Buying Blackstone (BX)

Steve Schwarzman spoke at the Merrill Lynch conference today, and I think some of what he said about his company, Blackstone, has been overlooked in the wash of John Thain rumors. I picked up a few shares of Blackstone today.

So what did he say that was interesting?

About the business:

He said that the alternative assset industry is a "marvelous place."

And that risk-adjusted returns are way above returns from traditional assets.

Importantly, he noted that institutional penetration is still low -- most big institutional pension plans have only 4 or 5% in alternative investments, and they are looking to increase that allocation.

(Personally, I think this increase in market share for private equity and alternative investments is a huge opportunity for Blackstone -- pension fund managers are going to be in a near panic to hit their numbers as the baby boomers retire, and they'll look longingly at the outsize returns achieved by David Swensen at Yale using allocations of more like 20-30% in various alternative assets like private equity, hedge funds, and real estate ... all areas of significant Blackstone strength).

Schwarzman also opined that Blackstone has been given a significantly lower multiple than traditional money managers, but has more than three times their growth rate.

Beyond that, he took a bit of a stab at the analysts who track the shares and noted that "We are not focused on quarters, we are focused on building value for the long term" -- which of course is something many people say, and I don't know whether Schwarzman is more or less believable in saying that than anyone else. They don't give quarterly earnings guidance, which is certainly one indication that they really believe this.

I like that management and employees are incentivized by the distributions and performance of the Limited Partnership Units. The existing partners, according to Schwarzman, are pushed out to an 8-year vesting schedule, significantly longer than average, which means they will be sitting on big embedded costs over the years that they vest these shares and that those people are very motivated to stick around -- the IPO wasn't a one-day gravy train for them. Those costs of vesting options are what surprised investors a little bit with the high costs during their last earnings release, but of course they have nothing to do with operating earnings.

Blackstone has separately stated that they more or less promise to have an ongoing distribution of 1.20 per year as a minimum through 2009 (close to a 5% yield), and Schwarzman reiterated that they will continue to distribute additional income as they make more. As befits a partnership, the reason for their existence is to funnel excess cash earnings to unitholders.

But what stood out for me in his comments was his hypothetical projection of Blackstone performance -- and of course, since they don't really give guidance this wasn't official guidance, but it was dramatically optimistic in comparison with current results. That specific kind of optimism is somewhat rare from CEOs in these post-SarbOx days, and it makes me wonder whether analysts really are lowballing Blackstone's long term potential right now.

Schwarzman said that the two keys for them will be the size of assets under management, and the rate of return on those assets. That's because they essentially make their money from the management fee, which is charged regardless of their performance, and the carried interest return, which is the percentage of gains that they charge.

Returns have historically been massive in comparison to the overall market, but also quite lumpy -- I think that if they can keep getting their average returns their income should be remarkable. (It's worth noting that many people consider the last five years to have been the "golden era" for private equity, and that those returns might be impossible in the future.)

So it's important to note that Blackstone is still raising record amounts of money, and still finding ways to invest it. Schwarzman said that "People fundamentally missed that we committed to invest 6.9 billion dollars in one quarter in private equity and real estate." That's $6.9 billion that they can start charging fees on.

If they have many future quarters like that, Shwarzman said that from just that one part of their business they could "theoretically make $8 billion in profit in a year."

And as part of that same hypothetical exercise, "estimates that show earnings in the $1-2 billion range could prove to be dramatically wrong."

I don't want to overstate this -- and Schwarzman tried to be quite politic about it, too, in emphasizing that the $8 billion potential assumes that everything goes their way, they get returns in line with their average, and they continue to attract a lot of money. But I am a little surprised at the lack of attention it got -- there was one Reuters story titled "Blackstone CEO sees earnings estimates way too low," but that was all I saw. You can, of course, listen to his presentation yourself if you like through the IR section of the Blackstone website.

They of course can't control their circumstances entirely, but clearly Schwarzman believes that there is potential for really dramatic outsize returns because of the power of carried interest and the massive amounts of money that the world is willing to give Blackstone to invest.

