Wow! I have to admit, when I wrote my piece on First Marblehead (FMD) late last night, the stock was at $52.35, and while I expected it to go up today, it has blown past my most optimistic guess of where it would go. As I write this, the stock has just passed through 60, up over 15%.

I still am bullish on the company , but in the short term, caution is probably in order. The stock is likely to have a significant move once the deal closes and final numbers are in, and while I believe it will be to the upside, given today’s gains, short term expectations may be too high. That said, I expect to add to my position on any pullback.

Disclosure: I hold a position in FMD

First Marblehead(FMD) is one of those stocks that people either love(First Marblehead: A Bull’s Thorough Defense) or hate(First Marblehead Proves Us Right). Count me in the love category.

The company announced today updated details on its upcoming securitization of student loans. The total loan volume being securitized has increased to an estimated $1.84 billion up from last week’s estimate of $1.56 billion. Much more interestingly, the company estimated that its up-front structural advisory fee would be $175 million or 12.6% of loan volume. Previous securitizations had consistently yielded up-front fees totaling approximately 8% of loan volume. What’s happening here?

It looks like the company has structured this deal to give them more cash up-front and less in the future. In past securitizations, additional structural fees have been about 1.5% of loan volume, and residual revenue has been discounted to around 7.5% of loan volume. Though the discounted value has been recognized as earnings, no cash is received for these revenue streams until 5-6 years after close. The company has not given guidance on those values for this loan and it seems likely that they will be lower than in the past to compensate for the huge increase in up-front revenue.

Taking more of the money up-front has several important benefits. Restructuring these deals to allow for more money up-front dramatically improves cash flow without impacting earnings and introduces more certainty into the company’s balance sheet as it becomes less dependent on present value of future residuals. This addresses some of the persistent complaints of critics who contended that First Marblehead’s estimates of residual revenue were inaccurate and inflated earnings.

First Marblehead has consistently and strongly grown revenue and earnings. The company has been making excellent progress signing up new partners like GE and National City to reduce its dependence on a handful of large partners. It is also awaiting approval for its bid to purchase a small bank which would allow it to expand the array of services offered. The stock has a reasonable valuation with a P/E of 12.5 against fiscal ‘07 numbers. There is currently a 1.1% yield and management has raised the dividend as earnings have grown. Despite more than doubling over the past year, I believe this stock still has ample room to continue its upward march.

Disclosure: I hold a position in FMD stock

You may not have heard of Lifetime Brands(LCUT), but you almost certainly own one of their products. The company owns or licenses a broad array of brands including Farberware, Sabatier, Hoffritz, Pfaltzgraff, KitchenAid and Cuisinart. Lifetime is the largest supplier of cutting boards, silicone bakeware, and pantryware, the second largest supplier of household cutlery and a significant player in the tabletop market.

Lifetime has shown an ability to grow quickly and profitably. Revenue has climbed from $131 million in 2002 to $307 million in 2005, and EPS from $0.34 in 2002 to $1.23 in 2005. The company’s guidance for 2006, most recently given on August 3, $480-500 million in sales and $1.50 to $1.70 in EPS.

Lifetime has been agressive in purchasing brands and assets. Last year the company purchased Pfaltzgraff which instantly made it a major player in the tabletop space. Pfaltzgraff doubled the number of outlet stores the company operates(88 after closing overlapping stores) and gave the company a direct-to-consumer business to complement the existing wholesale business. Lifetime also acquired Salton’s(SFP) tabletop business which expanded the product line to fine china and crystal and included licenses of premium brands such as Calvin Klein Home. More recently, the company acquired the assets of Syratech to move into the home decor and picture frame business.

With each acquisition completed, Lifetime has been able to quickly improve cost structure through its extensive experience with global sourcing, expand distribution through its extensive distribution network, and reinvigorate product lines with new products and designs by its in-house design staff.

