Thursday, May 3, 2012

David Einhorn's Greenlight Capital Reveals Stake in Oaktree Capital (OAK)

David Einhorn's hedge fund Greenlight Capital recently filed a 13G with the SEC regarding a brand new position in Oaktree Capital (OAK).  Per the filing, they now own 5.5% of the company with 1,679,750 shares.

Oaktree recently completed its initial public offering (IPO) on April 13th.  Readers will be very familiar with this company as we often post up letters from its Chairman, Howard Marks.  We've also posted up an excerpt from Marks' book on investing.

It's hard to say whether or not Greenlight participated in the IPO, but the regulatory threshold was crossed due to trading activity on April 20th which required them to file with the SEC.

Per Google Finance, Oaktree Capital is "a global investment management firm focused on alternative markets. Oaktree manages funds in investment strategies that fall into the six asset classes, which include distressed debt, corporate debt, control investing, convertible securities, real estate and listed equities."

If you missed it, we've also posted up a transcript of Einhorn's questions on the Herbalife call that caused the stock to drop almost 20%.

Citadel Boosts Stakes in Evercore Partners & OmniVision Technologies

Ken Griffin's hedge fund firm Citadel recently filed two separate 13G's with the SEC. 

Evercore Partners

First, they've increased their position in Evercore Partners (EVR).  The fund now owns 5.6% of the company with 1,612,188 shares.  This marks a 57% increase in their position size since the start of the year.  This disclosure was made due to activity on April 25th.

Ken Griffin was listed as one of the top 25 highest earning hedge fund managers in 2011.

Per Google Finance, Evercore Partners is "an independent investment banking advisory firm. It operates in two segments: Investment Banking and Investment Management. Its Investment Banking segment includes its Advisory services, through which it provides advice to clients on mergers, acquisitions, divestitures and other corporate transactions. It also provides restructuring advice to companies in financial transition, as well as to creditors, shareholders and potential acquirers. It also provides its clients with capital markets advice, underwrites securities offerings and raise funds for financial sponsors."

OmniVision Technologies

Second, Citadel also disclosed a 5.3% ownership stake in OmniVision Technologies (OVTI) with 2,747,057 shares.  This represents a 356% increase in their position size since the fourth quarter of 2011 ended.  Citadel filed with the SEC due to trading on April 30th.

Per Google Finance, Omnivision Technologies is "designs, develops and markets semiconductor image-sensor devices. The Company's main products, image-sensing devices, which it refers to as CameraChip image sensors, capture an image electronically and are used in a number of consumer and commercial mass-market applications. OmniVision’s CameraChip image sensors are manufactured using the complementary metal oxide semiconductor (CMOS), fabrication process and are predominantly single-chip solutions that integrate several distinct functions including image capture, image processing, color processing, signal conversion and output of a fully processed image or video stream."

We've also posted up more recent portfolio activity from Citadel here.

JANA's Investment Thesis on Barnes & Noble (BKS)

We originally flagged when Barry Rosenstein's hedge fund JANA Partners took a stake in Barnes & Noble (BKS).  So today we want to take a look at their rationale for buying.

JANA's Position in BKS

While they are activist investors, this was not an activist stake.  They instead filed a passive 13G with the SEC disclosing an 11.6% ownership stake in the company. 

At the same time, other investors like G Asset Management were leading the activist charge by filing a 13D a month prior pushing for a spin-off of the Nook e-reader business.  Then, news recently broke that Microsoft had invested in BKS' Nook e-reader business and shares rocketed higher.

JANA just filed a Form 4 with the SEC revealing that they sold 1 million shares at a price of $24.42 on April 30th.  They now own 5.9 million shares as it appears they've taken some profits from the big jump.

JANA's Investment Thesis on BKS

The hedge fund's investment thesis on Barnes & Noble was posted on on April 22nd.

LONG Barnes & Noble (BKS)
Price: $11
Market Cap (fd): $800mm
Enterprise Value: $1.3b
Average Daily Volume: $17mm


BKS is a long because it has an under-appreciated asset in the Nook eReader platform, whose value will be illuminated through a partial sale of that business segment in 2012. We believe a conservative sum of the parts valuation for BKS is $11/share for the existing Retail and College bookstores and $26/share for the Nook resulting in a $37 sum of the parts valuation or 230% upside.

Business Description

BKS is 3 distinct businesses: 1) the 700 Retail bookstores that carry the Barnes & Noble brand name 2) the college bookstore business which operates campus bookstores at 640 different colleges and 3) the Nook eReader platform which sells the devices and digital content and will generate $1.5 b in platform sales in FY12 (FY ending in April).

The Retail bookstore is a dying business as we shift from physical to digital online purchasing of physical. We estimate underlying SSS are declining ~7% annually. However, due to the liquidation of Borders and downsizing of selling square feet for physical books at WalMart and Target, actual SSS will be positive 1$ in FY12 and flat in FY13. EBITDA in FY12 will be $325 mm (or ~$294 mm excluding the Nook EBITDA that is accounted for in the Retail segment) and flat in FY13. Importantly, we believe there is significant value in the retail bookstores because their leases are increasingly becoming more short term (average duration of the portfolio is ~2-3 years) allowing for significant flexibility (and minimal friction costs) in downsizing the store base as 4-wall profit contribution turns negative. BKS is closing 20-30 stores annually or 3-4% of their store base.

