Gudovac1941

Happy Days are Here Again

2010-05-21T09:29:00.007-04:00

I love the smell of Napalm in the Morning

Gudovac's price targets remain more or less similar to those of 9-12 months ago. price in paretheses is the current price.

Owners might just observe good prices in the near term future.

The price that follows is Gudovac's buy target. In Green are the Stocks that are close to a buy target.

Red indicates stocks that are have a very long way to drop before Gudovac believes they represent good value.

ABB ($16) buy at $5

AA ($11) - $9

ALS - 30 Euros

AMSC ($28)- $5

CSX ($49)- $44

DOW ($25) - $12

EMR ($46)- $34

GE ($16) - $6

RBC ($57) - $31

Economics - Job Losses versus other Cycles

2009-11-06T08:49:00.004-05:00

Unemployment is a lagging indicator. This is true. We are going to hear a lot about that as the sell side tries to generate optimism for a glorious recovery.

Owners should understand the scale and scope of joblessness in the United States today. Gudovac does not know if a structural change has occured in the workforce, but believes a return to full employment levels of the boom years will take a number of years.

The following chart, courtesy of CalculatedRisk, describes the percent job losses versus other post-war declines. Clearly we are in a cycle which has some scope and scale differences with any post 1948 cycle. The red line represents the current cycle. Owners would do well to be prudent and careful these days.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Economics - Why did Buffet Buy BNI ?

2009-11-05T10:39:00.008-05:00

Warren Buffet successfully made an offer for the 70% of BNI Berkshire does not own. He made the offer at a 30% premium to the market price. He made the offer 70/30% cash-BRK shares or 100% cash - depending on the seller's wishes. For the rough purposes of this article, We can therefore consider Berkshire's offer an all cash offer.

Modern US rail is an immensely profitable business for certain.

Berkshire is paying more for BNI than BNI was worth at the absolute insane peak of the Market.

Berkshire is paying close to double the low price of just a few months ago.

Gudovac wrote about CSX a few days before Berkshires announcement. Gudovac concluded CSX (and likely BNI) would return about 8.37% CAGR to Owners. It is reasonable to believe that all 4 railroads would produce similar returns for their Owners. A 30% premium suggests approximately a paltry 5-6% CAGR on Berkshire's investment.

Why would Berkshire pay what appears to be a hefty premium for BNI ?

Berkshire's famous Owners Manual illuminates Buffet's screening tools for acquisitions. It is useful to examine the salient passages again:

Gudovac can accept that Berkshire is respecting the principles outlined above.

Why would Berkshire accept 1/2 the return it gets from the Goldman Sachs preferred of a year ago ?

It isn't because Railroads are going to be a booming growth business. There are some good arguments that Rail will capture market share from Long Haul trucking. However, these market share gains are likely to be made slowly over many years - perhaps decades.

Why is he accepting a 5% CAGR ? Couldn't Warren Buffet negotiate a better deal for BNI ? Why is he making an all cash offer ?

Perhaps it is because Warren Buffet doesn't want cash.

Perhaps Warren Buffet believes holding cash, and especially dollars, is making a high risk bet with little upside and plenty downside.

Perhaps Warren Buffet has concluded that hard assets are going to become very valuable in relative to Cash Dollars. Railroads are the ur-hard asset enterprise.

Warren Buffet by buying BNI has simply switched his dollars holdings into hard assets in one fell swoop.

Brilliant.

Owners can reasonably conclude that Warren Buffet has determined Dollars are going to lose value 'significantly' and 'soon'.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Emerson Electric (EMR) - 4Q Results - Buy Now ?

2009-11-03T13:46:00.008-05:00

Management reported their 30.Sept results this morning. They were in line with Gudovac's expectations from last July and August. Gudovac believes EMR is a well run mature enterprise that will return approximately 6 5/8% to Owners of common when bought at $34.

Management is restructuring the Enterprise to be nicely profitable with 20-25% lower revenues. The operating story for Emerson is quite simple - solid.

The Board of Directors felt confident enough to increase the dividend by 1.5% Yet, even with the growth in dividends the payout ratio dropped slightly to 50%.

At $34, Owners would be paying around 1.9x Owners Book Value which is a premium to Gudovac's usual book target of close to 1.0x. However, Emerson should be looked at as a steady dividend payer compared to a Debt instrument. In some ways, Emerson's dividend might be considered less risky than US Treasuries which are subject to inflation - devaluation risks. In a inflationary-devaluation environment, Emerson's dividends should come close to growing near the rate of US dollar inflation or devaluation. Nearly all of Emerson's expected revenue growth comes from customers outside the USA.

In sum, not much excitement in today's results. Emerson is a great dividend stock whose Managers have the situation well under control. Owners would do well to examine Gudovac's August 20th report referenced in the first paragraph.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Regal Beloit (RBC) - 3Q results Still a Buy at $31 ?

2009-11-02T15:06:00.006-05:00

Management released their 3Q results this morning. They are consistent with Gudovac's predictions from September and July. Regal Beloit has flat lined onto a reduced level of output and profits. Revenues and Operating Income are down 25% y.o.y. Gross margins are up due to a one time benefit from lower material prices. S, G, and A still has not been reduced in line with decrease in revenues. EBITDA for the quarter is on order of $50 million.

Most Troubling is the news that Emerging Markets orders are down 28%. This has profound implications for Regal's future growth. Every other industrial Enterprise Gudovac tracks has increased orders in Emerging Markets, despite the downturn. Regal is an outlier in this respect. If Regal can not compete in Emerging Markets, then Owners need to be very careful.

Back to the numbers - Owners can expect the new Regal Beliot to generate for the next 12 months between $130 and $150 million in FCF. This is in line with Gudovac's prediction of $144 million.

When to Buy Regal ?

The 3Q results indicate very little has changed since Gudovac established his $31 per common as a sensible price to buy. $31 remains a prudent purchase price.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

General Electric - 3Q Industrial Results; Dousing the Flames ?

2009-10-30T09:24:00.015-04:00

General Electric released their 3Q results a few days ago. This article will address only the Industrial side of GE. GE capital will be examined in an another article. Gudovac described the pleasures of hearing GE managers present their results back in July. It is worth quoting Gudovac's thoughts from that article:

"Gudovac always gets a pleasure from hearing polished Managers presenting quarterly results. These presentations can lull even the most jaded owner into a benign torpor. That Middle American quiet confidence. The array of perfectedly composed charts. The team spirit. The situation at the enterprise in question is always the very model of a modern major ~~general~~ corporation. GE's managers are the unquestioned masters of this craft.

Therefore, one should treat any GE presentation as one would a lush summer pitcher of Gimlets - Enjoyable for certain, but don't even think of driving until the next morning."

Segment Profit and Revenues:

The segment profit and revenue information illustrates the situation at GE. The most profitable business - NBC with a 17.9% segment margin is being disposed. Gudovac discussed the ramifications of the disposal of NBC some weeks ago. The 2 remaining Industrial Businesses: Energy Infrastructure with segment margins of 17.7% Technology Infrastructure at 17.1% are experiencing difficult bookings.

Gudovac also notes that both Energy and Technology should have higher margins given that an increasing percentage of their revenues derive from high-margin service business. Owners can reasonably expect further downward pressure on margins in Energy and Technology .

Backlog and Bookings:

The headline of Management's backlog slide suggests the backlog is growing. Strictly speaking the backlog has grown. The news that CSA backlog is up 3% qtr to qtr to a record $127 billion is welcome. CSA tends to have higher margins than New Equipment. Owners need to be careful about the large increase in CSA backlog. Some Services orders represent multi-year contracts. GE managers are well known for their pushing the limits of conservative accounting practices in recognizing revenue and profit. Gudovac suspects that the CSA backlog is filled with multi-year agreements fully recognized when booked.

The bad news about the Order Book remains new equipment which is down 8% since year end. New equipment orders have dropped 36% from their peak. Finally, the Book-to-Bill ratio remains under 1.0. Owners can expect top line revenues to continue to shrink over the next few quarters.

Cash Flow:

'Organic' Cash Flow at GE remains healthy at $11 Billion for the last 9 months. ( for Managment's definition of Industrial COFA see page 9 of 8-K) Subtract 'normal' CAPEX of approx. $9 billion and ones arrives at a Free Cash Flow of $2 Billion for 9 months. This works out to approx. $2.7 annualized FCF for the industrial side of the enterprise - call it $3 billion.

Whither GE Capital ?

Gudovac believes that GE Capital is not going to be cash flow positive anytime soon. Owners can sensibly discount to zero any GEC cash flows for the moment. GEC is more than likely going to consume cash over the next 36 months. Gudovac estimated, as of last quarter, that GEC would requires $15 billion of reserves to cover losses. $7.3 has been reserved as of 30.September. $8 Billion remains to be reserved to cover loan loses for GE Capital. Gudovac will examine this GE Capital is a follow up article. Management is "selling" its NBC stake which will generate much of the necessary $8 Billion needed to cover additional loan loses. Therefore, Owners can ignore (to some extent) GEC for the purpose of determining what price to buy.

Let's give management a free ride on GEC and consider it 'cash flow neutral'

Price to Buy ?

What is a sensible price to buy common shares in a Enterprise that currently generates about $3 Billion of annual Free Cash Flow with more than $500 Billion in Debt ?

Gudovac thinks about $6 a share.

True, its pulling a number more or less out of the air - but $3 billion of Cash Flow isn't a heck of a lot to support debt service on $500 billion.

and GE does pay a 40 cent dividend...paying six bucks means a 6 2/3% yield.

That seems to be just about right.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Durable Goods Orders in Sept - Green Shoots ?

2009-10-28T11:52:00.005-04:00

The US Census bureau released its latest Durable Goods survey a few hours ago. It shows significant improvement over July.

Note, this is the advance report which is subject to even more revision, manipulation, and distortion than the preliminary report. Eventually, there will be a final report, but hardly anyone will look at it. Owners should therefore not make any hard conclusions about the data, just yet.

Here is a snippet from the data.

What should leap out from the numbers is the $9 Billion increase in not seasonally adjusted & non-defense orders. Fully 1/2 of this growth is in Machinery orders. Volume is still below the peak. The Book-to-Bill ratio is still negative (or under 1.0) which suggest shrinking revenue for the next couple of quarters......but it appears a certain stability has crept upon us.

Gudovac can not say if we can collectively open up the champagne - but perhaps we can start chilling a few cases.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

CSX - Example of Premier Operating Managers

2009-10-23T08:56:00.018-04:00

Gudovac would like to devote one article highlighting the premier operating managers at CSX. Premier operating managers are able to pro-actively change their business ahead of external traumas. CSX's latest quarterly results were good. Gudovac reviewed these results from a financial perspective a few days ago.

This article will show how pro-active managers can protect their Owners. Sell side blather about strategy, global trends, and cool-neat-stuff adds zero value if managers can't execute.

CSX managers can execute.

The information we'll use to illustrate the subject are slides from CSX's 3Q presentation. We'll first start with the context and then move to the specific actions managers pro-actively undertook.

The economic environment for CSX is terrible. Volume is down 15% overall. It is down in every market. The Coal market is one example.

Coal shipments are approximately 20% of CSX's business by revenue. Management tracks Coal stockpiles (aka inventory) at Utilties closely. Coal inventory is at near record highs. Management doesn't sugarcoat this bad news. Utilities are not going to increase demand their for Coal.

The quarterly conference call made it clear that Utilities were shipping the absolute minimum required under their long term purchase agreements.

Management sums up the prognosis for 4Q in the slide shown on the right. We might think of this slide as the brown shoots slide. Management considers the outlook 60% unfavourable and 30% favourable. Management presented this harsh verdict clearly.

So, management recognizes the external economic environment is bad and not going to get better. What have they done about it ? The next series of slides describe that actions CSX management have implemented to protect Owners.

First, management slashed capacity by slightly more than the 15% decline in volume. Capacity has been slashed by 13% of employees 'furloughed', 17% of locomotives stored, and a mind boggling 32% of freight cars stored.

These managers don't sit around creating fantasies of how things-are-going-to-get-better-real-soon. They aren't grasping at feel good stories coming from corrupt Political Appointees. These managers slash capacity and costs by staggering amounts at the first hint of trouble.

The results of their actions are shown in the Cost Cutting chart on the left. Every single Manager on Earth should have their cost structure broken down into the same components as CSX shows: Short-Term Variable Costs, Long-Term Variable Costs, and Fixed/Indirect Costs.

CSX managers have slashed short term variable costs by 40% which is to be expected. However, they also slashed LT variable costs and Fxd/Indirect by 16% ! Fixed Costs are the most difficult to cut. CSX cut fixed costs by more than the decline in volume.

The results from the cost cutting are shown in the Productivity Metrics chart. Productivity remains high in the face of reduced volume. This productivity growth indicates that Managers have been able to slash costs without too much disruption.

Operating Managers know how difficult it is to cut costs without disrupting the workforce. CSX managers have executed well in this respect.

The net result of Management's efforts is increased margins.

Repeat - increased margins in the face of 15% decline in volume.

'nuff said.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Economics - Capacity Utilization Sept. Good News ?

2009-10-21T11:59:00.009-04:00

The Fed released its Sept Industrial Capacity numbers a few days ago. Overall numbers are starting to look consistently positive. However, durable manufacturing and machinery manufacturing still remain at depression level capacities. Here is the headline paragraph from the Fed's release:

INDUSTRIAL PRODUCTION AND CAPACITY UTILIZATION

Industrial production rose 0.7 percent in September after an upwardly revised gain of 1.2 percent in August. For the third quarter as a whole, output advanced at an annual rate of 5.2 percent, the first quarterly gain since the first quarter of 2008 and the largest gain since the first quarter of 2005. Production in manufacturing increased 0.9 percent in September, and the index excluding motor vehicles and parts rose 0.5 percent. Mining output strengthened 0.7 percent, while the output of utilities fell 0.7 percent. At 98.5 percent of its 2002 average, total industrial production was 6.1 percent below its level of a year earlier. In September, the capacity utilization rate for total industry increased to 70.5 percent, a level 10.4 percentage points below its average for 1972 through 2008.

The Fed has some good news to report and it is pleased to highlight Manufacturing Output (seasonally adjusted) is rising. However, the canary-in-the-coalmine is utility output dropped 0.7% in September. Utility output drops but Industrial Output increased ? Gudovac suspects some bug in the seasonal adjusting occurred.

Owners can conclude from the drop in utility output that companies which supply to utilities are not going to see their order books grow - ABB and AMSC are prime examples.

Digging deeper into the numbers and we see some areas of grave concern. The 2 charts Gudovac examines each month highlight the subject.

The first chart indicates how large the output gap is in total Industrial Production. The uptick in output is a welcome change. However, the gap between capacity and output remains vast.

Owners can conclude that Heavy Manufacturing will not return to boom era levels until the capacity gap is reduced. Companies will not invest in expanding capacity until demand pushes them ( D'oh ). Owners can guesstimate the correlation between change in the out put gap and increases in capacity by examining recovery from past recessions indicated on the chart.

The second chart from the Sept report is disquieting. This shows the sub-set of Equipment output. There was a sharp jump in Defense and Space related equipment in Sept. Gudovac suspects that this increase accounts for nearly all of the month-to-month growth in output. Business output certainly did increase, but at a small rate.

Owners need to screen their companies to understand which companies are dependent on Defense and Space related orders and which are not. Understanding this relationship how the second chart flows through to one's company, is important to fathom exactly how the 'recovery' will impact your company(ies).

The September Fed Report indicates that a bottom may have been reached in Industrial Output. It does not indicate the scope and scale of a recovery - yet. The output gap is large. Even sharp increases in demand will require years to close the gap. Output gaps of this magnitude have profound implications for pricing, margins, and cash flow.

Owners should be clear the US industrial sector remains mired in a depression level output gap and will remain so for in the medium term.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

CSX - Railroad Good for 8% CAGR on Equity ?

2009-10-16T08:57:00.017-04:00

CSX, the heir to the once might New York Central and Pennsylvania networks, released their quarterly results a few days ago. Gudovac believes that CSX is simply one of the better run Enterprises on Earth from a pure operating perspective.

CSX Management simply lives and breaths productivity improvements. Management also pro-actively addressing changing conditions to serve Owners' interests. CSX, despite plummeting revenues, still managed to earn a decent profit.

CSX is a prime example of a enterprise in which managers proactively change their business in the face of changing business conditions. Seems obvious, but most successful Managers refuse to change soon enough - Think General Motors whose managers refused to move past the 1950's. Owners of pro-active Enterprises can pay higher prices because proactive managers reduce risk to Owners.

