Digital River: Keep your eye on the tide

Digital River (NASDAQ: DRIV) provides comprehensive e-commerce solutions to retailers of software and other technology products. In other words, if you buy virus protection software from Symantec (Digital River’s largest client) over the internet, Digital River manages both the engine that delivers the software and the promotions that persuaded you to buy it. I’ve been following this stock for years, and have had pretty good success trading it - I bought shares between 27-35 in late 2005 and sold in the high 50s earlier this year on valuation concerns.

Last week, Digital River slashed revenue and profit guidance for the 2nd quarter and remainder of the year, citing delays in new initiatives for Symantec and Microsoft. The company tried to soften the blow by announcing an increased share buyback and new deal with Microsoft. Yet the market didn’t take kindly, dropping the stock over 10% to under 45.

While this latest development was a disappointing contrast to Digital River’s history of underpromising and overdelivering, I’m inclined to give management a pass this one time. I believe that the underlying business of digital delivery is still strong, as content providers across all industries move away from traditional brick and mortar sales.

Digital River is the number one player in e-commerce management, and its biggest competition is companies’ internal operations. Naysayers need only to look at ADP in payroll processing and Amdocs in customer billing to realize that specialized service outsourcing is a much-needed and lucrative business.

Digital River should get back on track once Symantec fully transfers its global subscriptions business and Microsoft ramps up its Vista sales. There’s also been rumors of Digital River making a big mark in the fast-growing video game market through a major deal with Electronic Arts.

Although I believe Digital River is a solid company whose shares should be much higher 2 or 3 years from now, I think there may be some more downside to the current share price. The current P/E of 30+ seems pricey for a company whose updated guidance calls for only 12% top-line growth this year. I suggest keeping a close eye on this one, but staying on the sidelines until we see a more compelling price or new positive development.

Disclosure: SmartGuyAB does not own shares of DRIV

Earnings Oracle: WSJ sees red flag

On Wednesday, Wall Street Journal columnist Scott Patterson pointed to a red flag that concerns me: waning corporate tax receipts. We all know that in order for the bull to keep steaming, earnings must continue flowing. Yet how are we to get a clue as to what earnings season will look like? If we don’t have any clues, then we will find out with the rest of the herd.

Patterson offers an edge:

“Gross corporate tax receipts collected by the Treasury Department in the second quarter grew by 0% to 4% from a year ago, according to Bank of America.

By comparison, the annual growth of corporate tax receipts from the fourth quarter of 2004 to the end of 2006 have ranged from 18% to 57%, according to Lou Crandall, chief economist at Wrightson ICAP. In the past three quarters, growth has averaged about 16%.

‘There’s a very clear downward drift,’ says Mr. Crandall. It follows logically that if growth in corporate tax receipts is slowing, then the profits that drive the taxes ought to be slowing, too.”

 That logic makes sense to me … but who ever said the markets are logical. Stay tuned …

PetMed Express: An investor’s best friend

• Buy PETS around 13.04

PetMed Express (NASDAQ: PETS), also known as 1-800-PetMeds, sells prescription and non-prescription drugs for dogs, cats, and horses via phone, fax, and its website. It is the largest mail-order retailer of pet meds and typically charges 10-15% less than its primary competition, local veterinarians.

PetMed Express has a rock solid balance sheet, with no debt and $40M of its $315M market cap in cash. Sales have risen consistently since the company went public, increasing from $10M in 2001 to $162M last year, an 18% jump from 2006. Profits have grown commensurately, increasing 20% last year to $0.60 per share.

Thus far, the company has benefited from the general migration of commerce to the internet. While this trend certainly isn’t going anywhere, I look for some other catalysts to keep growth at the company booming in the years ahead.

Today, pets are being thought of as more than just companions- they’re increasingly being regarded as actual members of the family. According to the American Animal Hospital Association’s 2004 Pet Owner Survey, 93 percent of owners would risk their life for their pet. Like any other family member, pet owners want Fluffy to get the best medical treatment money can buy.

From Technology Review: “I think the human-animal bond has changed in the last few years,” says Dawn Boothe, a veterinary internist and clinical pharmacologist at Auburn University in Auburn, AL. “People are starting to say, ‘My animal is a member of the family, and I am willing to pay the cost of drugs that were developed for humans.’ I think the pharmaceutical companies have picked up on that.”