The College bookstore is a much better business than Retail. The majority of what is sold in a campus bookstore is not trade books, but rather textbooks and college paraphernalia. SSS and EBITDA are stable ($124 mm of EBITDA in FY12). BKS operates the store on behalf of the school; BKS pays a % of revenues as rent so if sales decline the rent payments decline as well. In addition, there is flexibility to adjust the rent payment % or terminate a management contract on 60 days’ notice should a store become unprofitable.

The Nook eReader is the hidden asset of BKS. Nook is the #2 player in the eBook market with 25% market share behind Amazon at 65% markets share (iPad, Kobo, and others share the remaining 10%). Nook went from a standing start in 2009 to 25% market share by leveraging their 700 physical retail stores to sell the Nook to a predominantly women audience who value the in-store customer support. Nook has grown from nothing in FY10 to $900 mm of platform sales in FY 11 to an expected $1.5 b in FY 12 (ending 4/12). While Nook currently loses money (~$250 mm in FY12) given the large R&D and marketing budget, we believe this platform has real value due to a rapidly growing market (50% expected CAGR for the next 3 years) and customer stickiness that should result in Nook maintaining its market share. We expect a positive inflection point in profitability by CY14.

Short Thesis & Our Variant View

There are 17 mm shares sold short which is 29% of the shares outstanding. Many smart investors do not agree with our bullish view on BKS. Below we lay out the short thesis and our variant view.

Short Thesis: Bookstores are a dying business.  Variant View:  We agree! However, that does not mean that the bookstore business is worthless. First, 1/3rd of the EBITDA of the bookstores comes from the College Bookstore business which is NOT dying but rather is a stable business that does not face the same secular headwinds the Retail bookstores have. We value College at 4.5x EBITDA for a $500 mm valuation. For the Retail bookstores, because of the short lease length, there is minimal friction costs as they wind down the business. We run a DCF of the Retail bookstores that assumes a hard run-down of the business and come to a valuation of $780 mm which is 3.0x EBITDA. As a reference point, BBY, another secularly challenged retailer, trades at 3.0x EBITDA.

Short Thesis: BKS is losing money ... there is no margin of safety to make a valuation case on.  Variant View: You cannot look at BKS on a consolidated basis. The bookstores are quite profitable, but the cash flow is being reinvested into growing Nook market share while the eBook industry is still in its infancy and sticky customer relationships are being formed. If for whatever reason the Nook failed and was shut down you would still have the profitable bookstores. If you shut down the Nook, BKS would be trading at 3.5x EBITDA.

Short Thesis: Nook is not worth much because it is losing money and has deep-pocketed competitors.  Variant View: The argument that there is fierce competition in the eBook space is as true today as it was in 2010 when AMZN had ~100% market share. This did not prevent Nook from going from 0% market share to 25% in 2 years. The physical retail store presence is a large competitive advantage for the Nook that BKS has been able to leverage to grab share in this fast growing market. You do not need to assume further share gains in this fast growing market for the Nook to be worth a lot of money as a separate company or as a partner to a strategic investor.

Short Thesis: The recent anti-trust lawsuit and partial settlement over eBook price-fixing means that AMZN will be able to sell eBooks at a loss and drive out the competition (mainly the Nook). 

Variant View: the anti-trust settlement is clearly not a positive and introduces uncertainty over the next 6 months in terms of how the eBook pricing regime will evolve. 3 of the big 5 publishers which represent ~30% of trade books have agreed to it, while Apple and the other publishers are going to fight it out However, the conclusion that AMZN will pursue a scorched earth pricing strategy and successfully destroy the competition is misguided. A key industry dynamic that is critical to understand is that the publishers despise AMZN because of their attempt to cause eBook price deflation while also trying to dis-intermediate the publishers with their own in-house publishing effort. Read Jeff Bezos’ annual letter where he spent half of the entire letter talking about their publishing business, then think about what your reaction would be if you are a publisher. Because of this antagonistic relationship, the publishers are hell-bent on ensuring that there are several healthy customers, primarily BKS as the last physical bookstore of scale as well as the biggest competitor to AMZN in eBooks. This was the entire reason for forcing agency pricing scheme in the first place; to level the playing field for new entrants. The publishers will be doing everything possible to ensure that BKS is a healthy competitor that can serve as a governor on AMZN’s potential to destroy the traditional publishing business. In what form this support for BKS and other competitors is still uncertain, but as an example, there is a specific clause in the anti-trust settlement agreement that expressly allows a publisher to support bricks and mortar stores (ie BKS) with promotional and marketing dollars.

Financials & Valuation

We arrive at a $37 sum of the parts valuation for BKS by using our CY12 estimates and putting 3.0x EBITDA on Retail, 4.5x EBITDA on College, and 1.0x platform sales on Nook. From this $3.3 b EV we subtract net debt and pension of $240 mm, deferred rent of $160 mm, and our estimate of Nook losses until breakeven after-tax of $200 mm. This arrives at an equity value of $2.7 b or $37/share after fully-diluting the shares outstanding to 72 mm due to the Liberty Media convertible preferred.

