As a value investor, oen of my faovurite places to look for value is among the most out-of-favor sectors in the market.
In order to obtain maximum margin of safety, one must buy when irrational seeling is at a peak.
Ideally, illiquidity and disgust will pair up in tandem pugilism.
Right now, technology is in a bear market.
One key theme is business customers are putting off purchase decisinos today in order to minimize epxenses in the near term.
However, over the long run, this is bad management decision, and in the long run the purchases that need to be made will be made.
Based on A/R quality, cash conversion cycles, two businesses are my favourites in e-business integrators.
Proxicom and Diamond Cluster.
Both have positive cash flow, minimal exposure to dot-coms, rather Fortune 500 companies.
DiamondCluster has the best margins and working capital managmeent in thebusiness.
Management is quite strong, nearly half of business comes from oevvrseas.
Half the business comes from overseas, away from the North American metldown.
Dot-come exposure is less than 2%.
The balance sheet is pristine, with more than $150m cash (5/share) and no debt.
Backing out excess cash, DiamondCluster trades 10x newly lowered estimates, it reached cash profitability at a lower revenue than any competitors, and will remain solidly profitable despite the currnet downturn.
As a value investor, I aam quite used to buying cyclicals as the downturn loosk most dire, but before the actual bottom is hit.
The stock is something of afalling knife, rapidly accelerating its descent.
Fundamentally, the metrics look good.
The company is maintaining revenue per billable of $350,00, over 50% higher than prominent comparables.
The intrinsic value of this company is double curren levels, even using ocnservative growth estimates, well below those provided by the company.
The stock is priced as if the earnings will grow only 10% annually for the next 10 years, before falling to 6% growth.
A sharebuyack is underway, as it should be.
Whenever a company has an opportunity to purchase $1 of intrinsic value for 50 cents, it should do so.
Management continues to target annual 30% revenue growth long-term.
Intelligent investors would never take these growth rates, extrapolate a value from them, and call out "margin of safety."
But intelligent investors should be able to also look across the valley and see an opportunity for capital appreciation in a long-term hold from these levels.
Buying 500 shares at 14.75.
Later said DiamondCluster was a very big timing mistake.
I should note that DiamondCluster is about to lose significant European business because of Ericsson’s (ERICY, news, msgs) cost-cutting and the European slowdown. This non-U.S. business had shielded DiamondCluster from some of the rampant devaluation in the e-consultancy sector. Not anymore. Nevertheless, I expect both layoffs and quite significant cash drain over the coming quarters at DiamondCluster. At current prices, however, this pessimism is largely discounted. Whether DiamondCluster will recover before the end of the Strategy Lab round is a matter in serious doubt. Moreover, DiamondCluster has a big options compensation problem, much as I described with Adobe. Nevertheless, the value five years or so out should be greater than it is now, and the company has become an attractive acquisition target with a load of cash on the balance sheet. The earnings power in good times is roughly about 33% of the current share price net of cash, with no debt and a resilient business model.
I had previously bought stock in DiamondCluster (DTPI, news, msgs) this round at 14 per share or so (and subsequently offloaded it at 10 or so, thinking I could buy it back cheaper later). My thesis was that DiamondCluster was worth about twice the price I paid and would make a nice acquisition. In that same entry, I brought up Proxicom (PXCM, news, msgs) as an alternative to DiamondCluster. Yesterday, Compaq Computer (CPQ, news, msgs) announced it was buying Proxicom for 5.75 per share cash. Normalizing various multiples over to DiamondCluster based on this new standard for valuing e-business consultants, and adjusting for the higher margins and better cash production at DiamondCluster, one finds DiamondCluster to be worth about 21.50.
This is a bit lower than my original estimate of value, and no doubt reflects the distressed future facing many of these firms as stand-alone entities. DiamondCluster had the best shot, in my opinion, of remaining profitably independent, and because of this it might deserve a higher valuation. As for the opportunity to buy DiamondCluster back cheaper later, I doubt that opportunity will occur now. No investor has a 1.000 batting average, but every mistake deserves scrutiny and this one will get it.