So, the overhangs on Blackstone (and all other private equity firms, at least the public ones) remain -- lumpy earnings, a business that the analysts are going to have a really hard time projecting, and the threat of higher taxation on carried interest (which seems to me to be largely baked in to the stock at the current forward PE ratio of around 13), to say nothing of the possibility that tighter debt terms and higher interest rates might hurt the potential for really massive deals in the near future (though I think Blackstone has said that their average deal is a relatively modest $500 million, which certainly doesn't require massive debt financing when you're talking about investment funds of $20 billion or more).

This seems like a bit of a contrarian buy, as does anything financial these days, but I think the asset managers in general are going to be excellent investments over the next ten years, and as the leading light in a segment of that business that's well positioned to take market share from competitors, especially among the big pension managers that are the engine of private equity funding, I expect very good things from Blackstone over the long run ... and I think the downside is limited if performance of the company remains just average, especially in the near term with the backstop of that 5% dividend.

Full disclosure: I own both shares and options on BX.

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Cheap Gold in the Ground? (CELTF)

I'm not generally much of a "gold bug" -- I don't believe that the world economy is going to hell in a handbasket, and I don't think that paper currency is worthless. But I do believe that a little gold in your portfolio can be a nice buffer -- especially when prices are soaring, as they are lately.

But buying the gold ETF is so booooorring.

Kidding, sort of. Certainly if you like gold and silver the safe bet is the ETF for either.

But if you're going to dabble in minerals, not much beats the pop potential of a nice junior miner. I owned shares of Northern Orion a while back and enjoyed some nice returns there, then moved most of my commodities-related investing into Ambrian (AMNZF), which is the investment banker for many AIM listed exploration and mining companies (among other things). And though I'm not a mining expert and get sleepy-eyed reading the pages and pages of drilling assays, I can occasionally work up some enthusiasm for another miner.

This one, which I bought shares of a month or two ago after first hearing about them in June due to a fairly aggressive newsletter teaser ad campaign called "Gold of the Pharaohs," has been really fun to watch -- at least news-wise, if not stock price-wise.

Centamin Egypt is an Egyptian company, listed in Australia and Canada (CELTF on the pink sheets) that is aiming to rebuild the Egyptian gold mining industry. Egypt was a huge source of gold in the days of, you guessed it, the Pharaohs ... that's where all that gold came from that they found in King Tut's tomb, and that was so faithfully reproduced in the headdresses and jewelry of Yul Brynner (Rameses) in The Ten Commandments. Or maybe I'm mixing up my references a bit ... but the point is, Egypt and gold have been linked for a long time.

Until recently, however, there apparently hasn't been much modern gold mining in Egypt.

But this little company, Centamin, is on the verge of changing that. They bought a processing plant from Newmont that until last month was in Kori Kollo in the Bolivian boonies (it's now dismantled and is either in a warehouse in La Paz or on a boat, not sure of the precise details), and they're moving it to their mining site a few miles from the Red Sea.

A long way, I know ... and I hope they've got plenty of insurance for the sea voyage. This is an $11 million plant, not bad for some heavily used equipment half a world away from where you need it.

They're also building the infrastructure for the mining operation -- the roads, plumbing, electrical generation, housing, etc.

But that's not the exciting part -- it's nice to see that progress is being made, and they are good about alerting investors to how far they've gotten, including photos of the installations and updates on the progress of the plant dismantling, etc. I always like it when these little mining companies send out photos of their progress -- clearly they could still be lying or doctoring pictures, but at least they've made the effort to show that something real is happening on the ground, not just the churning of press releases.

The really nice part is that they're still exploring the property, even as mining operations are expected to begin by the end of the year, and the amount of gold they find keeps going up (up 25% or so in just the few months since I started paying attention).

Their mine looks to me (no expert) like it's going to essentially be strip mining away a few small hillocks called the Sukari Hill and what's underneath them, and they've still got several drilling rigs operating to help direct the first stages of the mining operations and further suss out their reserves.

