Closing FACT position at target $17.5

Biogen offered $14.5/share of FACT, which was unanimously rejected by FACT's board of directors:

CAMBRIDGE, Mass.--(BUSINESS WIRE)--Biogen Idec Inc. (NASDAQ:BIIB - News) announced today that FBC Acquisition Corp., its wholly owned subsidiary, has commenced a tender offer to acquire all of the outstanding shares of Facet Biotech Corporation (NASDAQ:FACT - News) for $14.50 per share in cash, in furtherance of its previously announced acquisition proposal. The tender offer is scheduled to expire at 12:00 midnight, ET, on October 19, 2009, unless extended or terminated.

Source: http://finance.yahoo.com/news/Biogen-Idec-Commences-Tender-bw-1296425047.html?x=0&.v=1


It looks like the market is pricing a potential new offer by Biogen of $25. I believe the current possible exit of $17.5 (last trade was $17.75, no bid available at the time) is safer than waiting to squeeze possible extra upside if the $25/share offer materializes, so I'm closing the long position in FACT.

Final PNL, assuming $17.5 exit: 94.4% between May 14th, 2009 and Friday Oct 2nd, 2009.

The S&P 500 index returned 14.8% over the period.

Performance update

TSS:
Bought at $12.76 on May 4 2009. Current close: $16.02. Performance (including $0.14 dividends): 26.6%
Performance of S&P 500 during period including all dividends: 17.4%
Excess return over S&P 500: +8.1%

FACT:
Bought at $9 on May 14 2009. Current close: $16.55. Performance: 83.9%
Performance of S&P500 during period including all dividends: 19.3%
Excess return over S&P 500: +64.6%

CSCO:
Bought at $17.9 on May 26 2009. Current close: $22. Performance: 30.7%
Performance of S&P500 during period including all dividends: 17%
Excess return over S&P 500: +5.9%

Performance of equal-weighted basket, assuming no cash: +37.6%
Performance of S&P basket, no cash: +17.9%
Difference versus index: +19.7%

Performance update

Sorry for the long lapse without updates. Here's the latest performance update

TSS:
Bought at $12.76 on May 4 2009. Current close: $15.39. Performance (including $0.07 dividend on June 16th): 17.5%
Performance of S&P 500 during period including all dividends: 11.8%

FACT:
Bought at $9 on May 14 2009. Current close: $10.37. Performance: 13.2%
Performance of S&P500 during period including all dividends: 13.2%

CSCO:
Bought at $17.9 on May 26 2009. Current close: $22. Performance: 18.6%
Performance of S&P500 during period including all dividends: 11.5%

10-Qs' Performance Update

TSS:
Bought at $12.76 on May 4th. Last trade: $13.97
Gain: 9.48%
S&P 500 performance during period: 7.24%

FACT:
Bought at $9 on May 14th. Last trade: $10.91
Gain: 21.22%
S&P 500 performance during period: 6.63%

CSCO:
Bought at $17.9 on May 26th. Last trade: $19.5
Gain: 8.94%
S&P 500 performance during period: 6.3%

Long Idea: Cisco Systems (CSCO) @ $17.9

Description: Cisco Systems is the leader in data networking hardware and software. It sells everything someone needs to set up and maintain a computer network.

Revenue breakdown for Q309, in millions:

Routers	1385	17%
Switches	2588	32%
Advanced technologies	2077	25%
Other	370	5%
Total Product	6420	79%
Service	1742	21%
Total Sales	8162

Monopoly: Cisco is the largest networking vendor with a market share of about 55% of the total market, which includes routers, switches and wireless. Trailing Cisco are Juniper Networks, Alcatel-Lucent and HP Procurve, with about 5% total market share for each. What's more, it's unlikely that Cisco's dominance will disappear anytime soon. Cisco seems to have reached the "nobody will get fired for buying Cisco" status among IT purchasers. The barriers of entry may be low for Cisco's gear, but earning the trust of buyers is hard. Firms are already dependent on Cisco network infrastructure, so people in charge of such capital expenditures aren't likely to risk buying from a competitor.

