Friday, July 9, 2010

Certified Hedge Fund Professional (CHP) Designation: Open For Registration

The Certified Hedge Fund Professional (CHP) Designation recently opened up again for registration for 300 new members into the program. Remember that Market Folly readers receive an exclusive $50 discount to the CHP, a program created for hedge fund professionals. Click here to receive the CHP discount and reserve your spot in the program. Take advantage of the discount while it lasts because registration closes after those 300 slots are filled. There's a 21-day no questions asked money back guarantee so it's definitely worth checking out.

So, what are the benefits of completing the Certified Hedge Fund Professional (CHP) Designation?

- Enhance your knowledge of the hedge fund industry
- Build your credibility/resume with specialized pedigree
- Huge networking opportunities (31,000 individuals in the Hedge Fund Group ~ HFG)
- Access to exclusive job placement services, recruiting connections & more
- Can be completed 100% online within 6-12 months
- Career workbook
- A hedge fund marketing guide
- Free access to with over 70 educational videos & webinars

You can get more information about the program & receive the exclusive discount here. The program's credibility is enhanced when you consider that the board of advisors consists of over 50 hedge fund, fund of funds, and industry professionals/consultants. The CHP Designation is created by hedge fund professionals for hedge fund professionals. It has been featured in Alpha Magazine, the Financial Times, WSJ Fins, & more.

Keep in mind that all types of industry members have completed the program including: analysts, hedge fund managers, investor relations professionals, lawyers, accountants, and students. There are two levels to the program and you can complete the CHP Level 1 covering hedge fund fundamentals as well as Level 2 focusing on due diligence, portfolio analytics, or marketing. The current pass rate on Level 1 is 76% while Level 2 ranges from 55% to 75% depending on specification.

There's no downside to checking out the program due to the money back guarantee. The Certified Hedge Fund Professional (CHP) Designation is ideal for anyone looking to build their resume and advance their knowledge & career. Click here to learn more and to receive the exclusive CHP discount.

Hedge Fund T2 Partners: Updated Long & Short Positions, In-Depth Analysis of BP

Whitney Tilson and Glenn Tongue's hedge fund T2 Partners recently released their June letter to investors. In it, we get an update on their performance but more notably, we see some of their long and short positions. Additionally, they've attached an in-depth analysis of BP plc (BP). As you know, we've previously outlined Tilson's reasons for buying BP. The extension included in the letter further elaborates on the analytical rationale behind owning shares of the oil spill giant.

Performance wise, T2 had a very impressive month of June, up 4.2% net of fees compared to the S&P 500 which was down 5.2%. T2 sits up 9.8% for the year net of fees, handily outperforming the S&P again. Since inception, T2 has returned 189.9% net of fees compared to only a 2.6% return for the index over the same timeframe.

Here are some of T2's current longs (in no particular order):

Berkshire Hathaway (BRK.A/B)
Iridium (IRDM)
Liberty Acquisition Corp warrants
BP plc (BP)
Winn Dixie (WINN)
Microsoft (MSFT)
Echostar (SATS)
General Growth Properties (GGP)

Of their longs, we've noted numerous times how hedge funds are finding value in large cap names and Microsoft (MSFT) is the perfect example of this. While some argue they face tough challenges ahead, there's no denying its cheap valuation by historical metrics. For another value large cap play, we also highlight T2 Partners' position in Anheuser-Busch InBev (BUD) as we presented their analysis of BUD from the Value Investing Congress.

In terms of other longs, we first covered when Tilson bought BP and the basic gist of this play is that there's a reasonable chance the oil could stop flowing sooner than people expect and that clean-up costs will be less than imagined a year from now. In the letter below you can read his full assessment of the oil spill situation, company balance sheet, and more.

And here are some of the hedge fund's short positions that they've revealed:

Pacific Capital Bancorp (PCBC)
Homebuilders via the Homebuilder ETF (XHB)
For-profit education companies (no specific names mentioned, most likely a basket)
Barnes & Noble (BKS)
Boyd Gaming (BYD)
InterOil (IOC) puts

While we've known some of these stakes from when we previously looked at T2's short positions, the disclosure of their Pacific Capital Bancorp short is new. This ties into one-half of the long moneycenter/short regional bank trade that many hedge funds have on. Additionally, Boyd Gaming (BYD) is another new short we're seeing for the first time from Tilson and Tongue.

Embedded below is T2 Partners' June 2010 letter to investors:

You can download a .pdf copy here.

For more investment ideas from Tilson and Tongue, they'll be speaking at the upcoming Value Investing Congress in New York City in October along with many other prominent hedge fund managers including David Einhorn, Lee Ainslie, John Burbank and more. Market Folly readers can receive an exclusive discount to the event here.

Hedge Fund Axial Capital Again Adds To QLT Inc (QLTI) Stake

Literally two days ago we detailed how Eliav Assouline and Marc Andersen's hedge fund Axial Capital was buying shares of QLT Inc (QLTI). This trend continues as Axial recently filed another Form 4 with the SEC regarding QLTI shares. On July 6th, 2010, Axial purchased 109,157 shares of QLT Inc. at a price of $5.79 per share. This brings their total ownership up to 6,304,586 shares. Eliav and Andersen's hedge fund has been accumulating shares over the span of a few months now, continuing to buy as QLTI trades lower.

