Virtual Stock Portfolio: Year End 2005 Review

The Burnham's Beat virtual stock portfolio closed out 2005 on a strong note up 4.6% in December vs the Nasdaq's 1.2% decline. Q4 turned out to be a great quarter after I spent some quality time in late September updating what had become an admittedly dated portfolio. Its 16.5% return was the second best quarterly return since inception.  Overall, 2005 was another good year for the portfolio as it was up a total of 37.1% vs. the Nasdaq's 1.4% gain.  This brings the total gain since the portfolio's inception in Freburary of 2004 to 84.0% vs. a 2.4% gain for the NASDAQ over the same period.

I only held one position the entire year and that was a short position in Wave Systems (+38% return on the year).  Other than that the entire portfolio turned over during the year.  My biggest gainers in 2005 were Neteller (Long, +116%), SportingBet (Long, +56%). SPSS (+53.5%) and  Microstrategy (Long, +52%).  My biggest losers were Autonomy (Short, -109%), Salesforce.com (Short, -39%), FireOne (Long, -13%) and my first trade in Actuate (Long, -5.9%).  Overall, 74% of my positions were positive which is pretty respectable.  I did end up shorting two of the year's best performing software stocks (Autonomy and Salesforce.com) but at least I limited my losses by selling out before they really hit their strides.

Repeating 2005's performance will be pretty difficult in 2006, but if the market stays choppy it should be continue to be a good environment for picking stocks.  To start off the year I am getting out of a few positions that seem to have run their course.  The first is the paired trade between Party Gaming (long) and SportingBet (short), by the end of 2005 the multiples of these two stocks had basically converged so its time to unwind this trade and move on.  I am also getting out of my short position in Emerge Interactive.  The company seems to have stablized a bit and I don't want to be too greedy as they have plenty of cash left.  I am also exiting FireOne group, one of the online gambling payment processors.  I just can't justify holding this stock when it trades at a premium the #1 player in the space (Neteller) despite lower margins and growth rates.

I am not replacing these positions this month, but will add a few more positions next month after the market settles down for the year.

Long Picks

Company: Microstrategy Ticker: MSTR
Sub-sector: Business Intelligence
Investment Thesis: I like the BI space in general and have been keeping my eye on Microstrategy.  This has recently been one of the cheaper stocks in the space, yet it also has one of the better product portfolios and market positions.  Businesses are still spending big bucks on BI and MSTR should be a big beneficiary.
Performance: Since 3/31/05: +52.3%,  Dec. vs. Nov.: 11.9%
Comments: Nice month and still chugging along despite a big short position.  I am bit concerned that the stock will start to sputter now that they are tapped out from a buyback perspective, but they should report a decent Q4 and the stock will soon start to trade off of 2006 which reflects all the buybacks.

Company: FireOne Group Ticker: FPA.L
Sub-sector: Financial Services
Investment Thesis: FireOne operates an Internet payment service very similar to Neteller. It is used primarily by on-line gamblers to transfer money around.  I I added FireOne to the portfolio because I wanted to maintain overweight exposure to the these kind of Internet payments plays without putting all my eggs in one basket (Neteller). Now that I have closed out Neteller this will be sole exposure to Internet payments.
Performance: Since 7/31/05: -13.3%,  Dec. vs Nov.: -0.1%
Comments: Closing this position out after the market has moved to such an extent that Neteller (the #1 player in the market and an old long pick) now trades at a discount to Fireone despite the fact that FireOne has lower margins and growth rates.  If I were going to own any stock in this space now it would Neteller not this one.

Company: Actuate Ticker: ACTU
Sub-sector: Business Intelligence
Investment Thesis: Acutate is a business intelligence company with a particular focus on enterprise reporting.  I had a long postion in ACTU in 2004 and lost money on it, but I think the stock is back on the upswing now thanks to an improved product line and focus.   ACTU trades at a healthy discount to rest of the BI group (kind of like SPSS did at one point) and every penny of upside in its EPS could really move the stock.
Performance: Since 9/30/05: +24.1%  Dec. vs. Nov.: -4.8%
Comments: Cooled off a bit in December, after busting through $3/share without a problem.  If they exceed estimates this quarter it could move past $3.50.

Company: OpenText Ticker: OTEX
Sub-sector: Content Management
Investment Thesis: OpenText is a content management company that went on an acquisition binge in 2003 and 2004.  The stock suffered from all the M&A related charges and fallout but managment now claims that they are going to resolutely focus on EPS growth.  OTEX trades at a healthy discount to the rest of the content management group and has a broad product portfolio.  Integration snafus could trip them up, but the low multiple on the stock should limit any potential damage.
Performance: Since 9/30/05: +0.9 % Dec. vs. Nov.: -5.6%
Comments: Weak in December, should recover in January (if it doesn't preannounce!).

Company: Cryptologic Ticker: CRYP
Sub-sector: Gaming Software
Investment Thesis: Cryptologic is a provider of gambling software to online casinos and poker rooms.  They license their software to numerous companies in return for a cut of the take.  About 70% of their revenues are from casino related software sales and about 30% from poker related sales.  Since they are a technology provider and not an operator they actually are listed in the US and do not appear to be in danger of violating any online gambling laws.
Performance: Since 9/30/05: 11.6%  Dec. vs. Nov.: -2.5%
Comments: I have been following the online gambling sector closely for the past two years and right now I really think that CRYP offers the best risk/reward of any of the stocks.  It trades at the lowest EPS multiple in the group right now (14X 2005) which is about a 30% discount to where the rest of the group now trades.  This despite the fact that CRYP is one of the only online gambling stocks to trade on a US Exchange and has a very diversified revenue base.  This should be trading at least 25% higher.

