Wednesday, December 8, 2010

Macro stuff from FPA Capital

I am not a macro guy but it doesn't hurt to hear some really smart people talk about macro issues. Even Seth Klarman has become very macro sensitive in past year. These guys were very early in recognizing the credit crisis and I put lot of trust in their research work.

Worth a read
"Based on the initially published size of the QE2

program, we expect the Fed will struggle to increase
the rate of inflation. Persistently high unemployment,
uncertainty about government regulation and its scope,
and a limited appetite for capital investment mean the
Fed will have to shock markets to have inflation achieve
its desired outcomes. The Fed will potentially have to
buy more than expected for longer periods if it wants to
make the most important impact — a shift in
psychology. After more than thirty years in the U.S.
with the experience of negligible inflation, dramatic
actions are required to shift thinking of individuals and
markets."

For the full article
http://www.fpafunds.com/downloads/paramount/September%2030,%202010.pdf

Monday, November 29, 2010

Text to Speech app for IPOD/ITOUCH/IPAD

Since I am not getting enough time from work nowadays I have started using the text to speech app for catching up while I am driving. With this app I can hear the conference call transcripts, research reports from VIC, 10k/q`s on the drive as well as convert ebooks and news articles.

http://itunes.apple.com/us/app/speak-it-text-to-speech/id308629295?mt=8

Now I find myself adding more and more articles to the playlists so I highly recommend it to anyone who is having difficulty in finding time to sit at one place and read.

Friday, November 19, 2010

Lessons of Value Investor

http://www.scribd.com/full/43383187?access_key=key-15j6ruromh1kdzbvhbih

Wednesday, November 17, 2010

St Joe Short Interest

I recently bought JOE at around 20 bucks a share. The stock price is falling like a rock throughout the year. But things are getting interesting. I am not going to comment here about the underlying valuation of the company but just about the stock itself.

As of today(11/17/10) in millions

Total outstanding shares : 92
Total shares sold short : 21.6
Average daily volume : 2
Days to cover short at this volume : 18

Now this stock is liked by long term value oriented investors who I can speculate would not be selling the stock at these prices. Most likely they will be buying more. Lets find out who these people might be

1) Fairholme Fund : 27 (including holdings in privately managed funds besides Fairholme fund)
http://www.thestreet.com/story/10890674/1/berkowitz-to-einhorn-thank-you.html?cm_ven=GOOGLEN
2) THS Partners: 4.8  ( long term long only investors)
http://www.thspartners.com/philosophyprocess/process/
3) Third Avenue Management: 2.2 ( there is no way they will be selling)
4) Royce & Associates: 3.1 (Again a value investor that might not sell)
5) Janus Capital Management: 10.3 ( JOE is held in Janus Contrarian fund. I am not confident about them but since they are also value oriented fund I may speculate that they wont also sell at these prices)

Hence,
Total stocks not available in market for trading = 27+4.8+2.2+3.1+10.3 = 47.4

Assuming all of the above is true, 21.6/(92-47.4) = 48% of the float is sold short.

If the short interest rises further or if the stock price falls further it will be a good trade to buy some out of the money CALL options on this stock expiring in 6 months or so.

What do you think ?

I am not sure how many shares David Einhorn have shorted. If its a big position then IMO he should start covering soon.

As of today option expiring in Mar 18, 2011 to buy JOE at $17.5/share is selling for $1.7/contract

Saturday, October 30, 2010

Portfolio Update October,2010




Another very busy month for me and hence could not spend enough time researching stock ideas. Still I did find an opportunity to put some cash to work.

St. Joe (ticker: JOE) stock dropped due to a short thesis presented by David Einhorn. I also found out that T2 partners are also short St. Joe. On the other hand Bruce Berkowitz(FAIRX) at fairholme capital and Michael Winer(TAREX) at Third Avenue have been bullish about its long term potential and have JOE in their portfolio as a long term holding.

Since I have followed all of the above investors for quite some time I know their respective investment styles.Both T2 and Greenlight are long/short funds and they do trade in and out of their positions quickly to take profits or if a better idea shows up or if their thesis is wrong. While both Bruce and Michael tend to make long term bets and are willing to wait for the investment thesis to work out. So to agree with the short or long thesis on JOE you need to know your own investment time horizon.

I personally like to make very few bets and feel guilty if I am doing lot of trading. My favorite stock would be the one which I never have to sell(besides for tax reasons). So I don't mind if St. JOE is dead money for sometime since I do have ample cash in the portfolio to invest. I don't know much about true value of St. Joe and this purchase is a pure call based on my trust in the fund managers that own it. If in future they trim their position that would be a red flag and I may sell out of this position also.

Saturday, October 16, 2010

Total Return vs IRR

As you might know I use IRR to state my portfolio returns. But it is a bit misleading. For example on September 30th of 2010 my IRR return stood at +19.9% YTD vs -3.49% for the S&P 500 index. But if you check any other website you will see that S&P 500 returned +2.34% during that time frame.

The difference arises from the fact that IRR takes into account the cash flow decisions you make i.e. buying and selling of stocks during the time frame as well as penalizes you for holding cash.

Even though the IRR makes it difficult to compare my returns with other portfolio returns I believe its a better metric for me to judge my performance. This method not just gives weight to my stock selections but timing of purchase and sale.

Following is a discussion of various ways to measure returns from Morningstar.com

Portfolio Returns
When portfolio performance is evaluated, the return should be concerned with the total change in wealth. One common measure of this change is Total Return, which is a generic term that defines performance as the change in the total dollar value of an investment over a given period of time. This methodology captures both the income component and the capital gains (or losses) component of a return. The two elements are reflected in the changing value of the portfolio, assuming dividends are reinvested.