It certainly appears they have - a flurry of new drugs from big pharma have been approved for pets in the first half of this year. In January, Pfizer won FDA approval for Slentrol, a weight-loss drug for dogs. The next month, Pfizer’s motion sickness drug for dogs, Cerenia, was given the OK. Merial (a joint venture between Merck and Sanofi-Aventis) and Boehringer recently began selling canine treatments for melanoma cancer and heart failure, respectively.

And in April, Eli Lilly’s newly formed pet division erased any doubts that doggy drugs are serious business - it received approval for Reconcile, a reformulation of Prozac.

If big pharma believes that the pet drug market is the place to be, I want to be right there with them. And I think that PetMed Express is the purest play on this trend. With only 30% of its sales currently coming from prescription drugs, the company stands to reap the benefits from the increased marketing and interest that accompany these new drugs. Its firm financial footing, strong brand name and future growth potential combined with a reasonable valuation (<22 PE and <2 P/S) make PetMed Express a long-term buy.

Disclosure: SmartGuyAB is long PETS

Endeavor Acquisition: Ramping up for American Apparel purchase

Endeavor Acquisition Corp. (Amex: EDA) is a publicly-traded Specialized Purpose Acquisition Corporation, or “blank check” acquisition company. Endeavor went public to raise capital to acquire white-hot youth retailer American Apparel. The deal is expected to close in the second half of 2007, and I am interested in snapping up shares if the price is right.

To get a hold on Endeavor, we really need to analyze American Apparel. American Apparel is a vertically-integrated manufacturer, distributor, and retailer of branded fashion basic apparel. They have become a hit with young people because their cotton is organic, their goods are made in the U.S.A., and they found the elusive edgy marketing frequency known as “cool.” Most importantly, the company’s financials look attractive too.

American Apparel reported total sales of $73.5 million for the 2007 first quarter, a 24% increase over the year before. Retail sales increased 61% to $38.2 million for the same period, with same-store sales rising 17%. American Apparel had 151 stores as compared to 116 stores last year. Wholesale results were stagnant: $35.3 million compared to $35.5 million.

I am interested in American Apparel because they have tremendous growth potential and their customers consume new clothes faster than the seasons change. To date, American Apparel has only 153 stores in 12 countries compared with bellwether Abercrombie & Fitch’s (NYSE: ANF) 950 stores in the US, Canada, and UK. Moreover, although their ravenous customers may slightly prune purchases as gas prices rise, anyone who has been around a teenager or college student knows these kids will go without food before stylish clothes – not to mention that they simply “throw it on the credit card” if personal income does not equal expenses.

At the moment, the two main risks concerning me are the company’s founder and CEO Dov Charney, and the blank check stock. Charney has been accused of being a bit mega maniacal and also engaging in some unsavory behavior with female staff. So far his ego has carried the flag very far, very fast – an advantage that has made American Apparel a new player with a very fickle crowd. I also think Charney’s high-octane personality is fair game in the always crazy fashion world. However, I will be keeping an eye on him because I do not invest in companies who waste my returns on egregious executive spending accounts or sexual harassment legal fees.

I am also not interested in owning shares of the blank check entity. As a former lawyer and investment banker, I know too many things can happen pre-acquisition that may dilute ownership or reduce share value. If American Apparel succeeds on a grand scale, waiting for the acquisition will be worth it regardless of the initial pop that might be missed. So, we will watch EDA like my new juniper bonsai.

Stay tuned …

Disclosure: SmartGuyDH does not own shares of EDA

Radvision: A play on the growing demand for video

• Buy RVSN around 20.04

Radvision (NASDAQ: RVSN) is an Israeli company that provides video conferencing over IP, 3G, and future networks such as 4G and WiFi. Radvision’s software responsible for controlling and managing real-time voice, video and data traffic among 3 or more people. This means you can be on your cellphone in an airport in China and fully participate in a meeting held in the Chicago office.

Video/web conferencing and telecommuting are two of the biggest growth trends in American business right now. International companies are increasingly realizing the benefits of conducting meetings and trainings virtually, rather than deal with the cost, complexity, and lost time of travel.

Radvision’s financials demonstrate the enormous growth of this market. Revenues have doubled since 2003, from $51M to an estimated $105M this year. Earnings have grown even faster, more than quintupling over the same period. The company has a strong balance sheet, with a market cap of $450M and over $130M in cash. Considering its growth, the Radvision has a reasonable PE of 29 - lower than 42 for competitor Polycom and the 52 of WebEx when it was purchased by Cisco. Radvision believes its stock is a bargain - it has been consistently buying back shares.

