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J.L. Halsey Makes Second Email Marketing Services Acquisition -- 10/13/05

Seeking to take advantage of its public currency and massive base of net tax loss carryforwards ("NOLs"), unknown J.L. Halsey (JLHY) has made two acquisitions in the email services space over the past several months. The result is by our estimates a nicely profitable, $20 million plus revenue business with strong growth and consolidation opportunities in the fast-growing email sector.

The successor to a physical rehab business that was closed during an industry shakeout in the late 1990s, J.L. Halsey has long been a debt-free public corporate shell looking for a new purpose. Armed with more than $25 million in cash and valuable NOLs, JLHY first popped up in May on our radar screen by acquiring email-marketing firm Lyris for $30.7 million in cash and notes. Lyris is best known for its robust in-house hosted email solutions, which have garnered more than 5,000 clients, including many "who's who" names. Lyris grew revenues 10% in 2004 to $12 million and posted $5.8 million in operating income.

Earlier this week, JLHY followed up this deal with the acquisition of EmailLabs for $16.7 million in cash (net of EmailLabs' cash on hand) and a $3.5 million earn-out. EmailLabs is best known for its hosted email solutions, and its revenues are poised to grow 50% this year to roughly $8.5 million after growing 80% in 2004. JLHY has not yet disclosed EmailLabs' bottom-line numbers.

Together, JLHY has created an email services firm with more than $20 million in annual revenues, strong bottom-line profitability, and just over $20 million in debt. Although the profitability of EmailLabs is not yet known, we estimate that the company is on a $4 million or more earnings run rate, if you assume reasonable public company expenses and the cost of the credit line. Thanks to JLHY's NOLs, the company won't be paying taxes on those earnings anytime soon.

We like JLHY's focus on the fast-growing email space, and the company has bought two important players with critical mass. Spam is a problem for the email marketing industry, but JLHY's two businesses - if run properly - should represent potential help for businesses and marketers struggling to manage spam overload and to get their emails properly delivered. If JLHY can innovate with smart product development in this area, the company's growth could significantly accelerate.

At 15x our estimated earnings for the company, JLHY is not expensive, particularly given its growth prospects. The real risk, however, is whether management can successfully integrate these businesses and keep them on track. Acquisitions of small businesses are often the most difficult to integrate, since these companies are often built around very important and passionate leading founders. In the case of both Lyris and EmailLabs, the founders are using these sales as their exit strategies.

Furthermore, on the topic of management, no member of JLHY's upper team appears to have a specific expertise in either the email or technology realms (although Lyris is still being run by a senior executive who was there prior to the acquisition). We've attempted to contact JLHY to learn more about its management, but the company has not returned our calls.

Thus, to sum things up, we think JLHY is certainly worth watching and doing more work on. If and when positive visibility emerges on the quality and operating capabilities of the firm's key team members, the stock could be an interesting play for small-cap focused investors.

As always, we'll keep you posted.

J.L. Halsey Corporation Acquires EmailLabs.



Smart Money Flexes Muscles in Battleground Homebuilder Stocks -- 10/13/05

Since hitting an all-time high in late July, the Philadelphia Housing Sector Index (^HGX) has fallen more than -18% as fears of a real estate bubble burst have played into the hands of bears. Heavy insider selling in the sector combined with less-than-positive sector and company-specific data has also helped drop most homebuilder stocks below their 200-day simple moving averages. With this backdrop, it's interesting to note that at least one major hedge fund is making what appears to be a contrarian bet on homebuilders.

Tontine Partners, a smart money hedge fund with heavy exposure to homebuilders such as Centex (CTX) and KB Homes (KBH), disclosed yesterday that it has increased its stake in Beazer Homes (BZH) from 5.2% at the end of 2004 to 9.9%. The firm, led by Jeffrey Gendell, was last buying shares of BZH in a range of $58.29 to $60.67 from August 29th to September 1st. Tontine is now calling on BZH to repurchase stock to close a "valuation gap" between it and its peers.