Obviously the most contentious part of this valuation is what the Nook is worth. It’s not worth zero just because they are currently spending through the opex line to grab market share in a rapidly growing space. We think 1.0x sales is conservative if it were to trade to a strategic or be IPO’d. There are no great comps but we found several data points that we think are relevant: 1) Kobo is a smaller ($100 mm of sales) eReader platform that was sold to Rakuten in Japan for 3.0x sales 2) NFLX traded as low as 1.0x sales when it was at $70 and the world thought the company was unprofitable and in a death spiral 3) LXK is priced to go out of business at 7x EPS and 0.5x sales. Additionally our conversations with bankers and cap markets suggest 1.0x would be conservative; rather, 2-3x sales could be on the table if properly marketed. Every 1⁄2 turn of sales is worth $13/share. 

Another way to frame the valuation is to think about what you are currently paying for the Nook at the current BKS price of $11/share. We think the core business ex-Nook is worth $11/share which means you are paying nothing for the Nook today. That strikes us as a particularly asymmetric risk/reward.

Management & Board

Management and the board are an important element of the story to BKS.

Len Riggio is the founder of BKS and owns 30% of the shares out. He has created a lot of shareholder value over time through the success of the Barnes & Noble concept, the acquisition and growth followed by a spin-off of Game Stop, the IPO of B& during the tech bubble followed by its buy-in post the bubble, and now the successful ramp of the #2 eReader platform which will be partially monetized this year. He made what must have been an excruciatingly hard decision to take all the cash flow the bookstores generated for the last 2 years and invest it in the Nook start-up which will speed up the disintermediation of his core bookstore business. Not many management teams can destroy a sacred cow like this (ie Borders).

John Malone via Liberty Media has a $200 mm convertible preferred that they completed in the Fall of 2011 that converts to 16% of the fully diluted shares at $17/share. Note that this preferred investment followed a terminated sale process where Liberty bid $17 for the entire company in May 2011. We believe the sale process was not terminated because Liberty found something they didn’t like but rather that the financing package that was offered to Liberty was pulled in the market melt-down in the summer. Liberty has 2 board seats (Greg Maffei & Mark Carleton). Malone has one of the best track records in the media business and we take his involvement in BKS seriously. We do not think it was a coincidence that only 4 months after the Liberty investment the company announced their intention to monetize a portion of the Nook business. Trackers, spins, and financial engineering that create shareholder value is vintage Liberty Media.

Mike Huseby was recently hired as the CFO of BKS which we think is another confirmatory data point to the Nook monetization thesis. Huseby was previously the CFO of Cablevision where he had extensive experience with trackers, spin-offs, leverage, share shrink, and MBO’s.


The biggest risk to our investment thesis is the future of the Nook and the execution of the Nook monetization. We could be wrong on the industry dynamics and Nook’s competitive positioning vs. AMZN. The market doesn’t give BKS credit for the Nook value today and without an event to illuminate the perceived value it is unlikely that the market will change its mind for the foreseeable future.

The Retail bookstores could decline faster than we expect and our DCF value could be optimistic.

The College bookstores could be less stable than we believe, most likely due to incremental pressure from digital textbook substitution. We think digital textbook disintermediation for college-level students is still several years out and even then will have a slow adoption curve.

Len Riggio has a mixed track record on corporate governance. Many investors believe the sale of College bookstores to BKS was not done on an arms-length basis. BKS also adopted a poison pill to fend off Ron Burkle in 2010. We are not concerned about this risk given Liberty’s involvement on the board.


The key catalyst is the monetization of the Nook. BKS announced strategic alternatives for the Nook in January and we believe there is a parallel process being run now to investigate potential strategic interest as well as prepare for a partial IPO of the Nook.

A secondary catalyst is separate segment financial reporting for the Nook which we expect in June on the Q4 earnings release. This will allow the market to more clearly understand the cash flows from the Bookstores vs. the Nook, which currently is jumbled into both the Retail segment as well as the B& segment. We expect to see more SoP analysis from the sell side following this disclosure.

While we aren’t expecting it, we could see a potential bid for BKS from Liberty Media & Len Riggio again. They made an offer to buy BKS at $17 in May 2011 that we believe was pulled due to the credit markets falling apart that summer. Given the credit markets have now recovered to frothy levels we believe the original financing plan is now viable again (4x debt/EBITDA).

T2 Partners' Portfolio Update From Latest Letter: NFLX, SNDK, BKS & More

Whitney Tilson and Glenn Tongue's hedge fund T2 Partners recently sent out their latest letter to investors providing an update on many of their portfolio positions.  T2 is up 25.8% for the year versus the S&P at 11.9%.

T2's Longs

Disclosed longs in this letter include: Netflix (NFLX), SanDisk (SNDK), Grupo Prisa (B shares), Goldman Sachs (GS), Citigroup (C), Barnes & Noble (BKS), dELiA*s (DLIA) and AIG (AIG).

T2's Shorts

Nokia (NOK), First Solar (FSLR), Tesla (TSLA) and Interoil (IOC) are mentioned as shorts.

On Their Position in Netflix (NFLX)

In the letter, he updates the latest activity on this volatile stock, writing:

"We’re comfortable with a 5-6% position size – but the stock price has been extremely volatile, ranging from $62 to $129 in the six months we’ve owned it, so we’ve done much more trading than we normally do, first trimming aggressively and banking a lot of profits as the stock skyrocketed earlier this year, and then adding to our position recently after it fell sharply.

The company reported very strong Q1 earnings a week ago: revenues grew 21%, domestic streaming subscribers jumped by 1.7 million to 23.4 million, international subscribers grew by 1.2 million to 3.1 million (up 282% year over year), and total unique subscribers grew by 2.9 million to 29.1 million (including the DVD-by-mail business).

