Boring Portfolio

Boring Portfolio Report
Friday, June 6, 1997
by Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA, (June 6, 1997) -- Hey, Dale Wettlaufer with the Boring Report. If you're wondering where Greg is this evening, I can't give you the full explanation because we're in the preliminary stages of an investigation. It seems as though "Mr. Nice Guy" hasn't been writing these reports at all for the last year and has been sub-contracting the writing to sweatshops offshore. Wondering how Greg's been taking all these vacations in Cazumel and those sorts of places? Well, now you know.

Let's review the Boring Port for the week, though, forgetting for now about this controversy in Boringville. The Boring Port L.P. VI gained 1.52% for the week, totally smearing weekly gains of 1.15% and 0.32% in the S&P 500 and the Nasdaq Composite, respectively. Puny little Nasdaq man, where are you now? Boring is now closing in on the 1997 return for the Nasdaq, which is up 8.8% while the Boring Port is up 7.6%. Among the big winners have been Oxford Health and Atlas Air, both of which have soundly thrashed the S&P 500 over their Boring lives. The biggest winner has been Borders, however, which has returned 77% per year, compounded, during the Borefolio's holding period. Nice.

Personally, I see BORDERS (NYSE: BGP) as boring, with a little "b." I don't really recall Greg's rationale for buying the company, but according to my calculations, its return on average invested capital last year was 8.7% (AOL users, expand window):

           Operating income after taxes                                   $62.117 million -----------------------------------------------              = -------------------
Total assets - cash - interest-bearing current liabilities          $712.9 million

That means, for all the earning assets Borders has invested in the business, minus the liabilities that are financed by others (such as its vendors), it's returning after tax 8.7% on that capital from operations. That's before its cost of capital, which it has to pay to the agencies to which it is indebted and to its stockholders (who are looking for at least an 11% yearly return, if they are rational, as that's the long-term rate of return on equity holding).

Admittedly, the company has done very well for its shareholders over the last two years, which is the result of fine earnings growth over that time, but one could wind up this business and put that capital in the stock market and receive the same after-tax return on invested capital with a heck of a lot less risk.

Where else could the company put the money? What about the stock of Coke? I know the vogue these days is to whine about how expensive a company like Coke is. But look what you're paying for a company like Borders, at 20 times 1999 earnings estimates, versus Coke, at 35 times 1998 estimates. Coke has almost zero business risk and generates ROIC in the mid-20s range, about three times that of Borders, which has a bunch of risk with its razor-thin profit margins, lots of competition, and risk associated with consumer tastes and location of stores.

Judging by the difference in ROICs, should Coke be valued at three times the EPS multiple of Borders or should Borders be judged at one-third the multiple of Coke? Should I pay 14 times invested capital for Coke or 3.4 times invested capital for Borders?

I'll take the company that generates the return that totally slams Borders and generates internal returns on capital beyond what I can make holding a basket of equities such as the Fool 4 or the S&P 500. That's especially true when a company like Coke can buy back shares year after year versus Borders, which isn't generating any free cash flow. Speaking of that, Boring old CARLISLE COMPANIES (NYSE: CSL), which I disclose I do own, generates an ROIC about 40% higher than Borders, which is a return that I can live with, especially given its current 1.64 multiple to invested capital, strong market share in chosen markets, ability to generate free cash and buy back shares, and grow its earnings and cash flow at a steady rate 15% or more yearly.

In ORACLE (Nasdaq: ORCL) news, I was quite excited to see the headline on Dow Jones today: "Oracle Unveils Financial Management Software for Government Agencies." Is there a market for this? Holy cow, just looking at the mess that has been made with streamlining the IRS computers, I think there might be a market here!

I saw on CNBC this morning a shot of the computers at the IRS -- they were DEC workstations! Come on, how about getting into the 90s, IRS? Oracle will be reporting sometime near the 16th of June; the company said they'd know the exact date either late today or on Monday. For the year-ending in May, the company is priced at 38 times estimates and 28.7 times 1998 estimates. Fairly valued on next year's estimates? Maybe, but I believe there's definitely upside. Your company may be plugged into its suppliers and customers, but a lot of enterprises out there are not. Longer-term, I also don't think the NC is some sort of wild dream. If you believe "futurist" George Gilder isn't totally off his rocker, then you believe that all the intelligence in a networked cloud of computers does not have to lie on each individual desktop. As much as a company such as Sun is about distributed computing, so is Oracle, or at least that's my understanding of Ellison's vision.

