who never would have considered flying before because of the cost. That's what built Southwest and RyanAir to some degree, and it's even more significant in a lower-income country like Brazil -- the percentage of people in Brazil who have never flown in an airplane is dramatically higher than in the US or Western Europe.

So fare wars bring in new customers, and they also may allow GOL to take advantage of market share incursions against the larger TAM, in my opinion, because GOL has the financial wherewithal and the cost-cutting chops to keep fares lower, longer, than TAM. That's just my opinion, of course, it's possible that TAM's stronger hold on the business flier will help them hold off GOL, but I'm guessing not.

And more importantly, my supposition is that this fare war, founded as it is in a short-term desperation period for Brazilian civilian air travel, won't last long.

You see, in my opinion the major reason for the fare war is the terrible fall and holiday season experienced by Brazilian air travelers -- many people were turned off by air travel because of long delays caused by labor distress among the air traffic controllers due to overwork and anguish about being blamed for the GOL crash last year.

So it's not that the fare war came up organically because these two companies are trying to kill each other -- no, the fare war started because both airlines saw major traffic declines over a few months this winter, largely because air traffic delays made air travel unpalatable for many consumers, and had to do something dramatic and slash prices to get people back on their planes. I wrote a bit about this not long after the crash last fall here and also here, FYI.

I think this is a temporary issue, and that when air traffic control systems and staffing in Brazil are finally upgraded (which may take a couple years, I suppose, depending on political will), general consumer opinion about air travel is likely to improve to pre-last-fall levels.

And when that happens, whether it's next fall or next year or in a couple years, the marketplace can return to a more reasonable level of competition, which I think strongly benefits the smaller, nimbler, lower-cost GOL.

I don't trade much on shorter term issues, so it's possible that the shares will fall further -- but I would be surprised if they're not substantially higher within the next couple of years. At a trading PE of about 18 and a very large and growing market to address, I'm convinced that the shares are a very reasonable buy here -- the anslysts might be wrong on the estimates that give this a forward PE of about 10, but in the long run this is one of the stocks in my portfolio that I'm most convinced has a bright future.

disclosure: in case it's not obvious, I do own GOL and do not own any other companies mentioned here.

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Fear Brings Opportunity: Buying Naspers (NPSN)

At times like this, with global markets running in fear of a bubble and bringing market corrections down upon us all, I like to look for companies that I've been interested in but couldn't justify paying up for, and see if bargains are available. Today I did just that and opened a small entry position in Naspers Ltd. (NPSN). I wasn't actually intending to buy today, and had no idea Naspers would fall this far, but had a limit order in at what I considered last week to be a fair price for a small purchase.

I've written about Naspers before, in more detail, and you can review those posts if you like (when I looked at Naspers' history and prospects, and when I talked about their highest-growth partially-owned division, Tencent Holdings).

And I made clear that I had some reservations about Naspers, the most significant one of which was that I was afraid their valuation might be too rich given the risk of coming competition in their most profitable division, South African pay tv.

But today, the price cratered by well over 10%, due to the global market decline as well as to some Naspers-specific thing:. They're issuing a secondary offering to raise money for acquisitions, which certainly shouldn't impact shares this much (especially given their past success in this area); one of the competitors that we already knew would be coming last week announced the impending launch of a pay tv service in some of their African markets; and, of more immediate impact most likely, there's probably some fear for what will happen to Tencent Holdings when the market opens in Hong Kong tonight, since Naspers owns more than $2 billion worth of that Chinese company at yesterday's prices (36% of the company, as of the last filings I've seen) ... which translates to mean that roughly a third of Naspers' market cap consists of Tencent shares.

And while it's still not a cheap stock it at least has given back some of the speculative advance it made in the first part of this year, so I'm somewhat comfortable entering a position here. I bought shares this afternoon at $23.85. As you can see if you check the quote, I certainly missed the bottom -- it dipped well under $23 in a closing-hour flurry of selling.

So it's not a shock to say that this may well be a bit too early to be buying, if all the pundits are right about a market calamity being right around the corner -- the shares, after all, have climbed fairly dramatically since last Fall's bargain prices in the mid-teens, which came before I had heard of the company. Naspers has its fingers in emerging markets not only in South Africa and elsewhere on the continent, but around the world in all the hot spots including Russia, Thailand, China, Brazil (and just look at Gol and Sadia to see how my portfolio's getting racked by Brazilian fear today, too). Tencent is by far the largest of those investments, but there are many other fairly big ones ... and if those investments crater, the share price will doubtless follow.

But with a strong position as a leading publisher and tv and internet service provider in South Africa, and diversification in their international investments, I think the company will weather any storm reasonably well -- they're quite large, about a $7 billion company, so even if Tencent or Mail.ru goes bankrupt (neither seems likely to me), the company should survive.

And of course, for a company that's on the lookout for promising investments in media and internet stocks around the world, and a bit frustrated about the high costs of some potential acquisitions, a nice stock market downturn might be just what the doctor ordered. That is, if you've got the patience to wait a few years.

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Super Future for Marvel (MVL)

Sometimes you invest in companies because they're cheap ... and sometimes you invest in companies because, though fairly valued, you think their future is brighter than the market believes.