So why was the stock down so much? Netflix’s guidance for Q2 was weaker than expected: a projected gain of only 190,000-790,000 domestic subscribers and 385,000-935,000 international subscribers. Bears see this as the beginning of the end of Netflix’s subscriber growth, but we see it as typical second quarter seasonal weakness combined with the company being very conservative in its guidance, setting a bar that should be easy to clear. We believe what the company wrote in its earnings release – “We see nothing new or particularly concerning this quarter to date in our member viewing, acquisition and retention. All are healthy.” – and have no reason to doubt Netflix’s guidance of “about 7 million...domestic streaming net adds” for all of 2012."

Embedded below is T2's letter where they also provide updates on their positions in SanDisk, Barnes & Noble, as well as Grupo Prisa:

For more from this fund, we've also posted up Tilson's presentation at Stern's Hedge Fund Association Summit as well as his talk at a long/short investing panel.

Notes From Warren Buffett's Meeting With MBA Students

Berkshire Hathaway's Warren Buffett recently met with MBA students from the Richard Ivey School of Business and the legendary investor talked about how his investing principles have changed over time along with numerous other topics.  Here are some highlights and notes:

Question:  The key to your early career was essential information arbitrage. Given the  changes in the world and that information now moves at the speed of light, how do you continue to have such great successes?

Buffett: People have better information now, but they still act irrationally ... Sometimes you have to work a little bit hard to get the good deals.  And looking through the Korean stock manuals I've found some of these same opportunities today.  But ultimately, the key to success is emotional stability.  You don't need a high IQ to get rich.

Q: Explain your overall investing strategy

Buffett: Invest in equities slowly over time.  And invest in yourself.  Enhance your own talents and weaknesses.  And look to buy companies that will go on forever, like Coca Cola.  For the more serious investor, buy equities strategically, opportunistically.  And go all in when you can, and when there is a good deal.  I had a limit in my fund on the amount I could put in to one investment.  There was a fantastic opportunity so I approached my investors and told them I wanted to increase that amount.  I ended up putting 75% of the fund in that investment and it worked out well.  And I'm sure I will do it again.  Don't use leverage, and sit on cash if there are no good investment opportunities.

Q: What is the most important thing you have learned in life?

Buffett: Find your passion.  You will know it when you see it.  It is more important than money.  You want to ask the question, "Where am I going to have most fun?"

Embedded below is the full set of notes from Buffett's meeting:

For plenty more resources on the Oracle of Omaha, head to:

- Buffett's recommended reading list

- Tour of Warren Buffett's office

Key takeaways from Buffett's 2011 annual letter

Wednesday, May 2, 2012

Jim Chanos Shorting Petrobras & Fortescue Metals, Bearish on Coal Industry

Jim Chanos appeared on Bloomberg yesterday from the Milken Institute Global Conference in Los Angeles.  The Kynikos hedge fund manager talked about his short selling strategy and his role as a "realtime financial detector."

Chanos on What He's Shorting Now

Chanos, of course, is famous for flagging Enron, among other notable frauds.  So what's he short now?  Petrobras (PBR).  He says that integrated oil companies are 'liquidating trusts.'

He also believes that natural gas is undergoing a revolution in the US and so he thinks this is bad news for the coal industry (particularly thermal coal).

He's also short Fortescue Metals in Australia.  This company essentially handles China's growth by supplying iron ore.  Chanos points out that iron ore prices have spiked up huge after being largely the same price for 100 years.  He doesn't think that's sustainable as it's not a rare earth.

You can also check out Chanos' bearish view on China.  He also thinks Chinese banks are "built on quicksand."

Chanos on Value Traps

The hedge fund manager says that a lot of his best short ideas have "looked cheap all the way down.  Just because a stock looks cheap does not mean it's good value."  He's short the personal computer space. 

We've highlighted how Chanos is short Dell and thinks it will continue to appear cheap as tablets continue to proliferate.  David Einhorn of Greenlight Capital (who is long DELL), would argue that the company is focused on the enterprise, not the personal computing market.  Chanos' secular shift in the personal computing world makes sense, but it seems like there might be better ways to express that bet.

He also mentions that while he's obviously a short biased fund, he's "long the market" as that's what he's benchmarked against.  His shorts have to inversely outperform the market for his hedge fund to earn its performance fee.

Embedded below is the video of Chanos' interview:

For more on Kynikos Associates, head to Chanos' presentation: beware the global value trap.

Dan Loeb's Third Point: Top Positions & Latest Exposures

For the month of April, Third Point's Offshore Fund was -0.1% and is up 6.4% year to date.  Dan Loeb's hedge fund has seen an annualized return of 17.4% and their latest exposure report breaks down where they're allocating their capital.

Equity Exposure

On the equity side of things, Third Point is 51.5% long and -11.5% short, leaving them 40% net long.  This is a 1.5% increase in net long exposure since the month prior, but is mainly attributed to the fact that they reduced their short book (they actually reduced their longs compared to last month).

Their largest allocation comes with an 18.9% net long position in the technology sector (largely due to their activist position in Yahoo and big Apple position).  They are ever-so-slightly net short utilities.

Credit Exposure

In credit, they continue to be short government issues to the tune of -11.7%.  Their largest net long exposure is in asset backed securities at 14.6%.  In total, their credit exposure is 40.9% long, -20.2% short, leaving them 20.7% net long.  This is a 2.2% increase in overall net long exposure since the month prior.

