Thursday, April 26, 2012

Excerpt From Howard Marks' Book: The Most Important Thing Illuminated

Today we have a special treat for readers as we've been granted permission to publish an excerpt from the book written by Oaktree Capital's Chairman, Howard Marks.

Marks' book, The Most Important Thing Illuminated (or Kindle e-book version here) features a section on combating negative influences, which we've excerpted below:

"People who might be perfectly happy with their lot in isolation become miserable when they see others do better.  In the world of investing, most people find it terribly hard to sit by and watch while others make more money than they do.

Howard Marks: Emotion and ego: A lot of the drive in investing is competitive.  High returns can be unsatisfying if others do better, while low returns are often enough if others do worse.  The tendency to compare results is one of the most invidious.  The emphasis on relative returns over absolute returns shows how psychology can distort the process.

I know of a nonprofit institution whose endowment earned 16 percent a year from June 1994 to June 1999, but since its peers averaged 23 percent, the people involved with the endowment were dejected.

Seth Klarman: Even the best investors judge themselves on the basis of return.  It would be hard to evaluate yourself on risk, since risk cannot be measured.  Apparently, the risk-averse managers of this endowment were disappointed with their relative returns even though their risk-adjusted performance was likely excellent, as borne out by their performance over the following three years.  This highlights just how hard it is to maintain conviction over the long run when short-term performance is considered poor.

Without growth stocks, technology stocks, buyouts and venture capital, the endowment was entirely out of step for half a decade.  But then the tech stocks collapsed, and from June 2000 to June 2003 the institution earned 3 percent a year while most endowments suffered losses.  The stakeholders were thrilled.

There's something wrong with this picture.  How can people be unhappy making 16 percent a year and happy making 3 percent?  The answer lies in the tendency to compare ourselves to others and the deleterious impact this can have on what should be a constructive, analytical process.

Joel Greenblatt: This is incredibly important.  Most institutional and individual investors benchmark their returns, and therefore most end up chasing the crowd: accent on the wrong sylLABle."

Excerpted from, The Most Important Thing Illuminated by Howard Marks.  Copyright (c) 2012 Howard Marks.  Used by arrangement with Columbia University Press.  You can also get the Kindle e-book version here.

His book is definitely a must-read so check it out.  And if you missed it, we also posted up Marks' recent commentary on contrarian signals.

Corsair Capital's Investment Thesis on SunCoke Energy (SXC)

Earlier today we posted up Corsair Capital's Q1 letter.  Now, we present their investment thesis on one of their latest positions: SunCoke Energy (SXC).  SXC was spun-off from Sunoco last year and the hedge fund thinks investors misunderstand the company's business model.

Corsair believes that "SXC offers both steelmakers and equity investors a compelling and valuable proposition.  SXC has modest debt, generates a tremendous amount of cash, and management has invested in SXC since the spin.  At 10x 2012 run rate EBITDA less Maintenance CapEx ... we derive a target price over $25."

That's some compelling upside seeing how SunCoke Energy currently trades around $14.  Corsair says that one of the main things that attracted them to invest was SXC's highly-structured contracts, recurring cashflows, and incremental (low-risk) earnings growth.

The hedge fund also sees growth opportunities as compelling as well as the potential to convert coke operations to an MLP structure.

However, the main risk here is that Arcelor Mittal (MT) accounts for 70% of the company's sales and they only have three primary customers.

As far as valuation goes, Corsair writes:

"Based on $300 million of EBITDA (2012 guidance plus Middletown for a full year of operations) less Maintenance CapEx of $60 million valued at 10x yields a target price of $27."

Embedded below is Corsair's investment thesis on SunCoke Energy:

Be sure to also read the rest of Corsair Capital's Q1 letter for updates on their other investments.

Corsair Capital Provides Updates on Their Positions: Q1 Letter

Jay Petschek and Steven Major's hedge fund Corsair Capital is out with their Q1 letter and in it they detail updates on their investments in: LyondellBasell (LYB), Shaw Group (SHAW), Republic Airways (RJET), Neo Material Technologies (NEM) and TNS (TNS).

Given that LYB has been owned by numerous hedge funds, we wanted to highlight their commentary:

LyondellBasell (LYB) - "Though the company reported a weak Q4 as expected, the market anticipates record-low gas prices will continue to suppress ethane prices, one of LYB's main input costs, thereby supporting high ethylene margins.  If current ethane prices are sustainable, the industry could enter a 'super-cycle' where LYB would show earnings previously not thought possible.  The company also took advantage of the current strong credit markets and refinanced $3 billion of debt, benefitting by both extending maturities and lowering interest payments."

