AOL smartens up? (GOOG)

If preliminary reports are to be believed this afternoon (and investors seem excited about them -- GOOG is hitting a new all time high again today), Google (GOOG -- free real time quote from ADVFN) and Time Warner have settled on a deal whereby Google purchases 5% of AOL and AOL stays in the Google AdSense network.

This is not quite as dramatic as what some folks were expecting, with a more significant stake being taken by one of the big guys in AOL.

And more importantly, this really gives Google a chance to make Microsoft look bad.

Now, I don't think this deal, if it has indeed happens, is going to change things materially for Google. AOL does make up something over 10% of their ad revenues, but they have to share probably 80% of that income with AOL anyway. Some analysts speculate that AOL contributes 2-3% to Google's net revenues, which seems reasonable.

And one billion dollars seems, likewise, a fairly reasonable price for Google to pay to maintain access to this large number of internet users and, more importantly, keep Yahoo or Microsoft or someone else from using that big AOL user base to jump-start an AdSense competitor. Plus, it gives Google something to do with their money, and it is an investment that might work out well on it's own -- after all, $20 billion is reportedly the kind of valuation that Time Warner considered they could get for AOL as a separate entity, and there's some possibility that if they do indeed get forced by Carl Icahn to spin off AOL entirely Google's 5% stake could appreciate.

And my back-of-the envelope calculations say that AOL's ad network brings in roughly $500 million for Google, of which probably $100 million is GOOG's (net of the AOL share). That means would pay roughly 10X TTM net revenue to keep those sales in it's network. GOOG right now is trading for well over 20X TTM sales (though that's not net, and obviously this isn't taking into account the ownership issues -- just the cost of keeping that sales revenue).

So my first impression is that it might not be a bargain, but it seems perfectly reasonable, especially if GOOG can, in partnership with Time Warner, breathe some new life into the AOL site network or somehow rejuvenate the access/subscriber side.

But this isn't just a snub to the less impressive ad networks of MSN or Yahoo/Overture -- this is a smart decision by Time Warner.

After all, Google remains by far the most significant online adversiting network, and while the network effect isn't as important for Google as it is for Ebay, it's still significant.

What do I mean by that?

Well, Google has the biggest and, so far, the most effective contextual ad network. It's also by far the easiest network for outside publishers, especially small ones, to join (believe me -- I'm one of those outside publishers and I've looked at the other networks).

That means that Google gets the biggest network of publishers to host its ads even as their own sites and search results bring in more and more users -- meaning that Google is addressing the largest market possible.

And having the largest addressable market means that advertisers are compelled to go with Google.

And as more advertisers go with Google, other outside publishers want to get in the Google network because more advertisers bidding for space means higher ad rates.

Which means that the network gets bigger and looks more attractive for advertisers ...

... and so on.

So AOL could strike a blow for the little guy and try to help build up a Google competitor like MSN or Yahoo.

Or it could stick with Google, and make more money.

Have I mentioned that I love being a Google owner?

I've written about Google a few times before, most recently here and here, and while I haven't bought any since around $240 I see no reason to sell anytime soon -- though that may change as Google begins to make up a larger and larger portion of my portfolio.

It's anyone's guess right now as to whether or not this will go through, but if it does I think it's relatively good news for both Time Warner shareholders and Google -- though the upside for Google is more limited than the downside might have been if AOL had moved to a competitor and been the catalyst for growing one of the competing ad networks. Even then, it's hard to see Google ever being overtaken in this arena, but we'll see -- everyone makes big mistakes eventually.

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Socially Responsible?

I don't generally believe that "socially responsible" investing is a particularly good way to go about getting good returns on your money, though it definitely works for some of the big managers in this area.

And there are several "sin" companies that I find interesting -- mostly in the gambling and alcohol sectors. I don't own any of them at this point, but it's certainly possible that I will in the future.

I have been interested, however, to find myself staying away from three companies recently that otherwise might be a bit interesting to me because I'm not comfortable for some reason with being invested in their businesses.

