SINLetter - July 2008

Welcome to edition 35 of Suria Investment Newsletter (SINLetter), a free monthly investment newsletter. The objective of this newsletter is to provide you with unbiased initial research and basic facts about individual stocks and other financial instruments so that you can research them further before deciding to add them to your portfolio or not. If you are reading this and are not a subscriber, you can subscribe by going to www.sinletter.com/subscribe.aspx and you will start receiving this newsletter from next month. I have provided relevant links throughout this newsletter, but if you have any questions or comments, feel free to write to me.


Portfolio Performance:

They say, "be careful what you wish for, lest it come true". I started June by writing,

"Something is not right about this market. The consumer sentiment index is at the lowest level it has been in almost 28 years, GDP growth in the last two quarters was an anemic 0.6% and 0.9% (revised upwards), weekly jobless claims have been rising, three regional banks have failed since the start of the year and the number of banks on FDIC's list of "problem banks" have jumped in the second quarter of 2008. To top it all food and energy costs are increasing rapidly but are not completely reflected in (the) official inflation number of 3.9%. Yet the market barely flirted with a 20% correction from the highs set in early October and has actually recovered almost half of those losses."

It looks like I got my wish when the Dow Jones Industrial Average delivered its worst June since 1930, the start of the great depression. Having 82% of the portfolio at the start of June in long positions certainly hurt our model portfolio as well. The cash position and an ultrashort position on the Russell 2000 index (TWM), helped soften the blow a little as you can see from the portfolio performance table below. We still had a loss of 7.36% for the month, which was a little better than the loss the rest of the market suffered.

Performance Metric Dow S&P 500 Nasdaq SINLetter
June 2008 -10.19% -8.6% -9.1% -7.35%
Second Quarter 2008 -7.44% -3.23% 0.61% -3.60%
Since Inception (Aug 2005) 6.84% 3.61% 4.45% 96.75%


SINLetter June 2008 Portfolio Performance

It also did not help that our pick from last month Textron (TXT) took a hard hit in June with a 23.37% drop. Textron tightened its second quarter earnings outlook to a range of 93 to 98 cents from its earlier forecast of 90 cents to $1 per share. The street was not very pleased with the 2% reduction to the high end of its forecast and promptly punished the stock with a loss of 17.6% through the second half of June. The company lowered its forecast because it expects to increase loan loss provisions at its finance arm to about $20 million. Analyst expectations for the second quarter were 98 cents a share but have since been lowered to 96 cents. The company reports second quarter earnings on July 17th.

Despite the turmoil in the markets, Lionsgate Entertainment (LGF) has held up well over the last few months and is posting a gain of 10.1% since we added it to the portfolio in March. If you are an investor in Lionsgate or have the company on your watchlist, I highly recommend checking out the article titled Lionsgate Entertainment: Misunderstood, Too Cheap to Ignore by Andrew Arons on SeekingAlpha.com.

A depressed stock market and worries about inflation gave Gold a nice boost in June. The precious metal closed the month at $924.10 per troy ounce, a gain of $47.1 or 5.3% for the month.

Portfolio Readjustment:

As discussed below I am going to add 10,000 shares of Towerstream Corp and 500 shares of Umpqua Holdings to the model portfolio. This will draw down our cash position to $16,206 or 8.24% of the model portfolio.


Towerstream Corp. (TWER) $1.27

The Story:

Once upon a time there existed a giant telecom company called AT&T Corporation that was the target of a 1974 antitrust lawsuit, which eventually resulted in the company breaking up into seven regional operating companies called the "baby bells", a long distance company and a computer company called AT&T Computer Systems. While this antitrust lawsuit broke AT&T's national monopoly, the regional baby bells still held access-monopoly to the consumer's household through what is commonly referred to as the last mile in the telecom industry. Traditionally the last mile is the copper line that leads into your house or business from the telecom network.

The Telecommunications Act of 1996 created a uniform national law that allowed new telecom companies called Competitive Local Exchange Carriers (CLECs) to compete against the incumbent baby bells like Verizon and SBC Communications by giving these new telecom companies access to the "last mile" and the ability to resell the networks of the baby bells. This law led to a slew of new telecom startups like Covad and Allegiance Telecom as well as spurred growth at companies like XO Communications and McLeod USA. After the crash of the dot com bubble and the ensuing "telecom nuclear winter" that resulted from the capacity hangover of the late 90s most of these CLECs went bankrupt.

The problems that plagued the CLECs were not just limited to the huge debt loads some of these companies acquired in the quest to build capacity that would support the expected bandwidth hungry applications but also extended to issues around their interaction with the incumbent telecom companies. For example if you ran into an issue with your Covad T1 internet connection, the problem could be at your physical location (has to be serviced by the baby bell telecom), at Covad's end or at AT&T's end. Despite these disadvantages the surviving CLECs do provide service at reasonable rates and often tend to provide service much faster than the baby bells. In my personal experience I have seen the baby bells ask for as much as a month to put in a new T1 line when compared to a week for a CLEC. Obviously in this day and age when internet service is as critical if not more critical than having phones, a month can seem like an eternity for a new business or one that has recently moved to a new location.

