Barel Karsan

The Charisma Myth

noreply@blogger.com (Saj Karsan) — Tue, 21 May 2013 10:10:00 +0000

Charisma is something non-founder CEOs are simply born with...or is it? Most people believe CEOs rise to the top of their fields because of some innate quality that makes people follow them. But Olivia Cabane argues that charisma is learned; some may pick it up more naturally, but with the right tools anyone can learn it. In The Charisma Myth, she describes how.

Through both verbal and non-verbal communications, charismatic people convey the message that they are worth listening to. Cabane claims to have deciphered this code, and breaks it down into three pieces, all of which can be discussed: presence, power and warmth.

A few techniques to whet your appetite on becoming more charismatic:

- Avoid excessive nodding when someone else is speaking
- Pause 2 seconds before answering
- Finish your sentences in a low/baritone voice

The book does more than offer what would have to be an extremely comprehensive, exhaustive list of physical behaviours required to convey charisma, however. Such a list would be difficult to memorize, and impossible for one's brain to co-ordinate in real life situations where brainpower demands are already high. Instead, the focus is on controlling one's state of mind. Recognizing that body language responds to what's in one's mind, different states of mind are required to convey different attributes.

It's also a quick read; so if you would benefit from an increase in charisma, the investment required to determine whether this book would help you is low.

Cisco: Let Me See That LONG

noreply@blogger.com (Saj Karsan) — Mon, 20 May 2013 10:00:00 +0000

Cisco has a dominant market share in an industry where scale is advantage. Considering this, its market price a couple of years ago was laughable. But it only looks laughable in retrospect. When I brought up the stock as a potential investment at that time, though commenters on this site generally agreed that the company was undervalued, commenters throughout the rest of the web (e.g. through Seeking Alpha) saw the company through Mr. Market's eyes. Here are some of the bewildering comments I received after arguing the stock is undervalued:

The stock price has fallen over the last decade
The company is run only for the benefit of its executives
Management always lowers guidance, punishing the stock
It's too hard for value investors to make money in large caps
The company is being run into the ground

And my personal favourite, because it somehow blends two separate concepts that both ignore price vs value, and manages to do so in the same sentence:

There is no catalyst for growth

Finally, one investor was certain enough to be able to predict the following (at least, I think this came from certainty, and not as some sort of threat):

If you invest, you will be sorry!

Having almost doubled from its price in the low teens in mid-2011, Cisco is now ready to graduate from the Stock Ideas page to the Value In Action page; I have taken my profits. Congrats to all the value guys (I know there are a lot of us!) that bought it back then.

Disclosure: No position

IFON You Up With A Deal

noreply@blogger.com (Saj Karsan) — Thu, 16 May 2013 10:27:00 +0000

InfoSonics (IFON) was already a deep net-net when it reported results earlier this week. But after reporting an EPS loss of 5 cents, the shares were pulverized, causing the company to lose almost one-third of its market cap, or 16 cents per share. Blood in the streets.

You might recognize this name from last year. It was featured on this site's Stock Ideas page before a run-up in its price got it promoted to the Value In Action page. The stock is now down about 75% from its high last year, providing deep value investors another potential opportunity.

InfoSonics makes low-cost handsets for Android phones. Don't expect any miracles from this thin margin business. But the good news is, you don't need any. At its current market cap of $6 million, investors are offered $4.5 million in cash, $10 million in receivables and $3 million in inventory, against total liabilities of just $5 million. This is a discount to net current assets of over 60% for a company that showed a quarterly profit as recently as 12 months ago.

Unlike a lot of other companies the market is currently shunning (in what appears to be a rather short list at this time!), management of InfoSonics is not incentivized to steal from shareholders. The company's CEO owns almost one third of the company's shares, so if the ship goes down, he goes down with it.

There is certainly a risk that the company will continue to lose money until it blows through its rather large margin of safety here. But with a large cash balance relative to share price, and a manager whose incentives are aligned with those of shareholders, the odds are probably in the investor's favour on this one. While this particular investment may not work out, I would be very surprised if a basket of these did not.

