Issue 19

12/09/04

Risk Capital Investments

Issue #19 - Risk Capital Investments

1. Risk Capital Investments
2. Opportunity Lost

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Dear Friends,

Due to my trip to Austin last weekend and the fact that I'm
leaving for Chicago in a matter of a couple of hours, this
will be the only issue of Investing With Mom you will
receive in the the next week or so. I will be back with the
regular schedule by the 18th or so of December.

However, part of the reason for this hiatus, is that I'm
rolling out a blog with RSS feed next week. It will be live
before you get the next issue of Investing With Mom. If you
don't have any idea what a blog is, or how to receive an
RSS feed, I highly recommend you take a quick look at
Site Sell RSS, for a complete rundown.

In order to take advantage of all that my blog will have to
offer, you will probably need to download one of the
recommended RSS readers that is mentioned in the article.
Alternatively, you can go to Pluck and download the same
reader that I use.

My blog will be free to the general public and if you
download a Pluck reader, you won't have to pay anything
for it either, making the entire experience completely free.

I'm hoping to be able to launch a second blog that will be
only accessible to Advisory Newsletter subscribers, but I'm
still working on the technical aspects of producing it, so
for now I can only say that the free blog will be up next
week.

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Risk Capital Investments

On Tuesday, I got a call from one of the subscribers to my
Advisory Newsletter service asking my opinion on Sirius
Satellite Radio (SIRI - Nasdaq), a stock that's not
currently in our portfolio. Now because I used to own shares
in SIRI, I felt that I could answer his questions regarding
the valuation of the company, so we discussed the idea of
risk capital investments, of which we have several in our
Advisory portfolio.

In the interests of full disclosure, I used to own SIRI, but
I sold my position nearly 8 months ago after making 70%,
before fees, in just 10 months.

I do not currently own SIRI, it is not currently in the
Investing With Mom Advisory portfolio, and it is not going
to be recommended any time soon.

In the last issue of Investing With Mom, I discussed the
need for fundamentals when investing, especially whenever
the market has decided it's time to take a dive. What I
didn't discuss however, was the need for risk/reward
analysis when you are debating whether to enter into a risk
capital investment.

First however, let's define what risk capital investments
are in the first place.

A risk capital investment is any investment using funds that
you don't mind losing completely. Obviously, you are not
trying to lose these funds, but you are investing in a stock
that is a risky proposition and doesn't have the
fundamentals in place.

While some could argue that every stock is a risky
proposition, I'm specifically referring to stocks that trade
for extreme levels that are not justified by the most
fundamental valuations, like P/E or P/B. I'm referring to
stocks that are so "hot", even your brother-in-law is
talking about the 3 grand he just made day-trading the
stock.

With these risk capital investments there are several ways
to valuate whether they still have room to grow or should be
shorted with glee. Now, I'm not necessarily advocating
shorting any stock, but if you already own this kind of a
stock and you can't handle the wild swings in valuation,
then maybe you just need to sell and reallocate your
capital.

Before I go any further, let me re-emphasize that SIRI is
not in any Investing With Mom portfolio, nor do I have any
plans to add it any time soon. I am solely performing this
analysis to give you an idea of how to valuate risk capital
investments, of which we already have several in the
Investing With Mom portfolio.

Getting back to our discussion of SIRI, let's take a quick
look at the fundamentals so that we truly know how much
risk, or downside, is currently in the stock. That way, we
can decide if the risk/reward ratio is too high.

SIRI currently has just 800,000 subscribers and although
they expect to have over a million by the end of the year,
I'm of the opinion that they'll be lucky to be there by my
birthday, Jan. 13th. That said however, SIRI is accelerating
the pace with which they are adding subscribers, so they are
making some progress.

My best guesstimate is that over the course of a year's
subscription SIRI generates about $145 of revenue per
subscriber and although they charge $12.99/month that may
even be a high estimate simply because of the number of
subscribers who receive discounts to sign up. Even so, this
means that they will generate about $145 million in revenues
from existing subscribers in 2005 and maybe as much as $105
million more from new subscribers.