Wireless service providers have started carving a niche for themselves that addresses not only the last mile problem but also promises faster installation (often in 48 hours) and better redundancy. One such company that provides high speed wireless access to businesses is Rhode Island based Towerstream Corp. I came across Towerstream almost 2 years ago while doing some research on WiMax equipment provider Alvarion (ALVR) and also mentioned the company in a blog post titled Hedging Your WiMax Bet. The company came to my radar once again a few months ago when a Towerstream sales representative out of their San Francisco office contacted me shortly after a Covad outage hit the San Francisco bay area. It looked like the company was pricing its products competitively and was aggressively expanding in major metropolitan areas.

A couple of weeks ago I noticed that a Towerstream installation contractor was putting up a wireless access point for a neighboring business that had just signed up for their service. I checked out the access point and it was made by Canada based WiMax equipment provider Redline Communications (RDL.TO). I started talking to the contractor and he was more than happy to answer my questions and even tried to show me the line of sight from the access station to Towerstream's base station on one of San Francisco's skyscrapers. He told me that Towerstream is using three base stations (two in the City and one across the bay in Oakland) to provide redundancy in San Francisco. It was interesting to learn that he had his hands full with installations for Towerstream and could barely keep up. He mentioned that things were very slow a couple of years ago when Towerstream entered the San Francisco region but after the company ramped up its sales team in California, installations have increased rapidly over the last few months. In terms of equipment, Towerstream is primarily using equipment made by privately held Aperto Networks and portfolio holding Alvarion (ALVR).

Stock History and Numbers:

Towerstream became a public company through a reverse merger with a shell company called Universal Girls Calendar. This method of going public (also adopted by portfolio holding WisdomTree Investments) is both quick and cheap and has been gaining more respect in recent years. The stock closed its first day of trading on the Over The Counter Bulletin Board at $7.75 on January 26, 2007 and started trading on the Nasdaq at the end of May 2007. The stock has been on a slow and steady decline since going public and currently trades at $1.27 per share. The big WiMax joint venture announcement by Clearwire (CLWR), Sprint (S), Google (GOOG), Intel (INTC) and Comcast helped energize the shares a little in May. While Clearwire has been getting all the attention as a WiMax service provider, TowerStream, which targets businesses instead of consumers, continues to remain under the radar.

Net revenue at Towerstream grew 31.7% to $2.08 million in the first quarter of 2008 when compared to the first quarter of 2007, while net loss widened to $3.61 million when compared to $1.64 million in the same period last year. Churn rate (customer discontinuing service) remained a low 1.35% when compared to 2.03% in Q4 2007 and 1.27% in Q1 2007. Beyond revenue growth, I think the most encouraging sign is that ARPU (average revenue per customer) for new customers increased to $842 when compared to $767 in the previous quarter. Gross margins decreased to 53.1% when compared to 58.1% in the previous quarter due to expansion into new markets. However the drop in prices of WiMax equipment and economies of scale should help the company improve its gross margins in the future.

The company expects to become EBITDA positive on a per market basis by end of Q1 2009. With over $36 million in cash, just $2.5 million in long-term debt, healthy gross margins and a quarterly cash burn rate of under $5 million, the company appears to be positioned well to reach its EBITDA positive goal in 2009. Towerstream sports a market cap of $43.89 and an Enterprise Value (market cap - cash + debt) of $10.43. Assuming conservative sales of $8 million for 2009 (flat quarter over quarter growth), we get an Enterprise-Value-To-Sales ratio of just 1.30. The company appears to be very attractively valued at these levels provided it continues the sales momentum it has built in recent months.

TWER 1 year chart


Conclusion:

All the usual risks that go with investing in microcap stocks such as high volatility, low daily volumes, potential delisting, low visibility, etc.. are in play with Towerstream as well. Please do your own due diligence before taking any actions. I am adding 10,000 shares of Towerstream to the model portfolio (one of our strongest position sizes to date) and also plan on initiating a position in my personal portfolio after this newsletter goes out to subscribers.


Umpqua Holdings Revisited (UMPQ) $12.13

Almost five months after writing about Umpqua Holdings (UMPQ) in a section of the February investment newsletter titled Umpqua Holdings: Can the free cookies last?, I have decided to make the leap and add Umpqua Holdings to our model portfolio. Like the rest of the financial sector and especially regional banks in recent weeks, the stock has taken a hard hit. The stock is now down over 28% from when we added it to our watchlist on February 1st at a price of $17 and down more than 50% from its 52 week high of $24.80. The weakness in the housing sector is far from over and we may be at the brink of a bear market but things appear to be stabilizing at Umpqua.