Pair Trades
Long: Party Gaming Ticker: PRTY.L
Short: SportingBet Ticker: SBT.L
Sub-sector: Online Gambling
Investment Thesis: Party gaming is the largest online gambling company in the world with an exclusive focus on poker.  Party went public this summer at 116p and got up to 140p before getting creamed when it talked down its revenue growth prospects on its 1st earnings call.  The stock is now below its IPO issue price and at this level it is not only at 12X earnings, but 12.4X cashflow (of $500M/year) for a cash flow yield of over 8%.  In comparison to Party, SportingBet is trading at a substantial premium (21X vs. 12X) even though much of the excitement surrounding SBT has to do with its acquisition of Paradise Poker (the #5 poker room).  It will be tough for SBT to sustain the premium to Party given Party's superior margins, cash flow and growth rates.  With the paired trade the legal risk facing the sector is minimized because both would likely suffer equally from any legal action.  Up until now these kinds of trades didn't make sense because all the names traded pretty much in line with each other, but with Party's somewhat unwarranted implosion this is a perfect opportunity to put on such a trade.
Performance: Since 9/30/05: +36%  Dec. vs. Nov.: +14.5%
Comments: This trade worked like a charm.  During Q4 party was up 43.4% and Sporting Bet was up only 7.2%.  The mulitples have now converaged, at least from a market perspective, so it's time to close this trade out and move on.  I actually believe that Sportingbet trades at a much higher multiple than the market seems to think (I would not be long the stock this year), but you can't fight that battle in a paired trade.

Short Picks

Company: Wave Systems Ticker: WAVX
Sub-sector: Security
Investment Thesis: I first encountered Wave when I wrote my initial analyst report on Wall Street in the mid-1990s. Wave has remained in business largely by claiming that it is developing revolutionary security technologies, kind of like a bio-tech company that never gets out of trials. With a grand total of $1.4M in revenues over the last 3.5 years, a $4M/quarter cash burn rate and only $4M or so in the bank, a day of reckoning is fast approaching.
Performance: Since 10/1/04: +25.3%  Dec. vs. Nov.: 15.0%
Comments: This company amazes me.  It makes CDSS look IBM, yet WAVX continues the ward off the grim reaper by raising more money.  Not that raising money is that hard when you issue fully registered shares at a 26% discount to the market with 18% at the money warrant coverage.  It's ridiculous the SEC let's companies do this without forcing them to make a rights offering.  What a scam.  Anyway, they were only able to issue about $3.5M in shares in mid-December which buys them less an full quarter at their current $4M+ burn rate.  Perhaps 2006 will finally be the year of reckoning for Wave.

Company: Citadel Security Software Ticker: CDSS
Sub-sector: Security
Investment Thesis: Citadel offers a subscription service to help companies spot security vulnerabilities.  It's a good idea, but a lot of other companies including a number of private companies offer the same service.  Lately Citadel's business has been falling off a cliff.  They are buring cash to the tune of $5M/quarter and yet the management team hasn't done any major cost cutting.  As a VC, I can tell you first hand that it is incredibly difficult to turn around this kind of situation even if you get some product momentum.  I haven't seen a single company in this kind of shape pull it out.
Performance: Since 9/30/05: 48.3%    Dec. vs. Nov.: 35.4%
Comments: I am going to be greedy and hold this 1 more month.  The management team all got employment agreements at the end of the month which means a sale is probably just around the corner.  They are running on fumes right now and nothing else.  Funny thing is that I think it will sell for at least $20M, but the preferred stock and debt will get all of that.

Company: Emerge Interactive Ticker: EMRG
Sub-sector: Vertical Applications
Investment Thesis: Do you need software to help trade and manage cattle?  Apparently not many other people do either, otherwise EMRG wouldn't have generated only $335K in revenues last quarter.  With cash finally running out after $205M in losses this company should be headed for the slaughterhouse shortly.
Performance: Since 9/30/05: +15.4% Dec. vs. Nov.: -15.8%
Comments: I thought it would be greedy to hold on to this after making 30%+ my first month and I was basically right.  Unlike WAVX or CDSS these guys actually have enough cash in the bank to last a few quarters at their current run rate, so the day of reckoning is not upon us and they will be able to spin a lot of "hope and prayer" stories before then that may cause this to back up.  Given this, I think I will take my gains and move on to the next rodeo.

Company: Entrust  Ticker:  ENTU
Sub-sector: Security
Investment Thesis: Entrust started out providing Certificate Authority software for use in public key encryption and now has a broader line of identify management products.  I know them from my days covering the security sector on Wall Street.  They seem to disappoint at least once a year and given that the stock has now fully recovered from their last dissapointment they should be due again.  It doesn't help that most of the major software players, including IBM, Oracle and CA, have made their own identity management acquisitions in the past 18 months either.
Performance: Since 9/30/05: +13.6% Dec. vs. Nov.: +3.2%
Comments: I can't see why people are paying 28X EPS for this company given the competition it faces and its repeated ability to execute.  That said, the stock always seems to float back up after they disappoint, so I think I will probably only stick around another month.