Taser International by Dick Weiss Equity Fund

Taser International, Inc. is a global leader in the development and manufacture of electronic control devices for use in law enforcement, military, private security and personal defense markets. TASER devices use proprietary technology to incapacitate combative or high-risk subjects who pose a risk to law enforcement officers, innocent citizens or themselves in a manner generally recognized as a safer alternative to other uses of force. The company is also developing SAAS-based software product to handle the back office needs of many of these same agencies.

 The taser gun has developed into a standard piece of equipment for many law enforcement departments in the U.S. While a replacement cycle may begin in the U.S. over the next few years bolstering sales, there is also still room to increase penetration from the current level of 50% of all domestic law enforcement. Another source of the growth will be the international markets which are under-penetrated relative to the U.S. The target foreign markets are largely the English speaking world as well as Europe. Current estimates are that these markets are only 15% penetrated.

The last few years have witnessed as enormous amount of new product introductions from TASER. These include a consumer device (C2), a 3-shot taser (X3), crowd-control tasers and an on-officer camera device with related software (AXON and Evidence.com). Unfortunately, most of these products have not been met with initial success, which is one reason the stock has been a poor performer. One offset to this lack of success is that the company has put much effort into controlling costs and is in the process of reducing R&D as well.

The key to the future success of TASER will rest upon the success of its AXON efforts and in particular its software effort. Evidence.com is a SAAS-based software system that can replace existing outmoded data-based systems used by most police departments. Most of these systems were not developed to cope with the proliferation of devices such as on-officer cameras, car cameras, evidence storage and other data-intensive information. Evidence.com can provide a cost-efficient, subscription-based model for data management, evidence collection/storage/management and overall analytics to aid in running the department. If successful, this SAAS model could become the standard of the industry where no standards currently exist.

TASER has unique technologies with high barriers to entry. It has used these advantages to dominate the U.S. law enforcement market for non-lethal devices. While the international opportunities remain large, the most compelling aspect of the story is its attempt to leverage its law enforcement relationships to sell a SAAS-based software product. If this strategic move into software is successful, it could radically change the nature of the company and its valuation. With the stock trading at 55% of a present value that assumes only modest success with Evidence.com, the risk/reward appears to be quite attractive.

51Job, Inc. by Ted Tyson International Fund

51Job, Inc. is the leading provider of human resource services in China. Its primary business driver is online recruitment services analogous to a Monster.com or CareerBuilder in the U.S. It enjoys a dominant position in a fragmented market with over twice the market share of its number 2 competitor. Overall penetration of the online human resources market in China remains low,  with 51Job servicing roughly 150k businesses out of a total addressable market of 30-40 million.

On top of the country’s booming economy and rapid urbanization of its population, 51Job is also capitalizing on several other trends that are taking place in China. First, there is a growing shortage of skilled labor across the country. According to the Zhejian Human Resources and Social Security Bureau, the province currently employs 8 million skilled workers, but is in need of another 7 million to fill vacant positions. The situation is similar in the Zhujian Delta where labor shortages are reported to be over 10% in the region. Second, although far short of offsetting the increase in demand, the supply of job applicants is also rising. According to the Ministry of Education, there will be 6.6 million college graduates in 2011, roughly 300k more than in 2010. This supply/demand imbalance is leading to wage inflation which is estimated to grow at a 15% compound annual growth rate over the next 5 years, a clear positive for the company. Finally, internet penetration is rapidly rising with users already approaching 400 million. China is in the midst of rolling out an aggressive national broadband plan, which should accelerate internet usage and add further momentum to 51Job’s penetration story.

During the third quarter of 2010, 51Job increased its number of unique employers by 56% year to year, and expanded operating margins by 1800 basis points year to year  to 29.2%. In addition to positive operating leverage, the improvement in profitability was driven by an aggressive shift from a brick and mortars model to an online platform, which incrementally improves profitability by 1000 basis points. Looking on to 2011, the Street is estimating revenues and operating profits to growth by 24% and 40%, respectively. This incorporates virtually no margin expansion from Q3 ’10 onward throughout all of 2011. Given the fact that recent channel checks point to no slow down in the 40% to 50% growth rate and also the continued success of migrating to the online platform, consensus estimates will likely need to rise substantially as the year progresses.

Even without factoring in China’s economic growth, wage inflation, and price hike opportunity for its services, 51Job should comfortably grow its business many fold over the next several years. The company currently trades at a 26x/16x PE multiple on 2012/2013 consensus estimates, with 12% of its market capitalization in net cash.

