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Wednesday, July 14, 2010
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Latest Hedge Fund Positioning: Exposure Monitor Report
Bank of America Merrill Lynch is out with the latest rendition of their hedge fund monitor report. Last week we took note that hedge funds had increased short exposure yet were still suffering poor performance. The May performance numbers for many hedge funds were terrible, and June wasn't a ton better for many. In June, distressed credit funds were down 1.66% and long/short equity funds lost 1.09%. So, how have hedge funds positioned themselves lately after such poor performance?
Long/short equity hedge funds continue to have low net long equity exposure at around 27% net long. This continues to be well below the historical average of 35-40%. L/S funds still slightly favor growth stocks over value at the moment. And while these hedge funds have favored high quality stocks for quite some time, this exposure is volatile and some funds have reduced exposure in this regard recently. Market neutral funds, while as of late they've taken opposite positions of L/S funds, are now flat in terms of equity exposure. Global macro hedge funds on the other hand have reduced emerging markets exposure and covered their short position on US indices. You'll recall previously that we highlighted how global macro funds were net short equities and they certainly banked on that trade.
Based on CFTC data, however, other hedge funds (large speculators) have added to their short positions in both the S&P and Russell 2000. Bank of America Merrill Lynch highlights two recent hedge fund portfolio moves of note. Firstly, they point out that hedgies are now in a crowded long in the Japanese Yen. Secondly, they highlight the net short position in Nasdaq futures that many speculators have put on.
To see the latest hedge fund exposure levels, view the full monitor report from BofA embedded below:
You can download a .pdf copy here.
You can also view previous exposure reports where we saw hedgies increasing short exposure. So while hedge funds clearly are having a hard time with this tape, market strategist Jeff Saut says that the answer is in risk adjusted stock selection and risk management, two solutions he lists as keys to portfolio success in 2010. We'll continue to monitor the latest hedge fund exposure levels to see who is able to generate some alpha out there.
Tom Brown's Second Curve Capital Boosts Western Alliance Stake (WAL)
Tom Brown's hedge fund firm Second Curve Capital recently filed a 13G with the SEC due to portfolio activity on July 8th, 2010. Per the filing, Brown's firm discloses a 5.07% ownership stake in Western Alliance Bancorp (WAL) with 3,710,383 shares. This is an increase in Second Curve's position as they previously owned 2,340,000 shares as of March 31st, 2010. Over the past four months, Brown's hedge fund has boosted its WAL stake by over 58% (adding 1,370,383 additional shares). For more from this hedge fund we've detailed some of Second Curve's previous portfolio shuffling. And if you're interested in what other prominent investment managers are up to lately, head to our hedge fund portfolio tracking series updated daily.
Taken from Google Finance, Western Alliance Bancorp is "a bank holding company. The Company provides a range of banking and related services to locally owned businesses, professional firms, real estate developers and investors, local non-profit organizations, high net worth individuals and other consumers through its subsidiary banks and financial services companies located in Nevada, Arizona, California and Colorado".
Hedge Fund Third Point Files 13D on Emmis Communications (EMMSP)
Dan Loeb's hedge fund firm just filed a 13D with the SEC regarding shares of Emmis Communications (EMMS / EMMSP). The activist filing was made due to portfolio activity on July 9th, 2010 and Third Point has disclosed a 2.3% ownership stake in Emmis Communications with 783,379 shares. This share total is reflective of their ownership of 321,057 shares of 6.25% Series A Cumulative Convertible Preferred Stock, traded on the Nasdaq under ticker EMMSP. (Emmis' regular common stock trades as EMMS). This is the latest activity from Dan Loeb's hedge fund firm, but you can of course view the rest of Third Point's portfolio and exposure levels as well.
Since this is a 13D filing, this means Loeb and his firm are back to their usual activist ways. On June 24th, 2010 Third Point purchased 10,000 shares of preferred stock at $22.00 per share. On July 9th, 2010 Third Point purchased a whopping 105,057 shares of preferred at a price of $21.7484 per share. Their stake results in ownership of 11.4% of the preferred stock and 2.3% of common stock if they were to convert their shares.
In order to understand why Third Point purchased this stake and has filed an activist 13D, let's first detail some background. Back on May 25th, 2010 Emmis Communications planned a merger that would result the company being taken private by Jeffrey H. Smulyan, the company's chairman and CEO. This transaction would result in a cash tender offer for the common stock, an offer to exchange the preferred stock for new 12% PIK Senior Subordinated Notes due 2017, and a proxy to amend certain terms of the preferred stock.