Therefore in the simplest case, the market value of a portfolio can be measured at the beginning and ending of a period, and the rate of return can be calculated as:

This calculation assumes that no funds were added to or withdrawn from the portfolio by the investor during the measurement period. If such transactions occur, the portfolio return, as calculated, may not be as accurate a measure of the portfolio’s performance. For example, if the investor adds or subtracts funds during the measurement period, use of this equation would produce inaccurate results, because the ending value was not determined by the appreciation/depreciation of the portfolio’s holdings. Instead, any cash flows in or out of the portfolio, excluding dividends, will alter the value of the portfolio, which does not reflect the performance of the holdings.

Although, a close approximation of portfolio performance can be obtained by backing out transactions within a given measurement period timing issues will still create a degree of error in the return. The following two means of return measurement help alleviate these problems and when compared, provide valuable insight into your portfolio:

Total Return
Total Return is a common performance methodology applied by mutual funds, because it does not consider the effect of investor cash moving in and out of a fund. Since managers do not have control of cash flows this method allows for the evaluation of their investment management skill between any two time periods without regard to the total amount invested at any time during that period. Basically, Total return is independent of the total amount invested.
To generate Total returns apply the fund’s share price or NAV to the formula provided in the Portfolio Returns section. The NAV is calculated by dividing the total value of the fund’s underlying holdings by the number of shares outstanding. When an investor purchases or sells shares in the fund the number of shares in the market is re-calibrated to maintain the NAV value. So while the assets under management fluctuate, the adjustment to shares outstanding insure that the NAV values used in the Total Return formula do not reflect the movement of cash in or out of the fund.
For instance, for a one year period the total return for a fund could be 25%. However, this does not consider that during this year the funds assets shrunk from $1 billion to $330 million.
In the following illustration, we demonstrate how the Total return is calculated with cash flows occurring in four different periods. In addition, let’s assume other funds performed better than Fund XYZ, which resulted in net asset outflows. By reading down each column you can see how the fund performs, as well as the fall in assets under management.
Using the total return calculation we would give equal weighting to each time period in calculating the annualized return:

Personal Returns
Personal Returns measures the actual return earned based on the beginning portfolio value and on any net contributions made during the period. Therefore, how an investor exercises control over cash flows is crucial in assessing their investment skill. Once again we will demonstrate using the table from above, but apply the Personal Return methodology to the figures.
On a more technical note, the true definition of the Personal return is the discount rate that equates the cost of an investment with the value of the cash generated by that investment period. So, by setting the above equation to 0 the result will provide the value for “r”, which represents the discount rate that will provide a net present value cash flow equal to zero.
The final step to Personal return is:

To make the point even clearer if we were to reverse the order of the (%) gain or loss by quarter you can see how the Personal Return is adversely affected by smaller returns on the larger initial balances.


Comparing Returns
Clearly the examples provided above show significant differences between the two methodologies. However, this is not always the case. Sometimes the two may be very similar depending on distributions and cash flows. For instance, if there are no transactions related to a particular holding in your portfolio then the two returns will be the same. The same holds true for your portfolio, which is why we only provide one set of figures for Watchlist portfolios.
So, in a three month period a holding will have the same Personal and Total return if:
• No shares are purchased
• No shares are sold
• No dividends are re-invested
A gap between Personal return and Total return indicates how well investors timed their stock purchases and sales. When the Personal return is less than Total return it means that investors didn’t participate equally in the portfolio’s monthly returns. In other words, the investor purchased a holding after a big run up or held on too long before selling as the share price fell. This sometimes happens when investors chase returns and assets flow into holdings when their performance starts to peek. This effect can be exacerbated when investors aim to break even and refuse to sell a losing holding.
On the other side of this, when Personal return is greater than total return it means that an investor participated in a holdings upswing or sold their position before the price hit a downswing. This can happen when investors are committed to a diversified strategy and continue to invest new monies into a holding, even when its style of investing has gone out of favor.
It is important to remember that if you want to compare the performance of your portfolio to an index, mutual fund or another portfolio that you use Total return figures and not Personal returns. This is based on:
• Indices calculate their performance based on total return methodology
• Mutual Funds calculate their performance based on total return methodology

Thursday, September 30, 2010

Portfolio Update September,2010




September was yet another boring month. Only activity in my portfolio was to sell BBEP at beginning of the month. I have been very busy at work and have hardly got time to look into more investment ideas. As you can see with over 50% of portfolio in cash I need to find good investments. But having a lot of cash is a good problem so long as you have the perseverance to wait for the right opportunity.

I wrote my opinion on BBEP`s valuation before here. The DCF value of the stock is between 16 and 21. But DCF does not take into account the leverage required to achieve the cash flows. At EV/FCF of 10 it certainly wasn't cheap. The positives that might drive the stock higher is relatively low inflation and demand for high dividend paying investments. The negatives that might tank the stock maybe high interest rates(has $552M of floating rate debt) without natural gas prices shooting up because of excess supply. Also there is an overhang of california increasing taxes on the oil production which would screw low margin producers like BBEP. BBEP has 10% of its production from california. Also the CEO sold 30k shares at 17.2 on August 23.I sold my entire position at 17.39. I might have sold too early but I was happy with the price I got for my shares. Here is my history of buys and sells with BBEP stock.

Wednesday, September 29, 2010

Value Investing in India

http://www.morningstar.com/cover/videocenter.aspx?id=336034
"India has the second largest number of listed companies in the world. There are lots of small companies that probably should not have been listed, that are listed. That gives an opportunity for people to find things when others aren't looking there."

