An article in the NYT today describes the rising cost of insurance for homeowners on the coast. Insurance premiums are rising between 100 and 1000% for homeowners, depending on the materials used in construction and whether the home is single-family or condominium.
Such high premiums are required. Despite the appearance of gouging, insurance companies are aware that historical loss models have not protected them. Coastal insurance premiums have been dramatically underpriced, given recent experience. This may finally bring people back to the reason that coasts were not populated in the first place - no one wanted the high risk of loss. Thus, the coasts were populated with disposable structures by people who could afford to lose them. Mortgages were rare on the coast.
Of course there is a wild card. The Federal Government may just tax the rest of the country to cover the risks taken by coastal dwellers. Already, flood insurance is subsidized by those who don't use it. FEMA has flood policies that are much cheaper than what private insurance would charge. A fair approach is for the government to move these risks and their management to the private sector so that coastal dwellers bear the true costs of ownership. However, the article suggests that perhaps costs may move the other way - all coastal insurance may be transferred to the government.
Tuesday, September 26, 2006
Small Cap "Sure" Seems High
Signs of factors driving up the valuation of smaller companies continue to appear. The WSJ announced that a private equity company named Innovative Brands LLC is expected to purchase the deodorant Sure from Proctor and Gamble (PG) for $100 million.
As stated in an earlier post, I am seeing large companies and private equity concerns bid up the prices of smaller companies. The result has been a dramatic premium for lower quality companies over their larger and more powerful competitors.
The sales of Sure last year, ex-Wal-Mart, were $35 million. Assuming about a 12% number for Wal-Mart, I estimate the total sales were $40 million, putting the total sales price at 2.5 times sales. This is roughly the same multiple that PG is selling at. Given the dramatically superior characteristics of PG as a company to the single product line of Sure, it would seem that either PG is cheap or Sure is too high. Or both.
As stated in an earlier post, I am seeing large companies and private equity concerns bid up the prices of smaller companies. The result has been a dramatic premium for lower quality companies over their larger and more powerful competitors.
The sales of Sure last year, ex-Wal-Mart, were $35 million. Assuming about a 12% number for Wal-Mart, I estimate the total sales were $40 million, putting the total sales price at 2.5 times sales. This is roughly the same multiple that PG is selling at. Given the dramatically superior characteristics of PG as a company to the single product line of Sure, it would seem that either PG is cheap or Sure is too high. Or both.
Monday, September 25, 2006
Impact of Tobacco
Tobacco presents an investing dilemma. On the one hand, the profits are enormous. On the other hand, the impact on lives is certainly destructive. A recent discussion with Pfizer's former CEO "Hank" McKinnell reveals a couple of significant facts.
First, he states, "the newly released Cancer Atlas says that upwards of one billion people will die this century due to smoking-related illnesses." The number speaks for itself. Is it really that bad? Can't these deaths be averted?
Apparently not. McKinnell states, "People are addicted to nicotine. In fact, it's as powerful an addiction as heroin. Therefore, telling people to just stop smoking obviously doesn't work. Over 90% of smokers try to quit, but only 5% who try actually succeed."
What makes nicotine so powerful? Apparently, it moderates personal reactivity. When someone is depressed, it lifts one up and when someone is too anxious or manic, it sedates them. The combination is miraculous, but the damage to lungs is overwhelmingly bad. The key is probably some alternate nicotine delivery system.
I remember making a loan to a classmate in high school who might have been up to no good with the money. How else could I explain his payment of 50% interest rate per week? Ultimately, I bought into that mixed line of reasoning - "the devil's had that money long enough."
First, he states, "the newly released Cancer Atlas says that upwards of one billion people will die this century due to smoking-related illnesses." The number speaks for itself. Is it really that bad? Can't these deaths be averted?
Apparently not. McKinnell states, "People are addicted to nicotine. In fact, it's as powerful an addiction as heroin. Therefore, telling people to just stop smoking obviously doesn't work. Over 90% of smokers try to quit, but only 5% who try actually succeed."
What makes nicotine so powerful? Apparently, it moderates personal reactivity. When someone is depressed, it lifts one up and when someone is too anxious or manic, it sedates them. The combination is miraculous, but the damage to lungs is overwhelmingly bad. The key is probably some alternate nicotine delivery system.
I remember making a loan to a classmate in high school who might have been up to no good with the money. How else could I explain his payment of 50% interest rate per week? Ultimately, I bought into that mixed line of reasoning - "the devil's had that money long enough."
Thursday, September 14, 2006
Small Cap Valuations
The recent purchase of Reynolds and Reynolds (REY) by Universal Computer Systems explains some of the unusual valuations of smaller companies. Small companies have historically been valued at 20-25% less than their larger rivals. However, over the past few years this valuation has dramatically reversed so that now smaller companies trade at roughly 50% higher valuations. What's going on?