The interesting thing with this play is that many have characterized QLT Inc as a value trap or a 'cigarette-butt' type of investment. It is essentially a play on the biotech company's royalty stream. Some argue that while the stream is healthy now, it is likely to decline. Assouline and Andersen seem to disagree as they continue to accumulate shares.

A little background on the firm for those unfamiliar: Julian Robertson seeded Axial in 2005 and the hedge fund actually resides in the same offices as legendary Tiger Management at 101 Park Avenue. You can view the proverbial 'Tiger Family Tree' of hedge fund managers that Robertson has spawned via that link. As of Axial's last 13F filing, they disclosed $799 million in assets invested in US equities.

Taken from Google Finance, "biotechnology company. The Company is engaged in the development and commercialization of therapies for the eye. The Company focuses on its commercial product, Visudyne, for the treatment of wet age-related macular degeneration (wet AMD), and developing its ophthalmic product candidates."

Stay up to date with the latest investments from top hedge fund managers at

What We're Reading ~ 7/9/10

If you haven't read it yet, Bill Ackman's first quarter letter [Dealbreaker]

A list of some top finance blogs of the internet sorted by traffic [iBankCoin]

David Tepper's Appaloosa Management settles short-selling charges [FINalternatives]

Yield curve says slow growth but no recession [Pragmatic Capitalism]

Honored to be included on a list of the top workhorse financial blogs [Reformed Broker]

Mr. Market Miscalculates: The Bubble Years and Beyond [James Grant]

BP's stock price and the now-or-never trade [Fortune]

Paulson hit with $2 billion in redemptions [Absolute Return+Alpha]

Pros and cons of independent trading [The Kirk Report]

An in-depth analysis of First Financial Northwest (FFNW) [Above Average Odds Investing]

The 1930 stock market versus the 2010 stock market: a visual comparison [ChartSwingTrader]

A look at SonicWALL (SNWL) [Merger Arbitrage Investing]

Get out of stocks warns Robert Prechter [The Globe and Mail]

AgBank's IPO: Emering markets continue to dominate developed world [WSJ DealJournal]

10 solid dividend stocks from the ultimate stock pickers [Morningstar]

A paper on the behavior of hedge funds during liquidity crises [SSRN]

Thursday, July 8, 2010

Hedge Funds Increase Short Exposure Yet Still Suffer Poor Performance

You might be surprised by the fact that hedge fund returns in the second quarter of 2010 might be the worst since late 2008, according to Bank of America Merrill Lynch. Obviously this is largely due to the ramp up in volatility and subsequent decline in equity markets that took place in May and June. May was a brutal month for hedgies and now as June performance numbers trickle in, we're seeing big players suffer. For instance, John Paulson's Recovery Fund was down 12% and his Advantage Plus Fund lost 6.9%. And despite Lee Ainslie of Maverick Capital's notion that 2010 would be a stockpicker's market, many long/short funds have been hammered.

Last week we examined the latest exposure levels of many funds and saw that they had historically low net long exposure in equities. Despite this, they continue to pump out poor performance numbers. Let's take a look at things to see if we can get a better idea as to where they've gone wrong.

Given the recent market decline, it's almost as if hedge funds have been reactive rather than proactive. Many of them clearly expected a pullback as they had been reducing net long equity exposure since the beginning of the year. Yet while they reduced risk/exposure levels, they weren't proactively building their short book as much as they maybe should have... until now, seemingly after the majority of the recent decline. Bank of America notes that the "aggregate adjusted short interest (ASI) for the S&P 1500 increased 6% from its lowest levels in more than three years. This is the largest one-time increase since early March 2009."

This notion implies that there is much more room for hedgies to increase short positions. At the same token, large increases in short interest has also served as a contrarian buying opportunity on many occasions. On a sector basis, the largest increase in short interest has recently been in Financials, Utilities, and Health Care.

Bank of America also updates us on the performance of their hedge fund generals index. This strategy that compiles a basket of the most favorite stocks among hedge funds is down 6% year to date versus the S&P which is down 7.6%. In 2009, the hedge fund generals index outperformed the S&P by a whopping 46%. Those of you with Bloomberg terminal access can pull this up using MLDIHGFN. We've also covered the stocks listed on the hedge fund generals index here.

So while the hedge fund consensus picks have lost money this year, they are still outperforming the general market indices. Some funds are even bucking the trend entirely, such as Dan Loeb's Third Point who is up over 10% year to date. Those of you looking for what the consensus hedge fund picks are these days would also be interested in Goldman Sachs VIP list.

Lastly, let's focus on where hedge funds have been positioned as of late. As the second quarter came to a close, hedgies were largely net long gold, short the S&P 500 and Russell 2000. Additionally, many have been long the US dollar and short the euro. The most recent data suggests that hedge funds are 27% net long equities, down from last time's 30% exposure and well below the historical average of 35-40%.

In treasuries, hedgies continue to add to crowded short positions in the 10 year and 30 year. Additionally, they partially sold their net longs in the 2 year. Many funds held their positions in various precious metals steady and some sold crude oil. Embedded below is the latest hedge fund monitor report from Bank of America Merrill Lynch:

You can download a .pdf copy here.