Disclosure: Author has a long position in shares of IFON

My Years With General Motors

noreply@blogger.com (Saj Karsan) — Tue, 14 May 2013 10:28:00 +0000

Alfred Sloan became CEO of General Motors in 1923, and stayed on for several decades. In that time, he transformed GM from a rag-tag collection of unfocused, poorly-performing businesses into the largest company in the world. In My Years With General Motors, he discusses how he did it. Bill Gates calls his book "[P]robably the best book to read if you want to read only one book about business."

When Sloan became involved in GM's upper management (mostly by way of his parts-supply business having been acquired by GM), Henry Ford was kicking the industry's butt with his Model T. This low-cost car had dominant market share, and even though GM had a number of car companies under its umbrella, none could come close to matching Ford in any way, shape or form.

But as Sloan describes, GM's operations at that time were a mess. There was no co-ordination between these various subsidiaries (so that sometimes they would compete against each other). Capital allocation decisions weren't even determined centrally, causing the company to have to frequently reach out to capital markets to fund the bloated budgets of the company's various divisions.

Sloan and his team changed all that. With help from DuPont (an investor which helped save GM from bankruptcy), capital decisions were made based on expected return on capital. Some level of co-ordination was introduced among the car companies, so that things like R&D expenses and benefits could be shared, but decentralization was maintained so that leaders were rewarded/punished according to their own abilities. A process of continuous improvement was implemented, so that each year a new car model would be introduced that was superior to its previous version. Eventually, this won over the customers, as the ever-improving Chevrolet managed to steal share from the stagnant Model T, even at a higher price point.

Some of these managerial moves will make perfect sense to today's management student. But when this book was written, the field was not where it is today. These were very much new concepts pioneered by Sloan, which turned GM into a behemoth, dwarfing its competition, including the previously heralded Ford. If you're a student of history, you will probably enjoy Sloan's description of how he made GM the envy of the world.

Hammond Manufactures Value

noreply@blogger.com (Saj Karsan) — Fri, 10 May 2013 10:34:00 +0000

Hammond Manufacturing (HMM.A) makes products like transformers, racks, enclosures and casing for the electrical products industry. You might expect a company in this industry to barely earn its cost of capital - and you'd be right. What you might not expect is that this consistently profitable company is a net-net and trades barely over 1/3 of it's book value!

Hammond has net current assets of $40 million against liabilities of $25 million. Meanwhile the stock trades for just $13 million.

In addition, the company has "Land and Buildings" (on which it runs its operations) listed at a cost above $8 million, and carried at a depreciated $4 million. The company also has an interest in a vacant, non-operating property (on which it has accrued some environmental liabilities) which it deems to be worth just over $1 million.

Finally, Hammond also has a 40% interest in one of its suppliers. This is carried on the books at $200K, whereas the supplier generated a profit of $100K last year.

Going back 10 years, Hammond's operating margin has ranged between 0.4% (in 2005) and 5.3% (in 2008). Last year's operating margin came in at 3%, which was good for 16 cents a share. Shares currently trade for just $1.10 each. So not only does this company trade at a discount to its earnings, but the downside appears to be protected not only by net current assets but by substantial land holdings.

Now for the less appealing aspects. The company does carry a decent amount of debt. Though this is factored into the net-net calculation, it does mean that if the assets aren't worth as much as they appear to be, this effect will be magnified for equity holders. Also, the company is controlled through a dual-class share structure.

To read the company's annual report, see here. To read more about the company, see here.

Disclosure: Author has a long position in shares of HMM.A

hhgregg Management Rips Off Shareholders

noreply@blogger.com (Saj Karsan) — Mon, 06 May 2013 10:23:00 +0000

hhgregg has always struck me as a rather shareholder-friendly company. So it caught me off-guard when hhgregg's management decided to re-price its underwater options. Such actions are a huge red flag for investors.