REY was just purchased by Universal Computer Systems. REY was founded in 1866 as a business forms company, refocused in 1927 to help car dealerships and has been recently a major computing systems supplier to the car dealership business. We have studied them for years. However, with no growth in earnings, REY's tremendous free cash flows have only justified a purchase valuation of $20 (10X cash flow) with roughly $40 as a sell price. That $40 is exactly what UCS paid. How do they pay top dollar?
Private equity. UCS is keeping the Reynolds and Reynolds name, trying to get some "synergistic" growth, removing a competitor all with private equity money. In a world of slow growth and low interest rates, these easily leveraged small companies are miracles of finance, justifying extraordinary multiples (63 here) in a low P/E market.
REY was just purchased by Universal Computer Systems. REY was founded in 1866 as a business forms company, refocused in 1927 to help car dealerships and has been recently a major computing systems supplier to the car dealership business. We have studied them for years. However, with no growth in earnings, REY's tremendous free cash flows have only justified a purchase valuation of $20 (10X cash flow) with roughly $40 as a sell price. That $40 is exactly what UCS paid. How do they pay top dollar?
Private equity. UCS is keeping the Reynolds and Reynolds name, trying to get some "synergistic" growth, removing a competitor all with private equity money. In a world of slow growth and low interest rates, these easily leveraged small companies are miracles of finance, justifying extraordinary multiples (63 here) in a low P/E market.
More About Wal-Mart
Wal-Mart is controversial. Here is a company which I believe is doing more for the quality of life for lower-income citizens than any company in the world and yet it is despised by the Democrats and loved by the Republicans. How can that be? Doesn't the Democratic party pride itself on helping the common man (which, IMO, is a goal worthy of pride)?
A recent Wall Street Journal article describes just one more fact supporting my nomination for Wal-Mart as the first corporate winner of the Nobel Peace Prize. It reports: "Wal-Mart's prices for the financial services are lower than many competitors. Wal-Mart charges 46 cents for a money order, compared with as much as $1.30 at the post office. The company also charges a maximum of $3 to cash a payroll check; check-cashing firms usually charge 2% to 3% of the check's face value." Generally, Wal-Mart increases the purchasing power of our lower-income citizens by 25%, but here it's 50%. No wonder the banks are screaming about Wal-Mart getting a banking permit. Better watch out; pretty soon the Republicans will hate them as much as the Democrats already do.
A recent Wall Street Journal article describes just one more fact supporting my nomination for Wal-Mart as the first corporate winner of the Nobel Peace Prize. It reports: "Wal-Mart's prices for the financial services are lower than many competitors. Wal-Mart charges 46 cents for a money order, compared with as much as $1.30 at the post office. The company also charges a maximum of $3 to cash a payroll check; check-cashing firms usually charge 2% to 3% of the check's face value." Generally, Wal-Mart increases the purchasing power of our lower-income citizens by 25%, but here it's 50%. No wonder the banks are screaming about Wal-Mart getting a banking permit. Better watch out; pretty soon the Republicans will hate them as much as the Democrats already do.
Tuesday, September 12, 2006
Iran: Next Powerhouse?
The investment community has some wonderful writers and thinkers like Warren Buffett and Bill Gross. But my nomination for the best political thinking goes to the folks at Bedlam Asset Management. Their outstanding essay can be found under "pick of the week" at their website, bedlamplc.com.
The writers argue that Iran is well-positioned to take advantage of a structural vacuum. Aided by a keen sense of history, they argue persuasively that Persia will rise again and be the leader of the Muslim world. Our movements to topple Saddam Hussein have simply hastened the process of making Iraq a vassal Shiite state. Not what the U.S. has fought for, but it might create a more stable Muslim world.
The negatives? Clearly, the primary impact is on Israel. The recent letter from the president of Iran essentially said to President Bush: "Leave us alone and we'll leave you alone, but let us deal with 'the phenomenon' of Israel." Assuming that terrorist threats subside in the U.S. and that Iraq moves to a Shiite state, then I can imagine U.S. citizens retreating to a focus on domestic issues, such as the housing bubble.
The lesson: forget Iraq, keep your eyes on Iran.
The writers argue that Iran is well-positioned to take advantage of a structural vacuum. Aided by a keen sense of history, they argue persuasively that Persia will rise again and be the leader of the Muslim world. Our movements to topple Saddam Hussein have simply hastened the process of making Iraq a vassal Shiite state. Not what the U.S. has fought for, but it might create a more stable Muslim world.
The negatives? Clearly, the primary impact is on Israel. The recent letter from the president of Iran essentially said to President Bush: "Leave us alone and we'll leave you alone, but let us deal with 'the phenomenon' of Israel." Assuming that terrorist threats subside in the U.S. and that Iraq moves to a Shiite state, then I can imagine U.S. citizens retreating to a focus on domestic issues, such as the housing bubble.