Sage Research came out with their ATM for the LAN brand share forecast yesterday. I see that CISCO SYSTEMS (Nasdaq: CSCO), which has done so many acquisitions in this area in the past three years, is forecast to increase market share from 6% last year to 19% this year. Note, this is different than the equipment that Stratacom sells, which goes into the WAN, or Wide Area Network, although I would think there are engineering solutions that are shared across product lines. CEO John Chambers reiterated this week at a PaineWebber conference Cisco's estimates of 30-50% annual industry growth.

GREEN TREE (NYSE: GNT) kind of missed out on the "interest rate sensitive" fun today, though I think that the market misses the point on interest rate sensitivity of the companies. Depending on the character of the assets of Green Tree -- that is, if variable rate loans are pegged to the long bond or some other market rate for longer-dated loans -- declining interest rates in a market where LIBOR (the London inter-bank offering rate) has been stagnant is not good. Much of the commercial paper is priced on the LIBOR rate, so any squeeze between long rates and LIBOR isn't to be welcomed. I guess the market for financial stocks is still very much driven by perceptions that low interest rates are good and vice-versa. Looking at Green Tree's assets, though, a good chunk of these are in interest-only securities, which gain in value as rates come down. I think I must say that Green Tree is a weird, well-capitalized bird, about which I don't know what the market is thinking. At 15 times, or so, trailing earnings, it doesn't look that expensive to me and the balance sheet looks very solid. Furthermore, it doesn't appear at though it's that overly sensitive to short-term interest rate changes, which aren't that brutal if changes happen relatively slowly. Since interest rates are moving in mere ripples right now, I'm sure Green Tree is able to manage their spreads quite ably.

OK, have I done enough damage in here today? I didn't knock over any vases or trash anything or…. Oh, ooops, I kind of trashed Greg. Don't worry, just kidding, Greg writes his own stuff. He hasn't moved production offshore. I might have to move Dale offshore when Greg finds out what I've been doing here, though. Gotta run -- have a good week-end (hyphenated, like Greg does, as do the French).

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Stock  Change    Bid
ATLS  ---      28.13
BGP   -  1/8   23.13
CSL   +  1/8   30.63
CSCO  + 11/16  64.75
GNT   +  1/4   35.63
ORCL  + 13/16  47.50
OXHP  -2 1/8   71.88
PMSI  ---      11.63
TDW   +  1/2   43.75
                   Day   Month    Year  History
        BORING   +0.02%   1.53%   7.66%  23.89%
        S&P:     +0.38%  -0.58%  13.85%  35.66%
        NASDAQ:  +0.75%  -0.73%   7.67%  33.54%

    Rec'd   #  Security     In At       Now    Change
  2/28/96  400 Borders Gr    11.26     23.13   105.44%
  5/24/96  100 Oxford Hea    48.02     71.88    49.66%
   3/5/97  150 Atlas Air     23.06     28.13    21.97%
  6/26/96  100 Cisco Syst    53.90     64.75    20.13%
   2/2/96  200 Green Tree    30.39     35.63    17.24%
  8/13/96  200 Carlisle C    26.32     30.63    16.33%
   3/8/96  400 Prime Medi    10.07     11.63    15.46%
 11/21/96  100 Oracle Cor    48.65     47.50    -2.36%
 12/23/96  100 Tidewater     46.52     43.75    -5.96%

    Rec'd   #  Security     In At     Value    Change

  2/28/96  400 Borders Gr  4502.49   9250.00  $4747.51
  5/24/96  100 Oxford Hea  4802.49   7187.50  $2385.01
  6/26/96  100 Cisco Syst  5389.99   6475.00  $1085.01
   2/2/96  200 Green Tree  6077.49   7125.00  $1047.51
  8/13/96  200 Carlisle C  5264.99   6125.00   $860.01
   3/5/97  150 Atlas Air   3458.74   4218.75   $760.01
   3/8/96  400 Prime Medi  4027.49   4650.00   $622.51
 11/21/96  100 Oracle Cor  4864.99   4750.00  -$114.99
 12/23/96  100 Tidewater   4652.49   4375.00  -$277.49

                             CASH   $7788.54
                            TOTAL  $61944.79