I have never held Altria, but this summer and fall it started to look appealing as an undervalued company with continuing dramatic international growth. Still, I never took it seriously because I can't see myself buying shares in and getting involved in a tobacco company due to a personal distaste for the cigarette business.

And recently, I started looking at Reed Elsevier (RUK). I'm an academic, and Elsevier is the dominant "brand" in academic publishing and most profitable scholarly publisher in the world, as well as owner of the strongest brand in legal research in LexisNexis and one of the bigger textbook companies in Harcourt. Still, I've been holding back even though I think the company will show a big return over the long haul -- I think Elsevier is a bad influence on scholarly communication and I'm a little wary of investing.

Along the same lines though to a much lesser degree, I've been holding off on investing in Microsoft (MSFT) . I don't think they're evil as some do, but I hate being a customer of theirs and I don't much like most of their products, ubiquitous though they are. I may still get over this personal dislike, but it is holding me back at the moment.

I don't avoid all companies that might be bad for the environment, or in an unpleasant business, or otherwise wouldn't pass "socially responsible" screens. I have owned plenty of oil companies in the past, for example, like Statoil (STO) and Petrobras (PBRA) and Suncor (SU), all of which are pretty rough on the environment to some degree ... and I currently own copper and gold miner Northern Orion (NTO), and there aren't many businesses that are as rough on the earth as mining. Even beyond that, my single most successful investing focus over the years has been on the oil tanker business, I made great returns on Torm (TRMD), Frontline (FRO), OMI (OMM), and Overseas Shipholding (OSG) in 2003 and 2004 (and, ironically, cashed in those returns last winter to buy a new car). I see Americans avoiding companies like those to be somewhat like a meat-eater decrying the death of animals from hunting or the livestock business -- kind of silly and a little bit hypocritical.

But my personal feelings about a company definitely are a part of my investing process. I don't screen my mutual funds in various retirement accounts to make sure that they don't invest in any company I dislike or disapprove of, but for the companies that I spend a lot of time researching and am interested in owning, a personal interest in the company and lack of distaste for them is important to me on some level.

This is really just to say, and perhaps it's obvious, that investing is personal for me. I invest in individual companies because I like being an owner of interesting companies with good stories and great potential, and it becomes much less fun and interesting if I don't like the companies. There are thousands of potential investment vehicles out there, I prefer to focus on the ones that I find interesting and appealing enough to make it worth my time and attention as well as my money.

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My Investing Philosophy

I've had a few folks ask recently if I subscribe to any particular philosophy of investing -- if I'm an aggressive growth investor, or a Graham and Buffett-following value investor, or a buy-and-holder or frequent trader.

Well, it's hard to say what kind of investor I am -- and I definitely invest differently with the "play money" that I talk about here than I do in my employer sponsored retirement accounts.

It's easiest to say what I am not -- I am not a committed low-PE value investor or a dividend hawk, though I'm happy to receive dividends and buy on the cheap sometimes, and I am not a momentum investor or day trader and generally don't make short-term moves.

I think I can generally sum up my stock investing philosophy in a few rules.

• Buy with the intention of owning a company for a long time.
• Diversify significantly. I'm not confident enough in my wisdom to invest in only a very small number of companies, and I find it interesting to follow many companies at once. At this point I'm overdiversified and I'd like to winnow down the list, but I think I will likely always hold a minimum of 25 companies or so (right now it's nearer 40).
• Only sell for very good reasons. My past mistakes in selling early have dramatically overshadowed my mistakes of holding too long. All else being equal, once I've committed to a stock I'd like to stick with it and I need to have a more compelling reason to sell than I need to buy. I'd rather hold a company and ignore it then sell out of impatience.
  

That "philosophy", if you can even call it that, translates into some specific behavior that I try to follow when investing. Basically, my relationship with a company follows this pattern most of the time:

1. I hear about a company from reading in the media, seeing them as a newsletter pick, culling them from a stock screen, or encountering their products in the real world. I put compelling companies on my watchlists and begin getting an understanding of their business model and prospects.
   
2. I buy an initial small position after researching and becoming convinced that a company has excellent growth prospects, is reasonably fairly priced, and has solid management. I'm not terribly price sensitive with this first purchase.
   
