Looking into Asset Managers (LM, RJF, AGE)

I sold my only big investment bank holding recently in UBS, and I've been thinking that, although I have a lot of holdings in insurance companies (in Markel and Berkshire Hathaway), I think it makes sense to own a US asset manager.

The primary argument for this is demographic -- with the retirement of the baby boomers looming, and the massive intergenerational transfer of wealth taking off in the decades to come, I think the companies that can offer simple solutions for asset management should do well for many years. Berkshire may get some benefit from this eventually, since they do sell some annuity products, but it certainly wouldn't move the needle of their performance numbers.

There are a few different ways to go.

I could invest in one of the big brokerage houses, but their shares have climbed so dramatically and they are so dependent on their own proprietary trading and on M&A fee activity that I'm not entirely confident that the demographic shift is going to be of huge additional benefit to Goldman Sachs, Merrill Lynch, etc. (though I do have some LEAP call options on Goldman Sachs, just in case they're able to keep this growth going).

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Or I could invest in one of the smaller regional brokerage/investment advisors -- this would include Raymond James (RJF), or AG Edwards (AGE). I think these might actually be good buys, and I think AG Edwards is often overlooked as an investment, so that's a strong possibility if I can get my head around which one of these companies is likely to be able to grow their footprint as well as take advantage of the growing assets of their near-retirement clients.

And finally, I could look at a company that primarily manages mutual funds. There are tons of these as well, and many of them are public -- two that have caught my eye in the past are Legg Mason (LM) and Affiliated Managers Group (AMG), which is the umbrella holding company for lots of excellent firms like Third Avenue. Most of these companies also manage private accounts in some fashion, and some also offer brokerage services. I think the AMG stable of funds is one of the finest ones in the industry, but I don't like the valuation of the company very much right here.

Legg Mason, however, really appeals to me. Being generally a long term investor, I am very intrigued by the huge fall the shares have had this year for what I consider to be short term problems -- they've had several hiccups in integrating their massive asset swap, the big deal everyone probably heard about when they swapped their brokerage for Citigroup asset management business, and they've gotten some negative attention over the past six months as it appears Bill Miller, their biggest fund managing star, is going to finally lose out to the S&P for the first time in 15 or so years.

LM might still run into trouble as they continue integrating their new funds and clients, and it's possible that a serious market correction could bring prices lower, but at the moment this company is at the top of my list as I search for investments that might benefit from the baby boomer retirement years. I'll let you know if I decide to actually purchase shares.

full disclosure: I own Berkshire Hathaway and Markel shares, and LEAP call options on Goldman Sachs, and I have money in several Third Avenue mutual funds.

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Understanding Mastercard: Priceless

I've been looking to put a little cash to work, and one of the companies that comes to mind is Mastercard International (MA), the hot IPO of the summer that's getting everyone's attention.

For those who don't know the basic background, Mastercard was a member-owned association that focused on payment processing and franchising its credit and debit card brands and, later, related consulting projects. In the 1990s, it began converting to a more independent share-based business, though still owned by the same banks, and this year it took a stride toward further independence by IPO'ing the majority of the voting shares.

Mastercard was the dominant US card for many years, but is now a distant second to Visa in the US and in most other markets -- if you look at market share and spending around the world, in most places you'll see Mastercard or its affiliates with about half the market share of Visa ... and you'll see Mastercard spending about half as much as Visa on building their market. It's been a nice, tidy system for a while that has allowed both of these companies -- both of which are very lean and consist primarily of brand names and computer networks -- to prosper. Visa remains a private concern, though there has been talk since the MA IPO of Visa doing the same.

Here's what I like about Mastercard:

1. They're part of a near-duopoly in cashless payments, but they're by far the smaller part of the duopoly in most countries, so they might have room to grow market share against Visa.
2. Cashless payments are growing incredibly rapidly around the world, in both developed and developing countries.
3. The business can generate massive amounts of cash with very few employees or capital costs.
4. Growth is projected to be remarkable, and the business is potentially very hihg-margin and scaleable.
   

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Here's what makes me nervous, and has kept me from buying shares so far:

1. The duopoly they enjoy with Visa gets plenty of attention from antitrust lawyers interested in price fixing -- they've settled disputes before, and it's possible that one reason for the IPO was to give Mastercard some independence from its member banks and shield those banks from liability.
2. They're planning to spend an awful lot of marketing money -- and while Visa and Mastercard both have some of the most creative and compelling advertising around, they may just spend each other into the ground with neither company taking market share from the other.
3. Visa might go public, too -- which would take away any advantage that Mastercard may have incurred with the cash inflow from their IPO.
4. While they have a lot of member banks, they are very reliant on Citigroup for a large percentage of their business. Trouble for Citi in growing accounts would mean trouble for Mastercard.
5. The member institutions have a lockup period following the IPO, and it's possible that there could be a wave of selling when that period expires. If I do decide to buy shares, that might offer a better buying environment (though at the rate shares have been climbing, that's certainly no guarantee).
6. Their newfound independence from their member banks might create a more aggressive and independent posture (many of those banks also issue Visa cards), which could lead to more price competition that has the potential to make earnings much more volatile. If Mastercard and Visa start to compete for accounts on price, they could kill the golden goose.
   