SimoleonSense.com interviews Chetan Parikh
http://www.simoleonsense.com/wp-content/uploads/2009/11/miguel-barbosa-of-simoleonsense-interviews-prominent-indian-value-investor-chetan-parikh.pdf

I particularly like Chetan Parikhs comment on investor bias
" 1) self-serving bias (i.e. an overly positive view of their own abilities and an overly over-optimistic view of the future) 2) self-deception and denial for they seem to have indulged in collective wishful thinking 3) bias from consistency tendency (they must have looked for evidence that confirmed their optimistic beliefs and kept on being consistent to their original ideas even when problems surfaced) leading to 4) status quo bias or the do-nothing syndrome 5) impatience in valuing the present more highly than the future again caused by incentives that made them so myopic 6) bias from envy from managers who were making large returns with apparently no extra risk which led to 7) distortion by contrast comparison because the steady escalation of commitments must have seemed incrementally small
caused by 8) anchoring to what seemed like small relative numbers 9) social proof which
led to imitating the behavior of their peers 10) bias from over-influence by authority in
that the CEOs of the banks that have suffered the most seem to have been run by people
who did not have a ‘trading’ or ‘market’ background and they were swayed by the
‘experts’ they were overseeing which led them to 11) sensemaking in that they were too
quick to draw conclusions and may have become 12) reason-respecting in that they
complied with requests from their subordinates merely because they had been given some
reason leading to 13) a do-something syndrome all caused by 14) mental confusion from
stress. "

Tuesday, September 28, 2010

David Tepper Interview

“In 1898, the first international urban-planning conference convened in New York,” he said. “It was abandoned after three days because none of the delegates could see any solution to the growing crisis caused by urban horses and their output. In the Times of London, one reporter estimated that in 50 years, every street in London would be buried under nine feet of manure.”


" Don’t listen to all the crap out there.”


http://nymag.com/news/features/establishments/68513/

Monday, September 27, 2010

Charlie Munger speech at Univ of Michigan

This post comes a little too late. I never miss a chance to hear Charlie Munger speak. So like a enthusiastic kid I heard the entire two hour talk which was available here
http://rossmedia.bus.umich.edu/rossmedia/SilverlightPlayer/Default.aspx?peid=4d215177cbe44b1e8e94d0dd68f5058f

But now the link seems to be dead. But if you missed it you can get a summary here

http://finance.yahoo.com/news/Charlie-Munger-on-Communism-fool-1939650256.html

Friday, September 17, 2010

Income disparity in US

WSJ has a interesting article .....read here
http://s.wsj.net/public/resources/documents/US-Income-and-Poverty-in-2009.html


Obama should show this chart to people who oppose the expiration of bush era tax cuts for the top 2% earners.

Saturday, September 11, 2010

Third Avenue Quarterly Letter

http://www.thirdavenuefunds.com/ta/documents/sl/TAF%203Q%20Shareholder%20Letters.pdf

Third Avenue`s fund managers quarterly and annual letters are always fun to read. Unlike other MF letters they do not talk about portfolio average performance vs benchmarks or what is their view of the stock market. They talk about individual stocks they purchased during the quarter and give a detailed overview of their investment methodology. I particularly liked the overview of  POSCO by Ian Lapey and I believe this stock is worth further investigation.I think Warren Buffett also owned/bought POSCO few years ago but I maybe wrong. Since cash makes up around 55% of my portfolio I am excited to see how Michael Winer is using his cash hoard.He is selling out of the money PUT options on stocks he is willing to buy. In volatile times like these selling PUT options can be a good source for generating incremental earnings.

Wednesday, September 8, 2010

Sequoia fund investor day Q&A transript

I know this is a long read but in my opinion its the best article on business insight I have read this year. Highly recommend it.
http://www.sequoiafund.com/reports/transcript10.htm
Question:

I'd like to know your thoughts on gold and energy. I'm looking at the portfolio of some other value managers out in L.A. here and I see that their allocation to energy is about 38 percent and yours is pretty much zero. I'm curious to know what you guys think.

Chase Sheridan:

Generally speaking I would agree with Buffett's comments about gold. You take the yellow metal out of the ground and then you put it to industrial uses or jewelry and then often you put it back into the ground. So it becomes a sentiment bet. You are making a macro bet on the level of worldwide confidence in fiat currency.

To me it just doesn't make any sense. You don't get a yield. If you are really worried about inflation risk, there are ways to hedge inflation risk where you still get a reasonable yield. You might look at timber, you might look at oil companies. But one very good way I think to hedge inflation risk is to invest in excellent companies that have pricing power. You get yield from that; so I don't really see a reason to buy gold when you can invest in a business that leverages the creativity of people and gives you an earnings yield at the same time.

Bob Goldfarb:

I'd add that I think the people who are buying the gold are making a macro bet and they may well be right. But we haven't done that well making macro bets; so we probably are going to stay away from it.

Greg Alexander:

On energy I'd give the same answer I gave a few years ago. Which is it's a good business; we spend time on it. At least three or four people here have written internal reports on energy companies within the last six months. There are some wonderful companies. We own a few shares of Canadian National Resources, which is a very smart company run out of Canada by Murray Edwards. But in general we don't know what the price is going to be of oil and gas. So sort of like with gold, we just don't know what the price will be, we don't really know how to forecast it. So there tend to be people who have firmer opinions than we do about what the price of oil and gas will be. Therefore, they end up being willing to pay more for the shares than we are.

There is a good saying in the oil and gas business that the cure for high prices is high prices, and the cure for low prices is low prices. So for example at the moment no one is interested in gas because the price is so low. But the fact is the gas supply goes down 25 percent in one year in the United States if there is no drilling. So if people would just stop drilling, any supply and demand problem that you could think of would be quickly corrected.

Bob Goldfarb:

One thing I'd add is that some of the oil price is driven by speculators rather than by natural demand of energy users. I'm just more comfortable with a price of a commodity that is set by market forces and doesn't have that speculative component that both oil and gold have.

Tuesday, August 31, 2010

Portfolio Update August,2010





In my 401k account I moved all of the money from ITRIX to VIFSX. I have held ITRIX(T. Rowe Price Capital Appreciation) since January 2009. It is a balanced mutual fund with value oriented managers. The reason for selling it was that it has 25% of its assets in treasuries and bonds. In my opinion both are overvalued presently. I bought VIFSX more out of dislike for other MF`s than liking for VIFSX. Its a low cost index fund tracking S&P 500.  Besides that I did a round trip trade in Amedisys stock which I have explained in one of the write ups before.

Basically it was a pretty uneventful month.