Also, the fund addressed their position in Shaw Group (SHAW): "two of its main customers received the final requisite Nuclear Regulatory Commission licensing to construct two new nuclear power plants and the EPA's increased environmental standards drove power plant maintenance contract wins.  The company also reported a strong fiscal Q2 and the upcoming divestiture of the Energy and Chemicals division in the next few months should create additional shareholder value.  We estimate that SHAW could earn $3.00/share in FY 2013, which would increase its net cash position to over $17.00/share."

We've previously posted up Corsair's investment thesis on Shaw Industries for further color.

Embedded below is Corsair Capital's Q1 letter:

Later this morning we also posted up Corsair's investment thesis on SunCoke Energy.

What We're Reading ~ 4/26/2012

Compliance: a marketing edge [FINalternatives]

Keynes: one mean money manager [WSJ]

Financial sleuth Howard Schilit back on the job [Barron's]

Schilit's great book: How to Detect Accounting Gimmicks & Fraud [Amazon]

The investment checklist manifesto series [Research Puzzle]

Jim Chanos to speak in Milwaukee [Make A Difference] 

Is Yale's Endowment the new Tiger Management? [aiCIO]

Why do value investors underperform? [Greenbackd]

Finding alpha in Israel's emerging market [AllAboutAlpha]

Hedge fund ads are a gamechanger [Marketwatch]

Bill Ackman & Sam Zell on turnarounds, opportunities & success [IBTimes]

John Maynard Keynes: star investor? [CXO Advisory]

Business troubles deepening at The New York Times? [Poynter]

An investment checklist [Portfolio14]

On Jesse Livermore & his legacy [MarketThoughts]

Hedge fund managers a gloomier lot in 2012 [Reuters]

Wednesday, April 25, 2012

East Coast Asset Management on Mispricings: Q1 Letter

Christopher Begg's East Coast Asset Management is out with their first quarter letter and in it they focus on mispricings.  We like to highlight their letters due to the focus on investment process.  After all, investing is a profession that requires continual education.

Begg shares his wisdom by writing, "Mispricing discovery is intelligent investing. We want to clarify that mispriced does not mean cheap - mispriced investments are not partial to any particular asset class nor are they partial to style boxes and growth rates."

We've previously highlighted how Greenlight Capital's David Einhorn looks for mispricing when investing, seeking to better understand situations to generate returns.

Begg goes on to breakdown mispricings into two types:

Structural - These exist "when an event occurs that forces a large population of owners to sell without any change in the investment's intrinsic value.  Examples of structurally induced selling would include: when an investment is deselected from an index, when a company is spun off from a larger parent company, or perhaps when a company's credit rating is reduced."

Psychological - He says that these mispricings "are driven from collective investor psychology which induces broad selling or a lack of buying in an investment."

East Coast feels that "our greatest source of mispricings occurs when myopic investors have difficulty focusing on the distant compounding merit of a great business (compounder category) or the inflection point of a material change in an industry that is improving (transformation category)."

Begg then goes on to highlight their investment in Colgate-Palmolive (CL) as a prime example.

Current Market Commentary

East Coast also summarizes their views on the current market, writing

"In aggregate, the market is reasonably priced at below 14 times 2012 projected earnings; inverting the multiple means that we are getting a 7.5% earnings yield.  If we include an economic growth rate of 2-3% we arrive at expected equity returns in high single digits."

Their letter also goes on to examine Apple (AAPL), concluding that, "We don't disagree with the quality of the business nor do we doubt that the valuation looks attractive.  What we do struggle with is the ability to truly compound at an attractive rate based on size."  We've also posted up on the subject with our post: The Apple Conundrum.

Embedded below is East Coast's first quarter letter:

For more from this firm, head to East Coast on embracing uncertainty as well as their great piece on gaining an investment edge.

Tuesday, April 24, 2012

Glenview Capital Buys More Health Management Associates (HMA)

Larry Robbins' hedge fund firm Glenview Capital filed a new 13G with the SEC regarding its position in Health Management Associates (HMA). Per the filing, they now own a 5% stake in the company with 12,824,276 shares.

This is an increase of 148% in their position size since the end of 2011 and the new filing was made due to activity on April 13th. This isn't the only health-related play Glenview's been buying as of late. They also started a position in Tenet Healthcare.