Fast forward to a few days ago and we see that on July 9th, Loeb's Third Point and numerous other investment firms entered into a lock-up agreement pursuant to which each of them agreed to "(1) vote or cause to be voted any and all of its preferred stock against the proposed amendments; (2) restrict dispositions of preferred stock; (3) not enter into any agreement, arrangement or understanding with any person for the purpose of holding, voting or disposing of any securities of the Issuer, or derivative instruments with respect to the Issuer; (4) consult with each other prior to making any public announcement concerning the Issuer; and (5) share certain expenses incurred in connection with their investment in the preferred stock, in each case during the term of the lock-up agreement."
So, the wheels are in motion for a bit of a stand-off in Emmis Communications' proposed takeover. Those of you looking to read an enthralling legal document can find the lock-up agreement as filed with the SEC here. We'll continue to watch the developments here and will update as necessary. For more from Loeb's hedge fund, we recently detailed Third Point's portfolio breakdown as well as Third Point's first quarter letter.
Taken from Google Finance, Emmis Communications is "a diversified media company, principally focused on radio broadcasting. It owns and operates seven fort minor (FM) radio stations serving New York, Los Angeles and Chicago".
For more from Dan Loeb, check out his recommended reading list. And be sure to check Market Folly daily for the latest hedge fund portfolio moves.
Tuesday, July 13, 2010
Bruce Berkowitz's Fairholme Capital Starts MBIA Position, Raises AIG Stake
Bruce Berkowitz's investment firm Fairholme Capital Management recently filed two 13G's with the SEC regarding two of its positions. Firstly, Fairholme has filed a 13G regarding shares of MBIA (MBI). Due to portfolio activity on June 30th, 2010, Fairholme now shows an 11.1% ownership stake in the bond insurer with 22,736,200 shares. The vast majority of these shares are owned by Berkowitz's mutual fund vehicle, the Fairholme Fund (FAIRX). This is a brand new position for his firm as it did not own shares back when we looked at Fairholme's portfolio from the first quarter.
While Berkowitz is now long MBIA, we've detailed how Whitney Tilson's hedge fund T2 Partners has been short MBIA. This is definitely somewhat of a battleground stock as there are many company naysayers still out there. In the past, hedge fund manager Bill Ackman had also been short the company. The saga surrounding his position is detailed in Christine Richard's book, Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff. Overall though, Berkowitz's stake in MBIA sticks with his contrarian bent theme.
Secondly, we see that Berkowitz's firm has disclosed a 24.3% ownership stake in the American International Group (AIG) with 32,789,000 shares. The amended 13G filing was made due to portfolio activity on June 30th, 2010. This is an increase in their position as they previously owned an 18.9% ownership stake back in May. So, over the course of the past two months, Fairholme has raised its stake in AIG by a sizable margin and you can see Berkowitz's AIG thesis here. Keep in mind that if the government were to convert its 80% ownership stake in AIG into common shares, Fairholme's ownership position would obviously be diluted. Shares of both AIG and MBIA are up sharply today after this news. In addition to these two portfolio updates, we previously covered Berkowitz's new position in Goldman Sachs (GS) as well.
Taken from Google Finance, MBIA is "provides financial guarantee insurance, as well as related reinsurance, advisory and portfolio services for the public and structured finance markets, and investment management services, including advisory services, on a global basis".
AIG is "a holding company, which through its subsidiaries, is engaged primarily in a range of insurance and insurance-related activities in the United States and abroad. AIG's four reportable segments include: General Insurance, Domestic Life Insurance & Retirement Services, Foreign Life Insurance & Retirement Services, and Financial Services".
For the latest investments from top managers, keep up to date with our hedge fund portfolio tracking series.
David Einhorn's Hedge Fund Greenlight Capital Buys Ensco (ESV)
David Einhorn's hedge fund Greenlight Capital just filed a 13G with the SEC regarding shares of Ensco (ESV). The filing discloses activity on June 30th, 2010 and reveals a 5.2% ownership stake in ESV with 7,416,880 shares. This is a brand new position for Einhorn's firm as we previously did not see it in Greenlight's portfolio last quarter. However, this is not the first time the hedge fund has owned Ensco. They last owned shares of ESV back in the fourth quarter of 2008. To hear Einhorn's latest investment ideas, keep in mind he's presenting at the upcoming Value Investing Congress in October (discount here).