"As you are aware, Tontine Partners, L.P. and its related affiliates have been active investors in both the homebuilding industry and BZH for a number of years. As a result of such investment interests, we have had the benefit of observing the dramatic growth and development of the industry and its participants, particularly over the past six years, a period in which the publicly traded homebuilders have experienced unprecedented geographic reach and earnings expansion. Given the above perspectives, we believe that such significant growth, both in terms of operational scale and financial metrics, necessitates the continual evaluation of the optimal allocation of capital between internal growth initiatives and return of investment to a company's shareholders. In other words, we strongly believe that industry participants, including BZH, are increasingly finding themselves in a position of generating earnings and cash flow meaningfully in excess of the amount of capital they can prudently reinvest in operations. Furthermore, based on current market conditions, the notion that it is cheaper to 'buy land on Wall Street' than it is to 'buy land on Main Street' has never been more clear," Gendell wrote in a letter to BZH CEO, Ian McCarthy, dated October 11th.

"In light of the above, as we evaluate our investment in BZH, it has become very evident to us that immediate steps need to be taken to address this notion of optimizing the allocation of the Company's growing capital base to include a significant share repurchase program (above the nominal share buyback initiative the Company currently has in effect)," Gendell continued. "Furthermore, given the Company's current valuation relative to its peers and the market in general, we believe such a repurchase program would be an important first step toward closing this growing 'valuation gap.'"

"As one of BZH's largest shareholders, we have exhibited a great deal of patience with and support for management over the period of our investment in the Company. We have, however, reached the conclusion that the time has come to express our views in a more formal manner, of which this letter represents the initial step in such process," concluded Gendell.

Tontine is a fund that we've tracked for sometime now. We've seen Gendell & Co. pressure iron ore producer Cleveland-Cliffs (CLF) to buy back stock, and we noted the firm's overweight stance on homebuilders and financials as of the end of the second quarter. Ever the contrarian, Gendell also amassed an over 5% stake in the parent of American Airlines (AMR) last month.

Tontine's outlook is obviously contrary to where we stand, but it isn't the only proven smart money investor sticking with their homebuilder longs or building new positions. According to a fresh filing, Ken Griffin's Citadel Investment Group now holds an over 5% stake in KB Home (KBH). Citadel has more than doubled its stake in KBH since the end of Q2. The hedge fund giant also owns smaller stakes in DR Horton (DHI) and Toll Brothers (TOL).

Given our basket of subprime mortgage shorts (LEND, NDE, and HRB), we regularly receive subscriber emails asking us if we'd be trying to play any of the homebuilders from the short side. While there may be some opportunities for nimble traders, we prefer to steer clear of these "battleground stocks", which not only have had high short interest levels for several years now and are prone to squeezes, but also have committed and smart longs.

That's not to say that homebuilder bulls like Gendell and Griffin won't be wrong, but something tells us there are easier fish to fry and our time is best spent elsewhere.
So far today, BZH is off -1.6% to $52.84, KRB is nudging up 7 cents to $24.57, TOL is down -2% to $36.80, DHI is basically unchanged at $31.38, and CTX is off -1.2% to $59.07.

Real Estate Market Shows Cooling Signs. (10/4/05)

Cleveland-Cliffs Announces Acquisition, Investors Clamor For Buyback. (1/18/05)

Looking Over The Smart Money's Shoulder. (8/16/05)



Market Works To Price In Corporate Earnings Weakness Ahead -- 10/12/05

The market is continuing to punish stocks across the board today, with all of the major indexes deep in the red. This selling extends a recent ugly streak that has pushed the S&P down -5% and the Nasdaq down -8% from their August highs. Year to date, the S&P is now down -2.9%, while the Nasdaq is off -6.2%.

The damage is even worse beneath the surface. For example, yesterday there were only 10 new highs on the NYSE compared to 306 new lows. On the Nasdaq, there were just 9 new highs against 188 new lows. Capitulation selling is becoming increasingly evident, with many highfliers down -10% to -20% over just the past week or two. On top of that, the market's once stalwart leadership (i.e. primarily the energy group) has come under fire. Without a leader like energy, it's not clear if the market can get back on track in the near term.