The lesson: forget Iraq, keep your eyes on Iran.
Friday, September 8, 2006
Consumer in the Dell?
Dell has an impressive history as a low-cost, online retailer. Their process and supply chain management tactics are the stuff of business school studies. Despite their success, Dell's stock is down about 30% for 2006 and 60% from 2000. Dell appears to have run into a critical problem: consumer patterns.
Dell has long ignored the consumer as a customer. While H-P has over 30% of sales to consumers and Apple has an even higher number, Dell has averaged around 15%. Dell has repeatedly acknowledged this pattern with CEO Kevin Rollins declaring, "We have never focused on the consumer as a company."
I've found that to be true. My IBM laptop was exhibiting a major problem and I needed a solution quickly. IBM couldn't get me a new model for eight days. So I figured why not try Dell? Since Dell was just down the road in Texas, I thought it might be quicker. Wrong. The computer took the same eight days, but was 25% less expensive. However, I needed to act quickly. I ended up going elsewhere for an immediate solution.
Dell is a high quality company with talented management. The consumer market has expanded rapidly while Dell has been focused on the patterns of the business market. In the meantime, Apple and H-P have been appealing to consumers with their stock prices up handsomely. I continue to believe that Dell has the right idea - direct on-line marketing is the superior low-cost approach. With some sexier features and some higher cost services, Dell could resume growth. The current stock price implies that Dell can't.
Dell has long ignored the consumer as a customer. While H-P has over 30% of sales to consumers and Apple has an even higher number, Dell has averaged around 15%. Dell has repeatedly acknowledged this pattern with CEO Kevin Rollins declaring, "We have never focused on the consumer as a company."
I've found that to be true. My IBM laptop was exhibiting a major problem and I needed a solution quickly. IBM couldn't get me a new model for eight days. So I figured why not try Dell? Since Dell was just down the road in Texas, I thought it might be quicker. Wrong. The computer took the same eight days, but was 25% less expensive. However, I needed to act quickly. I ended up going elsewhere for an immediate solution.
Dell is a high quality company with talented management. The consumer market has expanded rapidly while Dell has been focused on the patterns of the business market. In the meantime, Apple and H-P have been appealing to consumers with their stock prices up handsomely. I continue to believe that Dell has the right idea - direct on-line marketing is the superior low-cost approach. With some sexier features and some higher cost services, Dell could resume growth. The current stock price implies that Dell can't.
Monday, September 4, 2006
Housing Bubble?
More of my recent conversations center on the real estate market. I have three exposures: personal, anecdotes of friends and publications.
Personally, I purchased a lot in March of 2005 and sold it in early 2006 for an increase in price of over 30%. I sold it to a person who had planned to build. Since then, he sold it to a developer who is building a spec house. In addition, I have looked at the partial purchase and potential development of a lot next door to me. I asked a realtor friend to help me evaluate it. She forwarded to me an enormous list of unsold properties in the area. From this list, the market looks overbuilt.
Further, friends tell me that their houses are no longer appraising at higher values. In addition, the sold numbers of builders are dropping.
Finally, publications report that foreclosures are 18% higher than last July. In addition, Toll Brothers has reported horrible financial results.
It appears that Americans have been building bigger and more expensive houses for smaller families. It also appears that more of their net worth is tied up in these houses and more of their discretionary income is dedicated to maintaining and improving these houses. Psychologically, Americans have been comfortable as they viewed the value of their properties going up. This could change dramatically if houses decline in value.
Development is still hot. However, it appears that a saturation level has been reached and that those likely to be more affected are those who attempt to sell older properties while competing with those recently developed. This would be particularly damaging for the "no down payment" properties.
Personally, I purchased a lot in March of 2005 and sold it in early 2006 for an increase in price of over 30%. I sold it to a person who had planned to build. Since then, he sold it to a developer who is building a spec house. In addition, I have looked at the partial purchase and potential development of a lot next door to me. I asked a realtor friend to help me evaluate it. She forwarded to me an enormous list of unsold properties in the area. From this list, the market looks overbuilt.
Further, friends tell me that their houses are no longer appraising at higher values. In addition, the sold numbers of builders are dropping.
Finally, publications report that foreclosures are 18% higher than last July. In addition, Toll Brothers has reported horrible financial results.
It appears that Americans have been building bigger and more expensive houses for smaller families. It also appears that more of their net worth is tied up in these houses and more of their discretionary income is dedicated to maintaining and improving these houses. Psychologically, Americans have been comfortable as they viewed the value of their properties going up. This could change dramatically if houses decline in value.
Development is still hot. However, it appears that a saturation level has been reached and that those likely to be more affected are those who attempt to sell older properties while competing with those recently developed. This would be particularly damaging for the "no down payment" properties.
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