Before the Gulf oil spill, ESV was trading around a 52-week high at above $50 per share. Since the spill, shares hit a low of $33 and are now trading around $40. While Ensco is not directly involved in anything regarding the Gulf of Mexico tragedy, its shares have been sold off as worries have mounted regarding the drilling moratorium. Many hedge funds and investment managers have argued that ESV has unjustly been sold off and Einhorn has certainly joined in the mix as his filing speaks for itself. In the past, we've noticed that John Burbank's Passport Capital and Johnathan Auerbach's Hound Partners both held positions in ESV as of the first quarter of this year. What they've done with those stakes, though, remains to be seen.
For more investment ideas from David Einhorn and other top hedge fund managers, be sure to check their presentations out at the Value Investing Congress in October in New York City. Market Folly readers can receive a discount to the event here. In terms of other recent coverage of Greenlight Capital, head to our coverage of Einhorn's Ira Sohn presentation as well.
Taken from Google Finance, Ensco is "an offshore contract drilling company. As of February 15, 2010, Ensco’s offshore rig fleet included 42 jackup rigs, four ultra-deepwater semisubmersible rigs and one barge rig. Additionally, it had four ultra-deepwater semisubmersible rigs under construction. Ensco’s operations are concentrated in the regions of Asia Pacific, which includes Asia, the Middle East and Australia, Europe and Africa, and North and South America".
And for further elaboration on the potential thesis behind this Ensco investment, check out Manual of Ideas' in-depth analysis of ESV.
Pasco Alfaro's Miura Global Management Buys Crude Oil Via United States Oil Fund (USO)
Pasco Alfaro's hedge fund Miura Global Management recently filed a 13G with the SEC regarding shares of the United States Oil Fund (USO). Due to activity on June 29th, 2010 Miura now shows a 7.5% ownership stake in the exchange traded fund with 4,241,000 shares. This is a brand new position for Alfaro's hedge fund as they did not own shares back on March 31st, 2010 when first quarter portfolio disclosures were made.
What's interesting here is the fact that the fund has used an exchange traded fund as a proxy for investing in oil rather than directly playing oil futures. Before assessing further, remember that since this is a commodity related investment rather than a stock, the rationale behind the pick might not be what it seems. This could simply be a bullish directional bet on crude oil (in part possibly spurred on by the Gulf oil spill). At the same time, Miura could be using this vehicle as a hedging instrument as they often have various alternative energy plays in their portfolio.
Either way, the fact that they hold such a concentrated position in this crude oil exchange traded fund (USO) is intriguing in and of itself. This is by far the largest pure crude oil position we've seen from the equity focused hedge funds we cover. In the past, we've detailed how to invest in crude oil via exchange traded funds. While that comparison highlights the pros and cons of the various vehicles available to investors, it's surprising to see a prominent hedge fund investing such a large sum in a somewhat flawed exchange traded fund. There are numerous negative aspects to using USO as a proxy for oil, many of which we outlined via an in-depth piece, how contango affects crude oil ETF's. Needless to say, the fact that USO merely buys front month crude oil contracts over and over leaves much to be desired.
So while we don't quite know the exact rationale behind Alfaro's investment for his hedge fund, we do know that USO is a vehicle more-so suited for near-term trading rather than investing longer term. Maybe more than anything they might have selected USO purely for its liquidity as other oil funds are far less liquid on a daily trading basis. We'll have to see if we can glean further information regarding their investment purpose (directional versus hedge) and their investment timeframe.
This is the first time we've detailed portfolio maneuvers from this hedge fund so let's get some background. Miura Global Management is a long/short equity hedge fund founded in 2004 by Pasco Alfaro and Richard Turnure. While Alfaro still manages the firm, Turnure left to pursue an alternative energy endeavor after spearheading many of Miura's investments in that space. Miura grew from $5 million in assets under management to upwards of $3 billion. The hedge fund focuses on cutting edge research, multifaceted risk management, and non-correlated returns. Miura Global is a 'Tiger Seed' hedge fund because it was seeded by legendary Tiger Management hedge fund manager Julian Robertson. As such, the fund is a part of the 'Tiger hedge fund family tree'.