Top Positions

1. Yahoo (YHOO)
2. Gold
3. Delphi (DLPH)
4. Apple (AAPL)
5. Eksportfinans ASA

Comparing their April top holdings to the month prior, their top three stakes are unchanged.  Apple has jumped back up into their top holdings as they either added to their position or their stakes in other top holdings decreased in value.

In the month, their top winners included Yahoo, Portuguese Sovereign Bonds, Volkswagen, Lehman Brothers, and Ally Financial. Much of their positive performance offset in the quarter came from the credit side of things.  We previously posted Loeb's comments at a distressed investing panel.

Their top losers included Ivanhoe Mines (IVN), Consumer Short A, Redecard SA, Technicolor (multiple securities owned), and Metro AG.  This is notable because this is the first time we've seen their positions in Redecard SA and Metro AG disclosed.

For more on this hedge fund, head to lessons Dan Loeb's learned as an investor.

What We're Reading ~ 5/2/2012

Notes from the DoubleLine lunch with Jeffrey Gundlach [Reformed Broker]

On 'sell in May & go away' [Abnormal Returns]

On being a contrarian & spotting paradigm shifts in investing [DistressedDebtInvesting]

Interview with Morgan Creek Capital's Mark Yusko [Index Universe]

Coinstar still a buy after 40% gain? [MarketWatch]

5 hedge fund managers who lost their superstar status [Institutional Investor]

SEC & investors preparing for hedge fund marketing 'free for all' [Forbes]

Pounding the table on Symantec [Capital Observer]

Investment write-up on Boyd Group Income [Above Average Odds]

Notes from Biglari Holdings' annual meeting [Brooklyn Investor]

The obsessive habits of Bruce Berkowitz [Business Insider]

John Paulson vs Hugh Hendry [Mindful Money]

Hedgers net short position vanishes in US oil [Reuters]

Ben Bernanke and what the Fed does next [The Economist]

Richard Koo presentation on the global economic crisis [Business Insider]

When is a 'scoop' non-public information? [Felix Salmon]

Tuesday, May 1, 2012

Transcript of David Einhorn's Questions on Herbalife Conference Call

Earlier today, David Einhorn of Greenlight Capital surfaced on Herbalife's (HLF) conference call.  Below is a transcript of the questions the hedge fund manager asked and the company's responses.  Herbalife is multi-level marketing company focused on selling weight management and nutritional supplements via 2.7 million independent distributors.

Here's the transcript:

"Einhorn Question: How much of the sales that you’d make in terms of final sales are sold outside the network and how much are consumed within the distributor base?

HLF Answer: So, David, we have a 70% custom rule which is basically says that 70% of all products sold to consumers or actually consume my distributors for their own personal use. So obviously what we’ve seen with nutrition clubs is that we now have visibility for the first time to our customers. We know that we reported on this call for the first time the number of commercial clubs around the world, which is in excessive of 30,000, so that has given us feasibility to the tremendous amount of products that are being sold directly to the consumers and we see that as a growing trend in our business.

Einhorn: So, what is the percentage that actually sold to consumers that are not distributors?

HLF: So, we don't have an exact percentage David because we don't have visibility to that level of detail.

Einhorn: Do you have an approximation?

HLF: So well again going back to our 70%, where we believe is that it is that 70% or potentially in excess of that.

Einhorn: Okay. What is the incentive for supervisor to sign somebody up to become a distributor as opposed to – if they’re just going to consume for themselves as opposed to just selling them the product for the markup. How does the distributor – how does the supervisor come out better?

HLF: Sure.  So, I think there are two reasons for that. So, we know from our business today that many of our future supervisors and business builders come in as customers and then they become distributors. So, the benefit from a supervisor is the ability for greater retention of that customer/distributor because they are now earning a 25% discount. The second issue is that it preserves linage. So obviously, if I sign you up David as a distributor, my hope and my expectation is that based on the tremendous product result that you’re going to achieve that you’ll have friends and families go to you and say, gosh David you look great, what do you want. You’re going to respond to them, I’m on Herbalife, and that will encourage you to say, wow maybe this is a business opportunity I could be interested in. So, the benefit for me as your supervisor is one, the discount that you would get and that for my greater likelihood of retaining, it was a permanent customer and secondly, the hope that at some stage, you will decide to do the business and therefore that you are already in my lineage and is part of my group.

Einhorn: Right.  But just trying to understand this clearly, if I sell toa  customer, I bought it - I'm a supervisor, I buy at a 50% discount, I sell to a customer, I make 50 points, if he pays the full price.  If he signs up with a distributor and buys it himself, he gets a 25% discount and I get seven points as a royalty.  Is that how it works?

HLF: No, you would get the other 25%.

Einhorn: I will get 20% plus the 7%.

HLF: So, unless you're on royalty, you would simply (inaudible) in the difference.  So, you are in a 50% discount, you are selling at a 25% discount, and so the difference between the two is your profit on that sale.

Einhorn: Right, so if he signs up with a distributor and buys it for himself from Herbalife, I still get the 25%.

HLF: That is correct.

Einhorn: OK. Good.  One last question,  when you had your previous 10-K, you disclosed three groups of distributors at the low-end. You called 29% self consumers, 57% small retailers, and 14% potential sales leaders and then that disclosure did not repeat in the subsequent 10-K. So, I got two questions, first of all how do you track that and how do you characterize and know which ones are which? And second, why did you stop disclosing that in the last 10-K? Is that something that you stopped tracking or just stopped disclosing?