Those drilling results are released more or less monthly, and they have been able to consistently say that they're finding or proving new veins of gold and that they are upping their reserves based on the results.

Every time.

And after close to ten years of drilling and exploring this site, the last month's release included the largest increase in the reserves that they've recorded so far. And they've so far drilled a fairly small portion of their potential minesite, though they do have nine drill rigs currently still looking.

So now, before the actual mining operation begins, they stand with an exploration cost for the gold of about $5 an ounce. That's compared to well over $700 an ounce as a current market price, so we'll just have to separate out the mining costs (Egypt, as you can probably imagine, is a very low cost country, wage-wise), the royalties (they've got a good deal on royalties and taxes from the government, at least for their initial few years), and the transportation costs, and whatever's left will be lining their (and our) pockets. Let me clearly note that I have no idea what the average exploration cost is for gold miners, and I'm sure it varies widely, but with actual mining slated to begin in the very near term I really like this cost structure so far.

There's a decent overview of the company (which they essentially paid for, I believe) at Minesite.com, and the company website has a good number of informative presentations, announcements of resource upgrades, and updates on activities. Trading volume is pretty decent in Canada (at least in comparison to the pink sheets), where it trades under the symbol CEE.

So reserves continue to climb pretty dramatically, they've got a proven mining plant on its way to their site, the infrastructure is on its way, and this looks like it's going to be a real, profitable gold mine for years to come, with plenty of potential in the areas of the site that they've not yet drilled.

Of course, the bad part is that I'm buying a company that's already got a market cap of over $750 million that has spent ten years spending money, and hasn't yet sold an ounce of gold.

Still, I like the ongoing potential for this speculative investment. Over 10 million ounces of gold and counting are likely to be under those hills, all they've got to do is dig it up ...

Full disclosure: For those who haven't guessed, I do own shares of Centamin Egypt, bought on the pink sheets over the past few months at an average cost of $1.08.

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And ... back to the A Shares

Like a sloppy drunk returning to the roulette table, I've repurchased a position in the Morgan Stanley China A Share Closed End Fund (CAF).

Those who've been keeping up here (not so many of you, since I keep neglecting to post in a timely fashion), will remember that I bought these in the Spring because the discount was ridiculous, then sold when the discount shrunk to about 15% and the price was up well over 50%.

Well, I'm doing it again. I still see no fundamental reason for the decline in the A share market in the near future -- inflation is getting crazy in China, which should be good for stocks at least in comparison to bank deposits (and there isn't much else that the Chinese can do with their prodigious savings glut, even though they're beginning to loosen the restrictions a little bit and let some investors sample overseas fare).

And the discount is now back over 20% in this closed end fund.

So, I picked up some more shares today at an average of about $61.50.

This is, again, one of the few positions that I'm very cautious about -- I do have a trailing stop on these shares, which I almost never do with any other holdings, and I'm likely to sell if they continue to climb significantly and the NAV gets a little closer to the share price again.

But really, though I'm somewhat trepid about this position, I do think the A shares have quite a bit more potential in the short term of 6-12 months. Beyond being the most direct way of investing in the domestic Chinese economy, in my opinion, this is a play on supply and demand in two ways:

1) Chinese domestic investors have very few investments available to them, and they're mostly stocks on the domestic (Shenzen and Shanghai) A share market. So the A shares trade at a significant premium to the same company on the Hong Kong exchange, for example, in cases where companies have dual listings.

And 2) International investors have very little ability to invest directly in China. So this fund should trade at a premium to what foreign investors believe is the fair market value of the China A shares overall index.

The risk is that number 1 is moderated somewhat as the Chinese get the freedom to invest overseas -- but my bet is that this process will be extremely gradual, as most Chinese policy changes are, and that number 2 exposes the fact that most foreign investors believe the China A shares market is dramatically overvalued (due to number 1, mostly), so they may be paying a premium to what they believe the fair value is, but they believe, en masse, that the fair value is lower than the current net asset value.