Taken from Google Finance, the United States Oil Fund is "a limited partnership. USOF is a commodity pool that issues limited partnership interests (units) traded on the NYSE Arca, Inc. (the NYSE Arca). The Company’s general partner is United States Commodity Funds LLC (the General Partner) and is responsible for the management of USOF. The investment objective of USOF is for the changes in percentage terms of its units’ net asset value (NAV) to reflect the changes in percentage terms of the spot price of light, sweet crude oil delivered to Cushing, Oklahoma, as measured by the changes in the price of the futures contract on light, sweet crude oil traded on the New York Mercantile Exchange (the NYMEX)."
For the latest investments from top managers, head to our daily hedge fund portfolio tracking series.
Pat McCormack's Tiger Consumer Initiates Sonic Automotive (SAH) Position
Patrick McCormack's hedge fund Tiger Consumer Management recently filed a 13G with the SEC regarding shares of Sonic Automotive (SAH). The disclosure was made due to portfolio activity on June 29th, 2010 and Tiger Consumer now shows a 5.13% ownership stake in SAH with 2,081,757 shares. This is a brand new position for the hedge fund because they did not own any Sonic Automative in the first quarter (as of March 31st, 2010). Shares of SAH are trading at $8.50, a level where they temporarily bottomed back in November 2009. In the throngs of the crisis, Sonic Automotive traded as low as $0.72. We've previously covered Tiger Consumer's other new position as well.
This is the second time we've detailed portfolio activity from Pat McCormack's hedge fund. For those unfamiliar, Tiger Consumer was seeded by Julian Robertson, the legendary manager and founder of Tiger Management. McCormack's fund offices at the same Park Avenue address as Robertson's former fund. Tiger Consumer reported $919 million in assets invested on the long side as of March 31st, 2010. As its name implies, the fund focuses on the consumer sector and is one of the 'Tiger Seed' hedge funds (you can view the entire Tiger hedge fund family tree here).
Taken from Google Finance, Sonic Automotive "operates as an automotive retailer in the United States. As of January 31, 2009, the Company operated 145 dealership franchises at 122 dealership locations, representing 29 different brands of cars and light trucks, and 26 collision repair centers in 15 states."
For the latest investments from top managers, head to our hedge fund portfolio tracking series updated daily.
Monday, July 12, 2010
Jeff Saut: Risk Adjusted Stock Selection & Risk Management Are Keys to Portfolio Success in 2010
Raymond James' Chief Investment Strategist Jeff Saut has penned his weekly market commentary and in it he examins the possibility of the dreaded double-dip recession. Many economists argue that the recession ended around this time last year. Saut proceeds to examine the possibility that these economists are wrong in an effort to gauge the possible worst case scenario. He outlines the fact that 3 out of 38 recessions have qualified as double-dips since 1880. In practically all of those cases, the first recession was 'mild' and then the double-dip was quite harsh. Saut argues that we aren't in for the dreaded DD because the recession we just experienced was anything but mild.
Pursuant to his take on the markets, Saut is not bearish, but he is quite cautious. Last week, he pointed out that there were so many negative indicators that he wouldn't be surprised to see a contrarian stock market bounce. And, that's exactly what happened. You have to hand it to the market strategist as he's correctly removed his market hedges into the turmoil and then correctly called the rally. So, where does he stand now? Since that transgression of events, he has reverted back to his cautious stance for the intermediate term. He thinks any pullback will be contained in the 1040-1050 zone on the S&P 500.
In order to find success in these cautionary times, Saut points to risk adjusted stock selection and risk management as the keys to portfolio success. This is interesting because Lee Ainslie of hedge fund Maverick Capital previously opined that 2010 would be a stockpicker's market. Yet, when you examine the performance of many long/short equity hedge funds, that doesn't seem to be the case at all. Maybe 2010 is truly setting apart the best stockpickers from the rest of the pack. While 2010 has been rough on many big name investors, Abnormal Returns has dubbed the next decade the forthcoming golden age of stockpicking. In the near-term, Saut agrees that stockpicking is key.
A few weeks ago, Saut advised investors to protect gains from the March 2009 rally and his stance remains unchanged there. To help investors with their stockpicking prowess, he has recommended a few names: Microsoft (MSFT), Intel (INTC), Enterprise Product Partners (EPD), Allstate (ALL) and Walmart (WMT).