In the case of Marvel (MVL), I've bought shares for both reasons. I originally picked up shares in the comic book, toy and movie company a couple years ago in the teens, and though it dropped at one point down to $13 or so it was certainly a value proposition when I first got involved.

Now, it's less of a bargain -- but the future is significantly brighter ... and I bought a few more shares this morning at $28.38, upping my average cost per share to the low $20s.

Why now?

I had been hoping for a dip in the price, which hasn't happened (quite the opposite) ... though MVL remains a fairly small position for me even after this purchase, so another buy in the future is certainly possible.

And it would have been more prescient to make this purchase back in the summer when the price was a good 30% lower -- but I didn't.

What has changed since then is that Marvel has moved further past the lump caused by its transition to a new toy licensing deal (they make a lot of their money from licensing characters for toys), and the film slate for the next couple years has been firmed up, with very tantalizing possibilities for both toy and movie revenues going forward.

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The first thing, of course, is the next Spiderman movie -- Spiderman 3, which according to the previews looks pretty dark and impressive, and has the potential to be a mega blockbuster like its predecessors. Of course, this is just a small part of Marvel revenues, since the Spiderman deal was signed when the company was very weak, many years ago, and they only get a relatively small royalty from the movie itself ... though Spiderman toys are always big sellers, and this should help that further.

More important, in my view, is the fact that it looks like Marvel is really going to have a great product on its hands with their first self-produced movie. In 2008, they'll be releasing the first of several films that are produced with their own line of credit, and for which they'll make most of the money (and take on most of the risk -- I wrote extensively about this last February), unlike the relatively risk-free royalty deals they've had in the past for the X-Men, Hulk, Men in Black, Spiderman and other films in recent years.

So a lot of the company's fortunes are riding on making these self-produced films succeed -- and until recently, it was pretty unclear exactly what films would be made, and how promising they would look.

Now, it looks like the first movie, at least, should be a great one -- Marvel has decided to open its film slate with Iron Man, the story of alcoholic military-industrialist gazillionaire Tony Stark, who designs and builds a suit of armor that (eventually) turns him into a superhero. A great character with some depth, and potential for some seriously fun special effects.

But knowing that isn't enough -- in Hollywood it's all about the talent. And that's where Marvel's production head Avi Arad has really done his job.

Starring as Tony Stark will be Academy Award nominee Robert Downey, Jr, who might know something about portraying a wealthy alcoholic.

And as his right hand man Jim Rhodes, Academy Award winner Terrence Howard.

And as his secretary and conscience Virginia Potts, Academy Award winner Gwyneth Paltrow.

Directing will be Jon Favreau, who is certainly competent and well known after hits like Swingers and Elf, though he's much more recognizable as an actor.

That all tells me that Marvel continues to attract top talent (and I, at least, am also looking forward to Nicholas Cage as the Ghost Rider coming soon, though it probably won't move the needle for MVL), and that they are not trying to squeak out bargain basement flicks without stars as has occasionally been done in the past with their characters.

And it tells me that 2008 should be a year when they make a lot of money, since they'll want to front load their self-produced slate to make sure they get the surest hits made first (some of their movies are bound to flop, but as long as they've made money from some hits first they should be in fine shape). Following Iron Man, it'll be a sequel (really a re-start) for the Hulk, since no one was really happy about the first Hulk movie ... and then, hopefully, we're off to the races. Thor, the Avengers, Ant-Man, Captain America, and Nick Fury (already unfortunately immortalized in a terrible film by David Hasselhof a few years ago), and a long list of somewhat second-tier heroes are on the list for consideration for these self-produced films.

As I noted above, Marvel isn't cheap -- but it's a whole different company than the one that existed a couple years ago. No longer a safe bet on a continuing stream of decent royalties built on a stable of popular superheroes, it's now also a big film production house that will make two of its own movies each year and, in many years, rise and fall dramatically on the success or failure of those films. I continue to like their chances.

Disclosure: I own MVL shares as of this writing and do not plan to sell or buy more in the near future.

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Goodbye India Fund (IFN), Hello India Note (INP)

This morning I sold my shares of the India Fund (IFN) and purchased shares of the Barclay's India Index exchange traded note (INP).

I had bought shares of the India Fund, a closed-end fund run by Blackstone, early in 2005, largely because it seemed like the best way to track the Indian market (due to restrictions on foreign shareholders, there aren't any Index ETFs for India, and most Indian share ADRs are priced very differently from their domestic counterparts).

The shares were extraordinarily volatile, not only because the market itself has the tendency to move up and down rapidly, but because as a closed-end fund the shares usually trade at a widely variable premium or discount to the actual value of the shares (the value of the underlying stocks).

In many ways, the premium or discount (in recent years it's been a premium, though steep discounts have existed in the past) has been a good barometer for US investors feelings about the Indian market, which means the changes in that premium are likely to magnify dramatically the already wild swings of the underlying stocks.

I've lived with this because the fund seems to be more or less well managed, and has performed pretty well compared to their benchmarks -- but I didn't buy shares because I thought their stock picking would make them stand out from the pack of India mutual funds ... I bought shares because I wanted exposure to the Indian market.

And now there's a better way to get that exposure.

