Archipelago Learning Off To a Fast Start

The marketcap lines may soon intersect and with the upstart becoming more valueable. K12 has revenues of $350MMish and a marketcap of $523MM this morning. Archipelago, in its first day after its IPO debut, has convinced investors that its $40MM of revenue is worth $469MM. Shares are up about 13 percent since yesterday's IPO.

I'm hopeful that some of the luster associated with ARCL will rub off on LRN, a similiar story and, I believe, a better investment.

More Bank Dilution Looms

Investors in financial shares have fared well this year as almost all are significantly higher than their March lows. Those that bought shares near the lows have obviously fared better than the original owners. But the time has come to be wary. Dilution looms, again, on the horizon.

Banks have had ready access to capital this year as they attempt to work through their myriad mistakes. First, the Government provided needed support, then hungry investors started lining up to buy financial secondary offerings. The result was the same: loans were written off, capital depleted, new capital acquired, and original investors diluted. Painful only for the original owners.

While mortgage and credit card loan delinquencies are still at record levels, commercial real estate lending was poorly underwritten and is now showing serious weakness, another capital consuming issue is raising its head. On January 1, 2010, FAS167 will take effect unless delayed. The effect will be that banks must set aside additional capital to support off balance sheet credit card receivables and other securitizations. Whether or not the assets are brought back on the balance sheet or not, more capital must be found to support the potential risk of implied recourse. The big credit card issurers, JPM,C,WFC,BAC,COF, to varing degrees, will be affected. Since current capital isn't plentiful, they will sell more shares and dilute the current base.

Several days ago, First National Nebraska, a moderate sized regional bank with a large credit card operation, filed to sell $250 million of new common and preferred securities. The major reason given for the decision was the need to support off balance sheet credit card securitizations. The decision to sell new shares was a difficult one for First National as it is owned, almost exclusively, by one family. They felt the need, and pressure, to dilute themselves to comply with FAS167. What do you think the professional, non-owner, managers will do? Yes, sell new shares to whom ever will buy them, Government or public.

Setting aside concerns about the remaining potential loan losses and adequacy of loan loss reserves, capital raising is coming again to the banks courtesy of the accountants and transparency. Bank shares will be worth less in 2010.

I'm Rooting For The Oprah Effect

This past week has been an excellent news period for Smart Balance. The price of a share of its stock reflects the improved news flow. What's new? Here are the announcements:

1. A new credit agreement with relaxed covenants. The company stated they still expect to comply with the old covenant thresholds, but they don't have to. they now have added flexibility to grow. Moody's upgrades to stable.

2. The national roll out of their new milk product. After test marketing in Florida and the Northeast this year, SMBL will go nationwide in 2010. The milk business is considerably larger than the spreads market and provides the opportunity to grow sales, market share in the dairy isle, and profits.

3.Today the company announced an agreement with Bob Greene, Oprah's health and fitness guru, to develop and market Bestlife products. These healthy foods and drinks will carry the endorsement of Greene and, implicitly Oprah. Smart Balance will remain the premium products, with Bestlife a more affordable product line.

4. Steve Hughes, SMBL CEO purchased several thousand shares in the open market. A few days earlier a director did likewise.

All this news is nice and may move the stock upward, which makes me feel good, but Smart Balance is a five year play. If you have patience, I think we'll earn multiples of our investment when Hughes sells his then billion dollar company to a major food company for a considerable sum. I'm willing to wait.

Archipelago Learning's IPO Valuation Favors K12

Archipelago goes public on Thursday. The company intends to raise $100 Million, with shares coming approximately one-half from the company and the remainder from selling private equity companies. At the mid point of the anticipated offering, ARCL will be valued at $400 Million.

Providence Equity Partners bought the company in January, 2007 for approximately $85 million and owns 77 percent. Founded in 2000, the company had sales of $42 Million over the past 12 months. Earnings for the nine months ended September 30 were $6.9 Million while the net profit for the prior year was $1 million. ARCL has been growing their student enrollment and has recently enterd the high school market. Their business is basically internet based test preparation.

At $42 Million of revenue, and a market capitaization of $400 Million, the company is being valued at 10 times sales! The P/E of last year's earnings is 400! Interim results are up considerably, however I haven't delved into the makeup of the improved earnings.

K12 is a similar internet based marketer of lessons and test prep. Its market cap is a mere $550 Million and has trailing 12 month revenue of $330 Million or a P/S of 1.6, not 10. LRN trades at a forward P/E of 24, high but not the 400 or 40, depending on the time period, of ARCL. Both feature the cost savings of the internet, face state education cost pressures, but appear to be able to outgrow the reimbursement reductions. K12 projects earnings growth of 20 percent for 2010.

Today, after the ARCL IPO announcement, K12 increased $.71. I believe it will continue to move upward as investors compare the two companies. An investment in LRN garners a company that has more scale than Archipelago and excellent growth opportunities for a lesser, comparable valuation.