Specifically on Microsoft, Saut highlights its $3.50 per share in cash, 2% dividend yield, and cheap valuation. Regarding Walmart, he thinks its valuation is low here and sees the company growing revenues in the high single digits and buying back a lot of shares. Lastly, Saut puts in a plug for Putnam's Diversified Income Fund (PDINX) as it has the possibility to generate equity-like returns without the same risk profile as equities. Embedded below is Jeff Saut's entire investment strategy piece for this week:
You can download a .pdf copy here.
Overall, Saut remains cautious longer term. He currently favors growth over value stocks and has highlighted numerous technology sector names in his missives. While he thinks the selling will be contained near-term in the market, he points out the S&P 500's 50 day moving average as a key level of resistance at around 1,100. For more on Saut's market rationale, head to his commentary where he outlined his decisively cautious stance.
Buy When There's Oil In The Water: Bullish Case for The St. Joe Company (JOE)
Below you'll find an in-depth presentation from Broyhill Asset Management on an intriguing way to play the Gulf oil spill from an investment standpoint. Hedge funds like Whitney Tilson's T2 Partners are buying oil giant BP (you can see their in-depth analysis of BP here). Others are buying drilling companies such as Transocean (RIG), Noble (NE), and Ensco (ESV). Broyhill, however, takes a slightly different approach. Their presentation "Buy When There's Oil In The Water" presents the bullish investment case for The St. Joe Company (JOE).
As you'll see in the presentation, the case for St. Joe starts with the fact that they own numerous real estate assets along the Gulf coast of Florida (assets that unfortunately could possibly be in danger from the oil spill). Christopher Pavese, Chief Investment Officer of Broyhill outlines St. Joe's competitive advantage in their near-zero cost of land. He writes, "Its massive scale and low-cost basis is impossible for other developers to replicate, making JOE the partner of choice for all development activity in Northwest Florida."
Broyhill is a Family Office that was started to manage the assets of Paul H. Broyhill and has since evolved into a multi-pronged investment firm. We've previously detailed commentary from Broyhill's Affinity hedge fund with their contrarian bet on long-term treasuries. Additionally, we've covered their ten reasons to buy bonds. And now below, we'll detail their hedge fund's latest investment idea.
Aside from its real estate assets, JOE has a pristine balance sheet with tons of cash and practically no interest-bearing debt, a much 'leaner' cost structure compared to prior years. A true investor often models and examines the worst case scenario for a given company. Broyhill has done just that, outlining a scenario where no one is really ever interested in JOE's land. In such a case, they estimate the stock is worth $15 (JOE currently trades above $25), assuming the land is sold for a paltry $2,000 an acre. To put this in context, consider that Leucadia recently paid $80,000 per acre in the same region.
The key for this company is monetizing their assets and the assumption that they will be able to do so. This play obviously requires patience on the investing end and Pavese highlights that St. Joe already has some near-term catalysts already lined up. However, as the oil spill nears St. Joe's properties, the stock has become more volatile. Broyhill argues that JOE's volatility leads to opportunity. Embedded below is the full in-depth presentation on The St. Joe Company (JOE) from Broyhill Asset Management:
You can download a .pdf copy here.
So while many other hedge funds and investment managers target oil companies as a proxy for oil spill plays, Broyhill has taken a roundabout approach. And, they aren't alone in this investment either. Bruce Berkowitz's Fairholme Fund has St. Joe as one of their largest positions and has for some time. So while Pavese fully acknowledges that JOE is a slow and boring story, he is confident this unfortunate oil spill has presented a fantastic opportunity for the long-term. For more from Broyhill's Affinity hedge fund, head to their contrarian bet on long-term treasuries as well as their ten reasons to buy bonds. Stay tuned tomorrow as we'll be covering their latest market commentary as well.
Seth Klarman ~ Market Folly Quote of the Week
The Market Folly Quote of the Week is back in full force. Last week's quotation came from the Oracle of Omaha himself, Warren Buffett. So it's only fitting that our second quote comes from arguably Buffett's biggest competition in the 'best investor ever' category: Seth Klarman of Baupost Group.
~ Seth Klarman
For more from Baupost Group's manager, check out Seth Klarman's recommended reading list as well as an in-depth profile of Klarman.
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 HedgeFundPremium.com 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)
dELIA*s (DLIA)
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)
MBIA (MBI)
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 MarketFolly.com.
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 SelectedFinancials.com. 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 SelectedFinancials.com. 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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