Barclay's, home of the ubiquitous iShare ETFs, has recently started a new product called iPath, a family of exchange-traded notes (ETNs). These in practice work much like ETFs, with daily trading volume on the NYSE and a close correlation to an underlying index. In reality, they're quite different -- they're not mutual funds as ETFs are, they are debt instruments that promise to return a value equal to the movement in the underlying index (including dividends, etc).

So while these products are new and this is the first equity-based one available from Barclays (the other three currently available are tied to commodity indexes), I'm buying in. I sold my India Fund shares at $44.08 (they had been purchased at $33.90) and bought INP shares at $51.32.

Here's how I see the difference between the IFN CEF and the INP ETN:

India Index Exchange Traded Note (INP):

• INP carries Barclays credit risk, since they're the ones promising the return.
• They do not carry any stock picking risk because they're mimicking the MSCI India Index, which tracks the biggest companies in India (though only 68 companies at this point, I'd compare this with the S&P 500 as a good representative of the country's market).
• INP will mimic the index nearly perfectly as it goes up or down, partly because Barclay's offers to redeem large blocks of shares at NAV.
• As a debt instrument, INP has a maturation date when the proceeds, whatever they are, will be automatically returned to you -- they're 30 year notes, so the date in this case is December 18, 2036. Of course, they can be bought or sold on the NYSE just like a stock, so there's no need to hold to "maturity" to get your money. There's no guaranteed return of principal at maturity.
• All return is capital return -- there are no dividends or distributions, the entire return is reflected in the share price when you sell.
• As essentially an unmanaged index product, the expense ratio is the lowest of any product that gives broad Indian market exposure: .89% right now (I'd like to see it a little lower since it's an index, but I'll take it).
  

The India Fund CEF (IFN):

• The India Fund carries stock picking risk, since they don't try to be an Index Fund (comparing the top ten holdings of IFN and of the Index shows you they have about five stocks in common).
• The India Fund will magnify the performance of the market, most likely (great performance of Indian stocks will likely bring in more investors, upping the premium ... a crash will likely send them to the exits, creating steep discounts).
• India Fund offers repurchase options to existing investors that you really must exercise if you don't want to lose money -- they're diluting your shares of the fund by selling existing investors shares at a discount to NAV, so if you don't buy in you're losing ground. While it's fun to exercise your rights and buy shares that immediately appreciate, it's no fun that you're essentially forced to do so (especially if you don't have the funds available).
• The India Fund has a dividend yield, so income investors are likely to be more interested in this one -- the dividend is highly variable, right now ETF Connect puts it at 7.5%.
  
• And finally, the IFN and one or two competitors have had this space essentially to themselves for years, which has led to some extremely high expense ratios. Right now the cost is not too bad at 1.5%, but that could change. And if the ETN product takes off and inspires competitors, the CEFs may suffer if they have to compete for investor dollars, possibly hurting current holders.

It might well be that the IFN will have higher returns -- but in my opinion, it also carries significantly more risk and comes at a higher cost. For what I want, index exposure to the broad Indian market, I think INP is a much stronger choice.

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Looking at MMC Energy (MMCN.OB)

I mentioned a couple months ago, when looking into the potential gains to be had from California environmentalism, that I had come across an interesting power plant aggregator called MMC Energy (traded over the counter at MMCN.OB). I've since taken a little time to look at this company in more detail, and I'm ready to open a small exploratory position.

What is MMC Energy? It is a very small company (just about 75 million market cap at this point) that invests in small power plants in high demand areas. So far, they've got plants in California (two in San Diego which are online now, one in Bakersfield that they're recommissioning and hope to have online in January), and they continue to focus on acquiring what they call "deep value" generation assets in all the areas where high population growth and significant NIMBYism make it hard to build new power plants (mostly California, Texas, and the Northeast and Mid-Atlantic regions).

The San Diego plants, for example, were bought for about $30/kw, versus construction costs for those plants of closer to $700/kw in 2001, according to the company. They backed out of a deal to buy a plant in Utah, for reasons I'm unaware of (though it certainly doesn't fit into their stated geographic focus, so perhaps that's reason enough). Though electricity distribution is a near-monopoly in many places, deregulation and other factors in recent years have led to there being literally hundreds of very small independent (or owned by utilities but "expendable") power generation assets in just the high-growth areas that MMC targets, so they have lots of potential acquisitions (their own estimate is a minimum of 900 plants in their target market).

The small plants they're now acquiring are natural gas-powered plants, and in the case of the San Diego plants they're both trying to expand the plants with additional turbines, and pre-sell power or enter into supply contracts to be available for peak usage times. For their newest plant in Bakersfield they're also considering further partnerships with the local Chevron assets to possibly sell steam and excess energy to them.

The idea of the Resource Adequacy Contract is interesting, because in the case of these smaller nat gas powered plants, MMC can basically make a pretty good amount of money just contracting to be available at a moments' notice (typically, more like ten minute notice) to fire up the turbines to supply power during peak demand periods, typically in the summer, and prevent blackouts. Utilities are required to have extra capacity available to them, and they use these contracts essentially as insurance. MMC will then get paid for the power they generate as well as for their general availability, including daily sales of excess capacity that are auctioned in the spot market, but much of the time it appears that these smaller plants can be run remotely and only used for a portion of the year.