HLF: Hi, this is John. The criteria for grouping distributors into different classes was based off of their volume purchases and we are making assumptions that people below of certain volume. While doing the business, they were buying soft consumption and I don’t remember the exact amounts, but I can get it to you after the call, as how we delineated between the three classes.  And one the reason that we took out of the 10k is a change in CFO from which to me I didn’t view it is valuable information to the business or to the investors. However, we can easily provide the exact same breakout going forward if you would like [indiscernible] into our investors. Again, I don’t remember the exact delineation between the three classes, but I can certainly get it to you. Our objective is to be completely transparent, so."

It seems as though he's trying to determine how many actual retail buyers of the product (end game users) are out there versus the distributors.  The stock was down 20% today as traders postulated that Einhorn was short or thinking about shorting the company.  He has not disclosed a long or short in HLF.

For more on our coverage of this hedgie, head to why David Einhorn owns Dell as well as his extensive Q&A session from the CIMA Conference.

Pershing Square Exits Family Dollar and Fortune Brands Home & Security Positions

Bill Ackman's hedge fund Pershing Square Capital Management just filed two separate 13G's with the SEC.  Both revealed that Pershing has completely sold out of its previous positions in Family Dollar (FDO) and Fortune Brands Home & Security (FBHS).

Each stock has seen material price appreciation and so this could simply be a case of harvesting profits to allocate capital to more compelling ideas.  Pershing exited FBHS on April 27th and FDO on April 19th.

For those interested, we've previously highlighted Ackman's case for FBHS as well as his FDO thesis.

While Pershing has exited its FDO position, Nelson Peltz's Trian Partners continues to be a large shareholder in the name.  They provided an update on the stake in their first quarter letter to investors:

"On March 28th, Family Dollar reported 2Q12 earnings which included EPS of $1.15, up 17% year over year, and comparable store sales growth of 4.5%. Family Dollar also increased the low end of its FY12 EPS guidance by $0.05 and issued 3Q12 comparable store sales growth guidance of 5% to 7%, marking acceleration in comparable store sales growth from the prior two quarters.

The company has also strengthened its management team yet again with the appointment of Mary Winston (previously with Giant Eagle, a $9 billion privately held grocery chain) as Chief Financial Officer on April 10th, a move we fully support. This management addition follows the September 2011 appointment of Mike Bloom as President and Chief Operating Officer. Mike has already made meaningful contributions to the company and we believe that investors and research analysts have rapidly come to appreciate the level of expertise and enthusiasm he brings to his role as a prime driver of operational improvements."

Stay tuned as we'll be posting more excerpts from Trian's letter in a separate post.

For more on Pershing Square's latest activity, we posted Bill Ackman's latest interview up today as well.

Passport Capital's Top 10 Holdings & Saudi Equity Theses: Q1 Letter

Today we're highlighting commentary from Passport Capital's Q1 letter to investors.  We've already highlighted how Passport is net short and so now we want to shift focus to John Burbank's top longs.

Passport's Top 10 Holdings (at end of Q1)

1. Vivus (VVUS US): 5% of NAV
2. Cytec Industries (CYT US): 4%
3. Marathon Petroleum (MPC US): 4%
4. Yanbu National Petroleum (YANSAB AB): 4%
5. Etihad Etisalat (EEC AB): 4%
6. Google (GOOG US): 3%
7. Liberty Interactive (LINTA US): 3%
8. Apple (AAPL US): 3%
9. Saudi Basic Industries (SABIC AB): 2%
10. Wynn Resorts (WYNN US): 2%

Comparing the above longs to their list at the end of 2011, there are a few noticeable changes.  Their stake in Vivus has climbed from 7th largest holding to their top position.  We had previously detailed how Passport was bullish on Saudi equities and you see that reflected now in their latest portfolio. 

US tech giants Apple (AAPL) and Google (GOOG) weren't included in their 2011 year-end top 10 but both make the list now.  As of March 31st, their top 10 equity holdings accounted for 34% of the fund's net asset value.

Passport's Investment Theses on Saudi Equity Plays

Given that many of their top holdings are now plays in Saudi equities, we thought it prudent to highlight some of their rationale for owning them.

Yanbu National Petrochemical:  John Burbank writes, "Our rationale for investing in YANSAB is predicated on the company’s strong cash-generating capability.  The company has a highly advantaged feedstock position in Saudi Arabia, allowing it to generate  EBITDA  margins  in  excess  of  45%  and  FCF  yield  of  over  10%.    YANSAB  is  a  single  petrochemical  plant commissioned in 2010 with no plans for further expansion and we believe is likely to pay out all its  cash once its debt covenants are fulfilled.  Over FY2011, the company decreased its long-term debt by  over 30% with Net Debt/EBITDA now at 2.7x.  We think YANSAB’s 51% shareholder SABIC could  start paying out dividends in the 2H of 2012, which should significantly re-rate the stock."