Cisco also keeps a lot of cash around to buy its way into new markets, or to buy technology. Because of Cisco's size and pricing policies (which involve either bundling components or integrating technology into its switches, where it keeps a 70% market share), it is very difficult for others to compete with them.

In sum, scale advantages and high customer switching costs protect Cisco's business.

Evidence of CSCO's competitive advantage:

Over the past five years, Cisco has generated a monstruous amount of free cash flow, and its FCF margins have been consistently above 20%, suggesting the firm has strong pricing power.

in millions		TTM	2008	2007	2006	2005	2004
Sales		$37,946	$39,540	$34,922	$28,484	$24,801	$22,045
Cash from operations		$11,441	$12,089	$10,104	$7,899	$7,568	$6,962
Capex		($1,154)	($1,268)	($1,251)	($772)	($692)	($613)
Free cash flow		$10,287	$10,821	$8,853	$7,127	$6,876	$6,349
FCF/sales		27%	27%	25%	25%	28%	29%

Consistent high double-digit returns on invested capital also show Cisco's advantageous position in its market. The calculation assumes that all cash on Cisco's balance sheet is tied up in operations.

Average of period, in millions	TTM	2008	2007	2006	2005	2004
Total assets	$61,700	$56,037	$48,328	$38,599	$34,739	$36,351
minus current liabilities	$13,360	$13,608	$12,336	$10,412	$9,107	$8,499
minus goodwill	$12,481	$12,257	$10,674	$7,261	$4,747	$4,146
minus liquid securities	$23,618	$19,791	$16,528	$12,915	$13,429	$16,136
Invested capital	$12,242	$10,382	$8,791	$8,011	$7,456	$7,571
FCFROIC	84%	104%	101%	89%	92%	84%

Valuation: Despite hitting a 52 week low of $13.61 last March, this business remains cheap at the current price of $17.9. At this price, investors are receiving a business that yields 12% free cash flow on enterprise value, which provides a wide margin of safety for a monopolistic business like Cisco. Again, the calculation assumes all cash is needed for operations, which is why I don't subtract it from the firm's value.

in millions (except for price)
CSCO price 5/22/09	$17.9
Shares outstanding	5,768
Market cap	$103,245
plus long-term debt	$10,317
minus liquid securities	$26,192
Enterprise value	$87,370
FCF yield to EV	11.8%

Why it is cheap: Cisco is making an expansion attempt into low-margin server territory, where it will face competition from Dell, HP and IBM, among others. People seem to be focusing on the low-margin aspect of this business. Cisco's argument in favor of this strategy is that the server makers are not driving the demand for Cisco's high margin networking products. Instead, Cisco argues, the clients of the server makers are driving the demand for Cisco's product. I think the argument makes sense, as the strategy seems to be a "give the razor for free and sell the high-margin razor blades" approach.

Also, Cisco saw a drop in sales in the last quarter, especially for its emerging markets operations. Cisco attributed the drop to the slower economy, although some doubts remain about how much of a threat 3Com will pose in its new attempt to play the enterprise switches arena. Investors should remember, however, that it is the third time that 3Com attempts such a move, after being muscled out by Cisco in previous occasions.

Corporate governance: Cisco has been using some of its cash to repurchase shares. In the last quarter, for instance, they used $1.2 billion to buy shares at an average price of $15.58. Moreover, CEO John Chambers owns 23 million options and shares of the firm.

An idea to hedge the long: An interesting way to play this long would be to sell cash-secured in-the-money puts on CSCO. For instance, the bid on the Jun 09 put @ $18 is $0.7. This means that an investor would need $18 - $0.7 = $17.3 in cash. If the investor has the stock assigned, he owns CSCO at $17.3, which is a 3.3% discount on the current market price of $17.9. If the stock soars and the options expire unexercised, the investor would make 0.7/17.3 = 4% in 28 days, or 52% annualized.