I'm still learning more about the business, but I like the management team and their years of experience in the electric power industry, and I'm very encouraged that they've contracted with Bear Stearns to manage their power sales -- I may be reading too much into this, but that tells me that they have some significant growth in mind, and that Bear is interested in growing along with them (their current asset portfolio doesn't necessarily seem like enough to warrant having someone else manage their power sales for them).

Finally, as some icing on the cake, MMC has applied for an AMEX listing and expects to be listed there by the end of the year, which would still leave them in the small time but would at least move them off the bulletin board and make thet shares a little easier to trade (and more palatable for the institutions).

MMCN is on the verge of being profitable, and should have a good year next year as they've pre-sold resource adequacy contracts for their two main San Diego plants for close to $3 million to provide some nice baseline revenue even before they generate a single watt of electricity -- but with all the expansion they have planned, it's very hard to come up with a reasonable valuation for the company. At these prices near all-time lows for them (not that big a deal, since they've been public less than a year), and before the AMEX listing that will give them significantly more visibility, I'm willing to take my first bite. I'll post the actual price I pay once the purchase goes through.

Update: I bought shares of MMCN at $1.24 on Monday, December 11.

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Happy Sadia Investor (SDA)

I opened a position in Sadia SA (SDA) today, purchasing shares at $30.60.

Sadia is a Brazilian food products company, primarily producing and selling pork, chicken and processed refrigerated/frozen foods. They've had a tough year thanks to some problems with the strong Brazilian currency and weakness in some of their exports (the avian flu outbreakand resultant dip in poultry demand, and a Russian ban on Brazilian pork were negatives in the recent past) ... but management believes that the recently completed third quarter is the beginning of their export and sales growth rebound, and I'm inclined to think they have a good future ahead of them. The shares, while not at their lows, are nicely priced.

Brazil has some natural advantages in this business: inexpensive and available feed grains, inexpensive labor, a good agricultural climate, and a large number of farmers. Sadia has relied on that combination of factors for many years in building both a dominant food company in Brazil, and a significant export business to the rest of the world.

And the meat and processed foods businesses, I believe, have some significant tailwinds for the years ahead -- regardless of the success of Whole Foods and the organic foods movement in the US and Europe, I think the trend is definitively pointing toward much higher consumption of processed and convenience foods worldwide -- more people are working, fewer are farming or living near farms, and convenient refrigeration continues to spread to growing lower middle class areas in Asia, South America and elsewhere.

Add that to the fact that higher standards of living internationally almost certainly will bring higher protein consumption, as they have in the past, and I think meat and frozen convenience foods are good investment opportunities. The global trend for meat consumption has it increasing at 2% a year overall, and already we're seeing eye opening statistics -- including the fact that China now consumes half the world's pork. Meat consumption has climbed something like 500% over the last 50 or so years, and I don't expect to see that trend reverse itself in any meaningful way. That's likely to be quite bad for the environment and for global sustainability, given the inefficiency of a higher protein diet and the dirtiness of the typical factory farm, but for investment purposes that concern is largely incidental.

The company's sales are roughly evenly divided between domestic consumption and exports -- exports are a bit low at 44% of the total for the most recent quarter, thanks to the problems I noted above, but management during the conference call definitely noted that they see the balance returning to the 50/50 margin they prefer.

Domestically, Sadia is primarily a seller of frozen and refrigerated processed food -- everything from frozen chicken nuggets and pizza to ice cream and margarine, including some products like chicken carrot lasagna and cheese chicken burger hot pockets that I can only assume sound better to a Brazilian than they do to me.

The export business, in contrast, is largely in lower-margin products like chicken parts and commodity poultry and pork products. They're slowly adjusting that and trying to market their value-added processed foods in foreign markets, with particular focus on other South American countries and on the Middle East.

Sadia management sees continued opportunity for margin growth as they build and invest in their business, with a goal of seeing EBITDA margins increase to 17% by 2010 -- that would be pretty remarkably high for this business, and Sadia's operating margins are already significantly better than many competitors, including US based companies like Tyson or Smithfield (Sadia doesn't really export to the US on any meaningful level, though that might change with a free trade area for the Americas still possible, so comparisons might not be very useful). Gross margins slid dramatically earlier this year, as the fall in the stock price indicates, but have already begun a rebound and ought to return to their historical levels in the high-20s.

The company has a pretty high debt level, but with continued solid sales and growth I think that ought to be manageable, and the debt is helping to finance needed expansion. Right now, as the company believes they're on the cusp of recovering sales and margins, net debt to equity is at 53%, a touch above the board-mandated maximum of 50%.

There is also always a possibility that Sadia will make big acquisitions either domestically or internationally -- they tried and failed to take over their major competitor Perdigao earlier, and have been trying to build up their pork and beef operations, partly as a way to diversify away from potential avian flu exposure.

As with other Brazilian companies, Sadia pays out a minimum portion of earnings as a dividend to shareholders as required by law. The dividend is subject to Brazilian taxation and fluctuates significantly based on the performance of the business, but the TTM dividend rings in at well over 4%, and I expect to see a yield at least equal to that going forward.

I'm planning to hold this position for a long time, and hope to buy more at lower prices if there are further avian flu or similar short-term concerns. The opportunities for increasing sales of processed foods to the growing economies of South America, and the likelihood of increased protein consumption worldwide provide some real opportunity for a company that I think is value priced right now.

