Monday, March 30, 2009

OCD Stock Pick #2: ICE

This is the second in a series of stock picks for the stock pickers suffering from OCD who MUST go long in the world's most dangerous bear market...

The Intercontinental Exchange is a futures exchange regulated by the New York Federal Reserve that intends to become the premier clearinghouse for credit default swaps. Thus as unregulated insurance contracts decimate the financial landscape, the investor can benefit from the push to bring to transparency to this bidding process. ICE is even owned by a few of the major CDS brokers (i.e. JP Morgan and Goldman Sachs) giving it instant leverage in this new market.

Over the course of the year, there will be steady increase in business as the new regulatory framework is created for this financial instrument. Regardless of the red tape, there are huge market drivers pushing for CDS to be handled in the open market. First of all, no other instrument is available to hedge a fixed income instrument as credit default swaps. Considering the amount of fixed income securities outstanding the need for big banks to mitigate risk, the institution of this marketplace is a win-win for business and government.

With revenue growth near 50% YOY, ICE is benefiting from increased electronic trading. Even at this early stage for the market, ICE produces a free cashflow of $250m annually on 800m in revenue. The company holds net long term debt of only $300m after backing out $12B of cash and $12B of maturing liabilities.

In previous markets, this stock would be evaluated based on it’s growth potential at a high P/E ratio. The OCD investor needs to be defensive in their investment to receive desired feedback loop, thus purchase price needs to be evaluated as a measure of cashflow growth. ICE cashflow growth has been decelerating over the past few years from 60% growth from 2006 to 2007, and 25% from 2007 to 2008. Assuming only a 10% increase in cashflow growth this year, valuing ICE at 11x FY2009 cashflow yields a $3.6B market cap. Based on the market cap today of $5.4B at ($75/share), the OCD investor should place an order for ICE at $50/share. This price is also at technical support point and thus provides a likelihood for being executed and providing immediate positive feedback.

2 comments:

Lockstep said...

Great stock pick, maybe too conservative on the price. The equity markets are up 50% in general, but ICE has moved 100% since this original post.

I will continue to watch for potential entry points.

PENNY STOCK INVESTMENTS said...

Nice stock pick.