Long Idea: Facet Biotech (FACT) @ $9

Description
PDL BioPharma (PDLI) spun off its compound development arm, now Facet Biotech (FACT), in December 2008. As a research and drug development outfit, FACT receives money from pharmaceutical firms to develop compounds. FACT currently has six compounds. Two of them they develop in collaboration with Biogen Idec, one of them with Bristol-Myers Squibb. PDLI, FACT's former parent company, now focuses on licensing compounds and collecting royalty fees.

Spinoff
The spinoff came as a result of shareholder pressure on PDLI's management to increase the profitability of PDLI. In December 2008 shareholders of PDLI received one share of FACT for every five shares of PDLI. In addition, PDLI capitalized FACT with more than $400m and spun it off with very little debt. Because PDLI holds the rights for both current and future compounds developed by FACT, it seems reasonable to assume that PDLI will continue providing capital to FACT.

Valuation
This is a classic situation where liquidation value is higher than market value. Below is FACT's balance sheet off the March 31st 2009 10-Q:

		March 31,
In thousands		2009
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$287,998
Marketable securities		55,986
Prepaid and other current assets		20,029
Total current assets		364,013
Long-term marketable securities		33,624
Long-term restricted cash		5,807
Property and equipment, net		102,205
Intangible assets, net		6,998
Other assets		1,948
Total assets		$514,595
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable		$853
Accrued compensation		6,371
Other accrued liabilities		8,224
Deferred revenue		13,009
Current portion of lease financing liability		907
Total current liabilities		29,364
Long-term deferred revenue		41,856
Long-term lease financing liability		25,061
Other long-term liabilities		10,992
Total liabilities		107,273
Stockholders equity:
Common stock, par value $0.01 per share,		239
140,000 shares authorized; 23,905 and
23,901 shares issued and outstanding at
March 31, 2009 and December 31, 2008, respectively
Additional paid-in capital		456,190
Accumulated deficit		(48,669)
Accumulated other comprehensive loss		(438)
Total stockholders equity		407,322
Total liabilities and stockholders equity		$514,595

Most of FACT's assets are in cash and liquid securities. In fact, a conservative calculation of the firm's breakup value, assuming zero value for property and other assets, yields:

(In thousands)	Estimate		Source
Cash and cash equivalents	$287,998		Carrying value
Marketable securities	55,986		Carrying value
Long-term marketable securities	25,218		Carry, assuming 75% recovery
Total Tangible Assets (A)	$369,202
Total liabilities (B)	107,273		Carrying value
Total available to stockholders (A - B)	261,929

At today's price of $9.00/share, FACT has a market cap of $221m. This leaves a 15% margin of safety on the already conservative liquidation value calculated above. What's more, equity holders receive for free the firm's PP&E and compounds.

Long Idea: Total System Services (TSS) @ $12.76

Description
Total System Services (TSS) provides electronic payment services to financial, retail and healthcare companies worldwide. The firm offers everything from payment management to fraud detection to card imprinting. TSS has more than 300 clients and keeps relationships with more than half of the top 20 global banks. In addition to the United States, it offers its services in Europe, China, Japan, Mexico and Canada, generating 20% of its revenue abroad. Although TSS was spun-off Synovus (SNV) in January 2008, it was founded in 1982. It is based in Columbus, Georgia.

How TSS Makes Money
2008 2007 2006
Electronic payment processing services 977M 65% 956M 67% 989M 69%
Merchant acquiring services 261M 18% 254M 18% 260M 18%
Other services 254M 17% 218M 15% 185M 13%
Revenues before reimbursable items 1492M 1428M 1434M
Reimbursable items(1) 446M 378M 353M
Total revenues 1939M 1806M 1787M

(1)Reimbursable items include payments from clients to TSS for "out-of-pocket" expenses, such as postage.

