MARKET OVERVIEW

This morning while driving to the office I listened to CNBC on the radio as Becky Quick interviewed Warren Buffett, Charlie Munger, and Bill Gates. The discussion was remarkable in many respects, not the least of which was that three of the most successful investors who ever lived (estimated combined net worth: $143 billion!) would take the time to share their thoughts on a wide variety of topics with the general public for no apparent self-gain.

Although you may not think of Gates as an “investor” like Buffett or Munger, to my way of thinking there really isn’t much difference between a person that allocates capital to build a small company into a corporate behemoth (as Gates did with Microsoft), and a portfolio manager that allocates capital to build a small portfolio into a huge fortune (as Buffett and Munger have done).

In both cases success and failure rides on the judgment of the person allocating the capital, and an inability to anticipate future opportunities will most likely prove fatal. If nothing else, this interview reminded me of the importance of having a strict discipline for making buy and sell decisions when managing an investment portfolio. That is why we adhere so strictly to the BiQ/STR methodology that informs all of our portfolio decisions, and avoid getting caught up in the hype of whatever tech stock is hot at the moment.

Along those lines we are often asked about some of the stocks in our coverage universe that we do not recommend, especially those that appear to be enjoying a great deal of success. Lately there has been a lot of attention on Yahoo (NSDQ: YHOO) given the impending IPO of Alibaba, a Chinese ecommerce company in which Yahoo holds a large minority stake it purchased back in 2005. Since then Alibaba has grown to the point where in 2012 its portals generated more revenue than eBay and Amazon combined ($170B).

For those who have been following Yahoo, it is the prospect of Alibaba’s IPO which has driven Yahoo’s stock price higher recently (up 50% since last summer). Yahoo expects to net billions of dollars when Alibaba finally goes public. We say all this because the media machine cranks out so much nonsense that investors could get confused by the factor which has driven the stock up.

The media circus has focused on Yahoo’s fledgling CEO, Marissa Mayer, who has only been at the helm since 2012. Her admirers have pointed to her revamping of the look and feel of Yahoo as a portal since she took over. The truth is we have used Yahoo as a portal for a decade but now see the portal moving in the wrong direction.

For instance, where I used to use Yahoo for Sports – I no longer do. The reason is that they have made the site more glitzy but it now provides less useful information.  For example, if you want to know who is in the NBA playoffs and what their potential road to the finals could be, finding this information is now difficult on Yahoo so I now use ESPN instead where it is much easier to locate.

A year ago I decided to test whether or not the hype surrounding Mayer was, in fact, true. I paid for a Yahoo mail account but have found the paid site to be far less useful than a free one from Google (Gmail). Standard mail functions appear and disappear requiring me to reload the webpage which I never have to do with Gmail. I am going to be leaving Yahoo mail as a result.

Of course, I realize that Yahoo is not trying to market itself to middle-aged men such as me. Their focus is on mobile phones and younger clientele. This can help to explain their lack of email functionality, but the ESPN site I use for sports is also a mobile site – it is simply done much better.

The bottom line is Yahoo is in line for a nice payday once Alibaba IPOs; however, in the tech world your company has to be executing a sustainable growth strategy based on a strategy for innogration. Yahoo is not and this is why STI does not currently recommend Yahoo as either a value or a growth stock. We will be watching Yahoo closely AFTER the IPO of Alibaba to see how it intends to deploy its massive cash windfall, and determine if Melissa Mayer really does have a long term strategy for innogration. Stay tuned.

NASDAQ Composite Index:

Friday, May 2 = 4,123.90

Year to Date = – 0.5%

Trailing 7 Days = + 1.2%

Trailing 4 Weeks = + 3.0%

PORTFOLIO UPDATE

For the first time in a long time, none of our portfolio stocks have done anything notable during the past week so instead we will offer a very short term trading opportunity for your consideration. To be clear, this type of transaction carries with it far more risk than our other recommendations that we make based on our BiQ/STR valuation methodology.

Until a few months ago, life was good for NeuStar, Inc. (NYSE: NSR). As the sole vendor for a major local portability contract with the FCC it was able to operate almost unfettered by competition (local portability refers to the process of transferring your cell phone number to a new carrier when you change providers). Although this contract was certainly not NeuStar’s only source of revenue, it accounts for roughly half of its overall income and has been the bedrock upon which the rest of the company has been built.

However, this contract is up for renewal at the end of this week, and based on recent price action in the stock it appears most investors believe the FCC will assign the contract to a competitor.  At the start of the year the stock was priced at just under $50, but since then has plummeted in value to about half that (it opened this morning at $26.55). Until early April it was still priced above $34, but over the past five weeks it has dropped steadily on increasing speculation that NeuStar will lose the contract altogether.

At this point a good argument can be made that the stock price now fully reflects losing the contract, and perhaps even overstates its impact on future earnings. Generally speaking bad news tends to create negative momentum that compounds itself as each new support level is breached, thereby triggering a new round of stop loss orders and sell signals.

But if NeuStar does lose the contract, then why might the stock bounce back up on then news? There are several possible outcomes, but only the worst case scenario appears to be factored into the current stock price. NeuStar has been aggressively lobbying the FCC to allow it to keep the contract but at lower profit margins. If that happens then analysts will need to recalculate expected future earnings for NeuStar, presumably higher than what is now being assumed.

And if I’ve learned anything after living in Washington DC for the past fifty-five years, it’s that the influence of an effective lobbyist should never be underestimated. I wouldn’t be at all surprised if the contract is rewritten with standards that disqualify NeuStar’s competitor from consideration; that sort of thing goes on all the time around here.

Interestingly, the stock jumped up Friday on high trading volume, going from an opening price of $25.61 to a closing price of $26.62 for a gain of a full dollar. Today it has backed off of that level on lower volume, suggesting that a big investor was buying up a lot of stock on Friday. Who might that be? We don’t know, but the insiders on Wall Street have a funny habit of guessing right on these types of things.

All that said this is clearly a very speculative play. If NeuStar does lose the contract entirely then the stock may drop some more on the news, but it really shouldn’t go below $20 as its other business lines generate enough revenue to support that price. But if the news is anything better than that the stock could easily jump above $30 depending on exactly what the story is. Remember, this was a $50 stock only a few months ago.

If you don’t want to risk losing too much capital then simply buying the stock is the way to play this one. But if you are more of risk taker and want to go for the home run, then buying call options could be much more lucrative.