CSX financial highlights are shown on the left. CSX has a top line run rate of slightly more than $9 Billion in annual revenues. The railroad generates a whopping $3.3 Billion of EBITDA on these revenues which translates into a 35.8% EBITDA Margin. Using most recent quarter EBITDA as a proxy for long term operating income and adjusting for long term non working capital changes (such as CAPEX, Pension top-off, and Cash Taxes), CSX generates annual Free Cash Flow of about $3.4 Billion.

Free Cash Flow of $3 Billion on $9 Billion of revenues should give comfort to any Owner. That is a heck of a lot of cash generation for a decidedly mature business.

The Enterprise ratio versus book and versus revenue appear to in the high range. However, Owners should note that a high margin enterprise will have high multiples of book and revenues. CSX is certainly a high margin enterprise.

The dividend payout ratio is a prudent 29%.

Interest Coverage remains above 3x, after a 20% drop in revenues !

CSX appears to be a enterprise that can withstand dramatic negative swings in the external environment and still adjust to generate profits. Owners need to ask themselves what would be a good price to pay for such an Enterprise ?

What is a Good Price for CSX ?

CSX is the very model of a mature industry.

One can try and spin many strategic scenarios in which Rail steals Market share from Long Haul Trucking and turns into a double digit growth industry, but Gudovac dislikes betting that a 175 year old industry will suddenly be transformed into the next dotcom story.

Therefore, let us consider CSX from the prosaic standpoint of only a dividend payout. We often forget, but dividends - or the promise thereof - are what provide returns to Owners. CSX, is nearly a pure dividend play.

The current dividend is 88 cents. At $44 dollars per common, this is a meager 2% yield. 2% is minuscule and would not warrant purchase. However, CSX has been good about increasing dividends. Dividends (adjusted for stock splits) have grown at a compounded annual rate of 5% since 1981 and nearly 6% since 1990.

We can not predict when dividends will be increased at CSX. We only know there is a reasonable expectation that dividends will be increased in the future.

We can calculate what Mr. Market believes the eventual return will be once increased dividends are taken into account.

Gudovac has calculated that Mr. Market believes the equity discount rate for CSX is 8.37%.

This 8.37% CAGR for CSX is in line with its dividend growth performance over the last 28 and 19 years respectively. Mr. Market may be on to something.

Gudovac's calculation assumes on a perpetual Free Cash Flow growth rate of 2.125%. This long term rate is just slightly higher than the expected long term growth rate of US GDP. The After Tax cost of Debt ( and implied cost of other long term liabilities ) is 3.66%. Note, this is a implied long term cost of debt, not the actual cost of CSX debt today.

Gudovac believes that CSX could very well generate a 8.37% return for Owners. Mr. Market appears to be sensible about the price for CSX.

Owners need to ask themselves is a 8.37% long term return adequate for the risk presented by CSX ?

Gudovac likes CSX at a 8.37% return and would allocate an appropriate amount of cash-on-hand to the purchase of CSX at prices at or below $44.

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Don't Get Massacred !

Gudovac1941@gmail.com

Gudovac on his Methodology and General Investment Thoughts

Methodology Thoughts and Observations

Shanthi Gears (SHNT - Bombay) - 40% gain in 30 days

2009-10-15T08:59:00.003-04:00

Readers may have noted that Gudovac rarely recommends buying an Enterprise at Mr. Market;s price.

One Enterprise Gudovac recommended buying was Shanthi Gears. On August 11, He suggested that its then price of 37 Rs per common was good value.

Today, Shanthi closed above 52 Rs.

Since August 11th, Readers would have earned a 40% return on their investment. Not bad for 30 days work.

General Electric - Fire Sale of NBC ?

2009-10-14T09:50:00.012-04:00

General Electric is being forced into a fire sale of its NBC assets. Vivendi, GE partner in NBC, is exercising its option to sell. GE has the right to buy Vivendi's 20% share. But - GE is too broke to afford buying it. GE's managers are scrambling and doing a bang up job of making the best of a bad situation, but the fire sale of NBC is costing GE about $3 Billion of value.

Such is the retribution of the Gods who punish hubris mercilessly. GE's managers are hubris personified.......

The much reported GE-Vivendi-NBC-Comcast transaction appears to be developing some structure. Junior Investment Bankers and their Junior Lawyer counterparts are generating reams of paper right-this-very-moment. Owners can have a reasonable degree of confidence that the transaction structure discussed in the press approximates reality. Gudovac first wrote about the NBC transaction a few weeks ago.

This article explores the transaction from the perspective of GE's Owners. Owners should note that GE is being forced to off load its stake in NBC as a result of Vivendi exercising its call option. GE does not have enough resources to acquire Vivendi's stake. Gudovac believes the GE team has created a structure which limits the damage to GE from the forced sale of its 80% stake in NBC.

NBC generates approximately $3 billion in operating cash flow annually.

The likely transaction appears to be a JV between a Comcast and GE with each party providing a mix of assets to the new entity. Vivendi will realize cash from the sale of its 20% stake in NBC.

The table at the right is an attempt to quantify the transaction structure. GE appears to be getting between $11 and $8 Billion 'cash' at close. This represents a nice addition to GE's $50 Billion cash on hand. Gudovac has calculated that GE Capital will consume between $30 and $36 billion covering loan losses over the next 3 years. Cashing out of NBC will therefore cover about 1/4 of the loan losses.

In addition, GE will have a call on 49% of the JV's cash flows. The Net Present Value of the cash flows are between $9.8 and $17 billion. The Discount rate for these cash flows is taken from the table below. ( 15% and 8 5/8% high and low ) Default risk for any debt held by the JV appears to be on Comcast. Comcast owns 51% of the JV and will evidently 'backstop' all JV debt.

Therefore, net benefit to GE from the JV transaction is between $20 and $25 Billion. ('Cash' at close plus NPV of 49% of future cash flows)

It is interesting to compare the expected value of the JV versus expected value of GE buying the 20% Vivendi share. The Vivendi shares are worth between $4 and $7 billion. The table at the right suggests that the Net Present Value of NBC's future cash flows is between $16 and $28 Billion.

The Net Benefit to GE of the JV and buying out Vivendi are nearly identical. GE is arguably losing in the JV structure 11% versus a high value for NBC.

This is almost $3 billion dollars of real value being left on the table by GE. However, given the terrible bargaining position GE's managers are in, Owners can accept that GE's managers are making the best of a bad situation.

Owners may want to look closely at Comcast. If GE is leaving $3 billion of value on the table, then perhaps Comcast is the enterprise gaining $3 billion of value. Gudovac does not presume to understand media-entertainment companies and therefore leaves the stage for others to comment on the transaction from the Comcast point of view.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

Alcoa (AA) - Light at the End of the Tunnel ? 3Q Results

2009-10-08T09:45:00.015-04:00

Alcoa released the 3Q results. They are in line with Gudovac's expectations first outlined in early July. Management pro-actively cost cuts early in the economic crisis. Management recognized the impact and instituted brutal and forceful measures.

The cost cutting measures are nearly fully implemented. Alcoa has reduced headcount by nearly 22,000. Procurement targets have been met. Overhead has been reduced lower than target goals. Working Capital efficiency targets have been met. Capital Expenditure is on track at one-quarter of peak rates.

3Q Results - On Track

These efforts produced results. The Cash Flow hemorrhaging of last year is effectively under control. The slide from Alcoa's 3Q presentation presents the subject with some clarity. Free Cash Flow remains negative. However, it should turn positive in early 2010 as the full impact of cost cutting flows through the Enterprise.

Risks to generating positive cash flow in 2010 are illuminated by this slide. Prices are shown by the yellow line. World Inventory is shown by the fields. Prices have skyrocketed from their lows - which is good. The question Owners need to ask is whether price increases are sustainable in the face of tidal wave of inventory languishing in warehouses.

Alcoa's managers can read this chart as well as anyone, they are certain to manage their output to accommodate the glut of inventory. However, Owners should be careful to understand that pricing risks are more-or-less uncontrollable by Alcoa management at this stage of the cycle.

Debt remains a significant issue for Alcoa. Alcoa's 3Q interest coverage rate remained at a bare 1.0x. Management is doing a decent job of improving the balance sheet. However, owners should recognize that even a minor downturn in prices or volume could reverse this suddenly.

What Price to Buy Alcoa ?

Gudovac is ambivalent about determining a buy price for Alcoa at this time given the unknowns - but will make an honest college try

Alcoa's dividend has been cut to 12 cents per common. - which makes it nearly a immaterial consideration at this time. Prospective owners can venture that Alcoa will increase its dividends at some point in the future. At what time in the future is anyone's guess - an increased dividend is not taken into account in this pricing.

Alcoa's revenues appear to be leveling out in the $16-$20 Billion range with an EBITDA of some $1.5 - $2 Billion. Management estimates CAPEX to be $850 Million in 2010. We can assume that the $850 is close to maintenance CAPEX levels. Using EBITDA as a proxy for Cash Flow and subtracting out minimum CAPEX of $850 Million - one arrives at cash available to debt or equity of between $650 and $1,150 Million. This annual run rate appears to be possible for the foreseeable future.

What is a Equity worth for an Alcoa that generates those numbers ? Guodvac has plugged the numbers into the Gordon Growth model. The results are shown below.

Gudovac has been generous with the both weighted average cost of capital ( WACC ) and long term growth rate which significantly improves the Equity Value. Looking at the table it becomes quickly apparent that Alcoa has a heavy overhang of Debt & Long Term Liabilities relative to its ability to generate cash.

If commodity prices drop, Equity will have virtually no value at a total of $450 million. This translates into an approximate share price of 46 cents.

If commodity prices remain where they are and volume grows slightly from 3Q levels, then Alcoa's equity is worth nearly $13 Billion. This translates into an approximate share price of $13.30 - not too far off Mr. Market's current price of $14 and change.

Clearly Owners will need to make their own judgement regarding the prospect of a drop in commodity prices. The higher the probability of a drop in commodity prices, the closer to the 46 cents price an owner will price Alcoa common.

Commodities is not Gudovac's business. Therefore, he leaves speculation regarding the direction of commodity prices to those more knowledgeable than he.

Note - splitting the difference between 46 cents and $13.30 results in a median price of $6.88, not too far off Gudovac's price in early July.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

Emerson Electric (EMR) - Avocent Bargain or ?

2009-10-06T11:45:00.008-04:00

Emerson (EMR) and Avocent (AVCT) announced today that Emerson would acquire Avocent for $1.2 Billion in cash. Emerson is sitting on approximately $1.5 Billion of Cash. The transaction will effectively consume all of Emerson's cash on hand no matter how it is actually financed. Gudovac believes Emerson's first rate Management is prudent and normally sensible. However, he believes they are over paying for Avocent.

Avocent is a good company which has been hit hard by the downturn in IT spending, specifically server farms.

Perhaps Emerson's management know something the rest of us do not....owners can hope. The Emerson Teleconference and Presentation describing the benefits of acquiring Avocent did not reassure Godovac. The Emerson Presentation appeared to have been cooked up by some sell side investment banker types - full of blather about strategic fit. Avocent's business does fit well within Emerson's core business. Whatever. The important question isn't whether Avocent is a good strategic fit. Plenty of businesses would be good strategic fits for Emerson.

The important question is the price paid for Avocent high or low ? Is Avocent a bargain at $1.2 Billion Cash ? If Avocent at $1.2 Billion is not a bargain, then no reasonable amount of strategic synergies is going to make it add value to Emerson's Owners.

Avocent

Avocent is a company that used to have solid 14% EBIT margins in 2006. Avocent seems to have chased top line growth over profits. In 2008, Avocent achieved less than a 6% EBIT margin on revenues that were more than 25% higher than 2006. Mr. Market punished Avocent mercilessly for the drop in performance. Avocent's Enterprise value is now a quarter of its peak levels.

Bargain or Expensive ?

Is Avocent a bargain or is it expensive ? Owners can ignore the horrifying loses over the first half of 2009 to give Emerson's management the benefit of doubt. Let's assume that Avocent's performance in 3rd and 4th quarter 2009 is already known by insiders to be good due to backlog or order intake numbers. Some may suggest granting this benefit of the doubt is giving management a big get-out-of-jail-free-card. Since Gudovac has such great faith in EMR's management, he'll try and accommodate EMR's management as much as possible by ignoring Avocent's horrifying losses.

Gudovac will simply measure if Avocent is a bargain relative to Emerson's valuation. Since Avocent doesn't generate meaningful profits, the sole semi-reliable metric Gudovac can use is topline revenue versus Enterprise value. The revenue-enterprise value metric is crude - but illuminating in this case.

Emerson's Enterprise Value versus TTM revenues is 1.48

Avocent's Enterprise Value at purchase price versus TTM revenues is 1.96

Jaded Owner's might therefore conclude that Emerson's management is overpaying by some 30%. Emerson is buying a company that is in a proto- turnaround situation, yet paying more for it than Mr. Market values Emerson itself. The aqusition of Avocent for $1.2 Billion cash harms Emerson's owners. Owners should seek to limit Emerson's management ability to shop via Board Resolution.

Shopping for some managers becomes a bad habit - best cut up the credit cards as soon as possible.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

General Electric - Too Broke to Buy 20% of NBC ?

2009-10-02T11:47:00.005-04:00

The wires are abuzz with rumours concerning GE and its NBC unit. Various transaction structures have been suggested by those in the dark. Journalists have written the usual filler about synergies and strategic fit.

However, not one story has posed the core question: Why doesn't GE buy Vivendi's 20% stake in NBC for it self ?

Vivendi has a put option to demand GE purchase its 20% stake in NBC. Vivendi can exercise this option every November. Acquiring the remaining 20% of NBC would cost GE between $4 and $7 billion made up of a mix of cash and paper. This is not a large sum for GE which is sitting on $50 billion of cash.

NBC should be a good fit for GE . The business requires little working capital and minor investments to continue generating healthy cash flows. Analysts estimate that NBC generates roughly $3 billion annual cash flow for GE. TTM operating Cash flow for all of GE is $36 billion.

NBC, therefore, generates about 8% of GE's cash flow. Despite all the travails of all Big Media and NBC in particular, NBC remains a steady source of cash for GE.

NBC may be a nice little cash flow machine for GE, but GE is not able to take advantage of Vivendi's demand to sell....because GE is broke.

GE's overarching concern these days is generating enough cash to cover losses from GE Capital.

Gudovac has written about GE's inadequate reserves back in July. Gudovac estimated that GE Capital will require $30 - $36 billion of cash over 36 months to cover loan losses. This is significantly more than the $2 - $9 billion estimated by Management in July.

There is also risk that GE Capital might violate its debt covenants without a capital infusion.

Divesting NBC should provide between $20 and $30 Billion value for GE's 80% stake. If the divestiture is a mostly cash transaction, GE could cover its loan losses in a coup de main. If, on the other hand, the transaction involves little cash and much paper - owners should seriously question Management's judgement.

Owners should monitor developments carefully and be prepared to react quickly.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

American SuperConductor (AMSC) - Why Buy when Yurek Sells ?

2009-10-01T12:48:00.011-04:00

Gudovac would like to remind his readers of those 2 critical questions when faced with an opportunity. The first question is does management serve stockholders' interests. The second question is to whom do the economic rents of an Enterprise accrue; owners or managers.

Gudovac thought it might be useful to examine this question using American Superconductor (AMSC) as an example. American Superconductor is a fine technology development Enterprise which should generate oversized returns in the medium and long term.

However, the oversized returns of AMSC will accrue to Management and not to Owners. Evidence of Management's getting the lion's share of rents from AMSC have been suggested by Gudovac before.

This article explores the question: Does Management serve stockholder's interests ? There are numerous ways of framing the owner-agent quandary. Stock ownership is always high on everyone's list of how to verify the alignment of interests between Owners and their Hired Hands.

An ideal situation is one in which Management starves if their stockholders lose money. Not Possible ?

LBO Shops (aka Private Equity) to negotiate employment packages in which Management gets paid a base wage significantly lower than customary. Management then gets the opportunity to reap extraordinary gains if and only if the Buy Out Shop generates large returns on its investment. LBO Shops also offer their Hired Hands the chance to invest capital 'alongside' the LBO shop. The LBO shop will even help the Hired Hand get a 2nd Mortgage on their house if he wants to maximize the opportunity. Is that Manager going to starve if he can't make money on the stock ? You betcha !

If a Buy Out shop can demand this level of alignment between owners and management - wouldn't its be reasonable that Owners of Public Companies have similar expectations of their management ?