Lifetime has also moved aggressively to enter into licensing deals for trusted brands like KitchenAid and Cuisinart, both of which it has successfully extended into new markets like cutlery and kitchenware.

The company has been agressive in introducing new products, planning to introduce 1400 in 2006, double the number released in 2005.

Though the company has been agressive in taking advantage of opportunities, it has been disciplined. Earlier this year, Lifetime reached an agreement to purchase the assets of WearEver, a bakeware company, out of bankruptcy for $21 million. At the mandatory court auction, the company lost out to another bidder who paid $36.5 million.

What’s not to like? The company recently sold $75 million worth of convertible debt, increasing long-term debt to $80 million, but this hardly seems unreasonable for a profitable company with a $270 million market cap. The stock dropped when the company warned of a second quarter loss, but the company’s earnings are historically extremely seasonal, with almost all earnings coming in the third and fourth quarter, and the company has maintained its guidance for the full year. There have also been reports critical of the number of family members employed in senior roles at the company. While this certainly gives one pause, the numbers seem ample evidence of the job management is doing.

Lifetime trades at 14x 2006 earnings, and 10x 2007 estimates. The company also features a 1.24% yield. With a 5 year EPS growth rate of 27.3%, and well off its 52 week high of $30.10 the stock seems quite cheap at Wednesday’s close of $20.10. As the company’s earnings come in Q3 and Q4, I believe the stock can quickly rebound towards the mid-20s, and to continue to rise over the next several years.

Disclosure: I own LCUT stock

For nearly a week the scandal at Hewlett-Packard(HPQ) has dominated the headlines. Each day has brought progressively worse news. What began as news that George Keyworth had been identified as the source of a leak and would not stand reelection, quickly escalated with the revelation that investigators hired by board Chairwoman Patricia Dunn had obtained information about directors and reporters illegaly.

Subsequent reports brought news that Tom Perkins had resigned from the board in May in objection to this unethical act, that the California Attorney General was investigating criminal charges, and that the FCC, FBI, US Attorney, and Congress were also conducting investigations.

Despite this, Dunn has maintained that there is no need for her to resign, though she has said she will do so if asked by the board.

What is most interesting to me about this is the market’s reaction. Hewlett Packard stock has deflected each piece of news, closing Monday at $36.36, just short of its 52 week high. So while the headline writers and journalists(particularly those who had their phone records illegally obtained by Dunn’s henchman) have determined that this is a serious matter, investors have decided it’s immaterial.

What are the possible impacts that investors should be concerned with?

Impact to Business
Hewlett Packard is a well-established vendor it is hard to imagine this having a material impact on revenues. Purchasers will view this is an internal company matter, irrelevant to their purchasing decisions

Impact to Mark Hurd
Since taking the CEO position at Hewlett Packard, Hurd has been credited with vastly improving the company’s performance. Any indication that Hurd were involved that might jeapordize Hurd’s future role at the company would be viewed as a negative by the street. There has been no suggestion that Hurd played a role in this, and in fact, the investigation began during his predecessor, Carly Fiorina’s tenure. I view it as unlikely that Hurd will be adversely impacted by this.
Criminal Charges or Lawsuits against the Company
With the number of investigations underway now, criminal charges against one or more individuals seem likely. I suspect that the investigators are the most likely target. From waht is currently known, it would seem difficult to make a case against Patricia Dunn and even more difficult to make one agianst other board members. Lawsuits against the company by those journalists whose records were illegaly obtained seems possible, but of uncertain outcome.

Patricia Dunn’s Job Status
While it is unclear what Dunn knew when about the illegal activity, she ultimately should be held responsible by the board for the investigation that she ran. Dunn hired the investigators, managed communications with them, and received reports from them. Proof that Keyworth was the leak source must have included phone records. If she didn’t ask how they were acquired, she certainly should have. And if Tom Perkins knew what had happened in May, she certainly did, yet there is no evidence that she did anything at that time to rectify the situation. She may not have done anything illegal, but she has failed utterly at her job an ought to be fired.
Bottom line, the market has weighed these and other factors, and yawned. If I owned HPQ though, I would view this as an opportunity to sell. The stock has moved up significantly both over the last month and the last year, there remains risk of additional revelations, and I don’t want to own a company whose board allows this Chairwoman to remain.