So ... another gamble in a risky, isolated market. But frankly, in some ways I find the Chinese A share "bubble" companies to be somewhat more appealing than their US counterparts these days. If China can continue growing at 10% a year, as most believe they will come close to doing, especially as domestic consumption climbs in the Middle Kingdom, the valuations just aren't necessarily as crazy as they might look to jaundiced Western eyes that lived through the Nasdaq bubble.

We'll see, as usual ... I am leaving room to accept the fact that I'm wrong, and that an abrupt crash in the domestic markets in China is possible.

Full disclosure: I own CAF, and the China Fund CHN, as well as call options on the Hong Kong Index (EWH) and several individual positions in Chinese and asian stocks not directly mentioned here.

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Buying the Google Dip (GOOG)

Well, this is certainly not a contrarian assessment -- the web is achatter with people who are musing about this earnings shortfall as a buying opportunity in Google shares, including most analysts -- but sheep or no, I'm jumping in a little.

I've been a GOogle shareholder for about two and a half years, but I did sell a portion of my holdings about 18 months ago -- taking profits after my one year holding period partly because I was nervous about short term pricing, and partly because Google had become by far my largest holding.

Now, after a little share hiccup, I'm buying back those shares (for more than I sold them for, unfortunately, but for a price that I think is fair). I sold shares right around $400, and bought them back last night at an average price of $508, which brings my average cost basis all the way up to $350.

Thanks to a portfolio that is much larger now, Google is not back to being my top holding, but it is now in the top five again.

Why did I buy?

Well, the short answer is that the earnings were too good not to at this price. I understand that the price run up to $550 was based on some probably irrational momentum enthusaism, but I didn't think $550 was such a crazy share price.

Here's how the numbers compare from the March 2006 earnings release, when I sold a few shares, to today's news:

Sales
March 2006: $1.92 billion
July 2007: $3.87 billion

Earnings:
March 2006: $372 million
July 2007: $925 million

That's right -- sales about doubled, earnings came close to tripling. Even though the margins are not what was hoped for in this latest release due to a hiring binge, that ain't bad long term performance.

Gross margins have been pretty steady over the past year at near 60%, though net margins are weaker. I'll take that over the opposite outcome (better net margins, worse gross margins) because it means Google's problems are cost-related, not that they're losing pricing power due to competition.

And that's really the key: here in the US, at least, there is precious little competition, and no sign that competition is niping at Google's heels despite Microsoft and Ask and Yahoo ALL launching improved services and much better ad systems in the past year or so. Overseas, even in places like China where Google has market share problems so far, there isn't a single market where Google couldn't buy their biggest competitor without breaking a sweat. ... and overall, Google's international growth continues to outpace even the very good US results.

The "law of large numbers" argument, that Google cannot sustain its growth rate, is somewhat compelling ... but it certainly hasn't impacted Google yet in a meaningful way. It's true that earnings growth has slowed somewhat due to investment, but we're still talking about near-60% sales growth and a company that, I believe, is likely to hit an inflection point with their recent achievement of "full" staffing levels that may enable them to increase margins in coming years.

So ... I can't argue with the market pushing GOOG shares down by a few percent today, as seems to be the final result. But the 8-9% hairdcut the shares got overnight and early this morning was a bit overdone, and I'm glad I picked up a few shares.

I like the fact that Google is investing in more people right now, especially because many of them are overseas hires or hires who can help build Google's next generation of services. Google even indicated that a good portion of that 1% earnings miss may have been caused by the one-time $60 million impact of a change in ther HR accounting policies.

But really, I just want to hold Google shares as a significant part of my portfolio, and this dip gave me a timely opportunity to restore that position when I happened to have cash on hand. Google beat analyst predictions for sales growth during a seasonally challenging quarter, and they're investing in the future with more engineers and salespeople. I think we continue to underestimate the long term growth potential here, though Google will likely look expensive on a trailing PE basis for many years. I'll try to ignore the quarter to quarter volatility and keep my eye on the prize: world advertising domination.

disclosure: I do own shares of Google, and am also a Google AdSense publisher.