As usual, all of the talking heads have a reason for the sell-off, ranging from the Fed's continued verbal jawboning of inflation, worries about the Republican mandate in Washington, and growing concerns about the muscle of consumers and real estate. Take a quick look at the retail sector, or our subprime mortgage shorts (NDE, HRB, & LEND), and you'll see that there has been intense selling.

In our view, while all of the above factors are real, none of them are new. In fact, as subscribers, you've heard us talk about each and every one of these potential headwinds for upwards of a year now.

What's powerful now, however, is that investors are finally starting to do the math and are realizing that their double-digit growth estimates for 2006 corporate earnings are looking mighty lofty in the face of rising cost pressures, soaring energy costs, increased cost of capital (i.e. interest rates), and a possible inverted yield curve. Indeed, second-half 2005 earnings should also come under increasing pressure, particularly for non-energy sectors.

Add it all up, with interest rates rising, and earnings slowing or even starting to fall, it's not surprising that stock prices are feeling the pressure. The key to managing a portfolio through a storm like this to minimize your exposure to stocks that will feel cyclical headwinds (such as banks who are facing tighter yield curves or retailers who could see lower consumer demand), while focusing on sectors with clear growth drivers and stocks with attractive company-specific attributes. We're also believers in having at least some short side exposure to provide a partial portfolio hedge.

We believe that the market is still in the early stages of pricing in the potential risk to 2006 earnings and economic growth (we still think a first half 2006 recession is very possible), so you're not likely going to see us pull out our bull horns anytime soon. Still, we view market sell-offs like this as an opportunity to pick away at stocks that we like when they get thrown out with the bath water. See our recent purchases of Teekay (TK), Lone Star Technologies (LSS), Sasol (SSL), and Barnes & Noble (BKS) for example.

Interestingly, we could foresee a scenario whereby the Federal Reserve and high energy prices become less of a market boogeyman over the next couple of months. In our view, the Fed is mostly concerned with slowing housing, not totally killing inflation. As such, I think many of the recent inflation hawk comments out of the Fed could be its way of verbal jawboning the market (i.e. tough talk is often the equivalent of an actual interest rate hike, if a central bank has market credibility - which Greenspan still does).

Thus, IF we get some additional near-term data points pointing to a slowdown in housing, the Fed very well could turn out to be in the ninth inning of its rate hike campaign. Add on an easing in energy prices (as real demand destruction continues to emerge), and two of the biggest market headwinds may start blowing less strong.

Again, this is just a scenario, but IF interest rates and energy become less significant issues and stocks are repriced properly to reflect likely 2006 earnings, the market could reach a point of stability sometime before year-end. While this may not be enough to make us Raging Bulls on stocks, it would certainly make us more constructive on the market than we've been in more than a year.

As always, we'll keep you posted.

Fed Saw More Rate Hikes Ahead (press release)

Negative Housing Data Points Start To Emerge (9/19/05)

Technology Aside, Most Market Sectors Look Challenged (9/16/05)


Tracking And Profiting From Smart Money-Led PIPE Financings -- 10/10/05

As longtime subscribers know, hedge fund manager Jeffrey Gendell of Tontine Partners is one of the low-profile, smart-money investors that we like to track. Gendell isn't widely discussed by the financial media, but he is one of the sharpest investors on Wall Street.

Thus, I was intrigued by the announcement last week that energy-sector levered construction and repair and maintenance company Matrix Services (MTRX) had completed a $15 million private placement. The company's press release didn't say who the investors were in this raise, but I remembered that Tontine was a large holder of the stock and had been steadily accumulating shares in the liquidity-challenged small cap.

Ahead of the financing, Tontine held an over 12% stake in the company and had last been an open market buyer of the stock at the $4.50-$4.64 level back in June. Prior to that, Gendell's fund had been adding to its position at the $7.90 level back in February.

In digging through the filings MTRX made in the wake of its private placement financing announcement, it was disclosed that Tontine had initiated and led this $15 million raise. MTRX sold 2.3 million shares of common stock at a price of $6.50 per share, which represented a -20% discount to MTRX's closing price directly ahead of the announcement. There were no warrants issued in conjunction with the stock sale.