Update: HPQ announced this morning that Dunn will be stepping down as chairwoman effective January 18 but remain on the board. Mark Hurd will become Chairman. This is puzzling to me. If Dunn isn’t fit to serve as Chairwoman after January, she isn’t fit now, and she isn’t fit to be a director. There had been some speculation that Tom Perkins might be brought back to replace her, but with Dunn remaining on the board seems unlikely. It would seem to me that as long as Dunn and those board members who allowed her to stay remain, HPQ should be approached with caution.
Disclosure: I do not own HPQ

George at Fat Pitch Financials has begun a blog carnival called Festival Of Stocks. The first edition is currently up and our post on Consolidated Tomoka has been selected as Editor’s Choice. There is much other worthwhile reading featured, and all are encouraged to visit.

Rob Zenilman has a recent post on SeekingAlpha on warehouse club membership fees. Though the post is titled “Are Warehouse Stores Too Dependant On Membership Fee Income?” this post merely shows that this is the case, but doesn’t suggest any conclusion. I would maintain that not only is this desirable, it is an integral part of the business model.

There are 3 major players in the warehouse club market, BJ’S Wholesale(BJ), Costco(COST) and Sam’s Club(part of WMT). These businesses offer a wide range of product catgeories but typically limit brand and size selection for any given product. Costco, for example, sells only 2 brands of diapers, 1 of which is their house brand and in only 1 size package. Compare this to a local supermarket which will offer 4-5 national brands, different styles within brand, and several package sizes per brand as well. BJ’s carries more SKUs than Costco, but still far fewer than traditional stores. Limiting product selection gives warehouse clubs additional leverage with suppliers as there is great value in being the only choice. Warehouse Clubs pass this value on to consumers; Costco is famous for never marking up prices more than 14%.

Rob noted:

For the 12 months ending with 2006’s second quarter, Costco’s membership fee revenue was 72.7% of operating income and BJs was 83.9%. BJs has already reported Q3 numbers - the TTM ratio went up 4.5% to 88.4%

So, the bulk of operating income is not from selling merchandise, but from selling memberships. Bad news, right?

Wrong. There’s no great secret being uncovered here, this is the warehouse club business model.

Reasons why dependence on membership fees is good

1) Float

Members pay $45 at BJs or $50 at Costco per year. They pay this up front at the beginning of their membership year, and though it gets recognized over the next 4 quarters, the Comapny has all the cash up front. This is an attractive source of low cost working capital. Money can be used to develop inventory, open new clubs, market memberships or can just be allowed to accrue interest. One result of this may be that unlike many retailers, both BJ and COST have little long term debt, and none net of cash.

2) Ability to “underprice” competitors
Since over 70% of profit comes from membership fees, warehouse clubs have the ability to price items at lower margins and still make money. The typical customer will compare the price on their receipt to other stores. They won’t first allocate a percentage of their membership fee. This creates a perception for customers that warehouse club prices are lower than their actual cost to the consumer.

3) Repeat Customers

Customers who have paid a membership fee are likely to shop more frequently and conduct more of their purchasing at the club in order to take full advantage of their membership fee. Since they have already paid in, there is a “switching cost” during the membership term.

4) Elasticity in Membership Fee

Costco recently raised it’s membership fee by $5 to $50 and BJs may well follow. BJs raised rates from $40 to $45 several years ago and renewal rates remain above 80%. In addition both clubs have had success in offering their premium membership levels($80 forBJs, $100 for Costco).

Both stocks are well off recent highs, but BJ looks to me like the much better buy. BJ trades at only 13.5 times next year’s earnings, has a strong balance sheet with only $10MM in long-term debt, and owns substantial real estate assets to support it’s value. In addition, as Rob points out, there have been persistent rumors that it might be a takeover target.