Friday, August 20, 2010

Klarman's Perseverance

perseverance 

–noun
1.
steady persistence in a course of action, a purpose, a state,etc., esp. in spite of difficulties, obstacles, or discouragement.
Normally people know Seth Klarman as the genius who averaged over 20% per annum since 1983 while S&P 500 over the same period averaged only 7%. The difference between those two returns is that if you invested 1000$ with Seth Klarman in 1983 it would have become $137000 today while the same amount would be $6200 today if invested in S&P 500.

But one quality of Seth Klarman that gets under emphasized is his perseverance. Lets look at the following table

During the tech bubble of late 90's tech stocks valuations were sky high. Due to the lack of finding good values Klarman kept around 25% in cash, 30% in special situations, 10% in bond and only 35% in stocks. He also hedge the stock market exposure by buying PUT options. Every year from 1995 to 2000 he underperformed the index and also lost money on the PUT options that would expire worthless at end of the year. But consistently he held onto the cash as well as kept buying PUT options every year. 

As we all know well S&P 500 index fell 43% after 2000 and 10 years later is still 30% lower than its peak set in 2000.

He wrote this to his investors in 1999 
"We underperformed in 1999 not because we abandoned our strict investment criteria but because we adhered to them, not because we ignored fundamental analysis but because we practiced it, not because we shunned value but because we sought it, and not because we speculated but because we refused to do so. In sum,and very ironically, we got hurt not speculating in the U.S. stock market."
 Thus for long term success in investing you need not just the right technique but the right temperament.

In Buffett's words
"Success in investing doesn't correlate with I.Q. once you're above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." 

Thinking of buying Put options on TLT

Put option is basically an investment that increases in value as the underlying security decrease in price. If the underlying security increases in price or stays constant your worst case loss is the money you paid to buy the option.

Each option has an exercise price and exercise date. European style put options can only be liquidated based on the price on the date of expiry of the option.American put options can be traded all the time.Because of the exercise date there is a decay in value of the option as the exercise date comes closer.Hence with an option,unlike stock, you not only have to be right about the stock price but also the timing when the stock reaches such price.

Recently Seth Klarman gave a speech that can be read here
http://valuestockplus.net/2010/05/20/seth-klarman-notes-from-cfa-institute-speech/

Klarman is seeking an inexpensive hedge against dollar destruction as he is trying to protect against catastrophic tail risk. His way to hedge against inflation is through way out of the money puts on bonds. If interest rates go to double-digit ranges, he will make a lot of money. As long as the insurance is cheap enough, he will do it.
To hedge against inflation I have been thinking of buying out of the money PUT options on TLT(20+ year treasury bond).
http://www.google.com/finance?q=tlt

Shorting this bond means I am expecting inflation and long term interest rates to go up. To keep the risk of time decay to minimum possible I am thinking of buying the longest dated option available.....which currently is Jan 20,2012.

As of today(August 20th,2010) a Put Option with exercise price of $80 is available for $2.6. As each option contract comes in multiples of 100 the minimum money you have to lay out to buy such an option would be 1*2.6*100 = 260$. Here is how the returns will play out based on the interest rate movements
TLT Price vs Long Term Interest Rate


                        
Return in % vs Long Term Interest Rates

Hence this is a high risk high return bet. So I would put a small % of my portfolio in this position. But the advantage of this strategy is that if your bet does not materialize the downside is basically what you paid for the option but the upside is tremendous.

Another very important thing to keep in mind is that lot of people have made this trade since 2008 and none of their dire predictions have worked out.Timing is extremely important in this trade.Who knows 2 years from now this option might expire worthless with LTI rates still at sub 3%.

Wednesday, August 18, 2010

Breitburn Energy Partners (BBEP)

Recommendation : I would sell BBEP at around 18-19 if I find other more attractive stocks.


Breitburn Energy Partner is a Master Limited Partnership(MLP) which is in oil and natural gas production business. It buys or leases land or wells with proved Oil and Gas reserve with minimal exploration risk. Also it is structured as an MLP and hence has to distribute all its free cash flow(money that remains after all the operating expenditure) to its shareholders.

This company is my largest holding accounting 18% of my portfolio. Since the price has run up lately I wanted to revisit the valuation and see if its still worth holding at current price.Following is my attempt to use Discounted Cash Flow model(DCF) to value the stock of this MLP


I have assumed a hedged price per BOE of 58$ and unhedged price per BOE as 47.5(current prices).Also I have assumed a 8% discount rate above. In DCF the most tricky part usually is to choose the right discount rate. A wrong choice of discount rate could give a totally different valuation.

For example in case of BBEP

discount rate 7% gives a value of 21.14 per share.
discount rate 8% gives a value of 19.14 per share.
discount rate 9% gives a value of 17.35 per share.
discount rate10% gives a value of 15.74 per share.


I believe the choice of discount rate should be based on two criteria
  1. What is the current no risk investment yield ? In my case its less than 1% in the bank account.
  2. What opportunities are out there,given all other variables being equal, which are even more cheaper when compared at the same discount rate.
Recently Wells Fargo said this about BBEP
"We are upgrading our rating on BBEP on the heels of a number of positive developments occurring within the partnership. Specifically, distribution growth is poised to accelerate to a subsector leading 7-8% annual rate for 2011 and 2012 (versus 2-3% for the upstream MLP peer group), production is trending towards the high end of guidance, management is back to pursuing acquisitions, and option value tied to BBEP’s prospective Collingwood-Utica acreage in Michigan is steadily gaining visibility." 
So it seems like they are using a discount rate between 7.5 and 8.5.

In the above model I  have also not assumed anything about natural gas and oil prices. Their future values would significantly impact the present value of the stock.Generally MLP stocks are held by investors for dividend income and hence valued based on dividend yield. I do not believe in such narrow minded view. A company should be valued based on present value of its free cash flow it would generate. It does not make a difference if that cash flow is paid out to me as dividend or stays with the company for future investment as long as the management generates more than a dollar for every one dollar invested.

Personally I would sell BBEP at around 18-19 if I find other more attractive stocks.