I became even more intrigued with Gendell's decision to pump more money into MTRX shares, which were already up 60% from its summer lows, after I read a "side letter agreement" that he had signed with the company. The letter said that Gendell agreed not to wage a proxy battle or try to influence/control the company until the earlier of October 3, 2007 or Michael Hall no longer serving as MTRX's CEO. Hall was previously MTRX's CFO and was brought out of retirement earlier this year to turn the company around. He has been focused on improving MTRX's liquidity, margins, and risk profile.

It is interesting to see Gendell agree to these terms since he has a quite established track record as an activist shareholder and has shown that he isn't afraid to "go hostile" when need be. The fact that he was willing to agree to this condition to raise his stake in the company up to almost 17% suggested to me that 1) he was confident and comfortable with Hall and 2) felt there was significant additional gains to be had in the stock.

Unfortunately, I didn't dig into the filings on MTRX and this private placement until the night of October 5th, after which I realized that MTRX was reporting its quarterly results the following morning. I went to bed wondering if Gendell had just craftily upped his stake in the name directly ahead of an earnings report that would send the stock higher.

Indeed, this is exactly what happened. MTRX's fiscal Q1 results (ended August 31) demonstrated that the restructuring program the company had put into place earlier this year was gaining momentum. MTRX also made positive comments on its call about additional asset sales, securing more permanent debt financing, receiving a tax refund, and gave a bullish outlook on new contract demand in the wake of energy infrastructure damage from Hurricane Katrina and Rita. MTRX was awarded a contract in May worth $97 million to construct three liquefied natural gas ("LNG") tanks for Cheniere Energy's (LNG) Sabine Pass LNG facility. MTRX is bidding on additional LNG tanks deals.

MTRX shares closed last Friday at $8.90, up 10% since the private placement announcement and a quick gain of 37% for Tontine and the other hedge funds that were in this raise. MTRX shares are up 3.3% to $9.20 per share so far today. While I wouldn't be chasing the stock here and this remains a high-risk idea, in a cyclical business that is notorious for thin margins and costly delays/cost over-runs, the stock would appear to still have multiple catalysts ahead. I wouldn't be surprised to see MTRX trade up to the low teens over the coming quarters on its deleveraging progress and improving fundamentals.

MTRX is a prime example of why it can pay to keep tabs on PIPE (Private Investment in Public Equity) financing announcements, particularly when the deals involve proven smart-money investors, such as in the case of MTRX. Ideally, you want to look at stocks that just completed PIPEs where the deal was just for straight common stock and the stock was sold at just a modest discount to the market price (20% is a wide discount).

PIPEs that are for convertible or preferred securities or are common stock deals with a large amount of warrant coverage generally aren't as interesting an opportunity. These are often situations where the institutional investor is getting to invest on terms that are far more attractive than what you'd have to pay for the stock. In other words, never buy a stock just because a smart money investor happens to pop up in a placement, and avoid PIPEs that involve convertible securities with adjustable conversion prices. "Toxic" PIPEs were frequent among troubled small caps a few years ago after the market crash.

Finally, even if the private placement terms are similar to if you had just gone out and bought the stock on the open market (i.e. a simple PIPE of straight common stock at a discount like with MTRX), this doesn't mean that the stock is going to turn out to be a winner in time. Even smart investors make mistakes and can dig larger holes for themselves by going back to the well on a losing position via a private placement.

Also keep in mind that the risk profile on companies that do PIPEs is generally higher than non-PIPE companies. After all, companies that choose to quickly raise money via PIPEs generally do so because they aren't on very strong financial footing for whatever reason.

Bottom line, as is the case with tracking insider buying activity, overall I have found value in keeping tabs on the PIPE activity of smart-money investors. Tracking PIPE announcements are yet another source for new idea flow and homework starting points.

Matrix Closes $15 Million Private Placement of Common Stock.

Watch What They Do, Not What They Say. (9/21/05)

As Airline Sector Bleeds Red, Some Smart Money Emerges. (9/14/05)


Mortgage REITs Worth Watching, Not Time To Buy Yet -- 10/10/05

In the wake of the complete breakdown of the mortgage REIT sector, I wanted to quickly revisit two of the stocks in the group and share my latest thoughts. Recall that we turned bearish on mortgage REITs in September 2004, put on a profitable Annaly Mortgage (NLY) short in May (against a long hedge), and moved to the sidelines in July.