As with my investment in Gol Linhas Aereas Inteligentes (which I'm also considering adding to in the near future), this is in part a bet on the growing Brazilian economy. Rising minimum wages and inflation that is (hopefully) under control should allow for more consumption of prepared foods as well as cheap airline tickets in the biggest country in South America, but the risks with this volatile economy are certainly nothing to scoff at -- continued strength of the Real can hurt their export performance, and a return to high inflation or a wildly populist turn by the government (neither of which I expect) might be disastrous. On the flip side, one of the cabinet members is the former head of Sadia, so I'd imagine the company has a significant voice in the government.

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Back to Buying (PDS)

Well, after a few weeks in hibernation ... I'm back! And I did very little to my portfolio during my time away from this site -- I made one purchase a couple days ago, which I'll talk about in a minute, but generally just let things slide. Google brought some great earnings to the table yesterday, which everyone heard, and I've been generally impressed with the continued strength across my portfolio companies here, early in earnings season, but I didn't see any prices that made me stand up and take notice or add to any of my positions.

What I did do, just a couple days ago, was buy a small opening position in Precision Drilling Trust (PDS). The catalyst for this was the writeup by the excellent 10QDetective, but I wouldn't have bought this quickly if I hadn't already been looking at this sector. I didn't know that PDS existed, but once I found out about it and did my research, I was sold.

I have mentioned a few times that I have a great fondness for some oil services and energy companies -- I only own a few, including SeaDrill (SDRL.OL) and Chesapeake (Preferred D), but I still believe that energy is in a long term bull market as long as economic growth, particularly in the developing world, continues to outpace alternative energy development.

And I've been thinking for awhile about diversifying my holdings in this area a little more. Two options that were on the table were a return to some Canadian Royalty Trusts I owned shares of years ago, including Enerplus Resources (ERF). I took great profits from those holdings when I sold at the end of 2004, but also missed an even stronger run in 2005 and early 2006 ... and the fact that the recent 25% haircut in oil prices caused these shares to dip made me think it might be a buying opportunity.

But I think it's probably not the right time to pick up these royalty trusts -- while the income is great, they rely on purchasing new fields and new resources and they'll be paying pretty solid prices for those going forward if they want to replenish their reserves and keep the monthly distributions high. They have the same problems with reserve replenishment as the oil majors, even though some of these trusts have a good number of years of reserves at current rates of depletion, and they're no longer the "undiscovered" gem that they were just a few years ago, so valuations are still pretty high.

And I thought about some more of the drilling names as well -- Nabors (NBR) in particular caught my fancy, as I've noted a few times, and it is so ever-loving cheap that I still find it hard to resist ...

... but then I read David Phillips' excellent analysis of PDS and it looked like an excellent mix of the dividend yield and energy services exposure I'd been looking for.

I won't go into much detail here, because that work has been done by Mr. Phillips so recently ... but PDS became an income trust (a lot like the REIT conversion process in the US) less than a year ago, and has slowly raised the monthly income distribution since then but still distributes a nice, low percentage of their free cash flow compared to many US REITs, and with very low debt levels.

They are a broadly diversified oil services company, not unlike a Shlumberger or Nabors or Halliburton, and they provide drilling and a broad array of oilfield services. PDS is one of the largest diversified operators in Canada, which is quietly one of the world's great petroleum powers (and certainly the biggest one to have very limited political risk for the US).

So this nets me a company with a great cash distribution policy in a good business that shows no signs of what I would consider to be serious decline (not unlike Rayonier, one of my favorite core holdings), but one without the reserves replacement risk or the hair-trigger relation to oil prices of the royalty trusts.

Canadian income trusts come in several flavors, for those who don't know, and they have grown exponentially over the past few years as the tax advantages they convey have migrated out of the oil patch and into nearly every Canadian boardroom. Royalty trusts are open-ended trusts that pay a royalty on the commodities they mine or drill, but Business income trusts, like PDS, are operating businesses that pay a high percentage of their income out as dividends to unit holders.

You can buy trusts that are tied to everything from ice to restaurant chains to the yellow pages, and Canadian Bell phone company BCE and Telus are converting to trusts this year -- so there is some risk that this bubble of trust conversion will cause a regulatory or tax backlash (though I'd guess that's not terribly likely as long as Canada's budget surplus continues to climb on high energy prices).

I really just like the idea of buying an excellent land drilling company with a focus on high dividends but a relatively low payout ratio that allows for expansion, and with a valuation comparable to Nabors and lower than most any other major company in the sector.

A couple other nice things to recommend PDS, and which helped in my decisionmaking: They are considered a corporation for US tax purposes, so their dividends qualify for the 15% tax rate (some trusts are Partnerships, which give me tax headaches); They may well have a big end-of-year distribution since they're required to pay out a large percentage of their distributable income; and unlike many other income trusts, they have pretty ambitious growth plans, including re-expansion to the US market (often conversion to a trust hobbles a business, preventing them from investing in growth -- that appears not to be the case, at leaste not yet, for PDS).

We'll see how it works -- as we learn more about the company after they've finished their first year as a trust I may be interested in building on this position a little further (unless, of course, natural gas really does return to $3 as some pundits appear to believe ... then all bets are off).