William Kabourek owns shares of K12

All We'll Hear In 2010 Is Jobs, Jobs, Jobs

Soon the Democrats will have their healthcare victory. It may be a hollow victory that barely resembles their initial goals, but it will be declared momentous and beneficial to all Americans. We will have more laws and taxes for the sake of illusive healthcare improvements. Any consequences of the legislation, such as debt, increased taxation and job losses, will be several years away, so the celebration can begin.

With some sort of a healthcare victory behind Obama and the Democrats, they can turn their attention to what Americans are really concerned about. That is the economy and job creation. The party in power has been slow to realize that healthcare reform is not the voters number one priority. In 2010 the Democrats will innundate us with job creation legislation.

Just like healthcare costs and coverage, job creation can either be nurtured simply and effectively, or politicians can talk big, tinker, and accomplish little. Rest assured, Obama will get a jobs bill and victory will be declared. No, he won't accomplish an improvement in employment by simply lowering corporate income taxes or the highest personal, marginal rates paid by business owners of Sub Ss or LLCs. That would never happen as it would make sense. Jobs legislation will need to be targeted so social goals and constituencies can be served. Power must be preserved. The mid-term elections must maintain the Democratic majority and 10+ percent unemployment will not accomplish that. So, let the jobs tinkering begin.

What private sector growth can Democrats tolerate? The list is short: green jobs in sustainable energy, unionized workforces in manufacturing, the entertainment industry, design and construction of government building projects, data processing that consolidates and improves medical recordkeeping, and agriculture. These constituencies are apt to receive extra assistance.

We will see a general investment tax credit for the purchase of capital goods or additional employment. Capital goods purchases and employment growth in targeted industries will see an expanded tax incentive. Wind and solar projects, energy efficient appliances and transportation, almost any item manufactured and exported by a union member, will attain special status in the name of job creation. Rebuilding the construction industry with unionized labor by funding more school and transportation projects. None of this will be called stimulus as that has become synonymous with wasteful spending. In 2010 we will have job creation. Democrats will attempt to sound like Republicans.

Capital goods manufacturers that export will see an ITC driven sales boom on top of the weak dollar benefit.The likes of Cat, Deere,Trinity and Valmont, among others, will see revenue growth. Even in a "U" recovery some stocks will appreciate and select American manufacturing companies may benefit from Obama's next victory. Forget about the additional debt and taxation that will accompany, like healthcare reform, the job creation "success"as it won't cause credit and inflationary problems for several years. It will be a "victory" or the Republicans will get a chance to get change correct.

Back to stocks, Deere, while certainly not cheaply priced, is an unionized exporter that serves the agriculture and construction industries and might be a place to park a few dollars while Obama creates jobs,jobs,jobs.

SMART BALANCE REVISITED

Last month I wrote a positive article on why I liked Smart balance. At that time SMBL was selling for $5.90 and I found that figure a reasonable entry point. Two important things have happened since that time. First, the price declined steadily to a low of around $5 and change, making it nearly 20 percent cheaper. Second, today the company announced that it was rolling out its milk products nationwide beginning in January, 2010.

I liked the company at $5.90, so I was very happy to see it go lower. I now own more shares. The milk rollout is exciting. The company says the results of their test market this year in Florida was very favorable. That's good news as milk is a bigger market than spreads. Second, it's good to have feedback that some consumers are still willing to buy premium products in a very difficult economy.

The rollout will eat up some cash, but the company's structure lets them tackle nationwide distribution relatively conservative. Remember, SMBL doesn't own manufacturing or packaging plants. It's all contracted and they announced that they have assembled their dairy partners for the milk venture. The success of the spreads assures shelf space in the milk case.

Nationwide milk distribution and consumer acceptance positions the company well in its quest to become a billion dollar organization. Steve Hughes and his team have the expertise and nads to take on a major, although calculated, expansion in the midst of a difficult economy. They continue to execute their well thought out plan.

I remain encouraged by SMBL's progress and can't wait for 5 years to elapse. Shareholders will be nicely rewarded.

THIS FEELS FAMILIAR AND LOUSY

The past 5 or 6 trading days have been miserable. If I was fully invested my nausea would resemble the swine flu. While I've taken my inoculation of holding cash, writing calls, and shorting a few names, the sick feeling still overwhelms me as I watch the equities that I own crater.

The sweaty brow, clammy hands, and ache in the pit of my stomach are symptomatic of my feelings last Spring as the market plummeted. Is this downward move just a minor, sideways adjustment or the onset of a major correction that will again test men's nerves?

We've only slid down to 9750 on the Dow and 1042 on the S&P so the bulk of the market's recovery is intact. Yet it feels as if we've fallen off a cliff. Rebounding equities have felt so good after the misery of the recession and credit crisis. Will investors panic and attempt to avoid a repeat of the March lows by selling out or will they view a 10-15% correction as a buying opportunity and start pushing prices upward again?

My guess, and it is obviously just a guess, is that the bias is still positive and after some of the gains are protected and taken off the table, the buying will resume. But the names will be different. The crappiest of stocks have done the best in the rally, and even the boldest investor should sense that it is time to become more cautious. Speculative names will be replaced with reasonable investments.

Over the next 6 months I still believe we will head lower, but not yet. So, use upcoming rallies to lighten up so that when the swine flu of investments hits us the nausea, chills, and aching won't become terminal.