Let us return to the case of AMSC.

Let us examine how much faith Management has in AMSC's future.

Let us examine how aligned Management is with the interests of stockholders.

Let us examine how much common stock Management is buying in AMSC.

Let us examine at what prices does Management invest their hard earned money into AMSC ?

The example of the CEO and Founder Greg Yurek is instructive. Gudovac examined SEC filings for Greg Yurek to determine at what price Dr. Yurek buys AMSC shares. How many shares did Yurek buy last Autumn when the shares fell below $10 ?

Zero

That's right Kiddos - the Founder and CEO of AMSC , Greg Yurek, - believes that AMSC shares are worth less than $10 per share. At $10 per share,Yurek still refused to buy. Instead of buying when AMSC shares dropped below $10 with his hard earned cash, Greg Yurek is taking his money out of AMSC.

Greg Yurek has been steadily betting against AMSC for a long time. Yurek has been selling shares just about as fast as he can. Yurek does buy shares through his stock option plan - but he appears to like to turn around and sell these shares quickly, usually the same day for a tidy profit.

In the last few months, Yurek has taken a net $1.4 million from AMSC shareholders. Yes, this money come from AMSC shareholders. When Yurek sells his shares, someone buys them. The following chart summarizes Yurek's share transactions since June. How'd you like to be the 'investor' who bought Yurek's shares on 1.Sept ? If Yurek sells at $27, why would anyone buy at a higher price ?

Gudovac searched the SEC records back through 2006 and found a consistent pattern of betting against AMSC from Yurek. Now, Management and its Sell-Side PR flacks will be able to generate numerous justifications for consistent selling. Some of these reasons might even be plausible.

However, what the PR flacks can never escape is the simple fact: When Management sells, they have determined that their money is better placed elsewhere.

AMSC is good company with a great future. Owners need to determine how much of that future will accrue to Managers and how much will accrue to Owners.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observation

Emerson Electric (EMR) - Order Intake remain steady: down 25%

2009-09-28T09:21:00.013-04:00

Emerson Electric issued a interesting inter-quarter 8-k on the 24.Sept. Emerson indicates the order intake has stabilized at approximately 25% below last years figures. The reduced order intake supports Gudovac's recent analysis of similar industrial companies here, & here.

Gudovac suggested that Emerson might be a reasonable Enterprise to own back on 20.August, given its modest risk profile. Owning EMR at these prices levels is purely a function of each Owner's discount rate. Some owners may not believes Emerson's expected return warrants purchase. Others may differ. Gudovac suggested that Emerson would provide a CAGR return of 6 5/8% bought at the prices of 20.August. Gudovac believes the 6 5/8% return rate is still acceptable return for Emerson's risk profile.

The decline in orders at Emerson is spread throughout their product lines as shown by the chart copied from the 8-k filing. (all numbers in percentage change y.o.y.) The scope of decline implies that the decline is deep and will be persistent.

Owners should be clear about the long term profit implications of backlogs which are 20 - 25% lower than the boom period levels. Management at any first rate Enterprise such as Emerson will proactively reduce variable costs in line with the decline in revenues.

However, fixed costs will be difficult to bring down in lock step with order declines. Industrial companies simply have huge fixed costs imbedded into their cost structure. Owners can expect fixed costs to total 35% - 55% of revenues in these companies. When modeling likely profitability in the medium term future, Owners should attempt to model changes in fixed and variable costs.

Gudovac modeled the profit implications for ABB of a 25% decline in orders/revenues. Such a decline results in a Enterprise which is near breakeven profitability. This change has profound implications for the stock price. In ABB's case, Gudovac calculated that ABB stock price might drop by 75% from its current elevated heights.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observation

Jaiprpakash (JAIPRA) - 2% dilution to existing Owners (UPDATE)

2009-09-22T13:38:00.008-04:00

Update as of Wednesday: Mr. Market appeared to confirm Gudovac's assement. Jaiprakash shares were punished dropping to 233.50 Rs. This is lower than the bottom of the 238- 243 range for the equity offering sold on Wednesday. Jaiprakash's Investment Advisors have some explaining to do to their 'valued clients'.

Gudovac established that a good price to buy Jaiprakash is 160 Rs. back in August. The latest information indicates that Gudovac wasn't too far off prudent investment advice. Jaiprakash is raising capital via an equity offering to be priced in a few hours. The dilutive effect of the offering is obvious and may be harmful to existing shareholder. The pricing at a discount from today's close indicates that smart money does not value Jaiprakash shares as highly as Mr. Market. Owners will be soon able to determine what the impact is of the equity offering on the good-price-to-buy question.

Jaiprakash to raise up to $200 mln - sources

Tue Sep 22, 2009 7:30pm IST

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MUMBAI (Reuters) - Construction and engineering firm Jaiprakash Associates plans to raise up to $200 million through share sales, three sources with knowledge of the deal said on Tuesday.

The shares are expected to be sold in block deals on Wednesday in a price range of 238 to 243 rupees each, a discount of 2.8 to 4.8 percent of Tuesday's close of 250 rupees.

Bank of America Merrill Lynch are the arrangers to the deal, the sources said.

The shares form part of the treasury stock created after the company absorbed its units Jaypee Hotels, Jaypee Cement and Gujarat Anjan Cement, and group firm Jaiprakash Enterprises in March, creating a stock of around 200 million shares.

A Jaiprakash spokeswoman could not be reached for comment.

Earlier in June, Jaiprakash had sold 25 million shares from the block at 201.05 rupees each, raising $104 million.

(Reporting by Prashant Mehra and Narayanan Somasundaram; Editing by John Mair)

Economics - Capacity Utilization Aug. Good News

2009-09-16T10:01:00.006-04:00

The Fed released the August Industrial Production and Capacity Utilization numbers one hour ago. The numbers indicate a slight uptick in production. Motor vehicle production was distorted by the cash-for-clunkers program. Manufacturing production ex. motor vehicles is up 0,4%. There may have been some flow through to other sectors (ie steel) from the cash-for-clunkers which distorted the results. Owners should examine carefully next month's data to verify that Production and Capacity have leveled out.

Owners should also note that Production may have leveled out, but a large gap remains between capacity and utilization. The attached charts describe the situation in stark terms. Also note Equipment production appears to have been bolstered by Defense orders. Private Equipment demand remains weak.

Owners can conclude that Backlogs will remain at low levels. Margins will also remain weak. Gudovac examined the backlog and margin situation in some detail in July.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Economics - Owners Victory ?

2009-09-15T08:25:00.017-04:00

Background:

Gudovac is often focused on questions of owner-agent interests. Management forget they are hired hands. Board of Directors forget who they represent. Owners forget to whom should accrue the profits of a Enterprise.

The self-dealing and morally corrupt Manager became established as the norm sometime during the post WWII boom. Gudovac isn't sure exactly when it became normal for Managers to loot their company at the expense of Owners. However, today's Managers engage in routine corruption with nary a thought. Today's CEOs spend owner's funds on personnel PR agents and make-up artists with nary a thought. Today's Boards backdate stock options which are easily in the money if Managers generate a mere 2% annual return.

Gudovac is aware that Management corruption is as old as corporations. However, it is his observation that the boom years of 1982 - 2002 provided a climate for Managers corruption to flower. Owners easily overlooked Management corruption as long as equity prices rose 12% CAGR.

The Good Corporate Governance movement attempts to rein in the worst excesses of corrupt Managers to little effect. Private Equity has only made corruption worse. Owners need to be aware that Private Equity is run by Managers not by Owners. Owners such as the all-powerful CALPERS are unable to restrain corrupt Managers . Even the SEC enables Management corruption.

Gudovac has no illusions about legislative remedies to redress the weakness of Owners. Legislation is easily neutered. Gudovac believes the only method to eliminate management corruption is by forceful & continued effort by Owners.

However, perhaps the Courts can be a force for Owners to realize it is possible to regain control of the companies they own.

The latest ruling in the Southern District Court in New York may just be the catalyst Owners need.

Return of Owner's Rights ?

Owners can't be certain that the Wicked Witch of management hubris is dead.

But, Federal Judge Rakoff's order clearly rejects the insider dealing and looting commonplace today. Rakoff's pithy quote summarizes the situation in stark terms:

Rakoff signals that he wants charges filed against everyone. He wants to understand why charges haven't been filed against the BoA lawyers who drafted the merger documents. Rakoff recognizes that corporate lawyers are the great enablers of management looting. He realizes that lawyers believe they can hide behind attorney-client privilege. He makes it clear that lawyers are not immune from prosecution.

Rakoff's order is a forceful condemnation of the SEC. Readers should note that the SEC was asking for the Judge to approve a multi-million dollar fine. The SEC thought this would be a proforma approval process. Rakoff does not precisely accuse the SEC of collusion with BoA, but he comes close enough in this statement:

Raskoff wants full disclosure from BoA. He wants the SEC to fill its adversarial role and prosecute the BoA Managers who 'lied' to their shareholders. Owners should read the complete Order - it is worth the effort.

For readers who wish to learn more about Raskoff, the wikipedia entry with list of notable cases is a good start. Raskoff was the Judge for the WorldCom trial. He is an expert on white collar crime. A perfect Judge to sit on the Southern District Court. Raskof also teaches at Columbia Law School.

Owners should heed Raskoff's call to arms. Owners should no longer accept self-serving corrupt managers.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Regal Beloit (RBC) - Buy at $31 ?

2009-09-08T13:17:00.017-04:00

The Second Quarter Results were released on 4.August.

Financial Results are consistent with expectations.

Revenues are down 30%.

Management has done a fine job of managing A/R, inventory, and A/P in this downturn. They squeezed over $60 million of Cash from working capital in the quarter. The Current Ratio, excluding cash, more on that later, is a healthy 3.2.

Gudovac does note that Owner's Book Equity (stripping out Goodwill and other questionable 'assets') is a mere $300 million. This is yet another indication of how weak Regal is at operating metrics - it simply doesn't generate much profit.

Regal does have a big chunk of cash on its Balance Sheet - $290 million. This is burning a hole in Knuppel's pocket and will likely be used for another acquisition as discussed previously. Owner's should therefore eliminate the cash in pricing Regal. It will be consumed soon enough. Gudovac can't predict if the forthcoming acquisition will be beneficial to Owners. However, Regal's past acquisitions have been reasonably priced and have not destroyed much Owner's value. Owners can expect the pattern to continue.

So how much should Owner's pay for Regal ?

Let's start with how much Regal generates...

Annualizing 2nd Quarter EBITDA of $48 million equals $193 million.

Owners can venture that the 2nd Quarter is more indicative of the future than TTM results. There is a fair amount of judgement that 2nd quarter results can be annualized. Gudovac believes that reasonable Owners may differ whether the 2nd quarter results can be sustained. However, Regal's 2nd Quarter results appear to be more-or-less sustainable and can prudently be used to price the Enterprise.

Free Cash Flow in the 2nd Quarter, less the $60 million of working capital extracted in 2Q, is $36 million. Annualized FCF is therefore $144 million.

Owners can calculate a range of share values applying the Gordon Growth Model to the Free Cash Flow using the Weighted Average Cost of Capital (WACC) . Gudovac does not believe anyone can calculate a long term WACC within a few percentage points.

Corporate Treasury Departments need to develop hard cost-of-capital for medium term allocations. The hard value has more to do with streamlining corporate decision making as well as face saving on the part of Managers. How many CFO's can tell their Boards "Frankly, our hurdle rate is impossible to calculate with any accuracy" - and still keep their jobs ? Owners don't need to worry about such pretensions. Owners can accept that WACC isn't Newtonian rather it is Quantum.

Therefore, Gudovac uses a range of WACC values. A range of values better expresses the ambiguities of the very long term. A middling sized century old Enterprise such as Regal with a 50/50 debt to equity ratio might have an 11% WACC. Gudovac has made a table with a typical range of WACCs using the 11% as a starting point. The table indicates a range of values between $39 and $25 per share with a midpoint of $31.88.

Certain Owners may have a higher appetite for risk than Gudovac and be willing to buy Regal at $39. Other Owners may be somewhat risk adverse and not buy Regal unless it drops to $25. Gudovac is comfortable at a 11% WACC. Therefore, $31 per share appears to be a reasonable price to pay for RBC.

Mr. Market appears to have a different risk profile than Gudovac. Regal has been hovering around $45 per share for a fair number of weeks. Mr. Market's price implies a WACC of 9 3/8%. This might be a reasonable WACC for a Fortune 50 Enterprise. Fortune 50 Enterprises raise debt at a few dozen basis points above LIBOR.

However, Regal needs to pay more than a few dozen basis points on its spread. Regal needs to pay 125 to 200 basis points above LIBOR to raise debt. This suggests that Mr. Market's WACC of 9 3/8% might be just a trifle optimistic. Owners who buy at the $45 level should expect low returns.

Finally, please note, the $31 price is modestly above the $30 price Gudovac established in June. It also is above the price Henry Knueppel sold his shares early this year. Gudovac believes that Henry Knueppel knows how to value his company. If he sells at $30, Owners should take note.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

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Emerson Electric (EMR) - Sensible to Buy Now ?

2009-08-20T11:12:00.016-04:00

Emerson is a extremely well run Enterprise. There really isn't much more to say than that. Emerson is run by no nonsense operating managers. They live and breath the latest Kaizen success. They work hard for their money.

The following two tables describe Emerson well. The tables are from Emerson's latest 10-Q. The first table shows a company that has had steady earnings growth during the recent boom years. The second table shows key ratios. The key ratios also describe a prudently run Industrial Enterprise.

What is Sensible Price for Emerson ?

Emerson is nearly a perfect case study of a Value Stock. It produces a steady dividend. It is an Enterprise with predictable results. It's growth prospects are limited over the long term.

Although there are occasions when Mr. Market decides Emerson is a growth company, Owners should consider Emerson a mature enterprise. The short term ups and downs of Mr. Market's emtions should not concern an Owner. Therefore, one can price Emerson purely on the basis of When and How much will this Enterprise pay me back ?

Emerson's dividend should drive Owners' price expectation. Emerson's payout ratio is at a prudent 64%. Owner's can expect this ratio to increase in the next few quarters as Emerson's earnings are impacted by the Depression. However, it is unlikely that Emerson will need to cut its dividend, given the conservative capitalization structure.

Therefore, Owners can apply the Gordon Growth Model to the expected dividend stream. Owners can then arrive at a sensible price to pay for Emerson.

The annual dividend rate is a given at $1.32 per share.

Owners next need to determine if they believe Emerson will increase its dividend at the 8.9% CAGR rate of the last 5 years forever or if they believe Emerson will be able to increase its dividend rate at roughly double the pace of global GDP growth (ie 2.8%).

Finally, Owners need to determine what they believe to be an appropriate Equity Rate of Return. Gudovac believes it is reasonable that different Owners might have different Equity Rates of Return. This stance would horrify most financial professionals who believe Equity Rate of Returns can be calculated out to a 5 decimal places.

Gudovac believes financial models are simply not that precise. The implications of this lack of precision are manifest in the following chart.

The blue line is the price of Emerson at various equity return rates using the 8.9% dividend growth rate. Gudovac does not believe a 8.9% dividend growth rate is possible to sustain forever. However, he shows this in the chart to illuminate how reasonable people might reach widely differing conculsions. The red line is the price at same equity return rates but substituting a 2.8% dividend growth rate. The range of possible prices is rather wide. Suffice to say - Emerson's Price is highly sensitive to changes in the rate of Equity Return demanded by Owners.

What's an Owner to do ? Gudovac recommends that Owner's think deeply about their own required returns of Employed Capital.

Mr. Market believes Emerson is worth $34. This suggests Mr. Market requires a equity return of 6 5/8% at a perpetual dividend growth rate of 2.8% for Emerson.

6 5/8% is certainly more than US Treasuries are paying.

The question Owners need to ask themselves - does 6 5/8% adequately compensate one for the risks of owning equity in Emerson ?

Gudovac's own belief is that a 6 5/8% return is sensible for Emerson.

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Don't Get Massacred !

Gudovac1941@gmail.com

Methodology

Mr. Market and other thoughts

2009-08-17T09:57:00.011-04:00

Gudovac has escaped the City for a bit. He thought it might be reasonable to provide a bit more background on ownership of Enterprises during the interlude.

A large minority of Readers seem to immediately grasp the Ownership approach presented in these pages. However, another large minority of Readers appear to be positively offended by the Approach. This group of Readers sends angry notes describing Gudovac as some sort of evil magician. They suggest base motives. It is to this group of Readers that this explanation is written.

