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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Spekulatius who wrote (21865)	8/9/2005 12:16:34 AM
From: Brendan W	Read Replies (3) \| Respond to of 78520

My comments in bold. Thank for your comments about FMD, Spekulaitis. re FMD - not a buy for me. Here is why: 1) Cash earnings are only 40-50% of total earnings, the remainder goes into "Residuals" which are expected future cash flows from Loans. no market to market fopr "Residual" according to 424B statement. Discount rate is 12% which sounds high but that includes amortization over 24Y lifetime (I believe). This and the overall complexity/lack of transparency are the biggest risks IMO. 2) High stock option dilution - 105 of outstanding in 2004 Some dilution has happened. The 10-Q for quarter ending 3/2006 shows no significant difference between basic and diluted shares (66 and 67 million respectively), however. I don't understand the asserted 105 million shares. I wish I knew what the option exposure was at higher stock prices, but I don't. 3) IPO proceeds mainly went to stock holders very little wen to the companies equity. Owners are eager to sell out, why? This argument is not developed well enough for me to respond to. Insiders sell for the reasons insiders sell and I have not heard anything to suggest FMD's insiders are selling more than others, although you may know this to be the case. Also, I'm not going to take it as a negative that the company didn't itself feel like it needed to raise cash from the public. Clearly, this investment would be more compelling if book value and cash were higher. 4) More than 50% of revenues are coming from one customer . I believe this customer is Wachovia/Bank One. The big customer is BankOne/JP Morgan Chase. I believe Wachovia has no relation to it. Bankone accounted for 43% of service revenue in 2004 and 59% in 2003. If the private student loan market continues to grow at rates anywhere close to the 30+% over the last decade, the concentration risk should diminish. I don't know what JPMorgan accounts for. I think Charter One, Wachovia, and Bankamerica are big customers. 5) earnings are 80% dependant on securitisations - i would expect them to be lumpy based on timing. Yes, lumpiness should be expected, but the PE is such that we're not paying for consistency. 6) What exactly are FMD advantages against competitors? 424B mentioned a database of student loans, dating 18 years back. Other lenders will certainly develop their own data and many (SLM, Wells Fargo, etc.) should be attracted by the high margins that FMD is achieving right now. More competitions will pressure margins. The claimed advantages are in the 424b for all to review. Yes, competitor entry will hurt margins. But I look at the other side, which is this business has been around for almost a decade, and where else would the margins come from but competitive advantage? If you don't believe this company functions in a highly complex environment and that complexity is not a moat, I would not invest. I'm pretty comfortable that it will take 10+ years to come up with competing databases, and they won't be as valuable. FMD's customers (e.g, the big banks) have not forked out tens of millions if they thought could do it cheaper in-house. 7) It appears to me that the "Residuals" mentioned above are fairly interest rate sensitive. Is FMD adequately hedged. Rising interest rates could lead to tripple whammy of increased defaults, increased prepayments, and FMD being forced to use a higher discount rate. This is true, and the increased prepayments is interesting. The loans I believe are variable rate, so increased rates can mean increased prepayments. If I thought higher interest rates were going to occur, I would reconsider this investment. However, the yield on the 10 year US bond has risen .2% over the last year to 4.4% in the face of multiple 1/4 point Fed rate increases. So I see no justification for great concern here. The renmimbi valuation is a wildcard. The napkin case for FMD: assuming trends continue, assuming FMD has some durable competitive advantage... and Yahoo's ROA 44%, ROE 51%, forward PE of 11, triple digit trailing revenue growth... I'm taking the risk and have added to my position. Standard disclaimers on duing your own due diligence. I wish I had more confidence in FMD so I would invest more, but I am leery. And a special warning that I invested in Enron, Worldcom, and Healthsouth, so be prepared... Can you beat that, Paul? (I made enough on WCOM to offset the other two.) P.S. FMD's earnings release is on 8/11.