Distribution cuts are probably pretty likely in the next year or so if natural gas prices remain depressed and Precision's more desperate small competitors slash prices to keep equipment out of mothballs, but even a lowered distribution would probably keep the yield at 8-10% (it's nearer 12% at the moment), and my guess is that over the next several years prices are more likely to go up than down ... and that PDS' position as a dominant service provider in Canada's busiest energy patch will enable them to keep prices fairly firm.

Plenty of risk, but an intriguing company. Thanks to the 10QDetective for calling it to my attention at what seems to be an opportune time. I bought shares of PDS at $28.90.

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ASEI gets the orders we were waiting for (ASEI)

During the most recent earnings call, Anthony Fabiano, CEO of American Science and Engineering (ASEI), promised that there were big orders from the US government likely by the end of the year ... but that he couldn't yet disclose anything about them.

Today, the news came out on two large contracts -- and if he had disclosed anything about these, I think I can guarantee that the stock would not have fallen after the last earnings release. (I bought shares both before and after the last earnings announcement, FYI)

ASEI is a security company with proprietary X-ray backscatter technology, and they sell a variety of products for detecting weapons, contraband, and other unwelcome materials on persons and in luggage, trucks, cars, packages or cargo containers. Their primary product right now is the Z-Backscatter van (ZBV), a mobile backscatter X-ray system built into a van. And their primary customer for that product, though overseas sales have also been solid, has been the US Government, which is deploying them both domestically and in hotspots around the world.

The fear has been that ASEI has saturated the market for ZBVs, at least with their largest customer, and that none of their other products are yet ready to make up the slack for potentially declining ZBV sales.

But today's news makes that fear seem silly -- today, ASEI confirmed that the US Government placed its largest order yet for ZBVs, $42 million for 36 vans.

So that's huge.

But potentially even larger is the more surprising announcement that came out today: ASEI is sharing a huge federal contract for a new nuclear detection system for cargo containers with SAIC and L-3. Huge for them, at least, since ASEI is a small cap company with a market cap well under $5oo million and sales in the last twelve months of just about $160 million.

This new contract, which likely relies somewhat on ASEI's current gantry scan product for scanning containers as well as their existing radiation scanning tools, is much bigger than the already quite large ZBV deal: 1.35 billion dollars split across seven years, with the first couple of years designated for designing and testing a prototype and the potential for each company to get $450 million if they develop a working prototype.

And if Congress passes a law requiring this kind of scanning for all cargo, which as a citizen I think is long overdue, I think we can assume that this will be just the tip of the iceberg -- it would take a massive infusion of cash to extend this program to every single port in the country.

So, the lesson? Maybe we should listen when Anthony Fabiano tells us he's optimistic and sees great growth and some big orders coming their way. I'm actually quite surprised that ASEI is seeing only a small bump of 4% or so today, and I picked up a few additional shares at $46.70 this morning.

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After Hours IMAX Buy (IMAX)

Well, I couldn't resist. I might be grasping for a falling knife, which doesn't often work out that well for me, but I think the reaction to Imax's news this evening was wildly overdone, and I ended up buying a few more shares as the price tumbled by about 35%.

When I saw that Imax had not come to an agreement to be acquired or form a partnership with one of the four bidders who were interested, I certainly expected the shares to lose ground. But in my opinion, the possible deals were so nebulous and the performance of Imax films in the first quarter so weak that there really wasn't much of an acquisition premium built into the shares.

After all, the shares were well above $9, and they were doing pretty well on raised guidance for FY 2005, when they announced they were exploring "strategic alternatives" back in early March -- certainly, everyone who invested in this company since then has been focused on the possible takeover, and on a buyout premium that would drive the price to the neighborhood of $12 to $14.

And if the price had hit $14 before this announcement, the 30%+ decline would make a lot more sense to me.

But it didn't -- the premium never really got priced in, so I guess you can say the market was, very rightly, cautious that a deal would happen at that price ... or at all.

So how does Imax look without being an immediate takeover target (and it still may be in due course -- they are still exploring their options)?

Well, to begin with, they did beat the earnings estimates for this quarter, and they beat on the revenue number as well ... so this reaction to the announcement is clearly just a reaction to the buyout news, the company's operations seem to be fine as far as I can tell.

Analysts are estimating an average of 42 cents in earnings this year and 62 cents next year -- and given the good backlog of installations, the constant announcements of new theater deals, especially overseas, and the great slate of films for next year (Spiderman 3 and the next Harry Potter), I have no reason to question that estimate. Superman Returns has been big for them so far this Summer, and Imax is certainly starting to get more of a push for these simultaneously released blockbusters as studios see the gravy Imax showings can pour onto their box office results.

So I put in a limit order at $6.20 after hours, fully believing that this price, more than ten percent below the low hit in January, wouldn't deliver the shares to me. But I thought it was worth a shot.

And now, surprise, I'm the proud owner of a few more Imax shares. I've said before that this is not my favorite company in the portfolio, and that I would have given up my shares at $13 without a fight. That's still true.

But buying shares of this company, which I believe is growing well and has further growth prospects, at a forward PE of 10, is too good to pass up.

It might be that I'm just being stubborn.