So despite reducing exposure levels, hedge funds still seem to have taken it on the chin in May and June. Many funds have re-actively boosted short exposure in hopes to stem further loses. What's interesting is such a maneuver in the past has marked a contrarian buying opportunity (at least in equities). And, that's exactly what seems to have happened recently as markets have rapidly bounced. This almost makes you wonder if hedgies will put in poor performance numbers again if this keeps up. We'll have to see how they position themselves ahead for the rest of the year and if they engage in further knee-jerk reactions. Head here for more recent broad hedge fund exposure levels and here for Dan Loeb's hedge fund specific exposure which was updated this morning.

Latest Exposure Levels From Dan Loeb's Hedge Fund Third Point LLC

Dan Loeb's Offshore Fund at Third Point LLC recently released its latest performance and exposure breakdown. Loeb's hedge fund is worth following simply for this fact: it's generated an annualized return of 17.7% versus 4.1% for the S&P 500 since December 1996. Not to mention, they've done so with a correlation to the S&P of 0.40. Needless to say, those are impressive figures. Those of you desiring to follow in his footsteps can check out Dan Loeb's recommended reading list for wisdom.

For the month of June 2010, Third Point was down 2.0% largely due to their long equity positions in financials. Yet, despite the rough month, they are still up 10.2% for 2010. As of last tally, their Offshore Fund managed $1.793 billion. So while hedge funds had a brutal May, it looks like June was also a losing month for many big players.

Now, to the good stuff: the portfolio breakdown. We've covered countless times how Loeb's fund has been net long distressed debt. This trend remains unchanged. Third Point is 25.1% net long distressed credit and 19.8% net long MBS. While their distressed exposure contributed to negative performance in June, their MBS exposure contributed positively.

Here are Third Point's top positions (keep in mind they own multiple securities in each of these names):

- Chrysler
- Delphi Corp
- CIT Group
- Dana Holding
- PHH Corp

As you'll notice from previous times we've covered Loeb's portfolio, his top holdings remain pretty much unchanged. In equities, Loeb's hedge fund has their largest net long exposure in financials (at 7.8% net long) followed by consumer names (at 4.7% net long). In terms of total long/short exposure, Third Point is 37.9% net long equities and -12.2% short, leaving them 25.7% net long. This is slightly below the average hedge fund exposure levels of around 30% net long. Geographically speaking, Third Point continues to be net short Asia at -1%. They are net long the Americas to the tune of 87% and Europe to the tune of 13%.

In the equity realm, Loeb made note in a recent letter that Third Point still fancies post-bankruptcy equities, deeming them cheap. We'll have to see if any new positions pop in that regard when their next 13F filing is released in a month or so. Loeb's top winning positions last month included two shorts, Icelandic Bank debt, 'Asset Backed Security A', and Novartis/Alcon arbitrage. His top losers were PHH Corp (multiple securities), Liberty Media Interactive, Macy's, Lyondell, and CIT Group (multiple securities). Touching on some of those specific names, you'll recall that Jamie Dinan of York Capital recently stated he was bullish on Lyondell at the Ira Sohn Investment Conference (notes from the event here). Many hedge funds also own a position in Liberty Media and it appears on Goldman Sachs' VIP list. Lastly, you'll recall that David Einhorn's Greenlight Capital has a large CIT stake.

That wraps up notable information from Third Point's latest update. Be sure to savor these broad portfolio updates from Third Point as it's really all you'll get based on Loeb's new philosophy. Per his recent investor letter, his hedge fund won't be talking about their new positions until *after* they've been publicly disclosed via 13F filings. As such, these sector breakdowns are all we'll get in the mean time. As always though, we'll continue to monitor the SEC filings like a hawk. Recent disclosures made by Third Point in that regard include a stake in Xerium Technologies as well as a newly revealed position in Roomstore.

For more resources from Third Point, we of course point you to Dan Loeb's recommended reading list.

Hedge Fund Lansdowne Partners Covers Old Mutual Short Position

In the past, we've highlighted hedge fund Lansdowne Partners' short positions. This time around, we get word that they've actually covered one of these stakes. Due to trading activity on the 5th of July, 2010, Lansdowne has reduced their short in Old Mutual plc (LON: OML, pink sheets: ODMTY) to below the regulatory disclosure threshold of -0.25% of shares. Back in November 2009, Lansdowne's short in OML accounted for -0.49% of shares. Then, on July 1st, 2010 Lansdowne reduced it to -0.31% and now it has crossed below the -0.25% threshold.

It is entirely possible that Steven Heinz and Paul Ruddock's hedge fund still maintain a short position. The problem is, we won't know now as it's fallen below disclosure levels. Based on the pattern of their reduction though, it seems clear that they've been aggressive in ratcheting down this stake.

While hedge fund Lansdowne have covered the vast majority (if not all) of this short, they are still short the following companies according to the latest UK disclosures: Legal and General, Prudential plc, and Aviva. You can read up more on Lansdowne's short positions in our recent post.