Gudovac hopes this provides some clarity on why he might price a company at $5 when Mr. Market merrily prices it at $30.

Mr. Market

Who is Mr. Market ? Mr. Market is a figure created by Columbia University Professor Benjamin Graham. Graham used the figure of a high strung business partner to illustrate the short term lunacy of stock prices. At the bottom of page 204 begins Professor Graham's illuminating description of Mr. Market first written in 1949. Read it.

A modern real life Mr. Market is of course the most amusing Jim Cramer of Mad Money. It is unclear if Jim Cramer television character is a deliberate or accidental embodiment of Professor Graham's fictional character - Mr. Market.

Owner's Time and Speculator's Time

Gudovac writes for Owners. Owners think very differently about time than Speculators. Owners measure time in terms of Business Cycles - from bottom to peak to bottom again. This is a multi-decade time horizon. The Business Cycle just ending began in the early 1980's.

Not much happens in the course of a single day in the life of an Owner.

This contrasts sharply with the day of a Speculator. Speculator's days are filled with minute-by-minute action. Gudovac has described the Owners method of investment as similar to that of a Hunter carefully stalking his prey. Perhaps the Speculator's method is analogous to that of the Hummingbird quickly leaping from flower to flower hoping for some nectar.

Good Company Bad Price

Owners should be clear that there are many good companies which sell at a bad price.

Management

American corporations seem to have developed a breed of managers who forget they are hired hands.

The Sell Side and The Buy Side

Owners should be crystal clear that an entire industry exists to separate them from their money. The vast majority of the financial industry is a far reaching apparatus of selling, selling, and more selling. Owners should watch this clip from the film Boiler Room for a behind the scenes glimpse of the sell side in action.

The sell side is Abby Joseph Cohen, it is CNBC, it is the Money Honey, it is Barrons, it is Wall Street Week, it is mutual funds, it is wealth managers, and it is your stockbroker. The sell side is out there pushing, pumping, and trying to close the sale. The sell side is in-your-face every minute of every day. The sell side is what retail investors (aka Dumb Money) believe to be Wall Street. It isn't.

Wall Street is also the Buy Side.

The Buy Side is the sub-set of the financial industry that doesn't need or want mass media around. The Buy Side has capital to deploy. Why would it broadcast how, where, and at what price it intends to deploy its capital ? The Buy Side are Owners.

How to Determine a Price ?

Price is a simple mechanical exercise. Owners provide capital - Managers use that capital to generate profits - Owners allocate a share of the profits to themselves and a share of the profits to the Enterprise.

At some point, every worthwhile Enterprise will pay Owners a share of its profits. The size of the Owner's share determines price. If an Enterprise shows no sign of ever returning profits to Owners no matter what the story - well, then they can't be priced very high can they ?

Very bright people get PhD's & Nobel Prizes in the subtle aspects of pricing. These aspects relate to growth rates, dividend payout ratios, share buybacks, capitalization, and discount rates. However, Owners should never get mired in the theory at the expense of the big picture.

All Owners need to ask is - When & How much will this Enterprise pay me back ?

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Don't Get Massacred !

Gudovac1941@gmail.com

Please note - This article was written on of those thoroughly modern devices - the iPhone. Gudovac, being a old fuddy duffy, is not yet versed with this machine. Gudovac thanks his Readers, in advance for their tolerance of any grammar and spelling errors.

Economics - Capacity Utilization Good News

2009-08-14T11:46:00.007-04:00

The Fed released its Industrial Capacity numbers a few hours ago. They are finally good and show an increase, even after stripping out distortions which may have been caused by the Cash-for-Clunkers program. Here is the lead paragraph plus 2 illuminating charts from the release.

The first chart indicates how large the output gap is in total Industrial Production. The second chart shows only Equipment Utilization which is the critical sector for Gudovac and his readers. It is illuminating to see just how much business equipment has dropped in the US. The downward slope of the line is simply horrifying. Defense purchases have clearly propped up US equipment suppliers. Downward pressure on margins as well as tougher Terms and Conditions can be expected from Customers in orders being currently booked.Owners need to watch these indicators closely.

However, Gudovac is pleased to see some growth in Utilization. This indicates that we just maybe, possibly, perhaps have leveled out.

INDUSTRIAL PRODUCTION AND CAPACITY UTILIZATION

Industrial production increased 0.5 percent in July. Aside from a hurricane-related rebound in October 2008, the gain in July marked the first monthly increase since December 2007. Manufacturing output advanced 1.0 percent in July; most of the increase was due to a jump in motor vehicle assemblies from an annual rate of 4.1 million units in June to 5.9 million units in July. Excluding motor vehicles and parts, manufacturing production edged up 0.2 percent. The output of utilities fell 2.4 percent, reflecting unseasonably mild temperatures in July, and the output of mines increased 0.8 percent. At 96.0 percent of its 2002 average, total industrial production was 13.1 percent below its level of a year earlier. In July, the capacity utilization rate for total industry edged up to 68.5 percent, a level 12.4 percentage points below its 1972-2008 average.

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Don't Get Massacred !

Gudovac1941@gmail

American SuperConductor (AMSC) - still Buy at $5

2009-08-12T13:54:00.015-04:00

American Superconductor reported its most recent quarter 2 weeks ago. The results were consistent with expectations.

AMSC is an interesting case. There is enormous promise far off in the distant future when HTS finally becomes mainstream. AMSC long ago proved the technical case for the benefits of HTS wire and rotating machines. Customers and End-Users remain unconvinced of the business case for HTS. HTS remains, therefore, a brilliant solution to a problem no one wants to buy.

Management was wise enough to have seen the limitations of the pure HTS business model. Management went out and bought a little Wind Turbine business a few years ago.

AMSC has transformed itself successfully into a Wind Turbine Engineering and Development Company. D-Vars are the second wave of product which Management believes will follow Wind Turbines into steller growth sometime after Wind Turbines. D-Vars is a nice little side business which Owners can also discount a fair amount, since its real returns are off in an ill-defined future. Management currently believes that High Temperature SuperConducting products (HTS) will generates returns only the far distant future. The discount rate for HTS is significant. The discount rate and timing of HTS are such that they add modest present value to AMSC from a prudent Owner's perspective.

What is a Sensible Price to Buy AMSC ?

AMSC is essentially a Wind Turbine company. Perhaps a useful exercise is to compare AMSC with its industry peers - Vestas, Gamesa, Sulzon, Nordex. All 4 of these peers have active and liquid markets in their shares. Gudovac is not a slavish believer in the Efficient Market Hypothesis. Mr. Market is simply too emotional to be relied on consistently. However, in certain cases, using peers as comparables helps illuminate price distortions.

The table above summaries the four independent Wind Turbine makers. Together they have between 50-65% global market share. All four have grown exponentially. Finally, despite booming demand, profits are meager. The Wind Turbine sector is a highly competitive price sensitive business.

Gudovac selected Price to TTM Sales ratio as a rough-and-ready measure of price. There is a wide range of ratios which appear to be driven by profitability. Vestas is the leader in profitability at 6% net income. Vesta also commands a dominating market share. Vestas reasonably commands the highest multiple at 147% of sales. Sulzon, is barely eking out a profit. Sulzon's price is the lowest of all at 45% of sales. How does AMSC compare with these 4 ?

What first strikes one about AMSC is what a small Enterprise it is. The average revenues of the 4 peers is over $5 Billion dollars. AMSC is less than $200 Million. AMSC's growth rate matches the larger peers at about 350% -400% over the last 3 years. AMSC isn't growing much faster than its huge competition. AMSC wasn't quite yet profitable in the last TTM, but is expected to be slightly profitable in 2009.

Given the similarity in growth, the vast difference in scale, lack of profits, and the relative newness of AMSC's products - one would expect AMSC to sell at a discount to the 4 behemoths. Instead of a discount, We discover AMSC is selling at a substantial premium 686% versus 90% TTM revenues for its profitable competitors. Mr. Market values at nearly 7 times its competition - why ?

Gudovac has struggled to find a justification for this discrepency ?

Perhaps it is the promise of a HTS Wind Turbine ? But AMSC isn't the only Enterprise working on a HTS wind turbine. Pierre Bastid and his team Converteam has done some impressive work along these lines recently. Arguably, AMSC is behind its peers in developing a HTS Wind Turbine.

Perhaps AMSC's turbine designs are unique in some compelling way ? Guodvac briefly examined the performance characteristics of AMSC's Windtec designs and didn't discover any compelling performance difference.

Perhaps AMSC's growth opportunties are greater in China than its 4 Competitors ? 3 of the 4 peers have extensive sales & production operations in China. The one that doesn't have a significant Chinese operation is Sulzon with a 50% market share in the booming Indian market. Everyone involved in the Wind Turbine sector appears to be growing at double digit rates.

Perhaps AMSC's profitability is better than its 4 Competitors ? No. In fact, AMSC should generate in 2009 a profit margin similar to Sulzon which is priced at 1/10 of AMSC.

What would AMSC's price be if it sold in line with its Competitors ?

The table below outlines the range of possibilities which AMSC common shares would be priced. It is a significant decrease from today's price of approximately $34 per share. Gudovac stands by his earlier buy at $5 price - despite the real possibility Mr. Market may price AMSC in line with its low profitable peers at $2. Gudovac believes that AMSC should command a premium over its competitors - $5 a share represents just such a premium.

Shanthi Gears (SHNT - Bombay) - Still Buy below 40 Rs

2009-08-11T14:25:00.016-04:00

Shanthi Gears is one of those Mittelstand Enterprises which intrigue prudent Owners. Shanthi is tucked in the hill country of Coimbatore, far away from the glamour of Hydrabad's office parks and the posh lifestyle of Gurgaon. Shanthi traditionally supplied gears and gear boxes primarily for the textile industry. Shanthi has attempted diversification beyond its dependence on the textile industry. Starved of capital and influence during the License Raj, Shanthi learned to do much with very little. Shanthi is vertically integrated to an extreme extent - not only does Shanthi have its own foundry, it developed the capability of designing and producing its own machine tools.

Shanthi's culture of autarky is contrary to the fashionable business theory of specialization. Specialization attempts to wring every last drop of Comparative Advantage from a Enterprise's know-how. Owner's need to be comfortable with Shanthi's unusual methods. Gudovac views Shanthi's vertical integration as a sign of cultural strength. The ability to boot strap growth and operations is desirable. Shanthi has embarked on a rationalization program designed to eliminate some less critical operations such as the foundry. It intends to consolidate its core activities into 2 facilities. Gudovac has visited most of these 6 facilities and believes Management is acting wisely.

Coimbatore is certainly experiencing economic turmoil these days. Workstoppages, layoffs, and near riots among the population are the result of the decline in India's textile industry as well as the global credit crisis. Shanthi received its share of Coimbatore's trouble. Management even was forced to lock out its facilities for a few days in late July until calmer heads prevailed among the workers.

The turmoil shows in Shanthi's latest quarterly results.

Financial Results:

Shanthi's rationalization began in the First Quarter. The dislocations showed up in top line revenues which were down almost 50% from the prior quarter. Managers appeared to be disciplined about the rationalization. They reduced overhead in direct line with the revenue drop. This resulted in EBITDA % of revenues consistent with the prior quarters. This result is impressive beyond description.

Gudovac has, 30 years of experience, never seen a industrial Enterprise with the ability to eliminate overhead directly in line with revenue declines in the course of a few weeks. The fact that Shanthi's managers are able to achieve this speaks to their first rate skills and abilities.

Shanthi's 5 year record is precisely what one would expect of a prudently run Enterprise of middling size in India today. Healthy top line growth, Maharajah level margins, coupled with sleep-like-a-baby interest coverage.

Gudovac believes the recent quarter is a aberration brought on by a wise move to rationalize the Enterprise.

It is anyone's guess when Shanthi will return to business as usual. Gudovac believes Shanthi will return to revenue and EBITDA numbers more in line with the boom period within 9 months. However, for the purposes of prudent pricing, Owners should value Shanthi based solely on its 30.June results.

How much to Pay for Shanthi ?

Gudovac believes Shanthi is a prudent purchase at today's market prices. Annualizing the most recent (dismal) quarter one arrives of five times Enterprise Value/EBITDA. Five times EBITDA is a sensible price to buy a Enterprise.

In addition to the sensible price, Shanthi pays Owners a 3% dividend.

Gudovac continues to hold fast to his earlier calculation - Buy Shanthu at below 40 Rs.

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Don't Get Massacred !

Gudovac1941@gmail

Buying an Indian Company - Good, Bad, Profitable

2009-08-11T10:48:00.007-04:00

A general note to US and European owners who are used to slick Management presentations from their multinationals. Indian industrial managers don't produce perfect power points with stunning coordinated graphics. Indian managers don't have carefully orchestrated conference calls with canned puff-ball questions from sell side analysts. Instead, Owners get reports that have been scanned on dusty copiers by harried assistants.

Successful Indian industrial managers are simply too busy engaged in running their ever expanding Enterprises and generating massive profits.

When Owners start seeing slick power point presentations from Indian Industrial Companies is the time for Owners to be concerned. Slick power point presentations from Industrial Managers will be the first sign of reduced opportunities in Indian.

A visit to the Head office of a Indian Industrial Enterprise involves receiving a Victorian Era salute, complete with foot stamp, from the car park attendant. The choice will be to ride in a beaten up tiny elevator or take the stairs. Peeling paint; the ubiquitous Ganeesh shrine; supplicants waiting in the lobby; a walk into a insanely hectic 1950's style open office; and finally into the Big Man's office. The Big Man will have an office roughly the size of a junior salesman at a US multinational. Shabby furniture, reams of paper, and a endless stream of clerical staff asking for signatures complete the picture.

This is precisely the situation a prudent Owner's desires. Owner's should expect their hired Management to devote every last penny to productive resources.

Gudovac is appalled when he visits US or European Enterprises with exquisite furniture and carefully selected artwork. Money spent on Management's furniture and artwork is money that comes straight out of the Owner's pocket. Such excess is sign that Management has too much capital and not enough opportunities. Gudovac applies a hefty discount on such Enterprises.

Please note, Gudovac has also seen Indian enterprises who mimic their Silicon Valley counterparts with lavish campuses and elaborate atriums. Fortunately this illness hasn't yet infected Indian Industrial Enterprises.

Finally in examining Indian Enterprises of any scale outsiders are immediately struck by a rich tapestry of familial and clan connections. The intricate subtleties of the Indian clan system is beyond the deep understanding of Gudovac. Gudovac suspects even most Indians can't fathom every nuance of their clan structure. However, it is the wise Owner who recognizes that these powerful bonds exist and drive many business decisions. However, no owner should immediately conclude a clan inspired business decision is by definition a poor decision.Gudovac has seen enough business decisions driven by college rowing buddies to recognize that bone headed decisions are made in every cultural system.

In sum, Owners need to look beyond the smooth stories they are used to hearing from Multinationals. Owners need to ask one question of any Enterprise - Will the Managers I hire work in my interests ? - this is true for India as well as for Indiana.

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Don't Get Massacred !

Gudovac1941

General Electric - Accounting Scandal goes Mainstream

2009-08-07T15:40:00.019-04:00

scene from Pulp Fiction

Where is the Winston Wolf of GE ? GE has a situation on its hands. It needs a problem solver extraordinaire to help them out of this one.

GE is ultimately a sound Enterprise. Owners need to determine what they believe is a reasonable price to own GE. Gudovac stands by his $6 share value, despite the accounting scandal.

Readers were made aware of persistent questions regarding GE's books in every article posted on this site. Gudovac responded to a reader's query about GE's quality of earnings a few weeks ago, stating GE's earnings consistency was only matched by Bernie Madoff's. Gudovac wondered a few days ago why nothing was published about the accounting scandal revealed this week. Now it appears the delay was due to editors determining what angle to present on the topic. It isn't pretty - NYTs article follows signiature

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Inside GE: A Little Bit of Enron

by Floyd Norris

Friday, August 7, 2009

provided by

A decade ago, General Electric was the shining star of American business. Its longtime chief executive, Jack Welch, was named manager of the century by Fortune Magazine, and its stock seemed always to go up.

It ran a bewildering array of businesses but somehow always managed to make the expected profits. That record was viewed as proof of superior management, and the battle to succeed Mr. Welch in 2001 was watched all over the business universe. When a winner emerged, the losers quickly were hired to run other major companies.

G.E. is different now. The stock has fallen and the aura has dissipated.