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Switching Commodity Plays (NTO, AMNZF.PK)

I'm taking advantage of the Yamana offer for Northern Orion that boosted prices by close to 10% at one point, and selling my NTO shares in order to open a position in a very different kind of commodity investment.

Northern Orion (NTO) has been good to me -- I bought shares a couple years ago at around $2.20, and sold them yesterday morning at $5.90. I do think that their reserves are worth more than that, but they will be also very expensive to produce and/or take a long time top come to market, so I'll take the short term payout here and not hold on to Yamana shares.

Instead, I've decided to open a position in an investment bank that largely focuses on commodities -- a relatively new firm, now called Ambrian Capital, that's listed in the UK (AMBR in London, AMNZF on the pink sheets). I first heard about this when I saw it teased as the "best investment of 2007" by a newsletter publisher in my work over at stockgumshoe.com, but of course that recommendation and some other heavy buying (by Rick Rule and others, particularly US investors) made the price spike up significantly in April. It has since fallen back to more reasonable levels, so I've picked up some shares here at an average cost of about US$1.36.

Ambrian is an investment bank, asset manager, and adviser that focuses primarily on resource industries -- including underwriting and advising of commodity companies and trading of actual commodities, among them metals, energy and carbon credits.

They also own large or controlling interest in several mining and energy companies, including Jubilee Platinum, Centamin Egypt, Uruguay Mineral Exploration, Inc, and Anglesey Mining among many others.

At today's price in London they're trading at a PE on last year's earnings of just about 8 (8.6 pence in earnings, 67p share price.) -- that's substantially below most investment banks, and I assume it reflects some general pessimism that we're at the peak of the commodities cycle. I don't personally believe that, but even if we are, for these prices I'm willing to take a small chance that this is the peak earnings in the near term. Their yield is about 2.5% and growing, not bad for a very new operation.

But I think what I find most compelling about this investment, aside from what looks to me like clear progress in building an effective and focused investment bank in this sector, with rapid earnings growth, is the valuation of the shares if you consider their outside holdings.

Their principal investments group, which invests the firm's own money, holds investments worth roughly 50 million pounds (including those mining companies noted above). It's certainly true that those investments could all fall precipitously if commodities collapse, and about 10% of that money is in unlisted companies so it's even more illiquid than the rest, but the current market cap of Ambrian Capital is only about 72 million pounds. That means, if you want to do the math, that the value of the bank itself today, aside from its outside investments, is 22 million pounds.

If you then take out the realized gains from the income numbers as a "what if" exercise (the income for last year was roughly 60% realized gains/40% investment banking), you get income on investment banking of about 8 million pounds from a valuation of 22 million pounds. So that means if we ignore their assets, and they sold them off today for roughly book value (which may not be possible), as I read the numbers you'd then be dealing with a fast-growing investment bank trading at a PE of under 3.

[belated note: sorry folks, just realized my error here. I still like the valuation, but it's not a 3 PE unless you screw up the exercise, as I did. This fails to assign the majority of the administrative expenses to the investment bank. Admin expenses for the group were about 8 million pounds, and investment banking operating profit was about 8 million pounds -- so I think we need to assign probably at least 75% of the admin costs to the bank, since merchant banking is much more people-intensive than investment management. Ambrian doesn't break them out, since they have no good way to do so as all overhead is shared across the group. I still like the shares as much, since the whole is more important than the parts at this point and I expect dramatic earnings growth to continue, but my error in the exercise made the valuation look sillier than it is -- sorry!]

The group's general intention appears to be to realize gains on many of their portfolio companies or to use them to seed investment funds for various sectors (they currently manage one investment fund, Golden Prospect Precious Metals), and they recognize the need to diversify as much as they can given the volatile nature of commodities. They're also planning to start a small private equity fund that they hope will both make profitable investments and help steer firms to the investment bank for advising and IPO underwriting in the future.

Like many folks, Ambrian is also looking to the East -- they recently sold a small stake in the bank (about 9%) to Sun Hung Kai of Hong Kong, and they intend for this to be a pathway into the Chinese markets, both to advise Far Eastern commodities companies, and to help invest the cash that is pouring through many of those markets.