I really like the credit card business in general, but the antitrust issues make me a little nervous. I haven't yet reconciled that with the phenomenal growth that their market is seeing as the cashless society grows, but I am looking seriously at an investment in Mastercard or in American Express or one of the big credit card issuers like Capital One (or possible Citigroup or Bank of America).

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The Wish List

Companies that I would like to own but don't, and why:

Citibank (C) -- seems like a terrific value, with great international exposure and a very solid payout. Hard to believe you can get a company this cheap with the level of growth they have and still get close to a 4% dividend. They aren't nearly as sensitive to increased interest rates or narrowing spreads as many other financials, so I think their stock is irrationally depressed. But I probably won't buy this one -- I like to leave most of the large-cap stock picking to the experts, since I don't think I can beat the market by buying big, well-followed companies the same way that I might by buying small caps, fast growers or misunderstood or irrationally mispriced companies. Bank of America comes close to Citibank in my book, too.

Costco Wholesale (COST) -- I love this business, and by all accounts the are some of the best merchandisers in the world. This is one of the few companies that beats the pants of Wal-Mart (Sam's Club will never have the success or cachet of Costco). Unfortunately, it's a little too steeply priced right now and while I'm sure they will continue to be successful I'm not convinced that the growth rate will make the current price a value going forward.

Motorola (MOT) -- I think their growth rate is going to surprise people, and that this company can get back to being an innovator with the next generation of cellular phones. The Razr proves that they have a good eye for design and for developing what people want, as they first showed with the breakthrough flip phones in the 90s. I think Motorola is getting unfairly tarnished for some management mistakes following the internet meltdown, and I think their focus on new phone design and partnerships going forward (will we really see an Ipod phone someday? If so, I think it'll come from Motorola) will put them in good stead. I like Nokia too, and think both of these companies have a chance to ride new designs to great success in the coming few years, but this is a similar situation to Citibank -- I'm trying to let Dodge & Cox manage the large cap portion of my portfolio since I don't think I can have much of a competitive advantage in that sector of the market.

Dampskibsselskabet Torm As (TRMD) -- This Danish shipping company was in my portfolio for a year or so, I sold my shares in December 2004 with a pretty substantial profit, but it has continued to go up. This is one I should have held long term, it is going to be much less boom and bust than the typical shipping company (and especially less so than the typical tanker company, which is a big portion of their business). They run tankers as well as other bulk ships, but their strength is in product tankers, not crude oil tankers, so they stand to benefit from worldwide shipment of other liquids -- from food products to refined fuels to chemicals, all of which are steadier than crude in my opinion, though crude tankers are still a great business if your stomach is strong enough. If the price drops by 20% or so, I'd like to buy back in, but I can't justify it at $50+. I'm holding out hope -- it's quite thinly traded on the Nasdaq and can be wildly irrationally priced at times, as it was when I first bought it at under $30 when, frankly, the business looked even better than it does today.

Affiliated Computer Services (ACS) -- I've been toying with buying this one for quite some time. I actually first heard about them as a municipal contractor for running red light and speeding cameras, which I think will turn out to be a huge growth business, but they are a very diversified computer services outsourcing company. I like the idea of it, and their growth looks pretty good to me and valuation seems fair -- but I must not understand the company well enough because the little voice in my head won't let me buy. After looking at this one on and off for nearly a year, I think it's going to take a sale price for me to buy in -- maybe I'll get lucky and they'll lose a high profile contract or report a bad quarter and I'll have another chance to take a close look and buy in.

Coffee Holding Company (JVA) -- This one hasn't been public for very long, but it looks very promising and I may well buy in once I have the opportunity to do some more research. They seem to be holding their cards pretty close to their vest, but the company sells coffee at wholesale both in their own brand names and to retailers to sell as store brands. I think this is a good business if they are indeed really capable of putting gourmet products out there at reduced prices, and building up their own brands, but I'm not convinced yet. I also don't understand the competition very well, or if they have an advantage in their relationships with producers or retailers or in the way they source, roast or package their coffees. Earnings look very good, so I think I'll let this one percolate and see how it looks once I've got more information on the business.

I'm sure there are more, those are just the ones that I keep coming back to recently -- I'll keep adding to this list as I remember or discover other candidates for the portfolio.

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