I saw the following article in Microsoft Investor. Craig Columbus, an employee of Disclosure, looks for stocks with heavy insider ownership. He focused on the cable television industry, looking for cable TV laggards. He found two: (1) LodgeNet; and (2) CellularVision. Unfortunately, he chose to invest in LodgeNet and not CellularVision.
March 30, 1998
Buy LodgeNet (LNET), 500 shares at Tuesday's open.
After trading sideways for nearly three years, cable stocks have been on a tear since last summer -- and particularly since the beginning of the year. Check out a five-year chart of the industry on Investor to see what I am talking about. The group has essentially doubled since Microsoft announced its interest in the field via a stake in Comcast (CMCSK). I searched for stocks in the cable industry with a market cap less than $1 billion but greater than $50 million (anything below that tends to be too thinly traded for my investment style). The Finder screen produced 19 hits. Next, I hunted for stocks that had shown revenue growth of greater than 20% in the most recent quarter (versus the same quarter a year ago) and the last 12 months (versus the prior 12 months). I selected revenue growth rather than earnings since many cable companies have negative earnings, the result of high depreciation and interest expenses from their capital-intensive operations. This whittled my universe down to six stocks.
As a value player, I am looking for undervalued stocks that have struggled of late -- but are poised to move higher on positive developments. So, I set the Finder to locate stocks that had lost ground in the last six months (percentage price change as low as possible). Only two of the stocks were laggards, LodgeNet Entertainment Corp. (LNET) and CellularVision USA (CVUS), showing negative six-month returns. LodgeNet is not a pure cable play. It is the No. 2 provider of video-on-demand services to the hotel industry. Product offerings include movies, Nintendo, video check-out services, electronic banner advertising and in-room shopping services.
Impressive Insider Buy
LodgeNet stuck out in my head since it had shown some insider buying last summer -- but I hadn't looked at it in some time. I pulled up the recent insider activity on the stock only to find a 60,000-share purchase on March 4 by director Lawrence Flinn. The buying is particularly impressive when you consider that there are only 11 million shares outstanding on the stock and its average daily volume is 19,300 shares.
After a quick check of the price chart, I was relieved to learn that the stock was trading right around the prices where Flinn was buying ($10.88). Anyone who has read my prior Strategy Lab entries knows of my frustration in finding stocks that were still trading close to the insider buy point. I have been selectively paying up for stocks in Strategy Lab even though it violates one of the basic tenets of my strategy.
Too Good to Be True?
After digging a little deeper, I began to realize that like most small-cap stocks, LodgeNet is not without some warts. Part of the company's revenue comes from its ResNet business unit, a partnership with TCI Satellite that provides cable services to apartment complexes. The ResNet business is much less mature and its capital expenditure needs have dragged down the cash flow results of the overall company.
The firm intends to reduce its financing burdens by cutting its own ownership stake in ResNet, but it still maintains a strong presence in the residential market segment. Management has taken great pains recently to educate Wall Street on the total picture of its financial performance, i.e. that the core lodging business continues to show cash-flow improvement while garnering greater market share. Breaking the results of the two businesses apart helps the Street to understand the story much better. The company also carries some litigation risk as it is locked in a legal dispute with its main competitor, OnCommand. The two are scheduled to lock up in court this summer.
The good news is that as the firm has been garnering market share (currently installed in over 500,000 out of roughly 3.5 million rooms in North America), its capital expenditures have been dropping dramatically on per-room basis. In other words, once the infrastructure is in place, the company can continue to push new content through the pipe at little additional cost.
Much of the company's revenue comes from long-term contracts with the larger hotels. While this is the most competitive and saturated segment of the market, the contracts provide a stable income stream and reduce margin pressures. LodgeNet intends to capture greater market share by shifting its focus to the small and mid-size hotels that have gone largely unserved. Unlike its chief rival, OnCommand, LodgeNet's technology is more cost-effective for smaller hotel properties. Finally, the company has yet to penetrate international markets that will provide an additional source of revenue growth.
The industry currently trades at about 10 times the trailing -month EBITDA. By comparison, LodgeNet trades at 3.5 times trailing EBITDA (vs. 7.0 for rival OnCommand). In other words, the stock is trading at a 65% discount to the industry average and a 50% discount to its main competitor. Analysts expect LodgeNet's EBIDTA to grow by 40% in 1998 -- which seems attainable based on the company's three-year compound growth rate of 56%.
Cuts Across Industries
Potential Takeover Play
LodgeNet is also a decent play as a takeover stock. The story goes something like this: Analysts project that the rate of growth in the pure cable stocks will begin to decelerate in the next three to five years. Many of these same firms are trading at or near their highs, thereby providing a powerful currency to make stock for stock acquisitions. In addition, LodgeNet's services do not fall under the thumb of regulators and could provide a pure cable play with an attractive stream of unregulated, high-growth income.
All in all, it seems like a good time to check in with a purchase of LodgeNet.
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