So ... although this is certainly a risky investment and a tiny company, I like the risk-reward profile, and I think that this is the best play I can make on commodities right now -- if the commodity markets remain at all robust, Ambrian should be well positioned to continue rapid earnings growth, and they are not nearly as leveraged to any one commodity or one project as most other investments I would consider.

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A little Crazy ... a Little China

In what might be a dumb move, I've picked up shares in a couple of China closed-end funds in the last few days.

I've tried to hedge my bets a little bit, however: I have acquired shares of both the China Fund (CFN) and the Morgan Stanly China A Shares fund (CAF). These are extremely different investments, which I'll explain briefly. Basically, the China Fund is a mutual fund that buys stable, perhaps less-well-known companies that generally trade on non-mainland exchanges. I'd consider this to be the more stable fund, and a good long term investment. The China A Shares fund represents an investment in the actual bubble -- the Shanghain and Shenzen traded A shares market that is dominated by Chinese retail investors. Both trade at stiff discounts to their net asset value -- something on the order of 20% discounts in both cases, though that fluctuates a lot on any given day.

The China Fund is a more typical China mutual fund, with a long history, that happens to trade as a CEF. They have a couple of advisors, and they focus on buying non-state-controlled entities (this approach is common to many China stock advisors, including the newsletter editor Robert Hsu, who think the state owned enterprises are too bureaucratic and corrupt). I like this one because I appreciate the focus on smaller and unknown stocks that it would be difficult for me to buy personally -- they don't invest much on the A share market in Shanghai, but buy primarily Taiwanese and Hong Kong and other regionally traded shares that represent Chinese companies, or companies that primarily do business with China.

As of the end of April, their top holdings were:

Shanghai International Airport
Chaoda Modern Agriculture
China Merchants Bank
Daqin Railway
Shanghai Zhenhua Port Machinery
Golden Meditech
Financial Street
Xinjiang Tebian Electric
China Yangtze Power
Baoding Tianwei Baobian Electric
Powertech Technology
Cathay Financial
Merry Electronics
Formosa Petrochemical
China Oilfield Services

So I consider CHN to be a long term hold, which could obviously change. The expense ratio is a relatively reasonable 1.26%. CHN is now near a 20% discount to net asset value, which is nearly as high as the discount has ever been -- in contrast, the premium has occasionally gone as high as 60%, though I don't expect we'll see those numbers again. I don't think this fund deserves to trade at the same high discount as CAF, below, because of their relative lack of exposure to Chinese retail investors.

The China A Shares fund from Morgan Stanley (CAF) is more of a short-term bet for me. I think that it's entirely possible that the Shanghai markets will continue to climb for the rest of the next 12 months, on balance, even following the remarkable returns they've already had over the past year. There are definitely a lot more negatives with this fund, including massively higher expected volatility, but I think it's worth a gamble. With the shares trading at something like a 20% discount after being at almost as much of a premium as recently as December, and as the Chinese A share markets have continued to set new records despite all the talk of bubbles and state imposed control. This is essentially a small bet that at some point in the next few months -- before the Olympics next year, certainly -- US enthusiasm for the China A shares will return and that the markets will not have a crash. I could easily be wrong.

The top holdings of CAF, as of the end of March, were:
Huaxia Bank Co. Ltd
China Merchants Bank Co. Ltd
Shanghai Pudong Development BA
Daqin Railway Co. Ltd
Wuhan Iron & Steel Co. Ltd
Air China Ltd
Shenzhen Chiwan Wharf Holdings
Zhengzhou Yutong Bus Co.
China Coal Energy Co.
Maanshan Iron & Steel

As you can see, fairly limited overlap -- Dagin Railway and China Merchants Bank are in both funds, though I expect the CMB holdings in CHN are Hong Kong shares, not Shanghai (many companies list in both exchanges, at often different valuations). I've actually looked at China Merchants Bank as an independent investment idea before (in Hong Kong), because of their strong credit card business developing on the mainland, so I'm happy to have those shares doubled up in these positions.

