Universal Electronic Payment System (UEPS)
UEPS is a financial transaction system offered by Net1 which utilizes its patented Funds Transfer System and secure smart cards to provide real-time but offline payment solutions for un-banked/under-banked populations. These cards store all necessary information – available funds, user identity, etc. – and allows for transactions to take place without a connection to a host mainframe. As such, the cards are particularly useful to countries with under developed infrastructure.

As you may have guessed, Net1 does most of its business in developing countries, primarily South Africa, where it provides cards and point of sale equipment to governments which use the cards as a medium to distribute grants and other social welfare payments.

Investment Strengths

• Proven, cost effective technology serving a large niche – Unlike traditional debit cards or credit cards, UEPS offers a proprietary technology which does not require always on connection to a primary host or even a bank account. Data is stored on the card and information transferred at the point of sale.
• Adoption reaching critical mass – The Company has long been used by the South African Social Security Administration to distribute entitlement payments to citizens and Net1 has recently leveraged this success into a national contract with Ghana as well as a roll out of its technology in Iraq.
• Operating leverage and free cash flow generation – The Company’s equipment and cards are generally paid for by national governments which have chosen its system. Further, as additional customers are enrolled and begin using their cards for payments, the Company generates incremental transaction fees without significant incremental investment. Operating margins in the transaction processing segment are near 60%.

Investment Risks

• Exposure to South African Social Security Administration Contract – 65% of revenues are currently generated through five provincal contracts with the SASSA. This contract has been on one-year renewal terms for the last three years as SASSA attempts to bid the contract through a formal RFP process. The last RFP process ended almost a year ago without a resolution and Net1′s current contract in South Africa is set to expire on March 31, 2010.
• Exposure to South African Rand – The majority of the Company’s costs and revenues are denominated in South African Rands. While exchange rate fluctuations will not have a major impact on cash flow or liquidity, it can have a significant impact on valuation for USD investors. The Rand is currently trading at 7.65 per USD and has traded in a range from 6 to 12 historically.
• Political Risk – The Company’s growth plan relies on entering developing nations with sometimes tenuous governmental structures.
• Technological Risk – While the Company’s smart cards and other payment technologies appear to be quite forward thinking, the increasing availability of wireless communications infrastructure and cell phones poses a potential disruptive threat for a motivated competitor.

Quick and Dirty Valuation
Despite guidance of 20% yoy growth in EPS (constant currency) and long term catalysts for significant growth through new market entry internationally, the Company trades at 12.0x P/E and, in fact, represents a significant discount based on my analysis of PEG which has traditionally approached 1-1.2.

Further, for a smaller, growing company, UEPS generates significant free cash flow. As defined as operating cash flow minus capital expenditures and investments, the Company has averaged approximately $110 million in free cash flow over its 2008 and 2009 fiscal years good for a 13.75% free cash flow yield. Put differently, at no growth and a 10% discount rate this would justify a stock price of ~$24.00/share vs. its current price of $17.65/share. Obviously, with significant headline risk involved in the Company’s 65% concentration in South African Social Security payments, this discount rate may not be appropriate.

The Company, however, currently has ~$2.00/share in net net working capital and $3.35/share in cash on hand and management has shown a willingness to redistribute value to shareholders having recently approved a $50 million share buyback to be funded entirely from cash on hand. Netting the entire value of cash out of the shares, the Company’s cash yield would actually be closer to 17%, enough to pay back shareholders in less than 6 years if fully redistributed. Is this worth the risk of annual renewals of the South African contracts? I believe so.

Full disclosure: Author is long shares of UEPS at the time of writing.

A lot has been written since about how CEO Bill Klesse and Valero management has mismanaged the business and how this company deserves its well below industry average P/E ratio.  The all-knowing Jim Cramer even put Bill on the “Wall of Shame.” Is this all an over reaction or was I wrong about my purchase of Valero earlier in the year? Is Valero not truly a value, but a dreaded value trap?

One positive note with regards to last week’s bomb was that Valero was able to issue shares to the market at $18, establishing a relatively acceptable floor for share value relative to its lows for the year.

The decision to issue shares at $18 per share is, however, a pretty damning data point. Management has bought back nearly $9 billion of shares over the last three years at prices near $60 per share and this most recent offering is all but an admittance that they mismanaged their capital allocations. That being said, a year ago, these moves were being lauded as shareholder friendly and the right way to return value to shareholders. At the very least, we know that management has in the past been shareholder friendly (probably to a fault) during flush times.