3. I continue to monitor the company, follow their filings and research their business more deeply, and look for a better reason to fill out the position -- that might be a new line of business or unexpectedly quick success, or it might be a drop in price that presents a buying opportunity, or a reassessment of the company's fundamental prospects after doing further research. By the time I buy a second position in a company I should be quite committed to it and know it very well. I pay more attention to valuation when I fill out a position, and I'm likely to do a much more specific analysis of growth prospects and relative value for the company.
   
4. Finally, I try to have a very, very good reason before selling. A drop in price is not enough of a reason for me to sell, on it's own, and I try to be much more aggressive when buying than when selling. When significant changes occur at a company, I reassess and see if there are convincing reasons to refute my initial investment thesis -- if management is not as capable or trustworthy as I had previously thought, or their business appears significantly impaired by events I didn't foresee, or the company is otherwise showing itself to not be the company I thought it was, selling might be a reasonable reaction. I'm more likely to sell a small position than a large one, just because those are the companies I generally don't know as well and am likely to overestimate early in my relationship with them. I do also occasionally sell small portions of my holdings to take profits if I think a stock has gotten well ahead of itself or is overvalued, as I did in early 2006 with Vertex and Middleby -- but since I'm often wrong on this, I sell only a small portion, perhaps as much as enough to recoup my initial investment if it has more than doubled ... oftentimes, these stocks I sell will continue to climb, which makes me gnash my teeth.
   

I am perfectly willing to invest in "growth" or "value" companies as long as the growth rate and the valuation seem acceptable given my assumptions about the marketplace, or to invest overseas or in the US -- though I don't trade on foreign exchanges so I have so far restricted myself to ADRs and funds for my foreign holdings. I try to avoid OTC and Bulletin Board stocks, but I have broken that rule twice and I may do so again someday if the company is compelling enough (and especially if that company is likely to move up to the big exchanges eventually).

I generally do not invest in companies where my investment thesis is predicated on a short term event or a near-term catalyst -- for example, I generally wouldn't buy a biotech in the months before an FDA decision with a plan to ride it through the decision and then sell. I only add companies to my portfolio that I see as having a bright long-term future, and I don't plan to sell in the near future.

I do trade in options on occasion, though I almost never write about those because most people couldn't care less and, frankly, I'm no expert and probably shouldn't even do it. Generally, if I'm tempted to make a short term play on a company I'll consider doing so with a very small option position just to satisfy my gambling instinct. I am wrong as often as I'm right in the short term, probably more often.

That's not to say that I hold every company forever -- I have sold plenty of holdings, and some have been very briefly held over the years. Recently, I sold Great Wolf after just a few months because it became clear to me that the company was not as well managed as I had hoped, and was not as well positioned against their competitors. I also sold Cendant after holding it for less than a year, not only because performance was disappointing to some degree but because I thought their plan to break up was foolish and I didn't want to be a part of it.

I invest in individual stocks because I like to research and understand individual companies that are doing extraordinary things. I want to own companies that can grow significantly over many years, and I generally focus most of my energy on small cap or undercovered companies because I think small investors generally have an advantage in those areas and those companies are usually easier to fully understand.

I reserve the right to be irrational, and to make dumb mistakes. And if this ever stops being entertaining I might do almost as well by buying a few good mutual funds -- it would certainly take less time.

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More on Gol (GOL)

I've been thinking a little more about Gol Linhas Aereas Inteligentes (GOL) lately, and though that thinking and research has turned up more risks for the company it has also solidified my belief that it is extremely well positioned moving forward.

Before I get into the things that actually matter, you might note that GOL fell precipitously today -- they split, and as is often the case for these underfollowed stocks, not all of the data services noticed right away. I only bring this up because this is one of the rare cases where I think a split actually makes good sense -- I wrote about Rayonier's silly split a month or two ago and generally think splits of average-priced stocks are boneheaded. In thise case, however, the split was brought about simply to bring the GOL ADR's in line with the Brazilian shares -- ADR's for GOL had been a match for two shares on the Brazilian exchange, but now it will be a much simpler 1:1 ratio for the ADR which makes things slightly easier to follow their finances. I have no problem with it, though I also don't think it has any material impact on the company and you'll never see me being a cheerleader for splitting stocks.

