MONOPOLY PLAY

SMTS

I run my stock screen and this stock pops out. I remembered looking into this one, but not in great deal of details. Now I have a lot of time, and I dig a bit further, and surprise, this appears to be an excellent company, although valuation appears to be rather high.

The first thing I really like is that it is a monopoly. There is practically no competition in the market place, and it is the only game in town. It is the proud owner of the only Oximeter in the USA, and internationally. They have the absolute pricing power, and that is why they command a gross profit margin as high as 87% for the first three quarters of FY05 (November year end). Secondly, the sensor, which is a part of this Oximeter, is one-use only, which means reoccurring revenues. Third, the market is huge. The company estimates that the market size in the US is about $2.0 billion, and the company’s FY05 revenues are only 20 million, 1% penetration ratio. Up to Q3/05, the install base is at 985 and there are thousands of hospitals in the USA, not to mention Canada, Europe and Japan. The company’s revenues could go up to $200 million (a 10-bagger), the market penetration will remain 10%. Fourth, the company is growing Googlishly, with more than 60% top line and more than 100% of its bottom line and EPS. The company has more $1.0/share in cash and no debt. It is generating positive cash flow from operations and free cash flow positive. With a monopoly product, strong growth, positive cash flow, and relatively small size, this is an ideal take-over target, and I won’t be surprised if someone pops up the question.

While valuation is not cheap, it is certainly not in the league of Google. It is currently traded at 56X of its FY05 guidance. I conservatively estimate that it will make about 0.68/share in FY06, which leads to a multiple of 33X, and a PEG about 0.47. This compares to about 100X for Google. More importantly, I believe this company is at the very early stage of growth and its growth rate will unlikely slow down for a few years. Given that, I believe the valuation is reasonable as long as it maintains its growth rate in the next couple of years. The company will release its Q4/05 earnings on January 31, 2006 and will provide guidance for FY06. I believe Q4/05 results are in the bag because management raised its full year guidance in its Q3 release. I also believe the guidance for FY06 will be strong, which will move the stock to lower 30s. It has drifted downward in the last few days, which gives me an opportunity to buy at currently level.

Sold JPM (38.50) and put an order for SMTS (filled at 26.35).

SEAGATE

STX / NSTC

I sold my entire position of NSTC this morning and replaced it with STX, which reported very strong earnings last night. Revenues, earnings and cash flow all showed very strong growth and the company increased its outlook for fiscal 2006. ASP moves up and inventory lowered and all segments showed momentum. Pending merger with Maxtor removes the threat of pricing competition somewhat. Management is very confident. Despite the gap-up this morning, valuation remains rather modest (about 10X of its FY07 EPS). I have bought STX a few times and it appears that this one does not get any respect from the Street. Based on the fundamentals, I believe it could go to $30 easily this year, which is about 15%. I am not sure that NSTC will be able to generate the same return, not to mention that I have to take some earning risks in the next few weeks.

SES

I also opened a very small position on SES. This one is a pure bet on management. Four executives from Precision has recently moved into SES with significant incentives. These guys are pros and I would like to believe that they would want to create another PD in the next few years.

UNDERVALUED BIRD

BDT.V

I took a look of the prospectus this morning and I like what I see. I believe this stock is under valued presently and should be bought before the special dividends and conversion into trust.

Current pricing	38.50
Special dividend	8.35
Net price	30.15
Common share count (000's)	3,759.60
Market cap (C$000s)	113,351.82
Expected cash distribution	16,000.00
Unit count	11,278.79
Expected distribution per unit	$1.42
Estimated unit price	$10.05
Cash distribution yield	14.12%

To sum it up, the net price after the $8.35 special dividend is $30.15. Each share will be converted into three trust units, which implies a unit price of 10.05. The company estimates that the sustainable annual cash distribution will be at $16 million level, or 1.42 per units, with a cash payout ratio of 80%. This translates into a 14.14% cash yield. I believe this cash yield is way too high for this company and I expect it to fall into 10%-11% range.

Cash distribution yield	10.00%	11.00%	12.00%	13.00%
Expected unit price	14.19	12.90	11.82	10.91
Common share pricing	50.91	47.04	43.81	41.09
Discount	32.2%	22.2%	13.8%	6.7%

As shown in the table above, assuming a 10% cash distribution yield would result in an implied share price of $50.91. The current share price represents approximately 32.2% discount of its implied price. At 11% cash yield, 22.2%. Even at 13% yield, the current share price is still traded at 6.7% discount. Considering the conversion will be effective on March, the compounded return is significant.

Moreover, even without the discount, I believe this is a good trust. (1) Very long track records; (2) High level of profitability and free cash flow; (3) Good management team with experience and track record; (4) Strong balance sheet with no debt; (5) Long term trend in favor; (6) Opportunities to participate in the booming oil sand construction; (7) Reasonable payout ratio (80%); (8) Limited coverage.

There are a couple of weaknesses. (1) Cyclical; (2) potential slow down of the real estate business. These risks are partially mitigated by high level of reserve (20%), diversified revenue sources; and limited exposure to residential construction.

In summary, this one is definitely a BUY. Unfortunately, it is very thinly traded and I only put through a limited order this morning at 37. I doubt if it could be filled here. That’s alright, there’s plenty of time before the ex-dividend date. (filled at 38)

NEW YEAR, NO ACTION

NO RESOLUTION

It's hard to believe that the first week of the New Year is over and I had done absolutely nothing! I am being cautious, obviously as I am getting comfortable in my new office. I do not want to give anyone any reason for potential conflicts. On the other hand, I am fully invested, and I do not have any new money (wouldn't it nice if the New Year also brought some new money) to work with. The market was strong and I am happy to sit here and enjoy myself. I am up about 2.2%, approximately exactly the market did. I am looking closely though to see if there are any positions which I could take some profits off. Unfortunately, I has not found any. This return is pretty much generated by the recovery of some losers, not by the new profitable positions. If the market runs like this for another week, I have to look it harder and I may have to take some profits systematically regardless of their returns.