As far as operations go, the fact that Valero has managed to lose money due in part to downtime at refining facilities as well as lagging demand for diesel and poor sour crude margins this quarter is worrisome. This will require closer attention going forward, particularly if other refiners show an ability to turn profits over the last quarter. My original thesis on refining was that refined product demand ought to pick up before oil prices and as a result provide a synthetic “long oil” position in my portfolio. Unfortunately, it seems that oil futures have once again run ahead of fundamental demand (at least relative to US demand).

Strategically, I believe Valero is on the right track in this downturn. It has reigned in capex, but continues to look to use its industry leading position to find ways to improve the business’ competitiveness. It’s the largest petroleum refiner in the United States, but it hasn’t been complacent expanding into biofuels and making a move into Europe. As the market for fuel and distillates returns, this will only help to ensure that Valero stays on the cutting edge and continues to provide industry leading refining services.

While all the above are important to unlocking value at Valero, my Valero investment thesis is more an asset value play than simply a bet on improving refining margins and that hasn’t changed. Even if you agree with Jim Cramer and other bears out there that say that Valero management has no idea how to run a refiner, the assets the Company owns are worth something. According to the estimates I did in the post linked above, I believe them to be worth at a minimum $12/share and more reasonably $25/share if liquidated. Long term, as the industry rebounds and demand returns, these assets are probably worth significantly more. For a patient investor, this asset value as well as Valero’s continued support of a relatively generous dividend (>3%) should provide reassurance when the rest of the world seems to disagree.

The key to value investing is to invest with conviction when the rest of the market doesn’t seem to agree. Market oscillations and over reactions are a source of opportunity for continued purchasing and dollar cost averaging. Easier said than done. While I’m not selling my shares into the storm, I still find myself a bit shaken by the recent revelations at Valero. Only time will tell if Valero is truly a value or value trap. But, I’m willing to wait.

Disclosure: Long shares of VLO at the time of writing.

Crude GE Cash Flow Valuation
GE Cash Flow from Operating Activities was reported as $19.1 billion in 2008. This includes $2.4 billion dividend from GECS which we can conservatively assume will be zero in 2009. This would imply that cash generated from its “traditional” businesses – infrastructure, consumer & industrial, and NBC universal – was $16.7 billion in 2008. Net capex in 2008 was $5.0 billion down from an average of approximately $9 billion in 2007 and 2006. Crudely speaking, GE ex-GECC had $11.7 billion of free cash flow in 2008.

With no growth and a 10% discount rate, this implies $117.0 billion in value. GE ex-GECC carries only $13.2 billion in debt leaving $103.8 billion in value for equity. GE’s current market cap $115.53 billion @ $10.94 per share. Does this mean GE is fairly valued or maybe even slightly over valued? Maybe. Maybe not. Let’s not forget that this crude valuation assumes that the non-GECC business will never grow again AND that the Company will never receive value from the GE Capital business ever again. The flip side of this argument is that there remains some risk that GECC will parasitically poach cash flow from GE’s core business for several years in order to service its significant debt burden ($193.7 billion in debt). The Company did, however, announce 90% of its 2009 long term debt needs were financed, ostensibly the most difficult year for the Company to raise funds.

Some may also point out that GE’s infrastructure and NBC units are not likely to repeat their 2008 performance in 2009. Do not forget, however, that a cash flow valuation relies not on short term performance, but long term performance. Using a more representative model, we could assume that GE’s cash flow will decline in 2009 and then return to a growth rate more in line with GDP, very conservatively 2%. To target the $117 billion rate, GE’s cash flow could fall to $9.6 billion in 2009, or 18% from 2008′s level.

A Confirmation Valuation
I’ll admit, the discounted cash flow used above is rather crude. As such, let’s use another valuation methodology and try to confirm the conclusions above. We’ll break GE’s non financial businesses into three segments – infrastructure, consumer & industrial, and NBC. 

The GE Infrastructure segments (Technology and Energy) recorded segment profits of $14.2 billion in 2008. This actually marked a 13% increase of 2007 with growth coming mostly from increased orders in the Energy businesses related to oil and gas. The businesses included in this segment are probably most comparable public comps such as United Technologies (UTX) or classified by Yahoo!Finance as “Conglomerates” which trade at a 9x multiple. Apply this multiple to profits of $14.2 billion and you get a public market valuation of $127.8 billion. 

GE Consumer & Industrials business reported $0.4 billion in segment profit in 2008, down 65% from 2007. The best comp to this business might be Royal Philips Electronics (PHG), unfortunately this business actually reported a loss in 2008, a testament to GE’s performance in this segment. Philips is included in Yahoo’s “Consumer Goods / Electronics” segment and has an average P/E of 18. Thus, applying a similar valuation to this segment, we get a $6.4 billion valuation. 