Taken from Google Finance, Old Mutual plc "operates a financial services business and is engaged in the provision of long-term savings solutions, asset management, short-term insurance and banking solutions to customers worldwide. It also offers financial services in Africa through operations in Namibia, Zimbabwe, Malawi, Kenya and Swaziland. Its banking business in Africa is conducted by Nedbank Group, in which it has a 59 % controlling interest. The Company operates thorough a number of subsidiaries, including wholly owned Mutual & Federal Insurance Company Limited, the South African general insurance company, Skandia Life Assurance Company Ltd, which offers life assurance solutions, Skandiabanken AB, engaged in the banking sector, as well as Barrow, Hanley, Mewhinney & Strauss, Inc, an asset management company. Old Mutual plc operates in 34 countries worldwide. "

You can view our coverage of Lansdowne's new longs here as well as our posts on other hedge fund UK positions.

Wednesday, July 7, 2010

Three Investment Ideas: Interview With Seth Hamot, Founder of Roark, Rearden, & Hamot Capital

Today we're pleased to present an interview with Seth Hamot, 48, founder and managing partner of Roark, Rearden, & Hamot Capital Management. His fund has over $150 Million under management, has performed well through 2-3 recessions, and returned an annualized 17% to investors net of fees. This interview comes as a guest contribution from Ankit Gupta of We're always looking for rising managers here at Market Folly and Ankit has done an excellent job with the below discovery:

"The following is an interview to try and learn a little bit about Seth Hamot's experience. As you read this, do remember that he has spent 15+ years building this investment fund and this interview cannot capture that, but hopes to bring a small portion to the public surface. Dr. Sergio Magistri, who led a company through the dot-com bubble and exited with a large acquisition by GE also shares his thoughts on what happened. He led InVision Technologies, which turned out to be an amazing investment for Seth’s fund. Today, InVision’s products can be found in airports helping to prevent terrorism. With his input, we can analyze this amazing investment from the side of Seth and Sergio, both.

When did you launch your investment fund and what were you doing leading up to that?

RRH launched in the mid to late 90’s and prior to that, I was working with partners buying distressed and defaulted debt backed by real estate. I started doing that in 1989 and 1990. Prior to that, I was the President of College Pro Painters, a painting contracting company with a student labor force. I graduated college and since CPP was owned by a foreigner, and needed a local president and leadership, I was brought on board. It was going through financial distress, had no local leadership, and so I was brought in to turn it around. We went from $3 Million/year in revenue to $11 Million when I left. Shortly after, a real estate recession kicked and, and so I began looking for turnaround situations with distressed debt that could be bought. My partners from those ventures eventually retired and so I continued what I was doing into the public markets. We found poorly performing assets that were either too encumbered with too much debt or too little leadership, focusing on hard assets like real estate and mining assets.

What is your fund’s underlying approach? What wrong do you right in the markets?

I want to find companies going through a transition. Eventually, that transition will translate into others seeing that the company will be worth more than they originally thought. It might be divesting a cash burning division, or new credit facility, or maybe the company just did a merger or acquisition allowing the business model to be leveraged, etc. The objective is to NOT be an activist in these situations. There are a lot of great opportunities because really great companies make errors, but they can move on. We enjoy dealing with smart businessmen on a daily basis. Often times though, managers slowly become content to have a larger span of control and more remuneration. They change by rationalizing their business to make themselves better focused and more efficient and effective.

Where did you get your first 5 investors for your fund?

College roommates, families of college roommates, friends, my own money, etc.

What were the first 5 years of your fund like? How many employees did you have and what were some of the larger challenges?

It was a small fund and so picking investments was the main challenge. It was just myself initially. We took a very large position in a liquidating insurance company that lasted 2-3 years, but was very profitable because the markets misunderstood it entirely. It took a little bit of activism and at the end of it, I met someone, who introduced me to his own limited partners, and that’s where I brought in some fresh capital. One of the joys there was that I met some great people who were also doing small cap value investing.

Eventually I was introduced to a well-run fund of funds on the west coast. I was told that we made some great investments, but our documentation was on napkins and we used grid pads for calculations. We got a real lawyer, real documentation, put together information for investors, and then began to grow. From the original $2 Million that we started with, we had grown to somewhere around $15-20 Million, and then these guys came in. We’ve been successful in our performance with investors: Over the last decade, ended December 2009, we’ve returned 17% annualized, net of all fees.

The name of your fund has a very unique name – it has names of characters from the books of Ayn Rand. Can you tell us why you did this?

In general, we take a contrarian view. Doing it all the time is not contrarian and so this allows us to take investments from a unique vantage point.

What do you look for in an investment?

A perfect investment would be in a business that was once well covered by investors, analysts, raised a lot of money, etc. and then the company and industry went through a transformation and the stock trades very cheaply. Even after that, the underlying business itself makes sense and with some tough decisions, it can regain its value and it will right itself. A simplistic example is a REIT that for some reason no longer pays its dividend, driving the stock price very low. It’s a hard asset business that won’t just disappear. If you can foresee the dividend coming back, it will get bought again for its yield eventually. So if someone calls in and says, “I’ve got this REIT I want you to look at,” I’ll respond by asking, “Is it paying a dividend?” If the answer is yes, then I don’t care, but if the answer is no, then let’s talk!