The expense ratio is a relatively high 2%, thanks to the uniqueness of their portfolio in US markets, which is part of the reason I won't plan to hold this one for a very long time -- perhaps as much as a year or so, depending, of course, on how the market changes. I will likely keep a stop loss order on this one, which I almost never do for any investment.

So ... a couple Chinese investments. One long term because I like the investment strategy, one short term because I think the panic about A shares might be overdone ... and that short term one is on a much shorter leash, too. The CHN shares I purchased at $35.08, the CAF shares at $36.11.

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Another Buy From the Conviction List (ASEI)

Well, in the month or so since I posted my four-company "conviction buy" list, I've had the opportunity to buy two of those companies at even lower prices. The first was Gol Linhas Aereas a few weeks ago, and the second is American Science and Engineering (ASEI), which I picked up additional shares of this morning.

While I have been considering adding to my ASEI holdings for several months, today was the first time that I saw a stock price that I couldn't refuse. On no significant news that I'm aware of, the shares dipped by close to 5% today, and I picked up my additional shares at $48.09. This brings my average cost up to $46.55 (though I actually made my first of many purchases of ASEI shares above today's level, at $52 last year).

So why is the share price going down today? I have no real idea. It could just be a reaction to the fact that the order they announced, for $2 million worth of ZBVs, was pretty puny in the grand scheme of things ... or maybe there's some big institutional selling that I haven't seen yet.

As regards the ongoing announcement of contract wins -- their backlog of orders is still in the neighborhood of $100 million, so I don't much care what rules they follow to determine which orders to announce in press releases (they noted on a conference call a while back that they no longer announce all contracts, but will announce "more significant" ones). Generally, the ones they announce are larger than this of late, or are for "new" business with different countries or agencies, but I won't read too much into the tea leaves here.

I see no reason to doubt the long term performance of the company going forward -- their earnings will undoubtedly remain very lumpy, but in the big picture I expect that lumpiness to average out to continued significant growth. Not always year over year growth for any given quarter, since they occasionally have blowout quarters with big orders that won't be replicated 12 months later, as we've seen recently, but certainly growth writ large.

And the shares reflect some severe pessimism that is largely due, I think, to the lumpiness of earnings and the fact that management doesn't give much in the way of guidance and gets somewhat bristly on the conference calls when asked to do so (largely because they don't necessarily know what quarters will bring which business). Some good articles have been published on Seeking Alpha regarding ASEI, including a note about a positive analyst note last month and a more recent detailed analysis of their conference calls.

The PE ratio of 18 going forward is based on what I think are pessimistic numbers, but the PE of 20 for the trailing year could certainly be interpreted as a bargain given the company's growth potential.

I focus on a few things:

1, the big CAARS program for detecting nuclear contraband at US ports is in its infancy, and ASEI stands to potentially open up a new very lucrative line of business if it is successful. There is $2.5 billion in contracts to fight for in this business, and I expect ASEI to get at least a strong portion of that.

2, on a related front, the Omniview Gantry is the poster child for container scanning at ports -- if political pressure can continue to push for scanning more of the cargo that enters US ports, this product is the logical candidate to be rolled out.

3, the death knell for the Z-Backscatter Van, ASEI's core product, has been sounded multiple times -- but the orders keep coming in. I am encouraged by the ongoing development of the "ruggedized" ZBV for harsh conditions, and by the ongoing domestic adoption of this tool at border crossings and other security checkpoints.

and 4, there exist plenty of upside opportunities where expectations are fairly low -- including drive-through scanners, package scanners and personnel scanners. They had an order earlier this year for the Z-Portal system that can be used at drive-through checkpoints, and it's possible that this could build into a larger business. The package scanning products are in use in some government buildings and might be a more reliable product than the ones used in most airports and similar secure areas, and the personnel scanning, which is being tested by the FAA at one airport, is another potential piece of business. I expect to see some eventual success from the package scanning product line and perhaps from the portal drive-through line, but would guess that the personal scanners probably won't get a wide rollout due to time and privacy concerns (the scan takes a short time, and it reveals a lot about the human body, even in "privatized" mode).