NBC/Universal reported segment profit of $3.1 billion in 2008 roughly flat with profit in 2005, 2006, and 2007. Disney (DIS), owner of the ABC media network and the Disney studio entertainment business is likely the best public comp to NBC/Universal (the NBC TV and Radio network and Universal Studios). Disney trades at a 9.55 P/E which would implie a value of  $29.6 billion for NBC Universal. 

In sum, we get a valuation of $163.8 billion for each individual GE business segment excluding the Capital Finance segment. Segment profit does not include income tax provision, interest and other financial charges, and corporate overhead. To be conservative, we’ll attribute 100% of corporate overhead to the core segments ($2.7 billion). Since Capital Finance made up 32% of profit in 2008, we’ll only take 68% of income taxes (.68*$3.4 billion = $2.3 billion). And, we’ll assume the majorit of interest and financing charges are a result of GE Finance and thus will not include it in the valuation of the other businesses. Our blended earnings mutiple on the segment valuation of $163.8 billion is 9.2x and, thus, we must adjust out 9.2x $5 billion in additional expenses resulting in a total valuation of $117.8 billion. Remarkably close to our valuation in the discounted cash flow above, don’t you think?  

Conclusion
From the two valuation strategies used above, we find that GE’s stock currently trades at a level which basically assumes zero value for the GE Capital Finance business and potentially no growth in its core business. That is, you can buy GE Capital Finance and as well as any growth in one of America’s leading consumer products, infrastructure and media businesses for free. It would seem to me that GE shares continue to offer a very compelling value proposition to new investors.

Full Disclosure: Author is long shares of GE at the time of writing. No other positions in stocks mentioned in this post. 

In fact, GE’s stock is up over 30% this week and has rebounded swiftly from its lows. What gives?

It seems that with the uncertainty removed for the time being, investors are finally concentrating on the fact that GE’s core infrastructure business continues to perform and that the financial unit has generally outperformed its peers. While the financial unit’s $515 billion in debt ($220 of which will mature in the next 4 years) and questions over the true valuation of its $660 billion in book assets remain worrisome, it would seem that the outlook on GE’s capital costs and cash flow needs has stabilized.

Yes, dividends will be lower for the time being and maybe for several years as the Company right sizes its leverage, but the dividend investors who care have fled the stock and an annualized 40 cent dividend will provide a more than adequate 4+% dividend for new investors.

The ratings cut which usually increases capital costs will not likely cause any material changes for GE who, as a regular bond issuer, has had to offer debt at a premium to its ratings for years. Furthermore, near term risk of a collateral call in excess of $8 billion due to a ratings downgrade below A+2 are likely minimal particularly given how slowly the ratings agencies seem to move.

All clear to go long GE? Significant risks from further economic deterioration and continued frozen credit markets likely put GE out of the risk tolerance of its previous investor base – income oriented retirees – but I for one have liked and continue to like the risk reward being offered by this super large cap’s stock.

Full disclosure: Author is long shares of GE at the time of writing.

ComScore, a notoriously poor predictor of overall performance, released January 2009 U.S. search share data. 

Yes, Google lost a bit of market share but remains 3 times as popular as Yahoo for search in the United States. In the article mentioned above, the author notes that Yahoo has gained share from 19.7% in August to the current 21.0%. Of course, the “Fool” fails to note that Google’s share in August was 63.0%, the very same as it is today. So, long term, Yahoo seems to be taking share not from Google, but from the rest of the industry. 

This data also doesn’t even begin to elucidate on world wide market share where Yahoo and Baidu are duking it out for second place in search advertising and where Google continues to hold #1 or #2 position in most major markets. In fact, despite trailing Baidu in China and Yahoo in Japan, Google’s retains top status with 33% of all Asia-pacific search. To put things in perspective, Google derives 50% of its revenue from international sources while Yahoo gains just 24% of its revenues outside the United States. Don’t forget, 50% of Google’s business is greater than the 75% of Yahoo’s business inside the United States. What do you think that means world wide? 

Google is a search power house that has become an advertising monster as well. It’s reach across sites and partner networks is derived not just from search success but from success serving advertisements with better relevance and higher conversion rates. Looking at a 0.5% decline in the proportion of queries in a market that was up 7% quarter over quarter overall is no cause for alarm and shouldn’t make for headline grabbing news.

Full Disclosure: Author is long shares of Google at the time of writing.