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No. of Recommendations: 7
We will return to SI Pro and Garmin shortly, but Herb's latest e-mail

http://www.marketwatch.com/News/Story/Story.aspx?guid=%7b5F92D221-4FD8-4E6B-A3AF-2E889AEB21D4%7d&siteid=mktw&dist=nbc&print=true&dist=printTop

prompted me to look at Crocs (CROX), the maker of those funny looking (but comfortable, so I am told) shoes.

Have you checked this company out? For the 3 mos. Mar. 2006 Crocs made $6.4 million of GAAP profit. But their investment in working capital was $28 million, so operating cash flow was $(18) million. After deducting for capex, free cash flow was $(22) million.

Bowling companies. Hula-hoop makers. Pet rocks. George Foreman grills. Hot glazed donuts. And now Crocs. I fear many investors will get lose money on this fad, too; fortunately, however, it won't be anyone who reads this site.



Hewitt
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No. of Recommendations: 1
Hewitt
You really should consider ebay at these prices
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Bowling companies. Hula-hoop makers. Pet rocks. George Foreman grills. Hot glazed donuts. And now Crocs.

It is my opinion that you have made a very wise analogy.
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Dead -

I agree. Thanks for the prompt. I just downloaded the financials via Reuters and will run the numbers through my model in the next several days. Will then post my findings on this board.

How are you handling the stock options?


Hewitt
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Hewitt,
I agree, the options are a problem - but not enough to keep me away from such a great company. The average dilution rate has been about 5.5% per year the last 4 or 5 years so I have simply worked this into the model.
I am somewhat happier that the dilution was very low (1.9%) from 2004-2005. Overall mangement has proven to be very worthy of compensation so far. I think the paypal acquisition in retrospect was brilliant. Skype is still open to debate...but time will tell.

Return on tangible capital is over 100%. If you listen to Greenblatt he feels this is much more telling about a companies future ROIC than an ROIC with goodwill included (because the goodwill does not necessarily need to be replenished). They work with negative working capital. THey have a strong network effect which I think is one of the strongest types of moats a company can have. etc etc...

They are growing FCF at 50% per year and I believe todays price assumes that they can only do this for 1 year longer and subsequently only grow at 4% forever....this is a low bar for ebay IMHO.



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Dead -

Thanks for your insights. I agree that eBay has a durable competitive advantage; indeed, the auctioneer's moat seems much more durable than Google's competitive advantage (realizing of course, that the two companies are in different businesses).

Let me ask your thoughts on acquisitions, which I view as a capital spending-equivalent.* For your free cash flow estimate do you a) ignore?, b) expense at 100% in the year incurred?, c) depreciate over some period of time, or d) other?

In eBay's case this is an important question given the amounts spent on acquisitions in the last five years compared to its operating cash flow for the same period.

I generally capitalize acquisitions and then depreciate over five years. So if a company spent $1 billion on acquisitions in 2005, then the line in my defensive (free cash flow) income statement gets charged $200 million a year for the next 5 years. I know some analysts omit acquisition spending from their analysis, but I think you have to capture the cost because otherwise profitability and intrinsic value estimates are overstated.

I am curious to know what you and others think.



Hewitt


*Management can either build the business from scratch, which can take years and involve a lot of trial and error, missteps, etc., or they can buy an up-and-running operation from someone else today and just write one check.
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Hewitt,
I think you are right to capialize and depreciate acquisitions.
I think that 5 years may be too short for some of these.
I agree that to ignore them causes the profitability numbers to look very high. I generally calculate a traditional ROIC, a return on tangible capital which ignores acquisition and then I try to calculate a number which capitalizes and depreciates acquisitions which usually falls in between. For ebay, even if you do include all the goodwill, their return on capital comes out above cost of capital so I am not worried about profitability.

I'm still thinking about what the right way to think about ROIC should be but in the end the truth lies somewhere between ROIC(traditional) and return on tangible capital ..but probably closer to the latter....I find it remarkable how often Buffett talks about return on tangible capital when describing businesses like Coke. In "the little book that beats the market" Greenblatt also seems to prefer this measure. So as a measure of FUTURE profitablitiy I am trying to consider it more often....
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