So I still see plenty of long-term upside for this reasonably-priced technology leader that feeds a growing need for port, building and mobile security scanning -- especially as budgets for Iraq and Homeland Security remain on a growth trend. It should also be noted that as of last month there was a big short position -- close to 20% of the float -- so that might mean either I'm misinterpreting the company's future or there's a possibility of a nice short squeeze. I could certainly be wrong, but I want to stick with this one for a few years and see if my guesses play out.

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Bear Stearns Downgrades, Time to Buy (GOL)

I picked up a few more shares of Gol Linhas Aereas Inteligentes (GOL) yesterday, after a nice dip that was precipitated by a Bear Stearns downgrade and some very pessimistic comments by their analyst.

I've written many times about GOL in the past year or two, including a recent note that they were going on my "Conviction Buy" list ... but I haven't bought any shares in a while.

The prices we're getting now can't be ignored, however, and I've now bought just about all the GOL I can handle for my portfolio ... I picked up shares yesterday at $25.89, just a couple percentage points above the lowest price these shares have seen in over a year.

So what was the downgrade concern? Primarily, it's a fare war between GOL and TAM, the two dominant domestic carriers. The analyst sees this slashing profits, particularly in the fourth quarter when a lot of additional capacity comes online with new plane deliveries to both of these companies.

It's possible that Bear Stearns will be right in the short term (meaning, the next year or so), but I have my doubts. This company is so much leaner and so much better run than TAM (which is not a discount airline), that I think a fare war is probably not such a bad thing in the very long run.

GOL's goal, above all else, is to build a vibrant consumer air travel economy in Brazil -- something that is just in its first stages. And to bring people into the air and pull them off the buses that rattle along Brazil's unfortunate roadways, they use low fares.

A low fare airline depends on reducing costs and cutting fares to drive traffic, and on opening up a whole new market of people who never would have considered flying before because of the cost. That's what built Southwest and RyanAir to some degree, and it's even more significant in a lower-income country like Brazil -- the percentage of people in Brazil who have never flown in an airplane is dramatically higher than in the US or Western Europe.

So fare wars bring in new customers, and they also may allow GOL to take advantage of market share incursions against the larger TAM, in my opinion, because GOL has the financial wherewithal and the cost-cutting chops to keep fares lower, longer, than TAM. That's just my opinion, of course, it's possible that TAM's stronger hold on the business flier will help them hold off GOL, but I'm guessing not.

And more importantly, my supposition is that this fare war, founded as it is in a short-term desperation period for Brazilian civilian air travel, won't last long.

You see, in my opinion the major reason for the fare war is the terrible fall and holiday season experienced by Brazilian air travelers -- many people were turned off by air travel because of long delays caused by labor distress among the air traffic controllers due to overwork and anguish about being blamed for the GOL crash last year.

So it's not that the fare war came up organically because these two companies are trying to kill each other -- no, the fare war started because both airlines saw major traffic declines over a few months this winter, largely because air traffic delays made air travel unpalatable for many consumers, and had to do something dramatic and slash prices to get people back on their planes. I wrote a bit about this not long after the crash last fall here and also here, FYI.

I think this is a temporary issue, and that when air traffic control systems and staffing in Brazil are finally upgraded (which may take a couple years, I suppose, depending on political will), general consumer opinion about air travel is likely to improve to pre-last-fall levels.

And when that happens, whether it's next fall or next year or in a couple years, the marketplace can return to a more reasonable level of competition, which I think strongly benefits the smaller, nimbler, lower-cost GOL.

I don't trade much on shorter term issues, so it's possible that the shares will fall further -- but I would be surprised if they're not substantially higher within the next couple of years. At a trading PE of about 18 and a very large and growing market to address, I'm convinced that the shares are a very reasonable buy here -- the anslysts might be wrong on the estimates that give this a forward PE of about 10, but in the long run this is one of the stocks in my portfolio that I'm most convinced has a bright future.

disclosure: in case it's not obvious, I do own GOL and do not own any other companies mentioned here.

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