How do you find your investments? Are they brought to you or do you screen for them?

We don’t use as many screens as our competitors – we look for situations of transition. We monitor a lot of announcements for spinoffs, acquisitions, divestitures, distributions and one-time dividends, etc. A good 1/3rd of our investments come from people who call about how they’ve lost a lot of money and they don’t understand why the equity is performing so poorly. They want information, but in another sense, they’re questioning whether an activist could help out. More often than not, present management and the board of directors will deal with the issues. We don’t want to be activists, generally, but to the extent that we’re wrong that the CEO isn’t good, we have to do it.

If it’s activism, it’s because the board or CEO is not reasonable. When we are activists, we always say to CEO’s and board members that we see this (something specific) as a problem and that any reasonable businessman would see this as a problem. Reasonable owners, your shareholders, see this as a problem. “Why don’t you get in front of this and solve it?” It’s only when they refuse to address the issue and completely ignore rational shareholders that we become activists. It’s not a case of them not being granted an opportunity to fix it. Furthermore, when they stick to their actions – often to feather their own actions, they refuse to accept that we are the shareholders and owners of the business. Instead, they try to publicize that we are a “lesser class” of shareholder, a hedge fund. One extreme example is a board that said they had a program in place to find new, more docile, shareholders. Instead of realizing value by spending time to follow suggestions, they were spending time on finding money and new bosses.

How long do you typically hold an investment for?

Our average investment period is well over a year, probably closer to a couple of years. I’m the chairman at TEAM, chairman at ORNG, both of which we have owned for over 4 years. Some of our other big positions are in the 3rd year of our ownership. We’re not traders and our investors see it by the tax bill – we’re not paying short-term taxes nearly as much as others.

Some of your investments are in pharmaceuticals or biotechs along with energy, mortgage processors, etc., how are you doing this?

We’re generalists and start digging into anything. If the problem is product based, we don’t dig into that. We’re focused on the business. If the company has successful products, but is spending too much on R&D, it’s a question of capital allocation. We avoid biotech companies without significant revenues because we don’t have a take on science. At the same time, we don’t have any problem in investing in a pharmaceutical spending a lot on biotech, but already has successful drugs in the marketplace. If there is a mismatch between capitalization and value of drugs that are already in the market, there will be a major discount to the market value of the company. A big discount points out that investors don’t value the R&D pipeline even though the drugs are kicking off a lot of cash.

How much do you care about where the overall markets are and where they are headed?

We used to not care at all, and through 2008, a lot of my competitors and I started to care very greatly. I don’t really pay all that much attention to it though, because I’m investing longer term than most, 2-4 years, and if they can turn a business around in 2 years, any 1 days headlines today won’t be the headlines 2 years from now.

Do you take long positions only or short positions as well? Is any of this as a hedge or do you look for companies with something that is fundamentally wrong when taking a short position?

We do take short positions, but we’re not nearly as good at them as our longs. We look for bad business models, too much leverage, and companies generally run for the benefit of senior management and board members. Shorts tend to go against us because whenever any activity continues, the investment community rates it highly. We’re not too good at anything other than when the debt comes due causing the company to reorganize or hand over ownership to the debt holders.

Your firm seems to be okay with small cap positions. Do you ever worry about a complete lack of liquidity that small caps will see whenever there’s a downturn?

Yes, we worry about liquidity. We think about it more today than 2 or 3 years ago because it is an issue and with many stocks that we used to get involved in, we will no long get involved in.

How do you manage and define risk?

We define risk as leverage – certainly not beta. Our only use of leverage will be used to trade around positions. That said, liquidity is the first coward and when liquidity dries up, you just have to put up with the bumpy road. There’s a desire to avoid volatility at all costs. The flip side is that you’re paying for it in liquidity. Our 17% annualized return partly comes due to an illiquidity premium. Neither the auditor nor the IRS makes us give back our excess return due to that though!

Your fund has lived through 2 or 3 economic downturns – which one were you most prepared for?

2000 Internet crackup. In 2002, when the S&P500 fell 22%, we were up almost 10%. These crises are very good for us, eventually. They’re not so good short term because we go through hell too. Just after it though, we tend to double and show over 100% returns. Leading up to the recent troubles, we were short on homebuilders and held CDS’s at one point, however gave those up on suspicions that the markets were rigged.

Do you ever notice that it’s easier to be right than it is to know when you’ll be proven right?

Yes, very much so. It happens in real estate quite a bit. You can buy a property one minute and then in the next minute, you can come up with a number for what it’s worth. Sometimes, it takes longer, and sometimes it’s shorter. This applies to stocks too – you know what it’s worth when you buy it, you have to wait though. We were investing 3-4 years ago and are still waiting for the investments to complete. We see how they will, but the markets have not recognized it yet.

Historically, do you have any investments that you remember as amazing? Maybe an investment where you were just so darn right that it was memorable?

Yes, two in specific:

1. Nursing Homes: In the early parts of the last decade, nursing homes were providing elderly housing and elderly care. They were expanding the elderly care to provide ancillary types of procedures, like occupational therapy, breath therapy, etc. and all these things made tons of money. The underlying business was great, and then they issued a ton of debt, raised capital, etc. Shortly after, congress cut back funding. With that, the top lines and margins went through the floor, leveraged ones went bankrupt, and the industry in itself went through a transition.