This is certainly a small gamble, and I haven't put a ton of money into it. It's possible that the company will truly suffer in the short term without a deep-pocketed partner or a buyout -- but in my opinion, the risk is that they won't grow as fast as their market will bear if financing is weak, not that they will actually have operational difficulties in continuing to grow at the moderate pace they've kept up so far.

Wall Street is having a hard time believing that Imax is for real, and no one was willing to step up to the plate and pay enough cash for the company to make management recommend a buyout -- so it could be that the company really isn't worth as much as I think it is. But it could also be that the arbitrage rats fleeing the sinking ship are just being short-sighted ... only time will tell.

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ASEI Earnings Opportunity

It's just as well that I chose to split my buying of ASEI into a few parcels, since I clearly have no talent for making short term predictions.

American Science and Engineering released earnings this morning, and the market again was wildly disappointed -- a little deja vu from last quarter. The earnings per share number of .41 was a bit depressed by a very high tax bill and the options expensing, but sales were down by something on the order of 20% from the year-ago quarter.

I may be coating this with too much optimism, but I'm not terribly worried. I took advantage of a too mercurial market to fill out my position a little bit more this morning at $37.45, so my cost basis has now been lowered to about $44. That doesn't look so good today, but I think it will in the years to come.

The good news from ASEI is that the orders keep piling in -- lots more international orders for the vans, some indications that the orders for the bigger gantry scanning machines are starting to come in, and new products for package and personal scanning that have large markets to address ... all of which should help lessen their dependence on the US government. The upshot of that is that they reported a big increase to the backlog, which now stands at $63 million.

ASEI may keep going down, but I think the fundamentals of the business and the industry point to a much rosier future in the long run, even if the nature of big ticket government purchasing means that progress from quarter to quarter will be very lumpy, indeed.

More detail on my past analysis of ASEI here, here and here.

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More Security in an Insecure World (ASEI)

I've been wanting to add to my new position in American Science and Engineering (ASEI), and I decided to hedge my bets a little bit by picking up a few shares today before the earnings call tomorrow morning -- that way, if the earnings disappoint I'll still have something to look forward to in filling in my position further at a lower price.

ASEI took a tumble last time it released earnings, and I think this earnings announcement is a pretty good candidate to help them make up some of that fall. Opinions differ on why they fell short of estimates last time around, but management contends that if you consider their performance ex-items they would have actually beat the analyst estimates handily.

I'm no accountant, so I can't tell you whether or not I thought their GAAP or non-GAAP numbers more accurately reflected their performance last quarter ... but I do have a lot of optimism about the company going forward.

It's not just new orders -- though they have those, a total of about 10 million in new contracts announced for their ZBV vans and cargo security scanners in just the past couple weeks.

It's the environment, and the leading edge technology, and the wholesale pessimism baked into the stock.

I've written about what the company does in some detail, both before I bought shares and after. I think the new order from the US government for 8 more Z-Backscatter Vans that are enabled for tough operating environments and enhanced with radiation scanning ability (that sounds like Iraq to me), should reassure investors that ASEI's biggest customer still has plenty of need for their products ... and that's just the vans, that doesn't account for the huge demand for their port, cargo, facility and airport security solutions that offer leading edge technology that no one else can provide.

But more than anything else, I can't believe the pricing on these shares. The company has had a long history of poor performance before current management came on board, but Wall Street seems to be looking at that ancient history instead of at their renewed focus on profitability in the past few years, and on their recent performance.

I'm surprised that I was able to buy the most innovative security screening company in the world at a discount to the overall market ... but I'll take it. I picked up my additional shares earlier today at $46.25, and if accounting confusion and non-recurring items cause some more angst after the earnings call tomorrow I'll strongly consider buying some more.

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Security at a reasonable price (ASEI)

I've been on jury duty most of the week and not watching the intraday gyrations of the market, so apologies for not posting -- what with Tuesday's decline and Wednesday's boom I guess I'm right about where I was the last time I wrote.

I continue to be interested in fleshing out some positions at these depressed prices, but I've gotten a little trigger shy -- otherwise, I would have bought more Chico's by now, perhaps more Cemex before it ran back up, or even a little more Imax -- it looks like there must be some rumors on the takeover percolating somewhere to move that one up.

But I did make a purchase this morning, getting a small entry position into American Science and Engineering (ASEI) at $52 (which is also where it closed yesterday). I wrote about this company, which basically focuses on advanced scanning and x-ray technology for security, a few weeks ago when I was wondering if it was finally cheap enough to buy. Today, I think it is.

ASEI sells a variety of products -- their biggest moneymaker right now is the Z-Backscatter Van (ZBV), a mobile x-ray scanning van that can scan the cars parked on the street, or people walking by, or other difficult to scan items. Governments around the world are picking these up, and the US government has been a major customer.

But they also offer other systems and larger scanning platforms. They have gantry-size scanners for cargo containers that can do x-ray scanning as well as pick up radiation; they have a proposed personal scanner for airports that would replace metal detectors with something that can actually see through your clothing (with basic privacy protected) and scanners to inspect packages or luggage.

The company is certainly reliant on government contracts -- the US government is their biggest customer, and part of the reason for the recent decline in the stock price is the fear that the market for the ZBVs has been saturated here at home.