Per Google Finance, Health Management Associates is "by and through its subsidiaries operates general acute care hospitals and other health care facilities in non-urban communities. As of December 31, 2011, the Company operated 66 hospitals with a total of 10,330 licensed beds in Alabama, Arkansas, Florida, Georgia, Kentucky, Mississippi, Missouri, North Carolina, Oklahoma, Pennsylvania, South Carolina, Tennessee, Texas, Washington and West Virginia."

In other portfolio activity from this hedge fund, we've highlighted how Glenview boosted its stake in Mueller Water Products.

Monday, April 23, 2012

SAC Capital Trims Annie's Stake

Steve Cohen's hedge fund firm SAC Capital just filed an amended 13G with the SEC regarding its position in Annie's (BNNY). Per the filing, SAC now owns a 4% ownership stake in the company with 670,500 shares.

This is a slight decrease in their stake. We previously highlighted SAC's original stake in Annie's just a few weeks ago. Since then, they've sold almost 17% of their position.

Annie's recently completed its IPO and shares are up just over 9% in the open market. The big gains stem from the IPO itself when BNNY priced at $19 per share and gained 89% on its first day of trading, an event SAC almost certainly participated in.

SAC's filing was made due to portfolio activity on April 11th.

Per Google Finance, Annie's is "a natural and organic food company offering consumers products in packaged food categories. The Company sells its products in three product categories: meals; snacks; and dressings, condiments and other."

Steve Cohen was recently named one of the top 25 highest earning hedge fund managers of 2011.

JANA Partners Discloses Barnes & Noble (BKS) Stake

Barry Rosenstein's event-driven hedge fund JANA Partners filed a Form 3 with the SEC regarding shares of Barnes & Noble (BKS). Per the filing, the hedge fund has revealed almost a 7 million share position in BKS.

This is a brand new position for JANA as they did not own shares at 2011 year-end. BKS was up over 18% today as investors speculated the activist investor would push the company to split up. After all, JANA recently pushed for McGraw-Hill to split up.

However, the hedge fund has only filed a passive 13G with the SEC at this time, disclosing their 11.6% ownership stake in the company. If they were pursuing activism, they would have filed a 13D.

In the Form 3, JANA also disclosed "put options (obligation to buy)" representing 250,000 shares with an exercise date of May 18th, 2012 and a strike price of $13. We've quoted the above from the filing because it's caused a bit of confusion.

In the traditional definition of buying options, puts are the right, but not obligation, to sell shares. They've written "obligation to buy" instead on the Form 3. So, this could mean 1 of 2 things: they either sold the puts or they meant to write "calls (obligation to buy)."

Both are essentially bullish bets so it's just technicalities. We've sent an inquiry to JANA.

If they sold puts, that means they're more than likely willing to buy more shares at the $13 pricepoint. This would be the first time we've ever seen a fund disclose the sale of options, as usually they only disclose when they purchase calls or puts.

And if they actually bought calls, they most likely bought them when they were out of the money (due to the $13 strike). On the big surge today due to the news of JANA's stake, these calls (if that's what they meant) are now in the money. We hope to get clarification from them about this, but either way it seems to be a bullish wager.

BKS Top Holders

This is an interesting shake-up in terms of ownership stakes. Billionaire Ron Burkle owns a sizable stake in BKS, as does John Malone's Liberty Media (LMCA). (Interestingly, JANA also owned a chunk of LMCA shares as of the end of 2011).

Almost a year ago, Liberty made an offer to acquire BKS for $17 per share in cash, but the two eventually settled on BKS selling Liberty $204 million in convertible preferred bonds.

Other top hedge fund holders of BKS on record as of December 31st, 2011 include Balyasney Asset Management and Citadel.

Conversely, Mick McGuire's Marcato Capital had previously disclosed a sizable put position in Barnes & Noble. Whitney Tilson's T2 Partners has also been short BKS.

Bulls Versus Bears

The bulls point to Barnes & Noble's Nook e-reader segment as attractive. Some analysts believed that's what John Malone's company targeted in the first place and others have postured that JANA might push for a split up of the company.

Bears obviously point to the fact that it's no secret physical booksellers are facing heat in the form of a) competition from cheaper prices from (AMZN) and b) the digitilization of the publishing industry as books convert into e-books.

Barnes & Noble's primary brick and mortar competitor in this arena, Border's, filed for bankruptcy. BKS is looking to avoid the same fate and it looks like some investors are eying the e-book segment.

It will be interesting to see what happens given that BKS has been a favorite short of various hedge funds, but you also have potential activists involved (JANA) and potential buyers that have demonstrated their interest (Liberty) on the long side.

For more of our coverage of this hedge fund, head to JANA's presentation on MHP.