Mister Market Is Laughing At Me

I will never be a great investor because I never follow my convictions and place all my marbles on my view of the future. My hedged bets tend to minimize being right and being wrong. That approach suits me as I sleep well and am still solvent. In the current rally, my stock positions have grown nicely and make me feel good. My cash position, on the other hand, makes me want to go sit in the corner.

As I stare into the corner I calculate how much I could have made had I put all my cash to work in equities. That bothers me. Then I remember how horrible it feels when stock prices tick downward and net worth sinks. An especially sick feeling if you are retired and no longer earn any replenishing investable cash. That's why I attempt to stay cautiously invested. Home runs aren't worth the risks involved.

Within the next six months I'll be happy that I'm not fully invested and I hope that I recognize an appropriate time to pull back from my long positions. I probably won't and that is why market timing is difficult.

JP Morgan is instructive. I should have bought it six months ago. Now it sells at almost its ALL TIME HIGH! Even after the dilution that came from issuing lots of new shares to repay TARP loans. You'd think that all the problems are finished. No, they remain. Now JPM is the best of the big banks, but they are still loaded down with non-performing consumer loans and accelerating losses. Loss Reserves have been built, but they will need further provisioning. The market has been celebrating the slowing of JPM's rate of losses. Losses are still growing, just not as fast! Is that worthy of a stock price that is very near its all time high? I don't think so, but I wish I had bought some six months ago. Now sure isn't the time to buy, but traders are.

Goldman Sachs is a similar story, as are the BRIC and commodity stocks. Their recent results have been astounding. They make me green with envy and feel like donning a dunce cap. Until I think about the likelihood of them remaining at current levels, then I regain some comfort in my liquidity.

A review of a DOW chart of the Great Depression depicts a strong bounce back before returning to lower levels. We've had our bounce back, and it may go higher, but I suggest preparing for a return to bleaker times. I will sleep peacefully, even though I will wish I had made some easy money when Mister Market taunts me.

An Unscientific Examination Of Our Financial Future

Economic and financial education, the financial press, and prayer have failed me. No matter how crusty and savvy I think I am, my results don't equal the image I have of my abilities. While far from prescient, thank God I tend to eke out better results than the professional investment sages. Still, I'm about ready to take up the Maharishi Yogi's Flying Yoga and look for enlightened answers to our investment future.

Where are we headed? Television's talking heads swear it is upward, even though they hedge their verbal bets with a few negatives that could pose problems. Sideline money that needs to be invested, a weak dollar and strong commodities, and momentum are forces that are too strong to stop. The market marches on. Or does it? That's where I wish prayer or Yogi flying would work. Where are we going, because Mama needs new shoes.

Did we overshoot by 50 percent at the nadir? Is cost cutting and an inventory correction worth a 50 percent retracement? Can decent growth in China, Brazil, and India compensate for anemic economic activity in the US and Eurozone? Is deleveraging over or the impact exaggerated? Who knows?

After bouncing up and down on my ass and attempting to fly into meditation, I've come to the following conclusions. We over indulged for too long and we're going to deleverage and suffer for a long time. Our 50% party is overblown and will not last. After a quarter or two of easy comparables fueled by inventory replenishment and cost cutting, we are going to flat line for quite some time. Select companies, in select industries, will do well but the "market" will struggle. Deleveraging is brutal and we haven't experienced brutal yet. Government may slow the process, but they can't stop it, especially since they are attempting to with DEBT!

So, I'm keeping lots of cash and only investing in select stocks that "may" do well despite the upcoming economy. I've kept some emerging markets ETFs and international mutual funds. I've added some short positions and will probably add more, but I scare easily. I'd like clarity, but I can't find any. OM, OM, OM. Off to Fairfield.

TAKE A HEALTHY BITE OF SMART BALANCE

I've owned SMBL on and off over the past several years. The story hasn't changed, but the share price is inching lower. An opportunity is at hand if you can wait five years. Regardless of the "markets" results, Smart Balance will reach $1 Billion, control a significant share of the dairy case, and sell out for a very nice price.

The "story" is one of smart management that has built brands successfully before. Steve Hughes, SMBL CEO, has been the architect of tremendous brand growth at ConAgra, Dean Foods, and Celestial Seasonings. His team has years of experience and the goal of building SMBL into a billion dollar foods concern. They are currently at the $250MM level after several years of business.

Smart Balance is a BRAND. It doesn't own manufacturing or research facilities. It is product, marketing, and people. It makes a little money and generates cash. Enough to paydown it's acquisition debt to $65MM. They should be debt free in a year or so. The lack of manufacturing is an advantage in our current tough times.

At its current share price of $5.90 the stock can be gathered in at a price that is significantly lower than the IPO price, employee options, and the entry points of some of their largest private equity investors. While it isn't at its 2 years low point, it is well off its highs and hasn't participated in the market's run up.

A reasonable plan is to buy some and tuck it away for 5 years. Forget about what the market price is and let Steve Hughes do his magic. Within that timeframe he'll sell the company and you'll end up with a boatload of ConAgra, Kraft, or Heinz shares. That's my bet anyhow.