Speaking of Cisco, they are Radvision’s largest customer, and have been increasing orders since 2000. There has been speculation that Cisco’s recent acquisition of WebEx will hurt Radvision, likely the reason for Radvision’s languishing stock price. In fact, I believe the opposite is true. Cisco CEO John Chambers has repeatedly stressed that his company’s future is largely tied to video. WebEx’s strength lies in its web-based collaboration software and desktop presence, while Radvision specializes in the “behind-the-scenes” video architecture. To support this point, Cisco has placed orders for new Radvision products for delivery in the second half of ‘07.

Although Cisco is a major part of Radvision’s plans, the company also has strong relationships with IBM and Microsoft, among others. They are expanding relationships with 3G providers such as Nokia and Siemens. With the demand for video conferencing only increasing, I believe that this is a good time to buy Radvision.

Disclosure: SmartGuyAB is long RVSN

DXP Enterprises: Consolidating a boring industry

• Buy DXPE around 42.65

DXP Enterprises (NASDAQ: DXPE)  distributes heavy-duty pumps, power transmission and electrical equipment and other industrial supplies, largely to the oil, gas, and chemical industries. When you think “sexy”, this sure isn’t it. But DXP’s track record for growth and future potential more than makes up for it.

Growth over the last few years has been tremendous: revenues went from $161M in 2004 to $279M in 2006, and are on pace to exceed $350M this year. Net income grew 440% between ‘04-’06. The stock price has surged even more, going from $4.13 in 2004 to a high of $53.88 earlier this year.

Ok, so the company has had a great run. But I believe that there is much more to come. DXP’s growth has been driven in part by a strong oil and gas industry - which I don’t see faltering anytime soon. However, the real story here is industry consolidation.

Apparently, the distribution market for the specialized industrial equipment DXP sells is very fragmented. According to the company, sales of the top 20 distributors make up less than 10% of the market, and most distributors are family-owned. This is where DXP comes in. It’s been gobbling up companies left and right, buying up small operations with long-established products that have not been aggressive in seeking new business. They’ve already realized new pricing power: since 2004, gross margins have expanded from 24.5% to 29.8% in the latest quarter. CEO David Little, said recently that “we see more (acquisition) opportunities than we can act upon.” Through continued selective acquisitions, he seeks to grow DXP into a national industry force and billion dollar company. Given management’s successful track record for expansion, we don’t think this is unrealistic.

In order to continue this strategy, DXPE recently issued 1 million new shares at $47/share to pay down all its debt and provide new capital for acquisitions. The stock promptly dropped from $52+/share to its current level. Sporting a current market cap of $226M, a P/S under 1 and a forward P/E in the low teens, DXP is a core long-term holding of my portfolio, and this is a great entry point.

Disclosure: SmartGuyAB is long DXPE

Nintendo: A homerun in the fast growing video game industry

• Buy NTDOY.PK around 42.60

Nintendo (OTC: NTDOY.PK) manufactures hardware and software in the fast growing video game industry. Thus, the company makes the razors and the blades. More importantly, Nintendo is the only video game console maker with a profitable operation. On the game side, the company created such industry icons as Mario and Donkey Kong and launched franchises like The Legend of Zelda and Pokémon.

The video game industry has been growing gangbusters for the past decade. In fact, video game sales now rival sales of other major media including music, books, and movies. For those with a futurist bend, video games are sensory-rich experiential mediums evolving toward the inevitable virtual reality.

In addition to the exciting macro trend, Nintendo has recently taken center stage as a gorilla in the new console cycle. The Wii console offers revolutionary game play through controllers with sensitivity to full-scale motion. In English, this means Wii gamers swing the controller like a bat while playing baseball, or shadow box while boxing. This exciting development makes me believe the Wii is the new media killer app and will dethrone the iPod as the must have product of the times.

During the month of May, Nintendo continued it’s stronghold on the market holding down the two top spots for hardware sales with the Wii and handheld Nintendo DS, and lassoing four of the five top-selling game titles for the month. Also note that in Japan (a critical market for success) the Wii has outsold the PS3 fivefold and Microsoft’s Xbox 360 at a 2-1. One word comes to mind: domination.