The markets priced that as if nursing homes would go away. In reality, there would only be more elderly people given enough time. We were buying healthcare REITS, preferred shares with 20% yields, dividend-paying instruments for 50% of pay, etc. Lo and behold, the Internet stocks went to hell and these nursing homes were going through a change too. Even while they went through a change, they had to keep paying rent, and so the REIT dividends kept coming in. It was priced like a junk bond, but the yields were better and actual ratings were better too!

2. InVision Technologies (from Seth Hamot’s point of view). During the internet bust, you would hear tons of ideas that all began, “This company has so much cash on hand and is only burning this much per quarter.” We found INVN, which was a collection of venture ideas that were being commercialized. The CEO of this company, though, was committed to being profitable. Same sort of upside, but without the cash burn, as the Internet investments. The CEO basically said this: “They (our investments) turn positive NOW, not later on.” Meanwhile, I’m getting a ton of calls from people to buy 1 of 6 online pet food supplier stocks, they have a ton of cash and little burn – they don’t need money for two years! I heard that all day long and then went to buy Invision. I paid less than the cash they had and saw some upside on a logger product that was going to make logging much more efficient. They weren’t burning cash either, and that’s what made it attractive.

I went over just 1% of the company by September 10th, 2001. On the next morning, terrorists attack the country and so the markets don’t open for a while. Invision actually had technology that sniffs for bomb threats in airports. At this time, it was in beta testing at a few regional airports. I hadn’t paid attention to this part of INVN at all, but now it was a lot more important than all the other activity at the company. I had been buying the stock for $3 per share, less than net cash. It was a “net net.” As you know, the markets remained closed until September 17th, when it opened around $7.50. By that afternoon, it traded around $9. This is when all the value investors got out right away. Around this time, I said, “You know, if it’s a real business, and it’s up to $9 today, because it was installed as a beta test, the government will want hundreds and thousands of these in the recent future, these will be hot.” Eventually, I got out between $17-20. If you travel now and look behind the check in counter, those machines that they put your luggage through are Invision machines. I have no idea what happened to the log cutting advancements or anything else, I was following a CEO who wanted profitability even when everyone else had different ideas.

2a. InVision Technologies (now from Sergio's point of view - CEO/President)

Dr. Sergio Magistri was the President the CEO of InVision Technologies, which developed technologies for Explosive Detection Systems (EDS) and other civil aviation security. He joined in 1992, raised $21M in 1997, and entered into a merger agreement for $900M, or $50 per share, on December 6th, 2004. Below are some of his thoughts:

1. Does the description that Seth gave of the situation sound adequate?

Yes, from a contrarian investor point of view looking at the overall high-tech space near the end of the dot-com bubble. At InVision (INVN) though, we never felt that we were part of the dot-com mania. We had a long-term strategy that was quite simple: (1) Security is an event driven market (2) The best marketing is the quality of our products (3) Keep developing the best technology in the industry without running out of money and maintaining at least a cash flow break even or better (4) At some point in time, the market demand will come. In retrospect, I wish we would have been wrong or at least the demand (as a consequence of a terrorist event) would have been lesser.

2. Why did you care about cash flow break even or positive at a time when most others did not?

At the valuation we had before September 11th and during the dot-com period, the company was not re-financeable almost at any valuation, because we were not “fashionable.” We had real products, revenues, and even some profit.

3. Did you get a hard time from anyone for pursuing cash flow breakeven and profitability before others?

Quite a lot of our investors (and our own people) were pushing for some kind of splash change in strategy to appease the dot-com believers, but at the level of management and board of directors, we decided to keep executing our security strategy. We had a clear understanding that we didn’t belong to the dot-com world.

4. Seth mentioned a logging enhancement that your firm was working on, but that might have been hidden by the success of the Explosive Detection Systems. Could you tell us what eventually happened?

After September 11th, we were management and resource limited. For a while, we tried to spin it off as an independent and financed entity to avoid defocusing our security effort. Once this failed, we decided to abort the development. Even today, while recognizing the need for the decision at the time, I believe that this was and will be a very interesting opportunity.

And now, back to some questions for Seth: When dealing with small caps, do you ever think about why some of them are publicly traded to begin with?

All the time. If you actually understand the classical theory of public markets, they exist for raising initial capital. No one would actually give capital unless there’s an exit strategy, and the public markets allow that exit strategy to be a reality for small holders of stock.

Looking at your current positions, can you offer any insight as to some of the more interesting ones?

Aeropostale (ARO) – Aeropostale is the premier teen retailer in my estimation. When you compare the company’s fundamentals to the other large players, AEO and ANF, you see the superiority clearly. Yet, ARO is relatively cheaper than its competitors. Let’s first look at the ability to drive same store sales. In 2009, arguably the worst year for retail in the last generation, ARO had year over year gains every month. Furthermore, if you consider the gains in total sales compared to the recent trimming of inventory – that’s right, the decline in inventory – you realize the increasing efficiencies that are driving huge cash flows at ARO. [Specifically, let’s take the summation of the last four quarters of “percentage yearly revenue gains” and subtract from that number the summation of the last four quarters of “percentage of yearly inventory gains,” the latest quarter being actually a reduction in inventory. ARO’s resulting number is 50.83 and accelerating. AEO’s is 21.88, and going in the wrong direction and ANF’s is 34.68 and also headed in the wrong direction.]