The crash in mortgage REITs has been quite remarkable, providing a lesson in both the ignorant and whimsical nature of much of Wall Street.

For example, after nearly touching $20 in late May 2005, NLY now trades for just $12.15 per share, a decline of nearly -40%. The reason? Due to a flattening yield curve, NLY cut its dividend in Q1, Q2, and again in Q3. Citigroup now believes that it's possible that NLY could briefly suspend its dividend sometime in the next couple of quarters (it's estimating a quarterly dividend of 5 cents per share in Q1 2006, down from over 40 cents in Q2).

What's amazing is that anyone paying attention to the yield curve could have foreseen a drop in NLY's short-term earnings power. Instead, yield-starved investors only cared about the high rear-view mirror dividend payouts, in the process ignoring the significant risks to their underlying investment.

Now most, or all, of these stocks trade at or below their book value. For example, Anworth (ANH) now trades at -22% below its end of Q2 book, while NLY trades at a -2.3% discount. Both firms most likely saw a drop in their Q3 book value (due to a decline in bond values in their leveraged portfolios), but either way it's obvious that Wall Street has repriced the sector significantly lower.

Moving forward, we think it's worth keeping an eye on these stocks, but they're not worth buying yet. Further earnings pressure and tax loss selling into year-end will likely keep the pressure on both stocks.

Beyond that, we're always open to buying into pools of capital at a discount to their intrinsic book value. Note that the book value of these companies is made up of mortgage-backed securities that can easily be liquidated. When their stocks start trading below book value, the managers can choose to accretively buy back stock instead of holding mortgage-backed securities.

There are two primary names that we like to keep an eye on in this large sector: NLY and ANH. NLY is the best-known stock in the group, and is run by an excellent management team. The fund takes little yield curve risk and zero credit risk, and usually trades at a premium to the sector. NLY also owns a growing asset management business called FIDAC, which we estimate is worth between $1 to $1.50 per share on top of book value. At $11.50 to $12 per share, we'd become interested in buying the stock for medium- to long-term focused accounts.

ANH is a riskier play, as it has preferred equity in its capital structure as well as a mortgage origination business. Both of these mechanisms are beneficial to earnings when times are good, but they increase the balance sheet risk in times like today. Still, we think the fund is relatively well run, and relatively conservative compared to most of its peers (beware of funds with capital structures that have a lot of preferred or other non-repurchasable debt). ANH has already begun buying back shares, and we would expect the fund to continue doing so at the same time it starts to shrink the size of its balance sheet.

To sum things up, it's worth highlighting what Wall Street is thinking regarding the prospects for NLY's shares. To quote Citigroup, "As we move closer to the end of the Fed rate hike cycle, the argument for NLY's shares becomes more compelling, yet we believe it is still too early to get more constructive. We are lowering our 12-month target price for NLY's shares to $10, down from $13. We base our target price on an assumed 0.85x price-to-pro forma book value and a 10% yield on our 2007 dividend estimate. Previously, we assumed a 1.1x price-to-book for NLY's shares, but we believe a more conservative valuation is appropriate at this point, given the continued flattening of the yield curve and the Fed's more hawkish posture."

If you want to make money, the key is to get in ahead of when Wall Street gets "more constructive." In this case, we don't know when the yield curve will normalize, and could foresee tough conditions well into the middle of next year. That said, if you can pick up an NLY at a -10% to -20% discount to its intrinsic value (book + value of FIDAC), you can get enough of a margin of error to sit and wait patiently.

Again, with year-end tax loss selling and the potential inversion of the yield curve possibly lurking for late in the year, we could very well get a scenario whereby you could very cheaply pick up an NLY. ANH is also worth watching, but we don't like layering on that extra risk at this point in the cycle.

As always, we'll keep you posted.

Annaly Mortgage Slashes Dividend. (9/16/05)

ALERT: Special Opportunity Portfolio Closes Out Mortgage REIT Hedged Trade. (8/3/05)

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