The focus of the April 2007 edition of SINLetter was spinoffs and I only considered companies that had either been spun off from a parent or were planning on spinning off a subsidiary. Hence I decided to feature EMC Corp (EMC) and Sally Beauty Holdings (SBH) in the April investment newsletter and very briefly looked into two other companies.
A subscriber suggested one of these companies to me and it is a REIT called American Home Mortgage Investment Corp (AHM). According to this subscriber, the subprime mortgage meltdown has adversely impacted other companies in the mortgage industry even though they have strong fundamentals and AHM happens to be one of these companies.
AHM has lost more than 25% of its value year-to-date even though it has very little exposure to the subprime market (less than 2% of its business) and insiders who already own 20% of the company have been buying shares on the open market. This company also had an annual dividend of $4.48 or a yield of over 17%. I asked a contact of mine in the mortgage industry about the company and he thought it looked like a solid company. However the reason I decided not to feature American Home Mortgage Investment was because of my continued negative outlook on the housing and mortgage industries. As I mentioned in the April newsletter,
“the sector is not likely to recover this year and any bounce in home builder or mortgage lender stocks is likely to be a dead cat bounce”
This is the reason I still hold put options on the mortgage lender Countrywide Financial (CFC) and I would have contradicted myself by starting an investment in AHM at this time. My caution about AHM appears to have been well founded since the company reduced its first quarter and full year 2007 forecast today and cut its dividend to 70 cents a share, dropping the dividend yield to 10.84%. The company was also downgraded by Bear Sterns analyst Scott Coren yesterday. I am going to continue exploring AHM and if I feel that the mortgage industry is near a bottom (it is impossible to call the absolute top or bottom), it may make it into a future edition of SINLetter.
The other company I briefly considered was one of the surviving CLECs Covad Communications (DVW). I recently had to purchase a dedicated T1 internet line for a business and I found that Covad had an excellent rate and a very friendly and knowledgeable sales team. I was intrigued by the possibility that Covad may make a comeback like CMGI did this year. The focus of the company used to be wholesale telecommunication services provided through partners like AT&T, AOL and Verizon but over the last three years, the company has shifted its focus to the retail side. Retail now accounts of 38% of total revenue when compared to just 5% three years ago according to Chris Dunn who used to be Covad’s CFO until he resigned on Tuesday.
An excellent rate for the consumer usually means low margins for the company and I was not surprised to see that the company has been posting losses for the last three years despite posting revenue gains every year. While the balance sheet is not as debt laden as its pre-bankruptcy days, it still has $173 million in short and long-term debt when compared to $81.5 million in cash and short-term investments. The company’s 2006 purchase of fixed-wireless internet service provider NextWeb is going to strengthen its retail focus and give it a foothold in the rapidly growing wireless ISP space. However the company expects to post a wider loss of $15 to $39.5 million in 2007, despite continuing to grow revenue and I decided to put Covad on the back burner for now.