CKCM Part 2

Here is a guest column by btuff2. He is a fundamentalist investor and took the time to write a very nice piece on CKCM. It is a nice change of pace from my purely technical views and gives us another angle from which to look at CKCM. Also, BTUFF doesn't short, whereas I have no problems shorting. I find a lot of fundamentalist don't like to short because of their longer term tendencies, where short term traders feel the opposite. Just keep in mind that it is important to look at how all type of investors look at things.

If you missed it, I have two updates below from over the weekend. Enjoy.

Here is btuff's column.

I don’t normally short stocks. Maybe I think shorting seems somewhat un-American. Maybe I am just an optimist and would prefer to profit from success as opposed to failure. Maybe I just prefer an investment with limited risk and unlimited reward as opposed to unlimited risk and limited reward. Despite my preference to be on the side of good as opposed to evil, I am interested in the mentality of a short. What makes a good short? What types of questions does a short ask before selling short? Why do the vast majority of shorts post on public message boards in all capital letters?

I am about to free myself from my prejudice and step inside the mind of a short. I am going to randomly select a company from the Reg SHO list and put it through the rigorous routine that I think a short is likely to go through when making a decision to short a stock. Ok…here goes. Imagine me closing my eyes and moving my finger down the Reg Sho list….down….down…down. Ok…I have one….CKCM! It has been on the list for 65 days, shorts make up over 40% of the float and the days-to-cover is nearly 9. This thing must be a dog!

Given what seems to be the perfect short, I will kick the tires a bit on CKCM and see if I can’t find the answer as to why a short would short.

Is revenue growth slowing?

In looking at the most recent quarter, it looks like revenues grew by over 130% from the year-ago quarter. The quarter before last, revenues grew by 115%. The quarter before that revenues grew 107%. It looks like revenues are growing rapidly so it isn’t a lack of revenue growth that has attracted so many shorts.

Are margins getting squeezed?

If its not revenue, it must be deteriorating margins that are subsequently eating away at what falls to the bottom line. As I scan across my financial model for CKCM, I see gross margins holding steady above 60% and up sequentially in the most recent quarter. Operating margins are above 20% and almost broke 25% in the most recent quarter. Like operating margins, net profit margins are holding steady above 20% and came in at 23.37% in the most recent quarter compared to 19.47% in the year-ago quarter.

If revenues are increasing and margins are holding steady sequentially and increasing year-over-year, it doesn’t take a genius to figure out that earnings are also on the rise. In the past four quarters, starting with the most recent quarter, quarterly earnings increased 176%, 173%, 209% and 111%.

Is the balance sheet a wreck and is the company loaded with debt and strapped for cash?

CKCM’s balance sheet shows just about $6.4 million in long-term debt and over $11 million in cash. With more cash than long-term debt I am not seeing any problems with the balance sheet. Furthermore a quick glance at the cash flow statement shows that CKCM has generated positive free-cash-flow for at least the past twelve months.

Does management lack competence?

With the high level of short-interest in CKCM there must be something wrong. If it is not declining sales, weakening margins, falling earnings or a poor balance sheet, the company must be a run by a bunch of buffoons.

Taking a quick look at the return ratios on Yahoo, I see ROE at 26.87% and ROA at over 12%. Based on these numbers, it seems to me like management is doing something right. With a customer list that includes: Honeywell; Lockheed Martin; FedEx; Fidelity; Wells Fargo; Citibank; GE; Microsoft; Dell; Eriksson; HP; IBM; Cisco; Siemens; Ann Taylor; Blue Nile; Walmart; P&G; Carters; Verizon; SBC; Nissan; etc; etc; etc; I know management is doing something right.

Is management selling shares hand-over-fist?

I am coming up empty again. There have only been four insider sales in the last 12 months for a total of 23,145 shares. Furthermore, institutions added a net of over 800k shares in the last quarter.

Is the share price way overvalued?

I have yet to find a kink in the armor and I am left with only one possibility. CKCM must be way overvalued. I am talking this thing must have a PE of ludicrous proportions.

Oh but wait, I am calculating a current PE of 27.42 and a forward PE of 21.27 for CKCM. Can that be right? The last time I looked the Internet Software and Services group had an average PE of 49. When I compare the average growth rate for the industry to the recent growth rate for CKCM it just doesn’t stack up. Furthermore, when I take the recent growth rate for CKCM and calculate the current PEG, I can’t help but say that CKCM appears to be undervalued.

I am left scratching my head. Despite my very best efforts to understand the mind of a short, I more confused than ever. After doing a little due diligence on one of the most heavily shorted stocks, the only conclusion I can come away with (in all caps like a good short):

”GO LONG AND WATCH THE SHORTS GET SQUEEZED”

Please do your own DD.