Martin Marietta Materials, Inc. by Clyde McGregor Tyson Value Fund

Value investors are generally attracted to companies with the following characteristics: an undervalued stock, a business with attributes that protect it from competition (often  called a “moat”), favorable business dynamics that allow for growth in intrinsic value, and a management team that thinks and acts as owners.  We believe that Martin Marietta Materials, Inc. (MLM) demonstrates these characteristics.

Martin Marietta Materials is primarily an aggregates producer, supplying material to the construction industry. The company estimates that a typical new house uses 380 tons of aggregates, a school or hospital may require 15,000 tons, and it takes roughly 21,000 tons to repave one mile of a four-lane highway. The company owns estimated reserves of approximately 13 billion tons of aggregates including material located on land leased from others at attractive lease rates for very long terms. Applying industry standard values of $1/ton for owned reserves and $0.40/ton for leased reserves, the company’s asset value exceeds $190/share after deducting debt. This value is more than twice the company’s current share price. At the company’s recent production rate, its reserves should last into the next century.

Aggregates themselves are heavy and relatively low value. This means that the distance that aggregates must be transported to a project is an important cost factor to the purchaser. Individual quarries tend to have a significant cost advantage in their local markets. As well, environmental regulation has become more intense over the past 25 years, making it much more difficult for competitors to enter an otherwise attractive regional market.

The aggregates industry faces divergent business conditions. The housing industry remains moribund, and commercial construction prospects appear to be limited. The weak financial condition of many state governments is also a negative. Finally, it must always be noted that weather can play a meaningful part in this industry’s profitability in any given year. On the positive side, federal stimulus money for infrastructure projects is available, and the country’s need to repair its roads and bridges is well-documented. We also believe that we have invested in this stock at a point where any upside surprise in housing or construction would be a meaningful positive while continued negative reports are already discounted into the share price.

Finally, we respect the company’s managers and believe that they have made capital allocation decisions that have worked to grow intrinsic value per share. MLM’s acquisition strategy has been sensible as the company has been achieving benefits of increased scale. The balance sheet is also in solid shape. All of these factors combine to make Martin Marietta Materials an appropriate addition to the Masters’ portfolios.

Global Cash Access Holdings, Inc. by Jeff Bronchik Smaller Companies Fund

Global Cash Access Holdings, Inc. (GCA) is the leading merchant processor for the gaming industry in North America providing cash access points for gaming customers through ATM machines in which customers receive cash from debit or credit card transactions. This is a niche service offering that involves strong client relationships with casinos, 24-hour cash access uptime, navigating gaming regulatory issues and cash advance technology at the point-of-sale. GCA also offers ancillary services to the gaming industry including marketing and credit solutions, as well as the promise of “cashless” gaming.

 Despite high margins, high cash on cash returns, prodigious cash flow, and north of 70% market share by some calculations, the stock has been a poor performer over the last few years for a number of reasons. Prior management and the original founders of GCA were replaced in 2007 after a variety of gaming regulatory issues, as well as some very gray issues involving proper corporate governance. The difficult economic environment since 2007 resulted in a sharp decline in per-visitor spending with the net effect distinctly negative for GCA both on a revenue and margin basis. Lastly, the company was delivered bad news in July 2010 when Harrah’s Entertainment, its largest customer by revenue (but with below average profitability), declined to renew its multiyear contract. The stock declined over 40% in one day and provided our initial entry point.

Our investment premise is multi-fold. The stock is distinctly inexpensive with nearly a 20% free cash flow yield and trading at 6.5 times 2011 cash earnings, which may provide a margin of safety in the event the casino industry takes longer than expected to recover from the lows of consumer economic activity in 2009/2010. It also may provide some downside protection against overblown fears that Harrah’s move is the precursor to a massive industry shift, which our research suggests is somewhat far-fetched. Two large contracts are coming due in 2011 and it is not impossible that GCA could either lose parts of either contract, or reduce profitability to retain them. But as the largest industry player with both people and regulatory and technology scale, as well as hundreds of staggered, multi-year contracts, it is difficult to engender a wholesale takeover of GCA’s marketshare.

 GCA is also not sitting still during this economic turmoil. CEO Scott Betts (formerly of First Data Corporation) joined the firm in 2007, cleaned house, made smart tuck-in acquisitions, hired R&D talent and has both paid down debt and repurchased shares. A new CFO with broad gaming experience was brought in at the end of 2010. The company has $224mm in gross debt, which is a limited issue given its free cash flow and a 2012 maturity of its public debt which represents $127mm of the total.

Catalysts for the stock include a reasonable resolution for the contract issue over-hang in 2011 or any modest signs of life in gaming spend. Should either of these occur, we believe it is possible for the stock to provide meaningful returns for shareholders, without factoring in any longer term prospects for cashless gaming and further growth in non-ATM services.

These commentaries are as of 12/31/10. For industry terms and definitions, please click here.

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