TSS Has a Moat
Evidence of Economies of Scale
There is a reason KKR bought TSS' largest competitor, First Data, in 2007. Both First Data and TSS operate in a wonderful industry that lends itself to natural monopolies.

TSS estimates that its systems process 42% of the total U.S. credit card market and 85% of the domestic Visa and MasterCard accounts. This size result in economies of scale for TSS, so third-party competitors have a hard time matching TSS' prices. Even larger is TSS' advantage versus in-house processing systems, such as those of banks or retailers. Because of its scale, TSS allows its clients to save money on fixed costs.

We can see TSS' operating leverage in the income statement, as net income increases at a faster rate than revenues:

Total revenue change, trailing five-year period +63%
Total expenses change during period +59%
Net income change during period +66%

High Margins Further Evidence TSS' Moat (Data from Morningstar)(% of Sales)
2004 2005 2006 2007 2008
Revenue 100.0% 100.0% 100.0% 100.0% 100.0%
COGS 19.4% 53.3% 49.0% 63.4% 69.3%
Gross Margin 80.6% 46.7% 51.0% 36.6% 30.7%

SG&A 63.6% 28.8% 29.8% 9.1% 0.6%
Other NaN% 0.0% 1.3% 7.8% 10.9%
Operating Margin 17.0% 17.9% 20.0% 19.6% 19.2%

Net Int Inc & Other 0.2% 0.3% 0.8% 1.3% 0.3%
EBT Margin 17.2% 18.2% 20.8% 20.9% 19.5%

TSS' moat allows it to be more profitable than its competitors, as seen by their average ROA for the trailing five-year period (Data from Morningstar)
ROA FY04-08 2008 2007 2006 2005 2004
TSS 15.2% 16.5% 15.3% 16.4% 14.5% 13.2%
GPN 11.8% 12.3% 12.9% 13.4% 11.0% 9.5%
FIS 6.8% 2.5% 6.4% 4.4% 7.7% 13.1%
FISV 5,9% 5,37% 4,86% 7,35% 7,16% 4,84%

TSS' earnings are high quality: small capex needs result in high FCF/sales ratios (Data from Morningstar)
2004 2005 2006 2007 2008
Cap Ex as a % of Sales 4.5% 2.6% 1.5% 3.1% 2.5%
Free Cash Flow/Sales 23.4% 12.3% 20.1% 15.5% 15.8%
Free Cash Flow/Net Income 1.8 1 1.4 1.2 1.2

Dividends and Repurchases: The firm has given back some of its cash to investors in the form of dividends since December 1989 and now yields about 2% in dividends. Moreover, TSS' board has approved a stock repurchase plan for up to ten million shares until April 2010.

Profitability: consistent double-digit return on assets render excessive financial leverage unnecessary (Data from Morningstar)
2004 2005 2006 2007 2008
Tax Rate 37.8% 35.4% 33.9% 38.0% 34.9%
Net Margin 12.7% 12.1% 13.9% 13.1% 12.9%
ROA 13.2% 14.4% 16.4% 15.2% 16.5%
Avg Financial Leverage 1.48 1.39 1.34 1.75 1.56
ROE 18.8% 20.7% 22.3% 23.0% 27.2%

TSS' Balance Sheet is Solid
Despite its strong competitive advantage and the safety of its business model, TSS has minimal amount of debt. Where companies with similarly safe business models such as Fiserv (FISV) lever themselves up to 4x, TSS' financial leverage (total assets/total equity) has never reached 2x. This low leverage, combined with a healthy quick ratio, render TSS' balance sheet rock-solid. (Data from Morningstar)

2004 2005 2006 2007 2008 Latest Qtr
Current Ratio 1.61 1.85 2.52 2.14 2.51 2.51
Quick Ratio 1.45 1.52 2.26 1.82 1.92 1.92
Financial Leverage 1.48 1.39 1.34 1.75 1.56 1.56
Debt/Equity 0.01 0.00 0.00 0.30 0.21 0.21

TSS Operations and Growth
Because of the financial crisis, the banking industry has seen some consolidation that has caused TSS to lose contracts. For example, two of TSS' clients were acquired in 2008: Washington Mutual and Wachovia. While the latter is expected to remain with the firm, WaMu has agreed to discontinue the services provided by TSS as of March 2009. However, TSS has reached an agreement with WaMu's parent, JPMorgan Chase, where TSS will license their proprietary system to JPM.