Unlike Costco, BJs does not have a national footprint, and some have expressed concern about its ability to compete. However it continues to do well in markets where it is competing with Costco, continues to expand, and has differentiated itself somewhat. BJs has focused on the consumer as opposed to the small business, and as a result, stocks a larger number of SKUs and somewhat smaller package sizes.

Recent drops in gasoline prices are likely to lower revenues and earnings as BJS operates gas stations at many of its clubs, so there may soon be an opportunity to buy lower. Even at $26 though, I think this is good for the long term.

Disclosure: I own shares of BJ

After years with a stagnant stock price Consolidated Tomoka (CTO) has gone from 10 to over 60(with a brief stop above 90) in the last 6 years. Despite this, its share price is still well supported by the value of its assets.

Consolidated Tomoka began as a timber company and was perhaps Florida’s largest landowner with over 2 Million acres in the early 20th century. In 1923, the company was purchased by Baker Fentress and Company, now known as BKF Capital(BKF) and the subject of a recent investment by Carl Icahn.

Baker Fentress listed CTO in 1969, and in 1999 distributed its remaining stake to BKF shareholders. After dropping initially do to increased liquidity, CTO began a steady march upward.

Today, CTO continues to own nearly 12,000 acres in Florida, including 10,600 in the City of Daytona Beach. In addition, the company owns the equivalent of 284,000 acres of oil, gas, and mineral subsurface interests. There are currently 2 producing oil wells on the company’s interests.

Management undertook a new strategy in 2000 to use the tax-deferred proceeds of land sales to purchase commercial property with long term triple-net leases dispersed over a larger area. As of June 30, 2006, the company carried 25 such properties carried at a value of $104 million. Given the increase in real estate values, particularly in those parts of the country where CTO is active, it seems reasonable to assume some amount of appreciation, particularly on earlier purchases. Current revenue run-rate on this is over $7.4 million a year, and with high margins, this can be expected to deliver over $6 million in net income.

The land which CTO owns in Daytona Beach is carried at a ridiculously low value as a result of its acquisition almost 100 years ago. Though the land is on the balance sheet with a value of just $2.3 million, it is clearly worth many times that. In 2005, the company sold 317 acres at an average of $114,000 per acre. That was an unusually high amount per acre and it would be unreasonable to assume that all of CTO’s land has that value, but even in 2004, when a large(1000+ acre) sale took place at a substantially lower average price, the average was $17,800 per acre. Using that value, we might value CTO’s land at $200 million. Obviously this must be discounted as it will not all sell today, but CTO has been carefully doing things to build value such as donating land for recreation, hospitals, schools and roads. CTO has also developed special purpose areas such as auto malls and office parks. By planning development effectively and selling land slowly, CTO has been able to maximize price per acre, and continued growth should continue this virtuous cycle.

Recently, due to the destruction of timber in forest fires, Consolidated-Tomoka has begun growing and harvesting hay. Though this only produces a small amount of revenue, it allows much of the company’s land to qualify for taxation as agricultural land which yields significant cost savings.

Consolidated Tomoka’s last major business is its ownership and management of the LPGA International Golf Course. Though this asset has substantial value, golf operations have consistenly lost money and show little sign of improvement.

In summary while there are a lot of moving parts here, the key piece is the conversion of cheaply valued land into income-producing real estate. While the company currently offers only a small dividend(.6% yield) and sports a high P/E, as this conversion continues, I would expect the dividend to continue to rise(it was just recently raised), and the P/E to continue to fall. That said, this is a company with a market cap of $360 million, no debt, and assets that I would value above $300 million. While I would be nervous about the U.S. real estate market in the short term and wouldn’t necessarily advocate buying today, I believe the company’s assets limit downside risk, and, in the long term ensure another major upward swing.

Disclosure: I own shares in CTO.