London Exchange Awaits Party Poker IPO

Certain events signal the height of fads, manias, and bubbles. Just think back five years ago when the New York Stock Exchange was considering an IPO. Is it any coincidence that the stock market peaked shortly thereafter? Whether it be the record number of technology sector mutual funds that opened in 1999, or Nasdaq traders quitting their day jobs, we can point to many events that, looking back, should have warned us that there was indeed a stock market mania.

While the company has yet to initiate the process, it is widely expected that PartyGaming, owner of the Party Poker online gambling site, could begin trading on the London Stock Exchange as early as this summer. Analysts have already begun to estimate such an IPO could fetch as much as $5 billion in market value, based on the company’s 2004 EBITDA of $350 million. If true, PartyGaming would find itself a member of London’s FTSE 100 index.

First it was the World Poker Tour (WPTE) IPO last year, and now Party Poker. Nobody should really be surprised, but the real question is, what can we deduce from this? Would a Party Poker IPO mark the top of a fad, or the beginning of what will become a cultural mainstay? Will WPTE turn out to be worth $19 per share, 16 times forward sales, and 106 times forward earnings? Highly, highly doubtful.

However, it’s hard, if not impossible, to know for sure and it certainly gets market observers and poker enthusiasts wondering. Can these companies make enough money to justify their equity valuations, and can those cash flows be sustained and grown long term? It should be interesting to see how it all plays out.

Is Martha Stewart Worth $1.75 Billion?

Martha Stewart Living Omnimedia (MSO) is trading at $35 a share, giving the company a market value of $1.75 billion. Short sellers covering and momentum players have contributed to this stock’s meteroic rise from $8 within the last 12 months. At today’s price the stock trades at 194 times 2006 earnings. Now, I’ll be the first to tell you I don’t really trust those estimates. I don’t think anyone really knows how much MSO will earn next year. There are just too many uncertainties to come up with an estimate that one should feel confident with.

What we can do is take a look back and see how this company did when business was great. Here are the historical sales numbers for Martha Stewart’s company. The 2004-2006 numbers are current estimates. MSO reports its full year 2004 numbers next week (Edit–2004 sales came in at $187 million – as reported on 2/23).

1997: $133 million
1998: $180 million
1999: $232 million
2000: $286 million
2001: $296 million
2002: $295 million
2003: $246 million

2004: $187 million
2005: $176 million
2006: $219 million

As you can see, this company has never had $300 million in annual revenue. The highest net profit margin the company has ever earned is 7.5 percent. This stock trades at 6 times peak sales! That translates into 80 times peak earnings! How long will it take MSO to get back to peak sales and profit margins? No way to know for sure, but it won’t be anytime soon.

Granted, this stock has not traded on financial metrics for a long time. It has been event driven recently; the jail sentence, the Mark Burnett “Apprentice” show, etc. Interesting side note — Burnett got 2.5 million options when he agreed to make the show. When he exercises them it will dilute the company’s owners by a whopping 5%, as there are about 50 million shares outstanding right now.

Eventually, this stock will once again trade based on how much money it can make. Judging from history, it looks like that might be bad news for shareholders.

Covering the Tivo Short

I’ve decided to cover my short position in Tivo (TIVO) a little earlier than expected. The stock was trading at $12 per share last year when it became fairly obvious that cable giants like Comcast (CMCSA) were not going to partner with Tivo, but rather build proprietary DVR technology into their own digital set-top boxes. This development left little room for Tivo to differentiate itself enough to outdual the cable companies in providing a soon-to-be standard feature.

With the premise that Tivo’s fundamentals were going to be in steady decline, and profitability was years off (if ever in the cards), covering the short wasn’t something I was really considering. However, with today’s announcement of Tivo’s 3 millionth subscriber, I once again found myself looking at the stock’s valuation. After a precipitous drop from $12 to $3 and change, the time has come to take my profits off the table.

The financials are still pretty ugly. Sales for 2005 are expected to be just under $200 million, with a net loss of approximately $25 million. Tivo has boosted marketing expenses recently as it realized that its partnership with DirecTV will become less and less valuable over time. As a result, it wouldn’t surprise me if sales come in ahead of expectations this year, but losses are higher than anticipated.

The losses are less of a concern given that Tivo has little debt and a sizeable cash position. Further funding may be required later on, depending on how well increased marketing spend boosts sales and its impact on margins, but for right now the company is okay financially.

With the stock up 5% on the subscriber figures, the market cap is about $300 million, or about $100 per subscriber. This valuation seems to be very reasonable to me, and I have a tough time making the case it should be lower than that. As a result, today I am moving on to bigger and better opportunities.

Martha Still Relying on “Insider” Trading

Rough life for Martha Stewart these days, right? Perhaps. But at least she is staying on top of her finances from prison. On December 14th, Martha sold 300,000 shares of her company’s stock, MSO, for a little over $27 each, netting proceeds of $8.2 million. This is surprising, not because selling doesn’t make sense (the stock has rallied from $8 to $33 a share) but because it seems to me that maybe inmates should be prohibited from trading stocks from jail. But what do I know?