In an encouraging sign, Umpqua saw a decrease in both non-performing loans and non-performing assets last quarter. The company got a boost last quarter from the $12.6 million sale of Visa (V) stock and the reversal of a $5.2 million litigation reserve the company had set up in the fourth quarter related to Visa's settlement with American Express. With such one-time gains unlikely when the company reports second quarter results, year-over-year comparison with second quarter 2007 earnings of $19.91 million is going to be tough. However comparisons will start getting better in the second half of this year and since investors are "forward looking", it may be a good idea to initiate a starter position in Umpqua at this point and pick up more after second quarter results are announced later this month. Umpqua's dividend yield of over 6% is also attractive and the CEO has reiterated over the last two quarters that he does not see a need to cut the dividend.

UMPQ 1 year chart

I had an interview scheduled with the CEO of Umpqua Holdings, Ray Davis, last Friday but then had to reschedule the interview because it was so close to the end of the second quarter. I hope to be able to interview him after second quarter results are released on July 17th. For now I am going to add 500 shares of Umpqua to the model portfolio and will also initiate a position in my personal portfolio after this newsletter goes out to subscribers.


Every month we add featured stocks into a model portfolio started with a cash position of $100,000 on August 2, 2005. To keep calculations simple, trading costs and regular dividends are not included. Prices reflect the closing price as of the last trading day of the previous month (May 31, 2008 for the June 2008 newsletter).

Model Portfolio - June 30, 2008

Long Stocks

Stock Symbol Number of Shares Cost Current Value Diff ($) Diff (%) Date Added
Towerstream TWER 10,000@$1.27 $12,700 $12,700 $0 0% 6/0/2008
Umpqua UMPQ 500@12.13/share $6,065 $6,065 $0 0% 6/30/2008
Textron TXT 150@62.55/share $9,382.5 $7,190 $-2,193 -23.37% 5/31/2008
Companhia Siderurgica Nacional SID 200@43.15/share $8,630 $8,882 $252 2.92% 4/30/2008
Lionsgate Entertainment LGF 1,000@9.41/share $9,410 $10,360 $950 10.01% 2/29/2008
Tata Motors TTM 500@17.52/share $8,760 $5,025 $-3,735 -42.64% 2/29/2008
Barclays PLC BCS 200@42.27/share $8,454 $4,630 $-3,824 -45.23% 11/20/2007
Powershares Water Resources PHO 400@22.10/share $8,840 $8,284 $-556 -6.29% 10/31/2007
Marcus MCS 500@19.94/share $9,970 $7,475 $-2,495 -25.03% 9/14/2007
Ultrashort Russell 2000 TWM 50@71.00/share $3,550 $3,940 $390 10.99% 9/7/2007
Blockbuster BBI 3,000@3.925/share $11,775 $7,500 $-4,275 -36.31% 7/9/2007
Unilever Plc UL 200@32.53/share $6,506 $5,682 $-824 -12.67% 5/11/2007
EMC Corp EMC 600@13.85/share $8,310 $8,814 $504 6.06% 3/31/2007
ICON Plc ICLR 150@37.30/share $5,595 $11,328 $5,733 102.47% 1/31/2007
Diamond Offshore Drilling DO 80@76.65/share $6,132 $11,131 $4,999 81.53% 1/3/2007
Alvarion ALVR 1000@6.87/share $6,870 $7,060 $190 2.77% 1/3/2007
WisdomTree Investments WSDT.PK 1000@7.40/share $7,400 $2,300 $-5,100 -68.92% 11/30/2006
Teva Pharmaceutical TEVA 300@35.05/share $10,515 $13,740 $3,225 30.67% 9/1/2006
Suntech Power STP 250@25.93/share $6,483 $9,365 $2,882 44.47% 7/31/2006
Procter & Gamble PG 180@55.60/share $10,008 $10,946 $938 9.37% 6/30/2006
Johnson & Johnson JNJ 200@57.65/share $11,530 $12,868 $1,338 11.6% 2/28/2006
Medifast MED 1000@6.955/share $6,955 $5,260 $-1,695 -24.37% 11/30/2005
  Cash     $16,206.5      
  Total     $196,750 $96,750 96.75%  

 

Voluntary Disclosure: From the stocks that are currently in the model portfolio, I own shares of Lionsgate Entertainment (LGF), Tata Motors (TTM), PowerShares Water Resources (PHO), Barclays (BCS), Medifast (MED), Suntech Power (STP), Teva (TEVA), Alvarion (ALVR), WisdomTree (WSDT.PK), Unilever (UL), BlockBuster (BBI) and Marcus (MCS).

 

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