Analysts miss all this though. They are so wed to their bullish calls on ANF and AEO that they have conjured up a story that once the recession ends, all those customers who are moving to a lower price point by shopping at ARO are going to return to the competitors’ stores. Hence, ARO trades at 5.43x its LTM EBITDA, while ANF trades at 7.26x and AEO traded at 7.14x until it lost 35% of its value in the last quarter. Caught up in their past view of the world, they are missing one of the great retail stories around today, which continues to improve its business quarter over quarter.

Nabi (NABI) – this is a wonderful story. Nabi has a vaccine that helps with smoking sensations. Glaxo Smith Cline (GSK) actually put up $45 Million to partner with them on this drug. No one spends $45M on a drug that isn’t credible. That will probably move forward by the end of 2011. When I entered my position, I wasn’t paying more than cash and the NPV of royalties, probably lower and upper 3’s. GSK validated the vaccine and the ramifications of its approval are mind-boggling. You take 4-5 shots over 6-8 months and you can get over smoking. Our nation spends a lot of money on smoking and so there will be a lot of push behind this drug, you could make budgets balance if less people smoked. Even if you doubt it, the GSK guys have been looking at it for months and when they’re done with the next phase of development, GSK will pay NABI another $30 Million for the work they’re doing, and then the numbers get really crazy for royalty payments. When I was buying, I got in at prices where most of the story was for “free” because of where the stock price was trading.

(Market Folly note: There's an interesting tie-in here as readers will recall that Dan Loeb's hedge fund Third Point had been selling Nabi, though they still own a sizable position).

BreitBurn Energy Partners (BBEP) – This company found they were overleveraged at one point last year and so they cut the dividend distribution, causing the stock to go down to $6. Dividend money went to cut down debt and now it’s at $15. We went from $6 to $15. Baupost is there and the interesting thing is that they got involved with a proxy contest with the largest shareholder. Quicksilver, the largest shareholder, went on the board and removed 2 guys – the chairman and CEO, the two folks whose name is in the company name itself. They became management employees.

(Market Folly note: You can view the specifics of Seth Klarman's BBEP investment via Baupost's portfolio.)

Quicksilver (KWK) is overleveraged and owned 21 million shares of this company at one point, or about 40% of the company. They had a proxy contest and those 2 were removed. You have to take a step back and wonder what’s going on. If there is nothing going on, why would they bother to remove people from the board who will object and not be happy about the situation? There’s a possibility that managers were taken off the board of directors so that potential M&A activity could be kept segregated from the operations, which offers a potential exit strategy for Quicksilver. In the meantime, I got a 10% dividend and 37.5 cents per quarter per share, not too bad at all, and mostly tax-free.

How do you try and structure your portfolio? Your top holding is 15% of your invested portfolio and the top 5 make up 44% of your portfolio, even though you had 29 positions at the last 13F filing.

We tend to buy as much as 6-7% of the portfolio and will be pruning as it crosses the 10-15% threshold. We’re usually always pruning.

How do you deal with prices at which you are okay holding a stock, but not buying?

Opportunity cost would say that if you aren’t willing to buy it at the current price, you shouldn’t be holding it, because by not selling, you’re effectively buying at the current price. One of the pains is you buy stocks out of favor. Often times, they become in favor! Just because they’ve risen past fair value, and you saw that in InVision, where the fundamentals had markedly changed, you have to be patient and see it runs its course. By the same token, if I was buying for the log cutting machine software, and if it was done with the beta tests without much business activity, I would have found another investment to move onto. From my point of view, I can be patient.

Can you recommend a few books for investors that you found to be helpful?

Sure - Ben Graham's Security Analysis, The Intelligent Investor, and Seth Klarman's Margin of Safety. Additional reading includes Warren Buffett's annual letters and an understanding of topics of leveraged buyouts and stability of cash flows."

And that concludes the excellent interview. The above was a guest contribution courtesy of Ankit Gupta of Those of you interested in a .pdf copy of the above interview can download a .pdf here.

If you or anyone you know is a fund manager open to being interviewed, please send us an email.

Mark Rachesky's MHR Fund Management Receives Convertible Notes From Emisphere Technologies (EMIS)

MHR Fund Management run by Mark Rachesky recently filed a Form 4 with the SEC in regards to Emisphere Technologies (EMIS). Per the filing, Rachesky's firm received convertible notes on EMIS for reasons we'll discuss below. We see that MHR acquired $1,272,753 worth of convertibles with an exercise price of $3.78 and an exercise date of September 26th, 2012. These convertibles in aggregate represent 336,705 shares of common stock in Emisphere Technologies.

This is not the first time MHR has acquired EMIS convertibles either. Rachesky's firm has owned 11% Senior Secured Convertible Notes since May 16th, 2006. These convertibles have interest "payable in kind semi-annually in arrears through the issuance of the reporting persons of additional convertible notes." As such, MHR has filed this Form 4 with the SEC to disclose the receipt of these additional Convertible Notes as paid-in-kind interest on the notes they already owned. This is also not the only transaction relating to Emisphere for MHR in recent times. As we detailed in June, MHR also acquired warrants on EMIS.