Sirius/XM Valuations Top Clear Channel

December 7, 2004. Mark it down. Today’s the day when the combined market values of XM Satellite Radio (XMSR) and Sirius Satellite Radio (SIRI) reached $20 billion for the first time, topping that of terrestrial radio giant Clear Channel Communications (CCU), which Wall Street values at $19 billion.

Sirius and XM have about 3 million subscribers, a number expected to hit 30 million within 10 years. Investors really have no idea if that estimate will come to fruition, and if it does, how much revenue (and more importantly, profit) these companies will be generating.

What we do know, however, is what Clear Channel has that warrants a $19 billion market value. As of 12/31/03, CCU employs more than 35,000 people, owns 1,200 radio stations along with 39 television stations. They also own about 800,000 outdoor advertising billboards worldwide. CCU owns and/or operates more than 100 live entertainment venues across the globe. Cash flow, measured by EBITDA, for the last 12 months totaled $2.4 billion. Sales for 2004 should hit $9.5 billion, with net income reaching $800 million.

This comparison reminds me of the 1999-2000 bubble days when Priceline.com (PCLN) was worth more than the entire airline industry and AOL bought Time Warner.

Now, its true that 10 years from now SIRI and XMSR could prove to have been bargains at current prices. However, just be aware that today’s investors are not paying any attention to valuation (mainly because at this point we have no idea how much these companies will ultimately earn), and as a result, they are basically rolling the dice rather than investing in a business.

That said, individual investors seem to think their odds of profiting from satellite radio stocks are far better than the Powerball lottery or a craps table in Vegas. If you want to short these stocks, based on a valuation that cannot be justified, please restrain yourself. The momentum here is too strong in the short term for valuation to play a role. We’ve seen this as the stocks continue to rise in the face of multiple analyst downgrades based on valuation concerns.

Unlike the late 1990’s, the analysts are now doing their jobs correctly by warning that current prices don’t make much financial sense. So, it seems most have learned their lessons. However, as those of us who have followed the markets for many years know all too well, even when analysts are doing their jobs, investors can’t rely on their recommendations to make money. On that front, nothing has changed this time around.

More on Satellite Radio…

Sirius (SIRI) shares are up 20% after-hours after the company announced that Mel Karmazin, former head of Viacom, will become CEO. Increase in market cap due this development? $1 billion. Wow. Can one man really be worth that much money? Of course not, but investors are jumping on the bandwagon anyway. I just heard a projection that satellite radio will have 30 million subscribers by 2010. Once again, we can use this to try and justify a $14-$15 billion market value for SIRI and XMSR. With 30 million subs paying $10 per month, you get industry revenue of $3.6 billion. A 10% profit margin gets you net income of $360 million. So, these stocks trade at about 40 times 2010 earnings, if these assumptions prove accurate.

Investors Tuning In to Satellite Radio

The market is down today, but the satellite radio sector continues its ascent. XM Satellite (XMSR) and Sirius (SIRI) are seeing tremendous interest, mostly from retail investors looking to cash in on “the next big thing.” XM and Sirius today sport a combined market value of $13.5 billion, despite having never reported a single dollar in profit. Clearly, investors are betting on future earnings with this sector, but is there enough profit potential to justify the satellite radio market’s value at $13.5 billion today?

As usual, numbers can help us give color to the situation. While they can’t predict how the satellite market will play out over time, we can get a good idea of what the “upside” really is. According to the Department of Transportation, there are 200 million vehicles in the U.S. We’ll ignore the international markets for now, given that neither XM nor Sirius has hinted it will try and tackle those as of yet, probably for good reason. Even though prices of technology products and services tend to decline over time, we’ll assume that the $10 per month subscription fee will remain constant.

So, it’s relatively easy to determine the total market potential. If each and every car in the U.S. was equipped with a satellite radio, the industry would garner $24 billion in annual sales. Profit margins are tough to guess, especially when XM and Sirius are paying hundreds of millions of dollars to secure their content such as Howard Stern, Major League Baseball, and the National Football League. Leading radio companies such as Clear Channel and Cumulus Media net about an 8 percent margin, so we’ll use that as a guide to determine the total market’s annual profit potential: $1.9 billion.

These numbers are important because many investors who are buying these stocks today are not looking at the numbers behind the stocks, namely the extreme valuations already built into the share prices. Paying $13.5 billion today, for profit potential of $1.9 billion annually, seems excessive given that this assumption requires one to believe that every car, truck, and SUV in the country will eventually have a satellite radio. After all, only about 50% of households own computers and only 70% have cable television.

If we were to assume that in 10 years, half of all vehicles will have a satellite radio, the market will earn less than $1 billion in profit. So, investors today are paying 14x projected 2014 earnings. Clearly, a lot of people see this as a bargain. Only time will tell.