References:
http://sec.gov/Archives/edgar/data/1357371/000114420410012812/v176868_10k.htm
http://sec.gov/Archives/edgar/data/1357371/000135737110000009/file_10q.htm

Sunday, August 15, 2010

Enzon Pharma


  • $440 M in cash

  • NOL carryforwards of 90M and 72M for federal and state taxes respectively

  • Many famous value investors on the stock owner list including Klarman, Icahn, Highbridge capital and Iridian Investment.Iridian investment CEO is on board.

  • Core expertise has been in engineering improved versions of injectable therapeutics through the chemical attachment of PEG. Currently, there are six marketed biologic products that utilize our proprietary PEG platform, two of which we had marketed through our specialty pharmaceutical business, Adagen and Oncaspar, and three for which we continue to receive royalties, PEGINTRON, Macugen and CIMZIA.

  • CFO`s performance bonus is tied to "Complete the evaluation and potential sale of PEGINTRON royalties" for 2010

  • CEO resigned in Feb 2010 and was replaced by CTO

  • In Jan 2010 they sold off their specialty pharmaceutical business.This reduced their Research and development – specialty and contracted services expense by $24M per year.

  • Currently their main R&D effort is linked to developing compounds using PEG-SN38 technology for cancer treatment and LNA technology.

  • PEG-SN38 is in Phase 2 of the clinical trial for its efficacy against colorrectal cancer and breast cancer.

  • Corporate research and development expense was $45.6 million, $43.5 million and $44.0 million for the years ended December 31, 2009, 2008, and 2007, respectively.

  • The Royalty income is from 3 drugs PEGINTRON(Merck), CIMZIA(UCB Pharma) and Macugen(OSI Pharma).

  • In August 2007, we sold 25 percent of the future royalties from the sales of PEGINTRON for $92.5 million in gross proceeds.

  • It seems PEGINTRON is their cash cow and selling it will bring lots of money. From 10k "Our current sources of liquidity are our cash reserves, interest earned on such cash reserves and royalties — primarily those related to sales of PEGINTRON. In January 2010, we received approximately $300 million net proceeds from the sale of specialty. Once our board of directors has determined the funding needs for the continuing operation of our business, some portion of the value derived from the sale of specialty may be returned to our stockholders.."

  • Royalty revenue for past 3 years have been 54M,59M and 67M.

So how do we value this business as of Q2 2010 ?

  1. Cash + Marketable Securities(US bonds) = 440M + 70M = 510

  2. Royalty business = 3*92.5M based on valuation that Merck paid = 277.5

  3. R&D expense for future will be in range of 43per annum

  4. G&A = 24M per year. 1Q G&A was outlier because of stock options and salary cost of employees of the sold speciality business.

  5. Debt = $134M 4% notes convertible to common stock at 9.55 per share before June 2013
  6. Company repurchased $12.4M of common stock at price of $10.41 per share in first half of 2010
In short they have $10.7 per share of close to liquid assets. With current price of $10.4 we are getting their development pipeline with its potential upside for free. Following is quoted from a writeup at VIC
In many other, similar situations, I would not expect a pharmaceutical company to curb research and development spending; management typically stands to benefit substantially from the success of R&D spending, but bears none of the cost of failure. Enzon's Board and management, however, are not typical. They were installed after a proxy fight launched precisely because prior management was misallocating capital to research and development. Prior management ran into the arms of Carl Icahn to defend themselves in the proxy fight--prior management is now gone and Icahn has four people on the Board; Iridian has one. Chairman Alex Denner was previously a portfolio manager at Viking. So you have a Board that considers capital allocation as you do. Enzon authorized a $50 million share repurchase in December 2009 (8.4% of the then outstanding stock) and repurchased over $20 million of its convertible notes at a discount in 2009.
I would start a small position at current price of 10.4 and buy more on dips.