Rachesky received his B.S. in molecular aspects of cancer from the University of Pennsylvania and an M.D. from Stanford University School of Medicine. Additionally, he also holds an MBA from the Stanford Graduate School of Business. Prior to founding MHR Fund Management, Rachesky previously worked as a senior investment officer and managing director to Carl Icahn. While Rachesky was once viewed as Icahn's apprentice, it's intriguing to see them now essentially pitted against one another in a separate position. As we've detailed numerous times before, Icahn has been bidding for Lions Gate Entertainment (LGF), one of MHR Fund Management's largest holdings. We'll continue to watch and see how that one plays out.

Taken from Google Finance, Emisphere Technologies is "a biopharmaceutical company that focuses on a delivery of therapeutic molecules or nutritional supplements using its Eligen Technology".

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Market Strategist Jeff Saut Still Cautious, Highlights Negative Indicators

Raymond James' Chief Investment Strategist Jeff Saut is out with his weekly missive and there's honestly not much new from him in terms of commentary. Last week, we covered how Jeff Saut was decisively cautious and his stance stands seemingly unchanged this time around. While he still advocates caution, he notes that such extreme pessimism can often be seen as a contrarian signal. As such, it would not surprise him to see a rally as stocks have been compressed on a short-term basis.

Of the negative signs, Saut cites:

- Dow Theory sell signal
- His proprietary trading indicator flashing 'sell' (for the first time since December 2007)
- Negative readings on the monthly stochastic indicator
- Downside violation of the 12-month moving average in stocks (most stocks have broken 'triple-bottoms')
- A death cross (where the 50 day moving average crosses below the 200 day moving average)

You can't really argue with the fact that all of those indicators are indeed quite ominous. Saut notes that as of the month of June of the asset classes he follows, only gold, silver, fixed income and the Japanese yen were higher for the month and year-to-date. It's no coincidence that these are often areas where investors flee to safety when volatility ramps up and uncertainty reigns. A few weeks back, the Raymond James strategist argued that the market was in a bottoming process. However, as the negative indicators began to pile on, he was quick to adapt to the change in trend and advocated caution. Saut presumably has a portion of his accounts sitting in cash given his stance and the fact that he removed market hedges into the turmoil.

In summation, Saut believes that the first duty of investors at this point should be to protect capital (and in particular the gains from the March 2009 lows). At the same token, he would not be surprised to see a rally (at least in the near-term) given the abounding pessimism. Embedded below is Jeff Saut's weekly investment strategy publication:

You can download a .pdf copy here.

If you haven't already, definitely read Saut's commentary from last week where he was decisively cautious as it is much more in-depth than this week's note. And for more recent market commentary, we recently highlighted Crispin Odey's market outlook from hedge fund Odey Asset Management which is worth examining.

Hedge Fund Axial Capital Buys More QLT Inc (QLTI)

Eliav Assouline and Marc Andersen's hedge fund firm Axial Capital Management recently filed a Form 4 with the SEC regarding shares of QLT Inc (QLTI). Per the filing, we see that Axial bought 419,200 shares of QLTI spread out over the course of three days. They purchased:

139,200 shares at $5.74 on June 30th, 2010
80,000 shares at $5.75 on July 1st, 2010
200,000 shares at $5.73 on July 2nd, 2010

After their purchases, Axial's total position in QLTI totals 6,195,429 shares. This is not the first time Assouline and Andersen's hedge fund have bought shares recently either. Back in early June, Axial bought QLTI at an average cost of $6.20. Shares have obviously decreased drastically in the one month that's elapsed and that has whet their appetite for more shares.

This is only the third time we've covered Assouline and Andersen's hedge fund as our previous posts include detailing their addition to another position as well. Julian Robertson seeded Axial in 2005 and the hedge fund offices out of Tiger Management's old headquarters at 101 Park Avenue. You can view the proverbial 'Tiger Family Tree' of hedge fund managers here. As of their last 13F filing, Axial disclosed $799 million in assets invested in US equities.

Taken from Google Finance, QLT is "biotechnology company. The Company is engaged in the development and commercialization of therapies for the eye. The Company focuses on its commercial product, Visudyne, for the treatment of wet age-related macular degeneration (wet AMD), and developing its ophthalmic product candidates."

For more of the latest moves from prominent investment managers, stay up to date with our daily hedge fund portfolio tracking series.

Warren Buffett ~ Market Folly Quote of the Week

When Market Folly first came to be, a 'quote of the week' was featured each Monday. Somewhere along the line, that tradition fizzled away for no reason. As such, it's time to bring it back with a vengeance. To kick-start the series again, let's begin with none other than the Oracle of Omaha himself, Warren Buffett. And, fun fact: The name of this site (Market Folly) partially stems from his quotation below.

Quote of the week:

"Profit from folly rather than participate in it." ~ Warren Buffett

For more on all things Buffett, head to our coverage of Warren's recommended reading list and a multi-decade look at Buffett's career.