Etihad Etisalat: Passport's founder notes that, "Etihad Etisalat operates under the brand name Mobily, is the second largest mobile operator in Saudi,  and is a key beneficiary of the deregulation of the Saudi telecom sector.  Earnings have grown at around  48.7% CAGR in the last five years.  Mobily is capturing the growing data market (currently 22% of  revenue) due to what we believe are superior data services infrastructure compared to the competition.   In addition, Mobily is currently the leader in mobile broadband.  This segment is growing at an  exponential rate due to increased use of mobile tablets and 3G-enabled phones by the affluent Saudi  population (~60% of whom are below the age of 30).  Due to very high mobile penetration rates in the  Kingdom, Mobily is transforming from a high-growth company to a dividend opportunity given its SAR  4.25 FCF/share."

Saudi Basic Industries Corp:  The hedge fund's thesis on this name is that, "SABIC is the largest petrochemical company in the world by market cap and among the top five in terms  of production capacity.  SABIC has the key structural advantage of  very low-cost feedstock for its  petrochemical complexes in Saudi Arabia that helps the company maintain a healthy EBITDA margin of  approximately 32%.  The company increased its revenues by 25% and net income by 36% YoY. SABIC  represents approximately 11% of the market cap  of the Tadawul index, and while the stock has  underperformed the general market, we believe it will be a key beneficiary of foreign flows once the Saudi  market opens up to foreign investors."

Don't miss our other post from the hedge fund's Q1 letter on why Passport is net short.

Why John Burbank's Passport Capital Is Net Short: Q1 Letter

John Burbank's hedge fund firm Passport Capital is "net short both in dollar and beta terms" according to their first quarter letter to investors.  But even with this positioning, they obviously still have some sizable longs so we've also posted up Passport's top 10 holdings

Their Passport Global Fund started the quarter with net exposure of -3% and ended the quarter net short -12%.  On the subject of taking on more risk, Burbank writes (emphasis ours):

"For several years now, we have said that we would raise our risk budget when we felt it was prudent.  In  large part this would generally require three things to occur:  1) a lower correlation regime that could  benefit idiosyncratic stock selection; 2) the potential for a less-skewed distribution between stock winners 5  and losers; and 3) conviction in our macro and bottom-up view.  Since the March 2009 equity low, the  S&P has rallied 122%.  The Russell 2000 has rallied  over 152% in that time.  Given our forwardlooking economic assessment, this is the first time in a long while where we believe the best opportunity  to derive idiosyncratic alpha is in security selection on the short side."

This stance largely comes from their belief that central bank liquidity has fueled upside and that the easy money has been made.  We highlighted Passport's short positioning in Burbank's last letter.

He goes on to reiterate his conviction:

"To be clear, we think this is one of the most attractive environments for stock selection we've witnessed in at least five years and that now is a prudent time to run at a higher level of predicted active risk.  We aggressively increased our risk budget in mid-February ... If correlations stay persistently low, managers with stock selection skill should benefit."

We've also previously posted Lee Ainslie and Maverick Capital's letter with insightful commentary on the market's extreme correlation in recent years.  Now that dispersion has increased, numerous long/short managers are undoubtedly rejoicing.

Burbank concludes that central banks and 'performance anxiety' are the two main culprits for the hot start in equities this year:

"Through the first quarter, central bank liquidity provisioning has, we think, largely served to fix prices higher and has driven investors to become fully net long invested in order to avoid missing out.  Looking ahead, we believe we're going to see a great separation of winners and losers, of solvency and insolvency, of liquidity and illiquidity around the world."

However, it does appear as though Passport's conviction has spooked some investors as their main fund saw outflows of $509 million in the first quarter (it now manages $1.3 billion).  The firm in general now manages $3.2 billion.

Be sure to also check out more from the hedge fund's Q1 letter: Passport's top 10 holdings & Saudi equity theses.

Bill Ackman on Burger King and Barnes & Noble

The founder of hedge fund Pershing Square, Bill Ackman, guest hosted CNBC's Squawk Box yesterday morning and we wanted to highlight his comments for those who might have missed them.  His first segment talked about Barnes & Noble (due to the Microsoft investment news) as well as his position in Burger King.

On Barnes & Noble: He joked that he gives them credit for "existing."  Obviously, the brick and mortar business has come under fire given the proliferation of e-books.  Ackman thinks Microsoft's deal with BKS is a good deal.  We previously highlighted JANA Partners' stake in BKS.

On Burger King:  Ackman loves the new management team and says it's a great business.  They talked about how 3G Capital bought out Burger King just eighteen months ago and have already put in place a turnaround plan that they'll continue to pursue as they'll retain a large stake in the company.

Ackman says there's a lot of upside in the company as they've overhauled the menu and addressed quality.  He invested in Burger King essentially by owning a specialty purpose acquisition company (SPAC) a.k.a. a blank check company.  He and his partners have used it as a vehicle to take Burger King public so that management doesn't have to worry about an initial public offering (IPO).

We've of course previously posted Ackman's presentation on Burger King if you want to see the full investment thesis.

Embedded below is the clip from Ackman's interview:


Be sure to also view more from his appearance, including:

Bill Ackman on Canadian Pacific (his activist investment) as well as his talk on running a better railroad.  He also sat down and talked about his Hong Kong Dollar trade (a trade some people probably forgot he had on).

Ackman on His Hong Kong Dollar Trade

It's been so long since we've seen commentary about Bill Ackman's Hong Kong Dollar trade that we wanted to quickly highlight his comments on CNBC yesterday.

He says Pershing Square still has the trade on and they believe it's a good play.  He says that, "if you own the options, it's a 50:1 or 80:1 payoff, even if you renew the bet every 18 months to 2 years, one day you're gonna be happy."