The macro and micro story is firing on all cylinders, and a check under the hood reveals that Nintendo has the financials to support a solid long-term investment. The company had record operating profits of $1.91billion (FY ‘07), more than double FY ‘06. In addition, net income is up 77%.

I recommend nibbling on the stock whenever it pulls back. Keep your eye on Japanese interest rates because their rise will affect NTDOY, but not Nintendo’s super surging global growth.

Disclosure: SmartGuyDH is long NTDOY.PK

Comtech Telecommunications: Stellar track record and potential big contract

• Buy CMTL around 41.64

Comtech Telecommunications (NASDAQ: CMTL) sells specialized communications equipment such as satellite earth station modems and over-the-horizon microwave systems. Its products and services make possible voice and data communication in areas where terrestrial methods are inefficient or unavailable. Nearly 50% of their sales in 2006 were to the U.S. government, for whom they provide the army’s movement tracking system.

This is exactly the kind of equipment that will become increasingly important as we move to a more high-tech military, where it will be critical to be able to transmit large amounts of data from anywhere at anytime.

Comtech’s growth reflects this trend. Revenue has nearly quadrupled since 2002, and impressively, the bottom line has followed suit (see chart). The stock now a market cap of just under $1 billion, with over one-fifth of that in cash, and sports a P/E under 19.
The strong fundamentals and growth trajectory are great reasons to own Comtech for the long-term. But I believe that there’s a great short-term story here, too.

Comtech announced third quarter earnings on June 6, and the market didn’t react favorably. Despite beating analyst earnings expectations for the 14th time in 15 quarters ($0.71 actual vs. $0.54 estimated), the stock fell 10%. Revenue was a bit light ($119.4M vs. $121.9M), but apparently it was the drop in new order bookings and backlog (less than the year ago period) that sparked the sell-off. I believe this is deceiving, however, as Comtech looks poised to receive a huge new government deal.

On May 7, the Army issued the following intent to extend Comtech’s contract for its Movement Tracking System. The current contract was for 8 years and $418M expires in July. This new contract, which is expected to be formally announced as early as June 15, is for 3 years and $646M. By my calculations, this would equate to an additional ~170M in annual revenue.

Given its strong track record, balance sheet, and future prospects, the recent dip in Comtech presents an excellent buying opportunity.

Disclosure: SmartGuyAB is long CMTL

Covanta Holding Corporation: An overlooked area of renewable energy portfolios

• Buy CVA around 24.40

Covanta Holding Corporation (NYSE: CVA) operates waste-to-energy plants across the United States. The company generates one revenue stream from processing municipal solid waste, and a second from selling energy created from the waste. A Motley Fool writer likened the powerful two-punch revenue model to an imaginary one in which coffee bean growers paid Starbucks to pick up their beans, and then Starbucks made money again on the other side selling coffee created from the same beans.

As a strategic consultant with clients in the renewable energy industry, I am well aware that this sector is in the beginning of a nice multi-year (or multi-decade) bull run. Covanta is a hidden jewel in the space because Wall Street has been sun bathing in solar, blowing in the momentum of wind, and obsessing over ethanol. Although waste-to-energy is not as sexy as a Toyota Prius, Covanta’s financials have more juice: the company reported Q1 earnings of $0.08 per share (excluding non-recurring items), $0.07 better than the Reuters Estimates consensus of $0.01, and revenues rose 8.1% year-over-year to $330.2M versus the $310.9 M consensus.

One of the main drivers for this stock’s appreciation is growth. Covanta recently took a 40% interest in a new waste-to-energy partner in China, and they are exploring opportunities in the UK and Italy (two countries as hot on renewable energy as Wall Street). A keen investor knows that executing growth requires free cash flow, and Covanta has the green to make good on their plans. In the latest quarter, levered free cash flow (i.e., free cash flow minus payments of interest on debt and any dividends to preferred shareholders) was 14.2% of sales.

The main risks to Covanta’s success are capital expenditures and lead times. The cost of processing waste and generating energy is high. However, excellent free cash flow and long term contracts (e.g., waste processing and purchase power agreements) mitigate this risk. On another note, the time between proposing a new plant and generating revenue can take a few years. Thus, investors must be patient for new plants in China to begin hitting the bottom line.

Covanta’s PE and PEG are a bit rich here, but I think both growth and future earnings predictions are on the light side. Couple that with some exciting announcements about new domestic and international projects, and I think the stock has some nice room to continue powering ahead.

Disclosure: SmartGuyDH is long CVA