This week General Electric agreed to pay $50 million to settle a suit filed by the Securities and Exchange Commission that said the company fiddled with its books repeatedly early in this decade. In at least one case, that allowed it to preserve its reputation for making the numbers. Some of the details are eerily reminiscent of Enron.

As is customary in such settlements, G.E. neither admitted nor denied the charges. But it sounded contrite. "The errors at issue fell short of our standards, and we have implemented numerous remedial actions and internal control enhancements to prevent such errors from recurring," said a company statement.

Another view of G.E.'s accounting standards emerged a few years ago in a book written by a man who worked there for six years in the early 1980s, before concluding the corporate life was not for him and entering a seminary. James Martin may be the only Jesuit priest with a degree from the Wharton School of the University of Pennsylvania.

"The primary task of my first job was to issue very long, monthly statistical reports," he wrote in his book, "In Good Company: The Fast Track From the Corporate World to Poverty, Chastity and Obedience." "The first month," he recalled, "I informed one executive that our results were coming in low" because of losses in overseas operations.

"So what?" replied the executive. "Just reverse a few journal entries." Corporate headquarters, he explained, would come down hard on them if they missed the numbers.

Another boss told him he was "taking those accounting courses way too seriously."

The S.E.C. complaint makes it sound as if those days came back, assuming they ever left. It tells of corporate accountants discovering misstatements and secret side deals, and of more senior executives telling them to sign off on the books anyway. It outlines four separate violations, two of which it says descended to the level of fraud.

It is notable how this investigation came to be. Post-Enron, the commission used its authority to look at G.E.'s books to figure out whether there were violations in the area of so-called hedge accounting, which determines whether companies can avoid reporting profits and losses from a variety of derivative securities.

The commission evidently found three violations, two in hedge accounting and the other in an Enronesque scheme to inflate profits with fake sales.

"It was like peeling an onion," said David P. Bergers, the director of the Boston office of the S.E.C., as one accounting issue led to another.

The fourth violation appears to have been reported by G.E. All have been fixed in restatements.

While it may seem odd to view the government as an underdog, it was. G.E. says it spent $200 million on outside lawyers and accountants in dealing with the investigation. By contrast, the S.E.C.'s entire annual enforcement budget, spread over thousands of inquiries and investigations, was less than $300 million when this investigation began in 2005.

You can be sure that G.E. spent a lot of time arguing that the amounts involved, only a few hundred million per violation, were not really material to a company its size.

There may be more to come. The S.E.C. said that its investigation of G.E. was over, but it did not say that about any of the accounting officials at the company, or any of the people at KPMG, G.E.'s longtime auditor.

KPMG's role is interesting. The complaint indicates that unnamed accounting officials at G.E. failed to provide important information to KPMG, but G.E. says that information was later given to the auditors.

The S.E.C. filing says that on one of the hedge accounting issues, the KPMG auditors consulted the accounting firm's national office. But when push came to shove, and the question was whether to approve accounting that the S.E.C. now says was clearly wrong, the local auditors signed off without telling the national office what was going on. Could it be that the local auditor feared the national office experts would have backbone, and force him to anger a very important client?

A KPMG spokesman declined to discuss any aspect of the case.

This all took place in January 2003, days before G.E. was to announce its annual profits for 2002, Jeff Immelt's first full year as chief executive. Had G.E. not fudged the accounting, it would have missed its profit forecast by $200 million. Not since 1994 had G.E. failed to make the numbers.

You may recall something similar happened at Arthur Andersen when it was auditing Enron. In that case, the local auditors chose to ignore the national office.

It is easy to have some sympathy for G.E. on the hedge accounting issues. The rules are devilishly complicated, and the accounting penalties for a small deviation can seem excessive. For good reason, the rules are being rewritten.

But that sympathy vanishes when considering the accounting alchemy that G.E. used to make its numbers at the end of 2003. In a move reminiscent of Enron's Nigerian barges deal, it "sold" some railroad locomotives to banks, with side letters and verbal promises to assure the banks they could not lose money. That enabled G.E. to book profits early and make the numbers.

The banks, facing S.E.C. actions for doing similar deals with Enron, asked G.E. to reassure them that KPMG knew about the side deals and concurred with the accounting. The banks had reason to be worried, given that G.E. executives had asked them not to refer to the side deals in documents seen by auditors.

At G.E., a spokeswoman, Anne Eisele, told me that it was wrong to think these violations were "indicative of some larger problem in G.E.'s overall culture, its finance function or compliance practices. G.E. is committed to the highest standards of accounting and good corporate governance. We are confident in our controls and culture, which have been made even stronger through the process that we've just completed."

It is interesting to compare the G.E. and S.E.C. versions of the locomotive deal. In a company filing in 2007, G.E. said "several individuals in our rail business and in our capital markets group engaged in intentional misconduct that misled those responsible for accounting oversight." It added that the accounting oversight team failed to adequately review the transactions.

The S.E.C.'s complaint makes it sound as if the matter was thoroughly aired inside G.E. in 2002, when it was first used, and again in 2003. The corporate audit staff challenged the accounting in 2002, but was overruled by a "senior accountant," the S.E.C. said.

G.E. added that the amounts involved were so small that they were not material, "less than 0.2 percent" of the company's total revenue or profits each year. The S.E.C. says the fudges caused quarterly profits of the G.E. Transportation Systems business to be overstated by as much as 40 percent.

All those numbers are accurate. Tricks to take profits in the wrong quarter, as in this case, are not likely to change annual earnings very much, particularly for the conglomerate. I doubt anyone at G.E. thought at the time it would have been immaterial if the company missed its profit forecasts.

I called Father Martin, now an editor at America magazine, a Jesuit publication, and asked him to read the S.E.C. complaint and call me back. He did.

"Little of this is surprising," he said.

"I was sometimes asked to squirrel away 'excess earnings' in fake accounts with made-up names, to be used when earnings were down in later months," he said. One such account was called "Plug."

Ms. Eisele, the G.E. spokeswoman, declined to comment on Father Martin's book. Much has changed at G.E. since Father Martin was hired. The long paper spreadsheets that he used have been replaced by computers. Some of the financial instruments involved in G.E.'s hedge accounting violations had not been invented.

But some things, it appears, never change.

Economics - Job Losses

2009-08-07T10:57:00.004-04:00

Gudovac hesitates to post Economics here, but when the headlines are at variance with the data, he feels he must comment.

A typical headline on today's jobs report was Good News In Jobs Report. This headline is misleading at best.

The data indicates otherwise.

Calculated Risk and Shadow Stats track the underlying data. They produce independent Buy Side reports which Owners would do well to utilize. One chart from Calculated Risk should be enough to dispel any notion of Good News in today's Jobs Report. This is reproduced above.

Today's data indicates that Jobs continue to be destroyed at very high rates. Job Destruction is close to a record as Calculated Risk's graph indicates. The downward slope of Job Destructions continues to be steep.

Owners of Enterprises dependent on US (and European) consumer demand should recognize the extreme risk associated with this sector and act accordingly.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Jaiprakash (JAIPRA - Bombay) - Buy at 160 RS

2009-08-06T09:15:00.022-04:00

Background:

Gudovac first wrote about Jaiprakash in short piece last July. Their most recent quarterly results have been released. They are quite good.

Jaiprakash makes cement. Some 4o% of revenues are derived from the cement group. India needs a lot of cement.

Jaiprakash also builds infrastructure. Approximately, another 40% of revenues are derived from the construction group. India needs a lot of infrastructure.

The remaining revenues are derived from forays in glamour industries such as golf clubs and up market hotels, Formula One race tracks, and even cooking oil. Japiprakash has no particular expertise in real estate development. Neither does it have any particular expertise in cooking oil. Gudovac is willing to forgive Management for this potential waste of capital and talent. In family run Enterprises, these tangential forays are to be expected. They provide a venue for siblings and cousins to operate constructively but independently of the Patriarch. The amounts are small. The sector is wide open. Perhaps Jaiprakash will eventually generate excess returns in this sector.

Jaiprakash finally cleaned up its cumbersome share structure last May. A clean Ownership structure is always a good starting point.

Gudovac is familiar with Jaiprakash from a few years ago - when he became acquainted with the Patriarch's son who operates the business. The Chairman's son appears to be modest and hard working. Noteworthy is his total compensation of slightly more than $400,00o. This is an absolute pittance compared with the lavish pay of his less productive US counterparts. The next generation of Gaurs are likely to become playboys and fashion queens. But the current generation is exactly the sort of Owner-Manager who outside Owners wish to partner with.

Jaiprakash passes the first investment screen, Managers who are industrious and work for the Owner's interest. Next screen is to examine the numbers.

Financials:

What one notices at first with Jaiprakash is a double digit growth rate. Secondly, one notices margins are exceeded only by Madison Avenue Law Firms. The other number Owner's should notice is despite healthy margins, Jaiprakash consumes significant amounts of capital. This is to be expected. A growing industrial company will consume capital as fantastic rates. Constructing Power Plants and Cement plants requires staggering amount of up-front capital.

Breakneck revenue growth often results in working capital inefficiencies. Jaiprakash is no exception. The current ratio has slipped with revenue growth. Owner's would do well to monitor the current ratio closely. Gudovac would treat any slippage below 1.20 current ratio as cause for serious concern. A Current Ratio below 1.10 would be cause for alarm.

Debt at Jaiprakash has grown ahead of revenues growth. Revenue run rate has increased 250% over the past 5 years. At the same time book debt has increased 280%. This is exactly what one would expect. Debt taken on this year funds the next year's expansion.

However, the single financial ratios which does concern Gudovac is the interest rate coverage. Interest rate coverage at close to 3x PBTis low by conservative standard. Gudovac prefers to see coverage ratios of 4x PBT. However, the 4x threshold is a rule of thumb for mature companies in developed countries. Gudovac is not certain that applying a 4x ratio is appropriate for Jaiprakash. Owner's should note that the coverage ratio was a dreadful 1.01x PBT 5 years ago and has steadily improved. Therefore, as long as the coverage ratio holds steady or improves, Owners need not be too concerned about the debt burden.

However, even a slight decrease in the interest coverage ratio should be cause for concern. Decreases suggest the Enterprise is consuming Capital inefficiently. Inefficient use of Capital is often the first sign of grave misallocation within the Enterprise. Owners would be wise to examine this ratio every quarter.

The financials describe an Enterprise which one would expect given the Indian context. Insane growth, massive pricing power, and a not-so-great capital structure. At what price should an Owner buy Jaiprakash and partner with the Gaurs ?

What Price to Buy ?

Ascribing an appropriate price for Jaiprakash is an exercise fraught with unknowns.

How long can India GDP grow at 6-8% annually ? A Decade ? A Generation ? 3 Generations ? Where does India lie on the Solow Growth Model curve ? The answer to this question will determine at what point in time Jaiprakash will stabilize. 6-8% compounded over 10 years provides a very different result than 6-8% compounded over 100 years.

How long will it take India to create a national infrastructure equal to Germany's ? Gudovac has traveled extensively throughout India. Gudovac has toured dozens of factories, driven thousands of miles on Indian roads. Gudovac knows only that it will take more than a decade. He can conclusively state that anyone who tells you that he knows the answer with greater certainty does not have a clue.

So what is a prospective Owner left with to determine a sensible price ?

Perhaps using the efficient market ? In India ? The Efficient Market Hypothesis functions erratically on massive stable exchanges such as the LSE & NYSE. India's stock exchange(s) are buffeted by external Capital and animal spirits. A Owner would do well to ignore market signals while developing his own price. Further investigation is warranted, if there is a wide divergence between the market price and the Owner's price.

The sole benchmark one can use is comparables plus a liberal application of judgement. Jaiprakash might reasonably be expected to become the LaFarge or Holcim or Cemex of India. Therefore, an owner might reasonably use these 3 behemoths as a starting point.

All three have been hit hard by the developed world's downturn. Cemex is going through a painful debt restructuring. LaFarge and Holcim are generating small positive income. All three are laden with heavy debt burdens. The three have Enterprise Values of roughly 1.5 - 2.0 times TTM months revenues.

Jaiprakash currently sells for a significant premium over these 3. Jaiprakash sells for almost 7 times TTM revenues ! Is Jaiprakash worth nearly 4 times these comparable multi-nationals ?

Gudovac - believes No.

Jaiprakash is worth perhaps a healthy 3 times the industry titans of LaFarge, Holcim, and Cemex - in Gudovac's seasoned judgement.

This calculates out to a 160 RS. common share price. A 160 RS price calculates out to approximately 12 times TTM EBITDA. At 160 RS., Owners can feel confident they have bought Jaiprakash at a sensible price.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

GE - "bent the accounting rules beyond the breaking point"

2009-08-05T10:40:00.007-04:00

Quality of Earnings a Persistent Question at GE

GE's stock continues to be discounted due to a perceived lack of quality in its Books. The latest news will only increase Owners' concerns.

From the WSJ:

BY PAUL GLADER AND KARA SCANNELLGeneral Electric Co. agreed to pay a $50 million fine to the Securities and Exchange Commission to settle civil fraud and other charges that GE's financial statements in 2002 and 2003 misled investors. The fine settles a probe that started in 2005 into GE's accounting procedures, including financial hedges and revenue recognition. In a complaint filed with U.S. District Court in Connecticut, the SEC said the Fairfield, Conn., conglomerate used improper accounting methods to boost earnings or avoid disappointing investors. "GE bent the accounting rules beyond the breaking point," said Robert Khuzami, director of the SEC's Division of Enforcement.........

Readers will recall Gudovac's comments from 7 weeks ago:

GE's books are not exactly 'high quality'. Management is doing its best to clean up its books, but the process (already under way for 4 years now) is going to take another few years. Management is skilled enough to unwind the dreck without a Enron type implosion. However, who wants to own a company that you know has questionable accounting ?

This situation will only increase Owner's unease with GE's books.

Owner's should continue to assign a prudent discount to GE's price.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

General Electric (GE) - Blow through Debt Covenants ?

2009-08-04T11:31:00.012-04:00

FT reported

GE Capital may trip a fixed-charge covenant in its debt agreements late next year that would prompt its parent to infuse additional cash into the business. On the call, Keith Sherin, GE’s chief financial officer, said the company could earmark $2bn to $7bn for the finance arm in 2011.

Gudovac's back-of-the-envelope calculation is that GECC will need $9 Billion from the Industrial side over the next 30-36 months. This is significantly more than the $2 - $7 Billion Management estimates. Both Gudovac and Management agree that the Industrial side can fund the losses over at the Capital side without destroying the Enterprise.

However, any Owner should pause carefully when he hears the phrase "violate debt covenants". Covenants are financial datums whose violation indicate very high risk.

Gudovac can not stress enough that violation of Covenants is a rather expensive proposition. Violation of Debt Covenants triggers a avalanche of measures from Creditors. These measures limit Management's ability to operate normally. It completely changes the operating environment for Management.

GE's management believes a straightforward cash infusion will solve the pending crisis. GE's financial managers are first rate. Therefore, Owners can give them the benefit of the the doubt.

However, Owners should continue to carefully monitor this subject and be prepared to take quick action if the cash infusion becomes greater than $9 Billion over 30-36 months.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Durable Goods Orders -

2009-08-03T20:45:00.009-04:00

Gudovac hesitates to post economic information here. However, this graph tells the story in one stunning image. Click on image for high resolution. This data should clarify the Backlog situation at Capital Goods companies.

Please note, this data is only for the USA. If one would overlay EU and BRIC's demand the picture would be different. Therefore, Owners need to understand a Enterprise's market. Also note, this data does not represent final destination (ie to). This data represents shipments from US plants.

Therefore, the date includes Capital Goods which were manufactured in the US but ultimately exported. Owners would do well to understand exactly how a) trade weighted declines in the US dollar vs. b) demand destruction vs. c) increases in local content might change future demand.

Gudovac is confident that First Rate Management teams can respond pro-actively to changes in the macro-economic climate - benefiting their Owners.

Gudovac is also confident that the USA will continue to be a manufacturing powerhouse . US share of world manufacturing output will continue to remain in 20% range.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

GE Capital - Will Non-Earners exceed Reserves ?

2009-07-28T10:56:00.021-04:00

Non-Earners vs. Reserves ?

Is GE Still a Buy at $6 ?

GE followed up its 2Q 09 Conference Call with a call last week (28.July) devoted to GE Capital. Managers provided another high quality presentation and appeared confident as ever. GE's managers are surely the masters of the powerpoint.

Mr. Market is pleased with the information provided. GECC CDS rates dropped 15 basis points to 340 points the morning of the call. $10 million of protection now costs a mere $325,000 per year on GECC coupons which have a weighted average interest payment of $483,300 per year.