He thinks eventually it will appreciate and it can make sense to put some money in HKD's instead of US money market accounts as you can get some interest with the potential for appreciation in a lower risk play than the options.

We originally posted Ackman's Hong Kong Dollar presentation if you haven't seen it.

Skip ahead to 3:30 in the video to hear his thoughts on the HKD as the first part of the video deals with education reform:


Be sure to also check out Ackman's thoughts on CP and running a better railroad, as well as his latest comments on Burger King.

Bill Ackman & Hunter Harrison on Canadian Pacific & Running a Better Railroad

Guest hosting CNBC's Squawk Box yesterday, Pershing Square founder Bill Ackman talked about his activist investment in Candian Pacific (CP) and how to run a better railroad.

His hedge fund has waged a proxy fight with the company as he strives to shake-up management.  He hopes to place Hunter Harrison as the new CEO.  He says the profitability of the company (and operating ratio) of the company is worse than it was six years ago.

We've previously highlighted Ackman's presentation on Canadian Pacific if you missed it.

Ackman says 94% of (institutional) shareholders support management change and 74% of them support Harrison.  The proxy vote is on May 18th.

Embedded below is the video of Ackman's interview on CP:

On Running a Better Railroad

They then brought out Harrison as well as Stephen Tobias (former Norfolk Southern vice chairman) to talk about how to run a better railroad.

Harrison dismissed the lawsuit against him as 'frivolous' as his non-compete expired on January 1st.  He highlighted his track record of execution success at his previous employer of raising prices and improving operating efficiency. He says the railroad business comes down to execution.

Tobias highlighted his track record of 40 years of practical operating experience as a valuable resource he could bring to the board.

As to why CP should implement his management slate, Ackman simply stated: "What attracted us here is you've got a railroad that has half the operating profitability of its direct competitor and the only difference we could figure out is the people running it."

Here's the video:

Also check out Ackman's comments on Barnes & Noble and Burger King, as well as his update on his Hong Kong dollar trade.

Monday, April 30, 2012

Market Folly's 4th Anniversary

Yet again, we've been so busy we missed our own anniversary.  It's been four years since was founded during the financial crisis and we want to thank you for reading.

The site now has over 15,000 subscribers, so if you haven't already, click here to receive our free email updates.  You can also get them via RSS reader.

Our premium quarterly newsletter, Hedge Fund Wisdom, has been extremely well received over the past year and a half.  It tracks the portfolios of 25 prominent hedge funds and provides in-depth analysis of their latest investments.  A brand new issue is only a few weeks away, so check out a free sample in the mean time.

A Simple Request

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Thank you again for reading and stay tuned as we have some very exciting new developments coming soon!

Jeff Saut on Risk Management & Admitting When You're Wrong

Market strategist Jeff Saut's weekly commentary this time around is entitled, "Truth of Consequences?" and in it he compiles a compendium of quotes on risk management.

He points out that Benjamin Graham wrote, "The essence of investment management is the management of risks, not the management of returns."

He also singles out a quotation by Peter Bernstein, who said, "The trick is not to be the hottest stock-picker, the winning forecaster, or the developer of the neatest model; such victories are transient.  The trick is to survive.  Performing that trick requires a strong stomach for being wrong, because we are all going to be wrong more often than we expect."

Saut elaborates on this point by arguing it's what you do when you're wrong that can easily influence returns.  We'd also point to our post with Michael Karsch's thoughts on risk management.

Applying these thoughts to the current market, Saut is still waiting for a more buyable pullback and has been playing things conservatively by recommending equities with solid yields such as Rayonier (RYN) and LINN Energy (LINE). 

So he admits to being 'wrong' by being cautious as of late, but he highlights a myriad of technical signals in his latest market commentary as the rationale for his positioning:

You can download a .pdf copy here.

Be sure to also check out his past commentary on how currency dilution is fueling asset rallies.

SAC Capital Buys More Ariad Pharmaceuticals (ARIA)

Steve Cohen's hedge fund SAC Capital filed a 13G with the SEC regarding its ownership stake in Ariad Pharmaceuticals (ARIA).  SAC now owns 4.9% of the company with 7,876,700 shares.

This is a 208% increase in their position since the end of 2011. 

Last week we also detailed how SAC trimmed its stake in Annie's and also added to two of their positions.

Per Google Finance, Ariad is a "biopharmaceutical company. As of December 31, 2011, the Company’s pipeline contains three product candidates: ponatinib, AP26113 and ridaforolimus. It is building a pipeline of product candidates that expand upon treatment options for patients with cancer."

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

Glenview Capital Boosts URS Corp Stake

Larry Robbins' hedge fund Glenview Capital filed a 13G with the SEC regarding its position in URS Corporation (URS).  Per the filing, Glenview now owns a 5.16% ownership stake in the company with 3,910,140 shares.

Due to trading activity on April 17th, this marks a 10% increase in their position size since the end of 2011.  At that time, Robbins' hedge fund was already the second largest holder of URS shares.

This isn't their only recent activity as we've also posted up two other stakes they've increased.

Per Google Finance, URS is "a provider of engineering, construction and technical services. The Company offers a range of program management, planning, design, engineering, construction and construction management, operations and maintenance, and decommissioning and closure services to public agencies and private sector clients globally. It also is a United States federal government contractor in the areas of systems engineering and technical assistance, operations and maintenance, and information technology (IT) services."