AMEDISYS

Pros:
  • Is the largest player in home health care which is a very fragmented industry.
  • Home health care industry is set to grow by 50% by 2020 because of aging demographics.
  • Home health care makes lot of sense when you compare it to cost of treatment within hospital.
  • To top it off people obviously old people prefer in home health care over a hospital stay.
  • Amedisys has grown significantly by acquiring offices and by reducing their cost by centralizing management cost. Hence it has economy of scale advantage. This seems to help it obtain industry leading operating margins and free cash flow.Acquisition and consolidation has been going on in this sector since 2000 because an acquiring company can make existing offices more profitable by centralizing fixed costs.
  • Free Cash flow for 2009 was 125M
  • Expected free cash flow for 2010 is 130M
  • With a market cap of 700M and debt of 200M the Enterprise Value/FCF = 7 for 2010 which looks like an awesome buy for a growth company.
  • CEO founded the company in early 90s and owns 1% of the stock.His salary even though high is not ridiculous.The directors have been with the company for over 10 yrs.
Now lets look at the Cons:
  • As of 2Q 2010 Amedisys has 116 M in cash and 162LT + 40ST Debt making the lowest the stock can get zero.The majority of its balance sheet is comprised of goodwill which shows that when it acquires a business it pays a lot more than the assets of the company.Are those assets worth the premium ? At first glance it seems it is worth it since they have contributed to increase in free cash flow and AMEDISYS has reduced outstanding debt quickly as post acquisition.
  • WSJ reported in April the following http://online.wsj.com/article/NA_WSJ_PUB:SB10001424052748703625304575116040870004462.html
  • Basically they accused home health providers of swindling medicare into paying more by doing more home visits than necessary.
  • Company replied to this by issuing a shareholder letter http://www.amedisys.com/pdf/letter_to_shareholders.pdf
So why did I buy the stock ?
  • It was cheap even though the downside was zero.
  • The accusations of fraud seemed misguided by looking at the Amedisys as well as WSJ data.
  • It operates in a growing industry and has a scale advantage. Any reduction in medicare reimbursements would negatively impact the smaller players first and hence provide even more opportunity of growth for big players like Amedisys.
Why did I sell the stock ?
  • After buying the stock I heard the 1Q and 2Q conference calls. It seems management has suddenly made significant changes to their operating model since the WSJ article.They are decentralizing their operations while they touted this centralization as the reason they were able to have high operating margins. I also read a theory that the centralized version could have allowed them to do medicare fraud and they are moving towards industry standard decentralized model after the wsj article to hide their existing issues.
  • Management did not seem candid. They kept talking about cutting costs by closing offices and bringing the salaried employees to pay per visit reimbursement.But when asked about how many offices they plan to close, how much benefit that might have or how many employees are on salaried basis they declined to disclose. In Q1 conference call when they announced the closure of unprofitable offices they said they will give more details in Q2 which they denied to give. So something is fishy
  • The biggest reason for selling the stock was when I found out that the Medicare reimbursements are going to fall by 5% in 2011 and 5% more in 2012. That will cut their EBIT margin from current 15% to 5% and reduce the free cash flow by 70%. I should have known this before I purchased the stock.
  • Clinician recertification to Amedisys (a process of extending the treatment of a patient and as a result allowing Amedisys to get paid again for the same patient) fell off the cliff in month of June and has remained that way.This is very suspicious since that is the time when they said they have started decentralizing the operation. Also its possible that the doctors are referring to some other agency because of the WSJ article highlighted amedisys. The management was asked multiple times during both the conference calls regarding why the sudden drop and they said that they have no idea why. This is definitely very very suspicious.If management does not know whats going on then who will ?
  • And lastly I found a website where thousands of AMEDISYS employees reviewed the company. 99% of the people had bad things to say especially the employees who became part of AMED after acquisition. The work culture was very very stressful and filled with bureaucracy. All the employees said that they would change job in an instant if given an option.
So what did I learn ?
  • Buy a stock with a worst case downside much higher than 0
  • Do your homework before the purchase
  • Stress on the qualitative factors much more than quantitative ones since the former is hardest to evaluate
  • Home health care industry has two segments one that helps old people to regular chores etc and other that takes care of people with acute diseases. The latter segment is called Hospice.In the health care overhaul the reimbursement for this segment have not been reduced. Hence all of a sudden this seems like the well established segment in the HHA industry. The recent acquisition of Odyssey Healthcare by Gentiva at a huge premium price proves this.Amedisys did 95% of the first segment but very little of Hospice.
  • Basically I should stay away from a business whose operating profits could be significantly impacted by government actions.

Saturday, August 14, 2010

Takeaways from the book "Warren Buffet Way"

Recently heard a concise audiobook version of "Warren Buffet Way" - Robert Hangstrom

The author suggests that all of Buffett`s company purchases over time seem to have all or some of the following tenents:

1) Business Tenents:
  1. Is the business simple and understandable ? Investment should be based on business fundamentals and not economic forecast or any exterior factors.
  2. Does the business have consistent operating history ? Businesses that are turning around or have a new operating strategy increases likelihood of failure.
  3. Does the business have favorable long term prospects ? A franchise is much better than a commodity business. A franchise who is not regulated can increase prices without loosing market share or volume.Even if demand is flat the prices can be raised.Conversely a commodity products is indistinguishable from each other. Now banks,insurance etc have become commodity products.Franchises can tolerate mismanagement or mistakes.
2) Management Tenents:
  1. Is the management rational i.e. is it a good capital allocator ?
  2. Does the management communicate with shareholder candidly without hiding behind GAAP ? Does the management discuss failure openly ?
  3. Does management withstand the institutional imperative ? This is the act of imitating other corporate managers no matter how silly the behavior is.You can find that institutional imperative exists when 1) institution resists changes in its current direction 2) just as work expands to fill available time, corporate acquisitions and projects will be started to soak up available funds 3) Any ambitious craving of its leader will be quickly supported by a detailed rate of return and benefit analysis by its troops 4) behavior of peer companies will be mindlessly immitated
3) Financial Tenents:
  1. Do not take one year result seriously.......use 4-5 year averages
  2. Focus on Return on Equity and not EPS. Since most companies retain earnings from previous year so there is no big deal about increasing EPS. For calculating ROE all marketable securities should be valued at cost. You should exclude all capital gains and extraordinary items. Debt levels should not be too high.
  3. Use owner earnings instead of reported earnings. Owner Earnings = Net Income + Depreciation + Depletion + Amortization - Capex - Working Capital. Calculating future capex might just be estimates but guess is better than no guess.
  4. Look for companies with high profit margin. High profit margin shows that management is cost sensitive and keeps costs low.
  5. For every dollar retained make sure the management has created more than dollar of market value. The stock market tracks the business value over long periods. Hence we can compare the increase in market value with increase in retained earnings to estimate the effective allocation of capital by the management.
  6. A value of business is determined by the net cash flow to occur over the life of the business discounted by an appropriate discount rate" . If you are not able to project the future cash flow don't buy the company. Buffet uses discount rate of existing long term government bond.
  7. Difference between growth and value is pointless. Value is the discounted value of cash a business would generate over time. Growth is simply the rate at which the free cash flow will increase over time.Using the growth estimate you arrive at the intrinsic value of the company. The decision to buy one company vs other should be purely based on intrinsic value and not the growth rate since intrinsic value already should reflect the growth rate.
4) Market Tenents:
  1. Is the intrinsic value greater than the market value ? Always keep a margin of safety between your estimated value and the market value. Because if you made an error in your valuation the discount to intrinsic value might protect you from making a loss on investment.
If we make mistake in investment it can be because of price we paid,management we joined or the future economics of the business. Mistakes in estimating the future economics of businesses is the most common.

Friday, August 13, 2010

Klarman`s Portfolio Update June 30,2010

Added: Enzon and VIASAT
To me the most intersting part is that he kept holding BBEP which is the largest holding in my portfolio. Also he did not sell Solar Cap which I thought he had invested into at the depth of the crisis and might sell after the IPO. Since he is still holding it he might still see value in it. So I have to investingate this company further. Also VIASAT is a mystery to me........by no angle it looks like a value play but I had my doubts about ADCT too and look how that played out.