I don't know whether that's the case, but I don't expect it is. With facility and port security increasingly big issues, and border security growing in importance (these scanners can also detect a group of people hiding in a cargo truck, for example), I don't think demand will drop. And the upside could be quite significant -- if ASEI gets a contract to put large numbers of its personal or package scanners in US airports or post offices, for example, the market would be huge.

As you can see from the headlines, security remains a critical issue around the world -- ASEI should be in a pretty good spot to supply some abilities that very few police or security agencies have right now, and I think that's a very good bet.

There is certainly a flip side to this argument -- as of mid-June, when the price was quite near where it is now, just a few dollars higher, there was a large short position in ASEI (20% of the float). I think that's too much pessimism for a company with unique products, in a growing industry, with virtually no debt and a below-average PE ratio. But I'm just one guy, and the short sellers often have better information than I do.

I'll plan to watch this one closely over the next few months and see if I get an opportunity to fill out my position at better prices, or if order flow picks up and a higher price is warranted. Whichever way it moves, the shares I picked up today at $52 seem to be very reasonably priced.

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Counting on Cash Flow -- more SeaDrill (SDRLF.PK)

I don't have anything new to say about SeaDrill after my posting of a few days ago on news that they have opened a financing agreement with Ship Finance, but I did end up buying some shares after thinking about this one over the holiday. I hope that this SFL agreement will build and allow SeaDrill to return a lot of the cash that it has tied up in rigs to shareholders while still building profitability and enlarging the enterprise.

And I'm confident enough in John Fredriksen and his management team, and in their track record at Frontline, that I'm putting a little more money to work here.

So this is just the official notification that I added on to my SeaDrill position this morning with another pink sheet share purchase (SDRLF.PK) at $13.80 (that's between a 1 and 2% premium to the Oslo close, depending on how the next few minutes of Oslo trading go, which is pretty typical for pricing on this issue).

This is now among my largest holdings, and my average cost per share is standing at $14.93.

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Blackboard at bargain prices

I purchased a few more shares of Blackboard (BBBB) today at what I consider a very fair price. My last purchase back in April was at $28.26, so today's buy at $24.26 is about 15% off my initial buy. Average cost is now just above $26.

Clearly, I'm still optimistic about Blackboard -- but why buy now? I am terrible at timing the market, but when stocks decline to attractive levels for no business-related reason I get the itch to fill out my positions. I wrote a week ago that BBBB was almost a buy for me, and it's down about 10% from that point -- that's enough for another nibble.

Today, it was a tossup between Blackboard and Cemex (CX) as to which would get my next purchase. Blackboard won because I am more confident that the shares will recover within the next few months as next year's improved outlook starts to impact the market's valuation, whereas Cemex seems to be getting pummeled both as a Mexican stock and as a resource and infrastructure company -- I wouldn't be surprised to see it dip further just because of the sector it's in, and that would create some wonderful opportunity for a dominant cement company that is taking advantage of the worldwide commercial, infrastructure expansion and a US cement shortage. I may well buy as this decline continues.

But back to Blackboard. This company is in a growing sector that I really like, education, and is a long way from fully addressing its market. They have a lot of potential growth ahead of them, and there are two key factors that I think are significant:

One, college and university faculties are getting older, and there is going to be a significant retirement boom as the baby boomers age and, assuming they can afford to, ease off into retirement, just as we're in the midst of another fairly large generation's college years. This means a couple thing for colleges -- not only is there going to be a shortage of teachers in some areas, but the next generation of younger teachers are generally also more tech-savvy and more comfortable with (and perhaps reliant on) software tools that make managing large classes more palatable.

Blackboard is the market leader in course management software -- larger classes and younger teachers both make the path to BBBB's software more appealing for universities.

Two, colleges are universities are routinely squeezed by budget problems -- and while that may seem to be a problem for a company that relies on contracts with these entities, in truth Blackboard's products are generally designed to bring efficiency to college and university management -- not only in course management software, but in student accounts and all the other IT infrastructure that keeps a college running as a small town or city.

The efficiencies that the microcomputer revolution brought to businesses and allowed for our past 20 years of productivity gains are likely to be translated more and more to the academic environment as accountability, metrics, and assessment are the watchwords of the new guardians of the academic purse. That's good news, in my opinion, for software providers that can help colleges the way Microsoft, Oracle, and others have helped grow productivity in the corporate space.

This is a sector where being the first mover is a huge advantage -- once 5,000 faculty members are trained and online using one kind of software at a big university, there will be massive reluctance to changing that software. With ownership of the two primary commercial course management software systems in Blackboard and WebCT, BBBB has a tremendous tailwind as it fights off any other competitor -- no one can match their customer base, and it's extremely hard to convert customers from one system to another.

And that customer base, newly doubled with the WebCT expansion, also gives them inroads for their infrastructure suite of products -- with more and more colleges online with course management software, being able to provide a compelling product to upsell them on greater course capacity (especially with the legacy WebCT folks, who spent less money than average Blackboard customers), and to upgrade them to student account management, campus-wide transaction and card systems, and other software that can easily interact with the course management stuff is a great spot for a BBBB salesman to be in.

There is competition, and there is always fear of strong competition coming from one of the big guys like Siebel, Microsoft, Oracle or others -- but with first-mover advantage and a near-monopoly at the moment I'm not particularly afraid of even the biggest competitor right now. This is Blackboard's market to lose.

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