However, they just lost $160+ million in the 3rd quarter
alone, on $19 million in revenues, which means that at their
current rate SIRI will need to generate $750 million in
revenue to just break even. Only 3 times what I think that
SIRI will generate next year, which means that SIRI won't
probably reach profitability until sometime in 2006 at the
earliest.

Considering it's current valuation of about $10 billion in
market cap, SIRI would have to generate $500 million in
profits annually to be properly valued. This means that they
will need to have around 10 million subscribers to get to
that point and they won't have that until 2008 at the
earliest.

Now just for arguments sake let's say that SIRI will end up
with about 60 million subscribers before they stop growing
and let's say that at that level they are generating $4
billion in earnings on over $8.7 billion in revenues. Now
let's say that SIRI is worth 20 times earnings, or $80
billion in market cap.

At that level SIRI would trade for about $50/share, which
would be about 7 times higher than they are currently
valued at. The question is how long will it take for SIRI to
get to that level, and is it even possible.

Considering that SIRI has less than 1 million subscribers, I
would tend to think that they'll be lucky to 60 million by
2018. So then the question comes are you willing to hold
SIRI for the next 13+ years to make 7 times your money?

Some of you might be, but let me ask you this: Are you
willing to hold shares that right now are probably worth
less than $1/share for 13 years, hoping to make just 7 times
your money? Let's say that a different way. Right now you've
got the potential for profit of 7 times your money and the
potential risk of losing 86% of your money with SIRI.

Now let's compare that with one of my recommendations in
last month's issue, that I've been recommending since the
start of Investing With Mom. This stock has a profit
potential of about 5 or 6 times your money, but only about
20% downside risk, within the next 12 or 24 months at the
most.

Another stock currently in the Advisory Portfolio, has about
40% downside risk, but closer to 20 times profit potential
within the next 4 to 5 years.

Just so you can explain this to your super dense
brother-in-law, because I know that all my readers are
extremely smart, let's go ahead and summarize this real
quick. Because this is the key to risk capital investments,
comparing downside risk to the potential for upside gain.

A. SIRI 84% downside v. 7 times upside after at least 13
years

B. First Advisory stock 20% downside v. 5 or 6 times
upside in less than 2 years

C. Second Advisory stock 40% downside v. 20 times upside
in about 4 or 5 years

If you want to wait 13 years to make 7 times your money,
then blessings on you, but I'm not going to put my mom's
money in that kind of risky stock, it's just a little too
risky.

If SIRI were to drop 60% from here, then maybe I'd
reconsider but that would make SIRI a $3 stock, not exactly
where it is right now.

The key to Wall St. success for small investors like
ourselves, is to limit our downside risks because Wall St.
is a lot closer to a casino that most of us are willing to
consider or admit. If you don't limit your downside risks,
then you're begging Wall St. to take your money, and trust
me when I tell you that they will.

If you are ever going to truly make significant profits
investing in the stock market, the first thing you have to
do is never waste any time lamenting opportunities lost. You
will always have another opportunity, but the amount of
money you have to invest in the first place is limited. You
cannot lose it all in one investment, or else you'll no
longer have any opportunities at all.

Let me repeat myself one more time, you will always have
another opportunity, but the amount of money you have to
invest in the first place is limited. You cannot lose it all
in one investment, or else you'll no longer have any
opportunities at all.

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Opportunity Lost

Speaking of opportunities lost, you now have just 2 days to
subscribe to the Advisory Newsletter before the current
discount is lost for good. At just $64 per year, you can't
beat the value and with the option to pay month to month,
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For anyone who has ever received a discount code for the
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the presently advertised discount. There will be no
exceptions, unless I personally send you an e-mail telling
you differently.

The reason is simple, with the new portfolio being put
together early next week, I don't feel that it would be fair
to Advisory subscribers to have multiple discounts available
while I'm developing this new service. Once I've completed
the development of the new portfolio, a decision will be
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separate service. After that decision has been made, then I
will decide on any new discounts after that.

In the meantime, you have until Saturday night to subscribe
and pay just $64 per year.

Investments good for my mom and you,
Andy Prior

PS. I was recently asked if the free airline tickets were
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All you have to do is reference the very first issue of the
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