It does not take Jack Welch to fathom the ramifications of a $325,000 imputed CDS cost does upon the value of $483,300 interest income in the secondary market. However despite the pessimistic view of GE's creditors, Owners should examine the situation independently.

The key questions for Owners remain:

If management has provided adequate reserves to cover loan losses, GE Capital will spin off a fortune of cash. Quantifying how much cash is important for setting a price to buy GE.

If reserves do not cover loan losses, then GE Capital will consume cash by the bucketful. The question in this scenario, will be the cash flow of the Industrial side of GE. Can GE's industrial side of the business carry GE Capital through if loan losses exceed reserves ?

Let's first try and answer the reserves question. The numbers, while large, are simple enough. GE's Owner have lent out approx. $500 Billion - of this $500 Billion; a mind boggling $13 Billion of these loan are 'Non-Earning'.

Non-earning means exactly what one think it does - non-earning. No late checks, no half-payments, it means the guy who are supposed to pay ain't paying nuth'g. If you are slow pay or behind on payments, then GE's managers put you in another bucket (say, in the 30+ days ) . The amount of loans which are paid to some degree (ie late or partially) are slightly less than $50 Billion !

Gudovac will argue that prudent Owners should include the 30+ days late in any analysis of reserves.

$50 Billion + $13 Billion = $63 Billion - let's round down to be generous, call it $60 billion of weak loans

GE Capital has some $60 Billion worth of weak loans.

Key question - How much has GE reserved against this $60 Billion of weak loans ?

Answer - $6.6 Billion

Management provided a masterful presentation of its recovery rates on various loan segments. The story behind the numbers is that GE will be brutal in collections. The phrase "GE work-out" is going to ring through the land. They are going to make Tony Soprano wince when it comes to collections.

Management is confident that less than $2 Billion will be unrecoverable out of the $60 billion in weak loans. Management projects that it will eventually recover 97% from the weak loans.

Management didn't provide any data on recovery rates for past recessions. Historic recovery data may have set the stage for a useful discussion.

Instead, Gudovac can only shake his head in sorrow at the naivete of management. What will the recovery rate be on this building ? How's about these CRE leasing numbers ?and how are those English mortgages doing ? What will the recovery rates be from these middle market debtors ?

It is a reasonable assumption that recovery for much commercial real estate will be less than 50% LTV - because the value of commercial real estate will drop 50% from peak numbers. Any reader who doubts this, can simply look to the English and Japanese real estate bubbles as a reference. Japanese real estate was still more than 50% below its peak 14 years later. GE will be underwater on virtually every last one of its real estate loans since it lent at 75% LTV.

Machinery and Equipment recovery rates will also be dramatically lower than management's naive estimates. Who believes that used machinery fetches more than a 30% LTV rate these days ?

Gudovac will guesstimate that 25% of the weak loans now sitting on GE's books will be unrecoverable. 25% equals $15 billion out of the $60 Billion of weak loans and $500 Billion in total loans.

What is the impact on GE if $15 billion needs to be written off ? $6.6 sits in reserves. That leaves approximately $9 billion to cover through ongoing cash flow.

$9 billion is about 14 months of GE's Cash Flow from Industrial Operations.

Gudovac believes that feeding 14 months Cash Flow to GECC will not wreck GE. Gudovac believes this cash flow drain will occur over a 36 month period. This is manageable.

The GECC presentation does not change Gudovac's price to buy GE common. GE is still a good company to Own at $6.

Note 1 - Management provided some good information on the ongoing business of GECC lending more money. They are wisely shrinking new lending. Gudovac believes the key question for GECC isn't new lending, rather it is existing loans.

Note 2 - Management did not provide any information on how much GE industrial goods are paid for with GE Capital financing. Owners will want their hired Managers to provide this data soon. GE's Management culture is one of meeting-your-numbers-or-else. Owners do not want to see GE turn into another Lucent.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

GE Capital - First Impressions

2009-07-28T09:14:00.008-04:00

GE just finished their 28.July detail presentation following up the 2Q 09 conference call. Here are Gudovac's first impressions;

Management is forcefully trying to deleverage the enterprise. They are doing a first rate job given the situation. Two questions for Owners:

If management has provided adequate reserves to cover loan losses, GE Capital will spin off a fortune of cash.

If reserves do not cover loan losses, then GE Capital will consume cash by the bucketful. The question in this scenario, will be the cash flow of the Industrial side of GE. Can GE's industrial side of the business carry GE Capital through if loan losses exceed reserves ?

First Comment - In my cursory review of the information provided, there is no quantification of how much GE Capital finances purchases of GE equipment. This question eventually needs to be answered for Owners to no longer discount GE shares.

Delinquencies : How much worse can it get ?

This data should give pause to any Owner. The information speaks for itself.

Non Earners : It can't possibly be this bad !

The slope of the curve doesn't appear to be going flat anytime soon.

These are the two critical slide in the presentation. Gudovac will review the details and struggle with answering the questions posed above.

...................more to follow

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

GE vs. Alstom vs. ABB - Backlog and Bookings

2009-07-26T09:16:00.017-04:00

Trouble Ahead or Trouble Behind ?

Why Examine Backlog and Bookings ?

Most observers believe Backlog is the most critical metric for pricing capital equipment companies.

Owners might do well to compare the respective Backlogs and Bookings of GE, ABB, and Alstom. All three of these Enterprises supply equipment with lead times expressed in years. A large turbine-generator set might have a lead time of 36 months from time of order placement. The Backlog represents some 9 to 12 months future revenues at these 3 Enterprises

Therefore, Backlog and Bookings information can provide insight to the owner of these Enterprises of their likely performance 12-24 months out. Backlog and Bookings information also provides owners broader economic signals. Bookings represent booked orders often with a progress payment due with 30 days of issuing the PO. A PO coupled with a progress payment is a leading indicator which owners can judge reasonably reliable.

Owners seldom have such solid data on leading indicators. Owners would be wise to examine and compare Bookings data carefully.

GE vs. Alstom vs ABB: Backlog and Bookings

Owners can reach some preliminary conclusions based on the summary information presented above. The last row in the spreadsheet, Change in Absolute Backlog is illuminating. Backlogs declined 12% to 20% year over year.

The decline in absolute backlog is consistent with macro-economic data. Customers and end users have little need to order new equipment when capacity utilization is low. 50% peak-to-trough declines in absolute backlog are possible over a cycle as old orders are shipped and no new orders are booked.

These companies have only seen 12-19% declines in their Backlog. Therefore, owners can expect further backlog declines. Further declines are likely even with Emerging Market GDP growth remaining above 6%. Emerging Markets still do not provide the majority of these 3 OEM's revenues.

As the Backlog declines, operating managers become more concerned about marginal costs and marginal productivity. Manufacturing facilities for heavy equipment have shockingly large fixed costs which need to be covered by direct labor. Direct Labor may only be 5% - 12% of the COGS of an order. Activity Based Costing (ABC) has reduced distortions caused by the old style Burden Rate calculations. However ABC, still has not eliminated the need for order to cover overhead. A small decrease in direct labor (ie orders flowing through a facility) will have a dramatic effect on fixed cost coverage.

Pressure to book orders to fill the plant becomes greater with every new order that is shipped. Owners need to carefully monitor gross margins and actual warranty costs (not provisions) to determine if inappropriate orders are being accepted.

Another key metric for owner's to watch is Months of Revenue in Backlog. A steep decline in this number will indicate either a) future declines in revenues or b) declines in quality of revenues (ie margin destruction). General Electric has seen a 17% drop in months of revenue in its equipment backlog (note, the numbers cited for GE are only for their equipment and service backlog - not the entire enterprise). Owners can expect that revenues for GE's equipment groups to decline by this scale by 1Q '10.

Both Alstom and ABB have been able to manage their Months of Revenue in Backlog rates more consistently than General Electric. Owners can expect pressure to accept 'bad orders' to be lower at Alstom & ABB than at GE in the future. Owners might reasonably predict that revenues over the next few quarters will be more stable at Alstom and ABB than at General Electric.

Tenders Up = Orders Up ?

ABB provided this most illuminating graph in its latest quarterly report. It is supposed to indicate a continued boom in activity. Tender activity are useful proxies for future orders. Tender activity is a soft number and is subject to any number of distortions. Gudovac believes ABB's managers are incorrect in concluding a record number of tenders equals a record number of orders - soon.

One could also conclude from the data that a record number of projects are being red lighted at the last minute. A tender may go out and then the project is delayed, and delayed, and delayed, and..... Many Projects may have been put on long term hold until more economic certainty returns. Owners need to continue to monitor trends in this data for all OEM's.

GE Backlog as of 30.June 09

GE's backlog slide was cleverly constructed. As Gudovac has noted before, GE's managers are the supreme masters of the craft of the Power Point Presentation. This slide seeks to obscure the fact that the equipment backlog has shrunk by 17% y.o.y. Viewer's attention is directed towards the blue and green graph which suggests backlogs are steady at $169 Billion.

However, GE's best leading indicator of future business is new equipment orders. Gudovac appreciates that GE's managers are showing service booking information. This indicates they are serious about the effort to promote high margin service revenue. GE's managers have promoted service in its own right for a long time. Owners can be pleased that Service has a solid foundation at GE>

Alstom Backlog as of 31. March 09

Alstom's presentation of its backlog information is clear and concise. The breakout of service is welcome. Alstom's service business represents approximately 30% of its revenues. In the downturn, Service will represent possibly all of Alstom's profits. Service tends to have a shorter cycle time. Therefore, Owners should balance backlog change with service growth. Alstom's Owners will need to watch the Service side of the Enterprise closely throughout the down cycle.

ABB Backlog as of 3o. June 09

ABB provided Owner's with a number of slides presenting a a solid amount of data in a most compelling fashion. The long term backlog trend graph shown here describes just how quickly the backlog situation has changed at ABB. A trend graph for Alstom and GE would likely indicate a similar situation. Of particular note for Owners is the steep decline in large orders (orange).

Until large orders expand, one can not expect significant growth in top line revenue.

GE vs. Alstom vs. ABB Backlogs and Bookings

The backlog and bookings information for these 3 OEM's provides a critical insight for the Owner. At both Alstom and ABB, the next year's results are going to be rather predictable. GE's results will be less predictable due to the impact of GE Capital upon GE Industrial. However, in all 3 cases, Mr. Market appears to focus closely on the latest results, instead of understanding how the current backlog will flow through the next few quarters. Owner's may be able to take advantage of Mr. Market's myopia.

Owners don't need the Grateful Dead to tell them if there is Trouble Ahead or Trouble Behind ? - the backlog tells them exactly what lies around the next bend.

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

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Alstom - Areva Acquisition a Value Destroyer ?

2009-07-23T12:30:00.005-04:00

Today's press release announcing that Alstom's managers will be making a bid for Areva should concern any Owner. Here is the key language from the press release:

Schneider Electric and Alstom are considering making a joint offer to acquire Areva Transmission and Distribution (T&D), recently put up for sale by its parent company.

In order to achieve this, Alstom and Schneider Electric would create a common structure which would bid for Areva T&D and, if this offer is accepted, would ultimately transfer the transmission activities to Alstom and the distribution activities to Schneider Electric. Such a transfer of activities would have no social consequences

The high voltage Transmission (T) part of Areva T&D is very close to Alstom’s own activities in power generation. Alstom will bring to Areva T&D its expertise and knowledge in power networks and automated systems, its know-how in the management of large projects and the full benefit of Alstom’s worldwide commercial network which is particularly focused on power generation utilities, the primary market for high voltage activities.

The medium voltage Distribution (D) part of Areva T&D is a business in which Schneider Electric is very active and that it would like to reinforce. Schneider Electric would bring to Areva T&D its considerable technical and operational strengths in automation and medium voltage, its worldwide sales network, as well as a complementary access to Industry, Building and Infrastructures , major markets for medium voltage activities.

This consolidation around two major worldwide industrial groups, specialised in their own fields, would represent a considerable development opportunity for Areva T&D’s employees.

Gudovac presented his views on the subject on 8.July when he suggested that ALS at 30 Euros was a good buy. Here were Gudovac's thoughts:

Alstom's managers could always do something truely destructive such as trying to make a big acquisition. Owners should apply a massive negative discount to Alstom if a big acquisition is even rumoured.

Gudovac will be following these developments closely.

Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

Asea Brown Boveri (ABB - ADS NYSE) - Still a buy at $5

2009-07-23T09:38:00.054-04:00

Current Share Price approx. $16

Cash & Similar Per Share Outstanding= $2.28
Last Dividend= $0.44
Payout Ratio (ttm) = 34%
Payout Ratio (4*mrq) = 37%

Market Cap = $38 B
LT Liabilities & Debt (net of Cash) = -$2.7 B
Enterprise Value = $41B

Revenues (ttm) = $34 B
Gross Margin (year ago) = 32.7%
Gross Margin (mrq) = 30.7%

Operating Cash Flow (ttm) = $3.4 B
Operating Cash Flow (mrq) = $1.0 B

Enterprise Value/EBITDA (ttm as of 23.July) = 6x
Current Ratio (year ago) = 1.52
Current Ratio (mrq) =1.63

Background:

ABB released the 30.June numbers today. The 2Q results are consistent with Gudovac's 26.June analysis. Therefore, ABB remains a buy at $5 per share on the NYSE.

ABB's leadership decided many years ago to shift into businesses with higher knowledge and service content as a theme for the future. ABB exited the Rail and Large Power Generation business a decade ago. This long term strategic decision which may be turn out to be very successful someday. However, the strategy isn't successful today.

ABB's competes as a highest quality equipment supplier. Customer's describe ABB as expensive, but worth it. ABB can command price premiums of close to 30% in some sectors simply because of ABB's quality reputation.

Owner's should realize that ABB is the enterprise that Percy Barnevik successfully built out of the wreckage of Asea and Brown Boveri. ABB was considered one of a handful of truly superior enterprises when Percy Barenvik was at the helm. Owners should also realize that a one is partnering alongside (or perhaps in competition with) Investor and the Wallenbergs. The Wallenbergs are the premiere value investors in the world - full stop.

Finally, Owners should recognize timing expressed in years when examining an enterprise such as ABB. ABB's development and cycle times are are long. ABB's customers require years of preparation to embark on a major project. A decision to buy ABB does not require instant action. Events take months to gestate.

The decision to own ABB requires the patience of hunter - observe, stalk quietly, wait, wait some more, and then strike.

Operating Analysis:

As the 2Q results indicate, it is difficult to make spectacular profits in higher knowledge industrial capital goods when capacity utilization in the US is 68% and EU industrial production is down 17% year over year. It is even more difficult to sell ABB's clever Gird solutions when OCED power consumption is dropping for the first time since 1945.

The difficulties ABB's managers have is expressed in the right hand slide from ABB's quarterly presentation. New Orders are down nearly 30%. This decline can be expected to continue until industrial utilization expands significantly. It is unlikely that industrial utilization will expand in the next 2-5 years.

Owners can also expect margins will come under pressure as managers accept lower quality orders. ABB indicated in its statements today that customer are getting the benefits of lower commodity prices on ABB orders. In lean times, Customers will naturally bargain harder for price concessions which is straightforward to manage. (ie Do we accept this order at this margin or not ?)

What is more difficult to manage is that Customers will also tend to increase performance specifications on orders. Tough performance criteria which ABB might have been able to negotiate away in the boom times will be reluctantly accepted. These risks are impossible to quantity at the time of order acceptance. What is the risk that a $100 million ABB automation order will miss a increased productivity standard by 1% costing ABB a 20% performance penalty ? ABB managers are first rate Engineers with a solid track record of meeting performance specs, but in lean times everyone accepts tough spec. orders which may have been refused in a boom times.

The next slide indicates the full impact of under utilized industrial capacity on ABB's focus on energy efficiency, automation, and grid expansion. Orders are down in the US and Europe as one would expect.

But, ABB's orders for China are down 20% y.o.y. In stark contrast to ABB, both GE and Alstom's Chinese order intake rose in the same time frame. ABB's drop in order intake for China should be followed closely by Owners. If this is a consistent pattern over the next few quarters, then Owners should discount ABB's price accordingly.

The next operating slide came as a surprise to Gudovac.

Coil Winding and Assembly tend to be labor intensive operations sometime consuming 30% of the labor for equipment in ABB's size range. The operating initiatives listed in the slide may have been worth celebrating 15 years ago. One would expect that productivity efforts at a cost center representing 30% of labor content would have been exhaustively addressed a long time ago.