I wrote a bit about Gol when I opened my first position last week, so today I have just a couple things to share.

First, Varig -- the current flagship carrier of Brazil and Gol's largest competitor -- looks like it is finding it's way out of bankruptcy, and there was a brief article about the specifics from Reuters today. Varig has been faced with very similar problems to the US flagship carriers in the past couple of years, including a legacy of heavy regulation, huge labor costs, and large liabilities and big debt on the books. If this current deal holds (and it's anyone's guess at this point -- I don't think any other big Brazilian companies have yet gone through the new bankruptcy process they have now), Varig will be controlled by a Brazilian shipping magnate with no aviation experience.

So what does this mean for Gol? I'd guess, not much. One of the other possibilities was that TAM, the other upstart airline that splits most of the business in Brazil with Gol and Varig, would take over the company, but their offer wasn't as solid as this one on the table today. That might have changed the competitive landscape somewhat, but I'd be inclined to say that even if TAM and Varig combined Gol would still have a huge advantage -- neither of them has shown any ability to match Gol's low cost structure or low prices and "think different" approach in the long term.

But with Varig as an independent, there is some slight risk that their bankruptcy will enable them to dramatically cut costs -- as some of the big US carriers have done -- which theoretically would enable them to move more toward the low fare model that Gol and, to a lesser extent, TAM, have followed to great success. In fact, I don't imagine that to be a likely outcome -- I don't think that Varig will be able to dramatically change their corporate culture and become lean and efficient just because they are offloading their debt. US Airways is not a viable competitor for JetBlue and Southwest today, even though they've been through bankruptcy twice and cleansed their balance sheets. Change isn't that easy.

And the other risk I've been thinking about some is government regulation. Government regulation of the airline industry was a significant issue 20 years ago in the US, and it can certainly be argued that the removal of regulatory controls dramatically changed the landscape and brought real competition and allowed new entrants to grow into the marketplace, making air travel much more feasible for all Americans.

Brazil is not about to deregulate it's airline industry, as far as I can tell. The governmental philosophy is dramatically different -- as evidenced by the controlling stake the government holds in Petrobras, the big oil company, for example. The government is committed to letting private enterprise grow, but in my opinion it is also very concerned about directing growth in their economy. How that will work in the larger sense, I have no idea.

But I think it's working fine for Gol. I was surprised to see quotes from Gol management that they believe government regulation to be a benefit for them in many ways, but their argument makes sense.

According to GOL's leaders, the primary focus of the Brazilian government when it comes to air travel is ensuring manageable growth of the overall system. Individual routes have to be approved by the government whenever an airline wants to add capacity to make sure that the industry doesn't overbuild and go into a crash (though how the government can predict that, I have no idea).

But the key is that a focus on overall steady growth and the lack of a truly free market means that Gol's competitive picture should remain relatively steady. GOL now has a significant edge over the small upstarts that might fly a dozen or so routes and who want to build their business -- GOL is now an established company with 400+ flights a day, and they can certainly make a stronger argument for their ability to effectively manage additional routes than can a very small and, in most cases, financially unstable competitor.

So the way I read the regulatory landscape in Brazil (and I'm no expert on this topic), Gol has some protection from smaller carriers that might try to horn in on it's routes by buying market share with even lower prices, because the government doesn't want to see that kind of instability (prices moving dramatically up and down, small companies betting the farm on their ability to buy market share until they run out of money -- see Independence Air for the US version of this cautionary tale).

So Gol can focus primarily on what it does best, which is beat the pants off of Varig and, to a lesser extent, TAM, and, more importantly, build a whole new customer base by bringing in the millions of Brazilians who have never seen the inside of an airplane, all while growing rapidly but steadily with the government's blessing.

Nothing here to make me change my mind on Gol -- they're down a few points from when I purchased my initial position, and I'm hoping that they fall back significantly sometime in the next couple months so that I can fill out my holdings in this well-managed, fast-growing, and fun-to-watch company at a lower price.

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