So I will again revisit ENZN,VSAT and SLRC.

Wednesday, August 11, 2010

Identifying Business Moat

Here is a one line principle that summarizes investment thesis of Warren Buffett according to me:

"Buy a company that has a sustainable competitive advantage(moat) and still has lot of ground to conquer(growth) at a reasonable price and then just enjoy the ride :) "

So todays post is going to be about what are the characteristics that give a company a competitive advantage. Also how do you make an investment decision given a choice between two companies with high barries to entry business.Well...lets learn from the grand master himself
Buffett:
Generic brands have been with us a long time. But lately they’ve attracted a great deal of attention—partly because they’re doing better and in particular because of Philip Morris’s (MO) actions a few weeks ago—when, in reaction to the threat and the inroads of generics, they cut the price dramatically on Marlboro.

I wouldn’t say Marlboro is the most valuable brand name in the world. Coca-Cola (KO) is more valuable—and I think that’s been proven by subsequent events. But Marlboro earned more money than any brand name in the world.

And all of a sudden, Philip Morris took some actions which dramatically reduced the earnings of that brand and changed the pricing dynamic that had existed in the cigarette business for many decades. And since then, Philip Morris has had $16 billion lopped off its market value and RJR’s suffered accordingly.

It’s a terribly interesting case study and it illustrates one of the dangers of generic competition. Philip Morris cigarettes got to where they were selling for $2.00 a pack. The average cigarette consumer uses something close to ten packs a week. Meanwhile, the generic was at about $1 or thereabouts.So you really have a $500 a year differential in cost per year to a ten-pack-a-week smoker. And that is a big annual cost differential. You better have something that people think is dramatically better than the generic for the average consumer to shell out an extra $500 a year. It’s happening in other areas, too—whether it’s corn flakes or diapers or a lot of things...

In our case, I think the Proctor & Gamble's Gillette brand name, for example, is far better protected against generic competition than the main product of Philip Morris—although there always has been generic competition in blades and there always will be.

The average male purchases something like 30 blades a year. He pays 70 cents each if he buys the best—which is the Sensor.

That’s $21 a year. The best he can do if he wants something that leaves him Band-Aids on his face and an uncomfortable experience costs him $10 a year. So you’re talking $11 for a 365-day experience...

I think there’s a generic threat of some sort in any industry where the leaders are earning high returns on equity. It just stands to reason that that’s going to encourage competition.

And the threat may be accelerating in many industries. But I think that brand names with the right ingredients are enormously valuable. Sometimes infrastructure is a problem for the generics. The worldwide infrastructure for Coca-Cola, for example, is very impressive and very hard for a generic provider to duplicate.

But if somebody wants to sell a generic box of chocolates in California against See’s Chocolates, that’s obviously somewhat of a threat.

And I just hope that they take them home on Valentine’s Day and say, ‘Here, Honey, I took the low bid.’

Wal-Mart’s (WMT) selling Sam’s Cola. And Wal-Mart is a very, very potent force. One thing that’s helpful is that they were selling it as cheap as $4 a case here. And I don’t believe that’s sustainable. That’s 16 2/3 cents a can.

It’s been a while since I looked at aluminum—and it’s down. But I think the can is close to a six-cent item by itself. The can is far more expensive than the ingredients... Distribution costs, trucking, stocking and all that sort of thing have to be fairly similar. In a 12-ounce can, there’s 1.3 ounces of sugar—which at the domestic price, would be around 1 3/4 cents per can. And that’s got to be the same whether it’s Sam’s Cola or Coca-Cola.

The Coca-Cola Company sells about 700 million 8-ounce servings—largely of Coca-Cola, but also of other soft drinks—worldwide every day. If you take 700 million and multiply it by 365 days, you come up with 250 billion or so 8-ounce servings of Coke or its products in the world each year.

The Coca-Cola Company made about $2 1/2 billion pretax last year. That’s one penny per serving.

One penny per serving does not leave a huge umbrella. The generic is not going to buy the can any cheaper. And they’re not going to buy the sugar any cheaper and so on. Their trucks aren’t going to be any cheaper.


To summarize a company selling low cost product due to advantage of scale is better than a company selling high cost product due to customer goodwill(brand recognition).Hence with ROE or Price/Cash Flow being the same companies like P&G,Colgate,Unilever,Coca Cola,Gilette,Nestle,Cadbury,Wrigley etc will be a better buy vs Coach,Apple,Sony,Porche,BMW,etc.

Types of comptetive advantage a business can possess

One source would be economies of scale and scope. Wal-Mart is an example of this, as is Cintas in the uniform rental business or Procter & Gamble or Home Depot and Lowe's.

Another source is the network affect, ala eBay or Mastercard or Visa or American Express.

A third would be intellectual property rights, such as patents, trademarks, regulatory approvals, or customer goodwill. Disney, Nike, or Genentech would be good examples here.

A fourth and final type of moat would be high customer switching costs. Paychex and Microsoft are great examples of companies that benefit from high customer switching costs.

These are the only four types of competitive advantages that are durable,
because they are very difficult for competitors to duplicate. And just like a company needs to develop a moat or suffer from mediocrity, an investor needs some sort of edge over the competition or he'll suffer from mediocrity.

Sunday, August 8, 2010

Special Situation Investing or Risk Arbitrage

You can text search the database for “odd lot tender” or something similar with better keywords.

http://searchwww.sec.gov/EDGARFSClient/jsp/EDGAR_MainAccess.jsp

There are also different forms of arbitrage.

◦Cash only transactions where stock is paid for in cash
◦Stock for stock where the shareholders are given stock of the other company
◦Partial stock where a percentage of the share is converted to stock and cash
◦Purchase merger securities (the Greenblatt recommends looking into warrants)
Focus On This Checklist (source: fwallstreet.com)Before you invest any cash, you should be able answer all the items below.