It is shocking that relatively prosaic Kaizen initiatives (Preventive Action, Key Performance Indicators, and Parallel Processes) are so new at ABB to warrant inclusion in a CEO report. Conspicuously absent from the slide is any quantitative information on results. Enterprises with advanced manufacturing cultures would have presented the slide with quantitative information such as "30% reduction in cycle time" or "25% reduction in scrap". Instead, the CEO only is able to state that by June 30th, 2009, the initiatives were completed.

A cynical observer might imagine the completion occurred at 11:59pm on June 30th after some forceful messages to line managers came from on high.

Management projects significant cost savings over the next 18 months.

They present they have achieved 1/4 of their $2 Billion 2010 target. Three-quarters of the cost savings which has been achieved to date is via optimized global sourcing. This us likely to mean substituting Chinese and Indian for ABB's current German and Swiss suppliers.

Gudovac has directed first hand the promise, success, and eventual agony of such efforts. ABB's enterprise depends on remaining the highest quality supplier - with supreme confidence. The unforeseen effects of changing suppliers in the capital goods business are nearly impossible to manage. Capital goods supply chains are best changed at a glacial pace. ABB's dramatic efforts may be successful over the long term. Owner's should watch carefully warranty costs 2-5 quarter's from now. The slightest upward tick in warranty costs should be cause for very close scrutiny.

Gudovac is disappointed that management has set such a low goal for improving operational efficiency and quality. Opportunities must abound at ABB for efficiency improvements base upon the Winding Shop situation. Management would do well to focus on creating a modern operational culture at ABB to fit hand in glove with ABB's superior engineering culture. ABB would be unstoppable.

Finally, Owners should recognize that the easiest cost efforts are completed first. The last $500 Million of the $2 Billion target will be difficult indeed to achieve.

Financial Analysis:

The slide on the right underlies ABB's situation.

The 2 mature Power divisions experienced the smallest drop in EBIT margins and new order volume. The 2 higher knowledge Automation divisions saw EBIT percentage drops from 19% to 15% and 12% to 9% respectively. Owners can expect margins to continue to drop. This is evidenced by the 19% and 43% drop in new orders booked by the 2 automation divisions.

After more than 10 years of being the second leg on which ABB's strategy rested - Service is a mere 15% of revenues. Service revenue is flat year over year. Little or no mention is made of service by ABB management. Owner's need to understand if ABB still considers high margin service to be part of ABB's core strategy.

ABB's management has worked hard at reducing fixed costs. S , G, & A has been reduced by nearly as much as the drop in revenues as the summary spreadsheet indicates below. Owners can expect the pace of fixed cost reductions to increase as bookings drop. However, owners can not expect fixed costs to drop more than revenues. Capital equipment companies simply can not reduce fixed costs that quickly.

ABB's management has performed a journeyman's job of cleaning up the appalling balance sheet from the 2002 - 2005 period.

Trade Working Capital has remained steady over the last 6 months. Owners can expect the W/C DSO ratios to deteriorate over the next few quarters as customers stretch A/R and delay accepting finished orders.

ABB management has the benefit of being in a sector with large progress payments. Progress payments has remained steady at over $2 billion. This will decrease with the decline in ABB's backlog. The net cash position (including all long term liabilities such as pensions) is a acceptable $2.7 Billion. Owners should watch carefully changes in this position. In the last 6 months the net cash position has worsened by $300 million.

Gudovac calculates ABB as having a Owners book value of slightly less than $10 Billion. This is significantly lower than the accounting book value of $13 billion. Owners book of $10 Billion works out to some $4.32 per share.

ABB's Cash Flows appear to have suffered earlier than one would expect in such a long cycle business. Free Cash Flow is down 86% on a six month basis 1H 08 versus 09 and a down a staggering 94% on a 2Q 08 to 2Q 09 basis. Lumpy cash flows is typical of ABB's sector. Owner's should

not immediately conclude that the sky is falling at ABB just because of a wide quarterly swing in Free Cash Flow. Owner's should examine the root cause. Gudovac notes that operating cash flows have not decreased. The greatest year over year change in Free Cash Flows is due to the proceeds of the sale of securities which netted $2.8 Billion in 1H 2008. Therefore, one may conclude the operating enterprise is reasonably stable at this stage of the cycle.

Price to Buy:

What price would be reasonable to buy ABB ?

ABB is a high quality capital goods OEM with a strong Balance Sheet facing a devastating macro-economic climate.

Owners need to model what will ABB look like financially once the fat 2007 orders have long been shipped and forgotten.

What will ABB look like when the backlog is composed solely of lean 2009 & 2010 orders ?

Gudovac generated a back-of-the-envelope-model which depicts the likely range of possibilities for ABB as the bad orders flow through the factories (see below). Gudovac projects the ABB service business will remain flat at $5 million. New equipment revenues are likely to drop between 15 and 25% from 2007 levels. This is consistent with current booking activity.

Gudovac ascribes a range of Gross Profit with 'lean orders' of between 12% - 10%. The 12% Gross Profit is not far off from 2Q 09 result of 13.2%. The 10% Gross Profit level represents a 3 point drop in margin (nearly 30%). A 3 point margin drop is possible if ABB's competitors engage in price cutting to add volume. Destructive Price competiton of this sort happened in the mid 1980's and in the early 1990's. It could happen again.

Owners should note that ABB's EBIT was 11% as recently as 2006

Management can be expected to cut S, G, & A. Gudovac suggests management will have to reduce S, G, & A between 63% and 50% of 2Q run rate. This exceeds Management's Cost cutting goals - aka Target 2010. Gudovac believes that Management will be forced to push cost cutting onto S, G, & A as the full impact of Margin destruction becomes clear.

Therefore, ABB is likely even with successful cost cutting measures to end up with annual EBIT of positive $1,000 to negative $400 million. Adding the $600 million of annual D&A to the EBIT and one arrives at a EBITDA range of $1,600 to $200 million.

What should owners expect to pay for an Enterprise which generates these levels of EBITDA ? Owners can use EBITDA as a proxy for Free Cash Flow. Working Capital productivity eventually ends and should be excluded. ABB's weighted average cost of capital is in the 9% range. Owner's can expect ABB's long term growth rate to slightly exceed worldwide growth in GDP at 2.7%. Application of the Gordon Growth Model. One arrives at a wide range of values for 'lean order' ABB between $25 B and $3 B.

Readers should note this wide range of outcomes would horrify green eye shade analysts on the sell side. These are the type of analysts who want their 'customers' to believe they can predict net income per share to-the-penny 18 months from now. Gudovac does not have the level of wisdom nor insight that these brilliant sell side wage slaves posses.

The best that Gudovac can do is think like a mere owner and split the difference between $25B and $3B for a midpoint of value of $14 B. Subtracting the Net Cash Position (don't forget Pension liabilities), divide by the number of shares:

One arrives at a $5.04 share value.

Note, $5 per share is still a healthy margin over Owner's Book value of $4.32 per share. Owners of ABB would be able to generate modest returns over the long term at $5 per share.

Don't Get Massacred !

Gudovac1941@gmail.com

Description of Gudovac's Methodology

Emerson Electric (EMR) - Buy at $26.40

2009-07-21T08:38:00.008-04:00

Current Share Price approx. $35

Cash Per Share = $2
Foreward Dividend = $1.32
Payout Ratio (ttm) = 46%
Payout Ratio (4*mrq) = 67%

Market Cap = $25 B
Debt = $5 B
Enterprise Value = $30 B

Revenues (ttm) = $23 B
Operating Margin (year ago ) = 14%
Operating Margin (mrq) = 11%

Operating Cash Flow (ttm) = $3 Billion
Operating Cash Flow (mrq) = $500 Million

Enterprise Value/EBITDA = 6.7x
Current Ratio = 1.3x

Background:

Emerson reports its latest quarterly (3Q) numbers in 2 weeks. Enterprising owners can anticipate share movement as the 3Q numbers leak out. Owners may have the opportunity to buy Emerson at favorable prices depending on how Mr. Market judges the rumours about 3Q.

Emerson is one of those high performing corporations which has moved into relative obscurity since the Nifty-Fifty days. Emerson is able to generate above average margins year after year - through first rate manufacturing processes continually improved.

Proof of Emerson's superior manufacturing ability is in its 11% operating margins. Emerson generates these margins in near commodity type businesses - small eletric motors, low voltage drives, couplings, and garbage disposals.

Emerson's 2Q numbers indicated management has been pro-active in adjusting to the new economic reality. Management forcefully cut back capacity expansions and squeezed working capital. Trade Working Capital turns of 5x revenues are still higher than Gudovac would prefer. The high Trade W/C may be due to Emerson's Engineering culture rather than a bean counting financial culture. However, Emerson's management appears to be moving forward on addressing excess working capital.

Emerson's revenues will contiue to drop. Owners will need to examine Emerson's fixed versus variable costs as annual revenues drop below $20 billion. Owners also need to examine Emerson's dependence on North American markets.

Gudovac expects Emerson to produce quarterly Free Cash Flow in the range of $350 - $400 million during the next few quarters of the business cycle. This is less than one-half of Emerson's FCF during its good years. Low debt levels will allow owners to retain a dividend rate of $1.32 through the economic cycle.

A prudently managed, steady state Enterprise should generate a modest dividend for its owners. A 5% dividend translates into a share price of $26.40. 5% dividend provides owners with a modest return.

Don't get Massacred !

Gudovac1941@gmail.com

General Electric (GE) - still a buy at $6

2009-07-17T10:28:00.014-04:00

Still a Buy at $6 share - consistent with Gudovac's 26.June analysis

Gudovac always gets a pleasure from hearing polished Managers presenting quarterly results. These presentations can lull even the most jaded owner into a benign torpor. That Middle American quiet confidence. The array of perfectedly composed charts. The team spirit. The situation at the enterprise in question is always the very model of a modern major ~~general~~ corporation. GE's managers are the unquestioned masters of this craft.

Therefore, one should treat any GE presentation as one would a lush summer pitcher of Gimlets - Enjoyable for certain, but don't even think of driving until the next morning.

Gudovac had a good night's sleep and then looked at the numbers.

The industrial side is working through orders booked during the heady days of late 2007 and early 2008. One would expect that margins on these orders to be extremely healthy. They are. The operating margins are up in the key part of this group by 13 points. However, one can also expect that margins going forward will have steep downward trend. In 9-24 months we can expect Industrial margins to approach zero in some divisions.

GE's managers enjoy talking about their service business. It will continue to provide the cash flow and margins necessary to prop up the industrial side of the Enterprise. Senior Management will press service to make up the shortfall in new equipment. Owner's can therefore expect overall operating margins to remain postive throughout the down cycle.

Now on to the capital side of the Enterprise.

The capital side of the enterprise is simply a train wreck. Owners will look forward to 28.July when managment presents more details. The information presented yesterday was not reassuring at all.

Non-earning 'assets' are approaching mind boggling levels. The projected recovery rates are, at first blush, childishly optimistic. 75% LTV ratios may be prudent in a normal post-war recession. However, today's depression will see 50% drop in overall Real Estate prices in Anglo-Saxon economies. Industrial and Commercial properties may even experience more than 50% decrease in valuations. Management's reserves are woefully inadequate to address these levels of assets impairment.

Gudovac will wait until the 28.July detail to fully quantify what might be an appropriate reserve level. A back of the envelope calculation suggests that reserves for non-earning 'assets' are between 1/2 and 1/3 lower than necessary.

Owner's should understand that middle market industrial and commercial companies only went to GE Capital if they couldn't get financing at Commercial Banks. This suggests that some of GE's middle market lending may have been to weaker companies. GE's good sense to always be in a senior secured position with this market will buttress recoveries. However, when liquidation values are dropping 50% or more, even GE's most assertive recovery methods will not make owners whole.

Finally, Owners need to examine how much financing GE is providing for its own customers on the industrial side. Gudovac expects to have this question answered on 28. July.

At $6 a share, GE is priced at over $500 billion of Enterprise Value.
At $6 a share, GE pays a good dividend of 6.6%
At $6 a share, GE is priced at over 15x TTM EBITDA
At $6 a share GE is priced at over 3x Revenues

A $6 share value for GE implies supreme confidence in GE's management. Gudovac would only value an enterprise at such high multiples if he believed that management is first rate.

Don't Get Massacred !

Gudovac1941@gmail.com

Approach and Methodology

Alstom (ALO-Euronext) - Buy at 30 Euros

2009-07-16T10:29:00.007-04:00

Today's Enterprise Value approx. 13 Billion Euros ( approx. 3/4 of TTM Revenues, approx 9-10x free cash flow, 43 Euros share price)

Buy at 7- 8x Free Cash Flow - approx 30 Euros

Background:

Owners should recognize that Alstom is really a dull repair business obscured by the glamour of 300 kph Trains and Big Coal Power Plants. The latest numbers ( released today ) reflect this reality.

New orders are in free fall. Alstom didn't release much margin information today on new orders. Gudovac can speculate that the slope of actual margin destruction is not-quite-as-steep as new order intake. By actual margins, Gudovac does not mean at what estimated margins the latest orders were taken. Rather, Gudovac expects the latest order estimates to have been subject to heroic assumptions about improved learning curves, material costs, and engineering.

Owners can expect actual gross margins in the thermal power group for new equipment to turn negative in 20-36 months as these Hail Mary orders flow through Alstom's facilities. Margins on transport are likely to experience similar downward pressure but will get hurt less than power.

Grim, but this forecast is not causing Gudovac to abandon all hope - because the negative margin orders will be a smaller portion of Alstom's overall business in 20-36 months. It is a well known secret within the industry that Alstom's operating execution on new projects is matched only by Siemens Orlando (ie weak). In contrast, Alstom service is able to execute at the highest level in the industry. As far as Gudovac is concerned, the less emphasis placed on new equipment, the better for Alstom and its owners.

The value of Alstom is in its service and renewables segments. These 2 segments will continue to grow. Service will grow at perhaps double GDP. Renewables will grow at near double digits rates. Fortunately, when Alstom was near collapse, the service business recieved significant attention. A solid foundation has been created at Alstom in its service business - almost 20% of Alstom's employees work in Service. The service business has the advantage of high margins, low capital requirements, and relatively quick cycle times.

Alstom also has cleaned up it's balance sheet. The terrifying leverage of prior years has been addressed by management. Despite the lack of leverage, owners should expect that Alstom's dividend will be cut drastically.

Therefore, at reasonable prices, owners can expect reasonable returns from Alstom. Gudovac is able to justify a relatively higher than normal free cash flow multple (7-8x) for Alstom due to low leverage and service franchise.

Prospective Owners need to examine these questions:

Will the service business be able to carry the company ?
Will a 20% increase in Servce revenue at 17% margin fill the chasm when Traditional Power Margins drop to 0% ?
Will renewables expand at a double digit pace ?
Will Alstom stop all capacity expansion - as necessitated by the sea change in economic environment ?
Will Alstom be able to continue to off shore jobs given the European political climate ?

Finally, Alstom's managers could always do something truely destructive such as trying to make a big acquisition. Owners should apply a massive negative discount to Alstom if a big acquisition is even rumoured.

Don't get Massacred !

Gudovac1941@gmail.com

Jaiprakash Associates (JAIPRA - Bombay) - Buy at ?

2009-07-16T06:39:00.006-04:00

Enterprise Value approx. 320 Billion Rs. ( 187 RS. Share)

Buy at ?

Background:

There is a lot to like about Jaiprakash. Gudovac has been watching Jaiprakash since working with them on a modest sized (over $200 million) joint infrastructure project a few years ago. The second generation leadership is modest and hardworking. The forays into glamour industries (Hotels, Golf Courses) have been limited in their squandering of capital.

It is self evident that India will be consuming a fair bit of cement and heavy construction work over the forthcoming years. India will grow irregardless of which party or coalition is in power. It is just a question of how fast will India grow. Jaiprakash is well poised in this sector.

Jaiprakash made a great leap forward in cleaning up its accounts for owners by merging its shareholding. Owner's dislike buying into family run conglomerates with half a dozen independent share issues. The opportunities for compromise are far too great. Tata and Reliance both come to mind. Gudovac prefers clean ownership and lines of control. Jaiprakash has moved forward by its mergers.

Jaiprakash still has some work to do to consolidate its books and provide better discolsures before Gudovac will be comfortable with assesing a value.

Therefore, we'll look to the forthcoming results of Jaiprakash to determine what would be appropriate price to buy.