That said, TSS' growth in the international arena, as well as in the non-banking sector, offsets the domestic consolidation. The international credit card market is not as developed as the domestic one, providing opportunity for expansion. Examples include new agreements signed with several financial institutions in Mexico, Canada, Europe, Japan, Hong Kong and South Africa. In addition, back on the domestic side TSS has recently renewed its long-term agreement with Target to service its REDcard portfolio, and has announced a partnership with Paragon Benefits to provide an off-the-shelf card for flexible benefit payment processing.

TSS is Cheap
Relative Valuation
The current price of $12.76 is close to the firm's 52-week low of $10.36. Not only is the firm cheap compared to its previous price levels, it is also cheap compared to its competitors, which feature riskier business models. (Data from Morningstar)

P/E 2004 2005 2006 2007 2008 TTM
TSS 32.0 20.0 21.0 23.3 11.0 10.0
GPN 29.2 35.3 27.3 25.4 14.2 64.1
FIS 21.4 26.5 29.2 16.0 26.7 29.2
FISV 20.1 16.2 21.0 22.9 17.2 18.7

P/B 2004 2005 2006 2007 2008 TTM
TSS 5.5 3.9 4.3 6.6 2.8 2.5
GPN 4.3 5.6 4.3 3.7 2.5 2.8
FIS 7.4 3.6 2.4 2.1 0.9 1.0
FISV 3.1 3.2 3.7 3.7 2.3 2.4

P/S 2004 2005 2006 2007 2008 TTM
TSS 4.0 2.4 2.9 3.1 1.4 1.3
GPN 3.2 4.5 3.9 3.3 1.8 1.7
FIS 2.2 0.9 1.7 1.7 0.9 1.0
FISV 2.1 2.1 2.1 2.4 1.3 1.4

P/CF 2004 2005 2006 2007 2008 TTM
TSS 14.4 16.3 13.5 16.5 7.8 7.0
GPN 22.7 12.3 18.5 16.8 8.2 7.3
FIS 15.7 6.0 14.0 17.6 5.3 5.8
FISV 11.4 14.0 14.9 16.6 13.1 14.2

Absolute Valuation
With the 10-year treasury paying 3.14%, a 10% earnings yield from an excellent company with 15% ROA, great international growth potential and increasing competitive advantages provides a hefty margin of safety. Even more appealing is the firm's current cash return yield (FCF/EV) of 12.2%, as measured by Morningstar.

TSS Stock Ownership and Corporate Governance
A few value funds have been adding to their TSS positions lately. They include T.Rowe Price Mid-Cap Value (TRMCX), Fidelity Low-Priced Stock (FLPSX) and Royce Value Svc (RYVFX).

As of governance, most TSS directors are related to TSS' former parent, Synovus. This may generate conflicts of interest. Moreover,the latest proxy statement shows that only 6.8% of shares are held by directors and executive officers, with nobody surpassing the 1% ownership. This is especially worrying since directors get paid more than half their salary in cash, as opposed to equity. The compensation of CEO Phil Thomlison, however, is slightly better, as TSS pays significant portion of his salary in the form of equity and options.

Potential Problems and Risk Factors
TSS could lose a major processing client.

The firm's merchant business is also exposed to the perils of the retail sector.

More insider ownership and a clearer alignment of executive and director interests with those of shareholders would be ideal.