1.Due diligence by both parties2.Financing and regulator approval3.Get preliminary shareholder sentiment (or controlling shareholder approval)4.Obtain regulator (SEC, FCC, any and all) approval5.Get final shareholder approval at a meeting called for that purpose6.Insiders continually vesting or buying sharesRisks to Think About◦Calculate the potential upside and downside vs time. In the PSD merger, I’ve given the chance of success 90% with a gain of around 25% within 1 month. This is excellent odds.
◦Unpredictability: Anything can happen in mergers. Financing can break down at the last minute, the market can go crazy and take everyone with them, earthquakes could ruin the operation of the business etc etc.
◦Allocate assets accordingly depending on your odds.
◦Taxes will have to be paid because this is a short term strategy. Consider this when you calculate gains.
But most of all, stick to investing in solid companies if you are unsure or feel uneasy with the whole notion.

H/T : http://www.oldschoolvalue.com/special_situation/profit-from-special-situations-risk-arbitrage/

Saturday, August 7, 2010

Applied Value Investing - Book Author Interview

http://seekingalpha.com/article/177069-joe-calandro-jr-author-of-applied-value-investing-every-investor-should-be-active
Conversely, Graham and Dodd provide a framework to address assumptions up front in every valuation, which is important because, like it or not, when you value a business you are addressing these assumptions, either explicitly or implicitly.

You will make better adjustments if you understand accounting (financial and managerial), strategy, and operations management. There isn’t a silver bullet with this activity, or anything else for that matter. When you read books like “Margin of Safety” by Seth Klarman, “Security Analysis,” “The Intelligent Investor,” and Buffett’s Shareholder letters you see very carefully that they have thought through the assumptions in their valuations very carefully. They aren’t assuming anything away, but rather addressing issues head on, which I think is a key factor of their success.

The need to focus on cross-discipline analysis, which is important for both investors and business people.

When a beginner starts investing, they should do so with a small amount of money because they are going to be wrong (possibly very wrong). Therefore, learning from each failure is critically important; I suggest that every investor conduct a post mortem on each of their investments (both failures and successes) and by so doing they can refine their circle of competence over time. This is important because the circle of competence is essentially what you are offering people as an investor so the sooner you start developing one, the better.

Friday, August 6, 2010

Options Tutorial

http://www.duke.edu/~charvey/Classes/ba350/optval/optval.htm

Wednesday, August 4, 2010

Bond market is hot...good time to get out

I will be selling ITRIX which holds 31% in fixed investments. I have decided to go for low cost Vanguard S&P 500 mutual fund. Reason for this fund is

1)I will be fully invested in stocks since this fund will have close to 100% of its assets invested.
2)Close to 50% of the earnings in S&P 500 come from outside US.
3)Market is not cheap at all but alternatives are not much safe either.
4)I already have a big position in cash.

I have been saying for a long time but have not yet acted upon my instincts to short long term treasury bonds or if possible high yield bonds. Unless I trade in futures options there are not many savy ways I can make this trade but doing something is better than doing nothing. Hence I might soon take a position in TBT(ultashort treasury bonds)

References:
http://www.distressed-debt-investing.com/2010/08/credit-market-quite-possibly-insane.html
http://www.dailymarkets.com/stock/2010/08/02/stock-market-valuation-08012010/

Monday, August 2, 2010

Bankruptcy Process Explained by SEC

http://www.sec.gov/investor/pubs/bankrupt.htm

A company's securities may continue to trade even after the company has filed for bankruptcy under Chapter 11.

During bankruptcy, bondholders will stop receiving interest and principal payments, and stockholders will stop receiving dividends. If you are a bondholder, you may receive new stock in exchange for your bonds, new bonds, or a combination of stock and bonds. If you are a stockholder, the trustee may ask you to send back your old stock in exchange for new shares in the reorganized company. The new shares may be fewer in number and may be worth less than your old shares.The bankruptcy court may determine that stockholders don't get anything because the debtor is insolvent. (A debtor's solvency is determined by the difference between the value of its assets and its liabilities.) If the company's liabilities are greater than its assets, your stock may be worthless.

Steps in Development of the Plan:

The debtor company develops a plan with committees.

Company prepares a disclosure statement and reorganization plan and files it with the court.

SEC reviews the disclosure statement to be sure it's complete.

Creditors (and sometimes the stockholders) vote on the plan.

Court confirms the plan, and

Company carries out the plan by distributing the securities or payments called for by the plan.

Friday, July 30, 2010

CEO compensation

In my opinion the CEO should be purely compensated for increasing the intrinsic value of the company over long periods and for producing reasonable risk adjusted returns. In most cases this is hard to measure but quantitatively free cash flow growth measurement is as close as you can get to measuring increased intrinsic value.Ofcourse this is not the only criteria.In certain types of industries brand name recognition/reputation is as important. I recently found the best example of CEO comepsation while looking through proxy of O.I. Corporation ticker symbol OICO.

Mr. Lancaster. For 2010 and subsequent years while he is actively employed by the Company and in addition to his Base Salary as defined in his employment agreement, Mr. Lancaster will be eligible to earn a cash bonus equal to 10% of Free Cash Flow in excess of $3,000,000 annually, as adjusted by a charge of 15% on any Incremental Investment Capital (defined below). The charge for investment capital shall be applied annually year-over-year but shall be pro-rated based upon the month in which the invested capital is contributed by the Company. “Free Cash Flow” refers to the Company’s earnings before interest, taxes, depreciation, and amortization (“EBITDA”), less capital expenditures. “Incremental Investment Capital” refers to capital invested subsequent to January 1, 2010 pursuant to approval of the Company’s Investment Committee for strategic initiatives, such as the acquisition of a business or product line. The Committee has the discretion to exclude certain one time events such as the sale of assets from Cash Flows and to provide a discretionary bonus in addition to the Free Cash Flow based incentive. The revised Plan does not provide for an award of options to purchase shares of the Company’s common stock; however Mr. Lancaster remains eligible to receive an option to purchase up to 25,000 shares of the Company’s common stock as noted below.