Regal Beloit (RBC) - Buy at less than $30.26

2009-07-09T17:03:00.012-04:00

Enterprise Value approx $1.2 Billion ($39 per share )

Buy at less than $30.26

Background:

Regal Beloit used to be a quiet company; humble, but profitable with an 18% operating margin. No Debt. Solid dividends. 3 Midwestern plants, making small gears. A great company for Owners.

Then one day, Patriarch Henry Knueppel went down to Chicago to meet some investment bankers from Baird who were trying to offload Marathon Electric. Buying Marathon would double the size of Regal. The Baird salesmen explained how Henry could double the size of the company by leveraging it to the hilt.

Henry took a deep breath, closed his eyes to the obscene fees Baird charged, and dove right in. Fortunately for Henry, the industrial market boomed in the late 1990's and he was able to service the debt from the Marathon transaction.

Almost 15 years later, Henry and his buddies at Baird are still at it. Leverging up the company and buying cast offs from the industrial manufacturing world. Regal doubles the size of the company very few years via a big acquisition and continues to make small acquisitions inbetween.

It isn't quite a roll-up strategy and it isn't quite a conglomerate strategy - but it has made both Henry and Baird prosperous. Owners also did quite well over the years securing nearly double the S&P 500 gains.

While Henry has been using inexpensive debt to fund his buying spree, Owners might want to know how the operating companies fare. Managers who buy 20 companies a year (Regal's number of acquisitions in 2008) don't have much time to attend to the mundane tasks of operations.

At Regal the operating companies appear to muddle along - Operating Marging for the last 12 months were just under 10% at 9.34%. 9% operating margin is not good and is not bad in this sector. However, it is 1/2 of what operating margins were 15 years ago. Regal used to have some of the best margins in its space, now it has below average margins.

Now that the era of cheap money is over, what can we expect of Henry, Baird, and Regal-Beloit ?

Regal Beloit just raised $150 million via a secondary offering. This equity raise diluted existing shareholders about 10%. Interesting that Regal couldn't secure inexpensive debt financing and had to go the expensive equity raising route instead.

The financials tell us that with the $150 million secondary and some $80 milllion cash on hand - Henry is sitting on over $200 million cash and his cash flow can easily service his existing debt. Plus, he doesn't have any significant term debt due until way out in 2012. Regal's Owners can expect that the $200 million cash will be married to some $400 million of debt to make a big purchase.

Plenty of buy out shops are desperate to off load companies they bought a few years ago during the height of the cheap money craze. $600 million might buy a industrial enterprise with $1.8 Billion in revenue these days - effectively doubling the size of Regal once again. Perhaps Regal/Baird already has their eye on one....

Should owners invest alongside Henry in his latest adventure ?
Should owners expect another 15 years of double digit stock growth ?

Gudovac1941 can't predict the future, but he is able to make some basic conclusions based upon Henry Knueppel's actions (which speak louder than words, don't they ?).

Henry has such confidence in the future of Regal Beloit that he sold a little over 103,000 shares in the last 11 months. He sold 34,996 shares at $30.26. If Henry thinks Regal shares aren't worth $30.26, who are we to argue ?

Henry's 2008 stock options also indicate a certain attaitude towards Regal's future stock appreciation. In May 2008, The Board of Directors awarded Henry a few stock options at a $42.28 exercise price. This was the approximate value of the shares trading on the open market at the time. Granting stock options with a excerise price equal to the sale price at the date of award is common enough practice not to be questioned by auditors or regulators. However, it indicates a rather low bar for management to be 'in the money'.

Gudovvac1941 likes to see management options priced such that managers need to generate for stockholders a 15% annual return. If the market price per share was $40 at the time of award and the options have a 3 year life. The exercise price should be north of $60.

If Regal's Board had granted Henry options with an exercise price of $60, owners could have a high degree of confidence that management would be driven to increase the value of shares over time. Instead, Regal's Board priced the options such that even a paltry 3% annual increase in share price will make management's options very valuable.

At $30 share Regal Beloit's Enterprise Value would be about 1.1 times book value. Owner's would be paying approximately 4 times EBITDA. 4 times EBITDA is a reasonable price to pay for a 9% operating margin business growing through acquisitions for those who can bear a fair amount of risk.

Don't get Massacred !

Gudovac1941
Gudovac1941@gmail.com

Alcoa (AA) - still a buy at $6

2009-07-08T19:50:00.006-04:00

Alcoa is released 2Q earnings a few hours ago. Management is doing a first rate job of readjusting to the new realities. They have moved forcefully to eliminate costs and drive cash flow. This is exactly what owner's want to see in an Enterprise. Brutal and quick action to protect the owner's interests.

Gudovac1941 stands by his June 26th analysis that Alcoa is a buy at $6 a share

Alcoa management has successfully managed to stop the cash flow bloodbath of the past 3 quarters. 2Q free cash flow is neutral. Management's achievment is remarkable in the face of a staggering decline in prices and volume.

Gudovac1941 calculates that Alcoa has a $12 billion Enterprise Value. $10 billion debt on Alcoa's books subtracts a significant amount of value from the share value. After subtracting out the debt, only $2 billion of value remains for the owners. As this debt gets paid down, the share value will improve significantly. $2 billion translates into a $6 per share price.

Alcoa is a great company will dedicated managers who can successfully prosper in the hard times.

Don't get massacred

Gudovac1941

Shanthi Gears (SHNT - Bombay) - Buy at 40 Rs. UPDATED

2009-07-08T11:06:00.009-04:00

Enterprise Value approx. 3,700 million Rs. share price approx. 40 Rs. (Enteprise Value 1.5x revenue or 5x EBIT)

Buy Now at approx 40 Rs.

Background:

Shanthi gears is a small company which I have been following for a number of years. I was first introduced to Shanthi while searching for a gearbox supplier for some Asian projects. The trek to Coimbatore was worth it. Shanthi's operations were simply the most impressive of any gear manufacturer I had ever seen - ever. Shanthi follows its home grown version of lean manufacturing which would humble most Toyota plant managers.

Shanthi's lean approach shows in its numbers. It consistently generates 30% PBT year in and year out. 30% PBT in the commodity gear businss. !

In line with all Indian companies, Shanthi has had orders canceled and slow paying customers. due to the economic crisis of the last 18 months. Shanthi also has been hit hard by the decline of Indian textiles. However, despite these severe negative influences, Shanthi's most recent quarter (end March 2009) shows a 25% PBT. This indicates a pro-active management team able to quickly adjust in a crisis.

Shanthi pays a modest 1.2 Rs dividend, a roughly 20% payout ratio of net income. Shanthi's debt to equity ratio falls under a 50/50 range appropriate for an industrial enterprise.

Shanthi's founder, Chairman Subramanian, is starting to get too old to run the enterprise. However, the managers I saw and spoke with, were more than capable of keeping Shanthi moving forward. Chairman Subramanian has created a powerful corporate culture which will outlast him. There have been rumours of a strategic buyer, but that will not change the fundamentals of Shanthi.

At 40 Rs., one would be buying Shanthi for less than the liquidation value of the machinery I saw during my inspection tour. Buying a highly profitable enterprise for liquidation value of the machinery is a good investment, even if the multiple of EBITDA is a bit high at 5 times.

Please note, some readers were kind enough to inform me that my Enterprise Value was incorrect. It has been corrected.

Don't get Massacred !

Gudovac1941

American SuperConductor (AMSC) - Buy at $5 - UPDATED

2009-07-02T07:48:00.008-04:00

Today: Enterprise Value approx $1 billion ( $26 per share)

Buy at Enterprise Value of approx $250 million ($5 per share)

Background:

AMSC is a interesting phenomenon, Its executive team has paid itself a fortune over the last decade, while producing nothing of substantial value for the owners. I have known AMSC for more than 15 years. The AMSC lead team is a master of managing information and publicity, but they believe they deserve big rewards today rather than later.

The superconducting wires do perform as AMSC promises. The HTS motor/generators are indeed game changers and perform much better than AMSC reports. But, dropping electricity consumption will not create a sudden need for HTS wire

US electricity demand has dropped 3% y.o.y. Chinese electricity demand is also dropping, albeit at a slower pace. The drops in electricity demand is a pure function of the economic downturn. When electricity demand exceeds grid capacity will be dependent on when economic growth returns and how quickly this growth impacts the grid. Only when the grid requires massive expansion will HTS wire be needed.

HTS isn't going to generate meaniful revenues until well into the next business cycle. AMSC's HTS competitors will likely have caught up to AMSC's technology by that time. Even the ham fisted bureaucrats over at GE might have finally completed their HTS program in time to compete with AMSC.

Yurek was masterful in buying the Wind Turbine business. The Wind Turbine business saved him from hard questions about HTS. He finally is showing revenue and swears AMSC will be positive cash flow real soon. Yurek knows he better show some positive cash flow fast if only to molify AMSCs owners.

Yurek recognizes even his brilliant PR work won't be able to obscure the simple fact that a AMSC is a Engineering Company in a highly commoditized sector of the power business: wind turbines.

So let's examine AMSC from the standpoint of a Engineering Company

The most recent quarter's P&L shows $60 million revenue and $40 million COGS - say 30% gross margin. That's nice for a 2nd tier manufacturing company, but not so good for an engineering enterprise with 520 employees, 125 who are paid Chinese wages.

This leaves $20 million for Yurek to play around with. How does he spend the $20 million ? A paltry $5 million goes into R&D (yeah that's the much vaunted HTS and next generation wind turbine). $10 million gets hoovered by Yurek and his managment team. So in other words, AMSC spends twice as much on its management team as it does on R&D.

UPDATE: The reader's comment is well taken (see below). Perhaps by way of clarification: 'AMSC spends twice as much of its discrtstionary budget on its management team. Gudovac understands that customer funded work may have legitimate R&D value. Gudovac has also taken orders at low margins because of their R&D value to his Enterprise. He therefore understands the limitations of P&L conventions to illuminate the long term value such orders may generate. However, Gudovac also is painfully aware that customer funded development work is often a distraction..........

Readers should note, that the SEC disclosures on management team pay will not show how much is being spent on 'Executive Meetings in Boca" and 'my girlfriend needs a plush consulting gig'. Therefore, we won't know the precise details of how this $10 million was spent.

However, we can discern from the company's own records just how well management thinks of itself. Page 24 of the most recent proxy statement is illuminating. It lists how much each member of the management team earned in 2008. Each and every member of management generates a cash wage far greater than he would having similar responsibilities in a comparable Engineering enterprise.

In addition to the rich cash wages, owners are also expected to double the number of shares available for stock options to management.

A quick glance though the prior pricing of options already granted show strike prices which hardly inspire confidence in management's incentive to drive the stock value up significantly.

Equity investors (ie the company's owners) can safely conclude that AMSC management does think highly enough of themselves to get paid richly. We can also safely conclude that AMSC management isn't a lean & hungry team of technologists pulling all nighters while living on peanut butter and cold pizza - obessively driven to generate over sized returns for AMSC's owners.

UPDATE The reader's comment (see below) suggests that applying an appropriate percentage ( in this case 17% ) of revenue to R&D should satisfy owners' who value AMSC as generating value through breaktrough technology. Gudovac1941 believes that hungry managers are most likely to generate breakthroughs regardless of the ratio of R&D to revenue. AMSC"s managers simply are not hungry and incentivized enough for Gudovac to believe they will create the-next-big-thing...........

The good news is that, we can believe that Yurek will eek out positive cash flow sometime soon. Positive cash flow means he can put off another equity fund raising round for years. AMSC also still has about $2 a share in cash which provides a modest cushion. However, since AMSC has limited ability to raise debt for woring capital needs, owners should consider the $2 cash a minimum working capital support.

A growing engineering company with $250 million of revenues ( 4 times mrq revenues) with a breakeven cash flow should have an enterprise value of roughly 2 to 3 times revenue. This valuation must be tempered with the knowledge that AMSC management will continue to skim off much of any gains the company generates. A prudent owner would require a discount from typical value to allow for management's lifestyle needs. Therefore, AMSC might garner a reasonable value of 1 times revenue - $250 million - or $5 a share

Don't Get Massacred

Gudovac1941@gmail.com

CO2 Solutions CST.TSX - Buy Now

2009-07-01T08:27:00.007-04:00

Market Cap approx. $12 million

Buy at any time

Background:

No revenue, no history - but plenty of promise - enough cash on hand to fund another year of development. In addition, non-dilutive capital (ie. Grants) are available which have to potential to accelerate development dramatically.

This 15-24 person enterprise is developing a advanced CO2 scrubber. Their design has the potential to be the critical link in making Coal fired Power Plants viable under Cap-and-Trade. CO2 Solutions scrubber has the potential to be 1/2 the cost of more traditional solutions.

Management was weak, but the new team installed 10 months ago is sucessfully driving the enterprise forward. Ownership is divided between two groups of small investors who collectively own less than 50% of the equity and options/warrants.

CO2 Solutions has recently completed a 30 day 'smokestack' test. This is a critcal test which none of its (privately held) competitors have been able to achieve. CO2 solutions is approximately 9-12 months ahead of development versus its competitors.

If CO2 solutions is able to continue achieving its technical milestones, then the company will be worth tens of billions.

Buy a handful of shares with a few pennies.

Don't Get Massacred -

Gudovac1941

Methodology - thoughts and observations

2009-06-29T09:08:00.009-04:00

Readers will note a rather tough approach to these valuations. They might ask themselves if these valuations are unreasonable and harsh. They might aks themselves if waiting for the prices to reach the values calculated by Gudovac1941 will cause investors to Miss-A-Major-Opportunity.

Finally, they might ask themselves what other alternatives exist ?

In reply to these questions, this writer can only state that:

First: one must think in terms of market cycles lasting a few years. During time of excessive pricing, one must simply accumulate capital and wait. Imagine a hunter stalking prey. Good hunters don't crash through the underbrush. Good hunters are able to sit quitely for long periods waiting for the perfect opportunity.

Second: one must also examine alternatives to the straightforward long equity investment. Modern markets provide multiple avenues for investing against an enterprise.

Third: Gudovac1941 has bought many companies at the valuations calculated in these pages. There are many ways one can invest one's capital. The capital markets are just one vehicle of many.

Fourth: Be discerning when gathering information. The vast majority of information on investments is generated by the sell side. The sell side of investment is siren call that one should ignore.

The root of anyone's valuation should be at what cost would I want to own this enterprise ?

Gudovac1941 does not spend much effort in examing macro-economic trends. Great management teams are able to navigare through a variety of macro-economic environments profitably. Certainly, macro economic trends, effect long term valuation significantly. However, these trends are not too difficult to discern. There are numerous sources of macro-economic trend information. Again - be careful to determine is the source is from the sell-side. If the source is on the sell side, then ignore.

Gudovac1941 spends much effort slogging through the details of these enterprises' reports, conference calls, and numbers.

However, the greatest single factor which drives valuations (in his mind) is whether management serves the stockholder's interests ?

One can develop the most highly nuanced CAPM with a refined multi-varient WACC - but miss the most salient question: to whom do the economic rents acrue - owners or managers ?

Gudovac having hired (and fired) his share of operating managers over the last few decades has seen his share of self-serving looting by operating managers.

Gudovac is positive that the silly market levels of the past 15 years are behind us. He hopes for further steep declines in the equity prices over the near future.

In sum - Don't get Massacred.

Gudovac1941@gmail.com

Dow Chemical - buy at $12

2009-06-26T14:25:00.005-04:00

Today's Enterprise Value = $25 billion (share at $16 - 110% of book)

Buy at Book - say $12, which equals about 10 times Free Cash Flow

Background:
Cash Flow highly sensitive to marginal output.
Management efforts to address capacity will begin to show up in accounts in 2-3 quarters.
10x FCF is a bit expensive, but what the heck at $12 is pays almost a 5% dividend.

General Electric (GE) - buy at $6 (or $10)

2009-06-26T10:24:00.003-04:00

Today's Enterprise Value $580 billion (approx. 19x EBIDTDA - $11 share)

Buy at $10 - acceptable risk
Buy at $6 a share - good risk

Background:
The Good -
GE has paid a dividend since 1899
At $10 share its (reduced) dividend of 10 cents a qtr. = decent return

The Bad -
GE's management is self dealing + arrogant + average performers.
GE's books are not exactly 'high quality'. Management is doing its best to clean up its books, but the process (already under way for 4 years now) is going to take another few years. Management is skilled enough to unwind the dreck without a Enron type implosion. However, who wants to own a company that you know has questionable accounting ?

The Ugly -
GE has almost $5 a share cash on hand, coarse implication is that market values shares at merely 2x cash on hand.....not exactly a sign of confidence.