The handout of options to managers is always justified on the premise that it aligns manager and shareholder interests. What is often glossed over, however, is the fact that options contain an inherent asymmetry in their outcomes: a poor outcome, even an extremely poor one, results in option values that never go below zero, whereas a positive outcome results in positive gains. Because of this asymmetry, managers who are paid in options are incentivized to take far more risks than shareholders would deem appropriate. This is no small issue; as I've written before, the use of options likely contributed to the downfall of Lehman Brothers.

So even left untouched, options already provide perverse incentives to management. But by re-pricing options, as hhgregg just finished doing, the incentives become even worse. Rather than option values that go to zero when the stock price gets pummeled, management actually gets long-term benefits from a felled stock price! For example, CEO Dennis May just saw the strike price on 75,000 of his options go from $28.31 to just $13.56!

The explanation offered up by the company is that these strike price reductions were accompanied by a three-year increase in vesting periods, encouraging employee retention. But that sounds like a lame excuse; by providing even more time before the options expire, the options become even more valuable. For example, in the Dennis May example cited above, his options went from being worth 7 cents each to being worth over $3.50/option! (Calculations are based on this Black-Scholes option value calculator.)

Instead of expiring in 2017, his options will instead expire in 2020. Did shareholders really benefit from this extra vesting period? Probably not, I would venture.

The strange thing is, this company has otherwise behaved in a rather shareholder-friendly manner. Management owns a considerable number of shares, only grows when it is profitable to do so, and buys back shares when the stock is cheap. But this option re-pricing appears nothing more than a cash grab. Going forward, this company should be closely monitored for more unscrupulous activity.

Disclosure: Author has a long position in shares of HGG

Alco-Stores: Large Shareholder Disappears

noreply@blogger.com (Saj Karsan) — Fri, 03 May 2013 10:40:00 +0000

As previously discussed on this site, shares of Alco-Stores (ALCS) trade at a deep discount to the company's net current assets. While that discount started to narrow late last year, it started to widen again over the last few months. At the same time, a large shareholder (who previously owned more than 15% of this illiquid stock), started to sell piecemeal! My guess is that the latter may have been causing the former.

On Wednesday, however, this large shareholder disappeared all in one go, managing to unload 500,000+ shares (whereas average volume is only a few thousand per day) in a single trade!

The large shareholder is technically considered an insider, but I'm not so sure investors should worry that these guys were selling. I couldn't find any performance data for the funds that reported to hold these positions, nor has anyone appeared to have written about the investing prowess of these guys running it, though they have been forming funds since the 1990s. Instead, there is a plethora of information about numerous funds they have opened (though many of them were no doubt quietly closed), which tells me these guys are probably better at raising money than they are at managing it. These may be exactly the kinds of guys you want to be trading against!

Now that this seller is out of the market, perhaps the company's 50%+ discount to its net current assets will start to narrow again. Unless, of course, the new buyers are now looking to turn around and sell for a quick buck! Hopefully we find out who the new buyer is soon. Here's hoping that it's a value investor!

Disclosure: Author has a long position in shares of ALCS

Walking to Value

noreply@blogger.com (Saj Karsan) — Thu, 02 May 2013 10:13:00 +0000

I recently watched Jim Chanos' April 5th presentation. He provides the latest update on his China thesis, including some great commentary in the Q&A session that follows the presentation...

While I agree with Chanos' conclusions on this topic, I'm far too much of a chicken to actually short the things he's talking about. The ability of governments to lever up or print their way to growth scares me out of his short suggestions. Plus (or maybe because of that), timing these kinds of macro bets seems extremely difficult from everything I've seen/read. Nevertheless, there is a lot one can learn from this type of presentation, in my opinion.

Incidentally, this video and a lot of other great resources are available on ValueWalk.com. Keeping up with what the smartest investors in the world are talking about isn't easy, but ValueWalk does it for you. I'm always on the site looking at presentations from Berkowitz, Chanos, Ackman etc. You can subscribe to the site here.

Rise and Fall of the Third Reich

noreply@blogger.com (Saj Karsan) — Fri, 26 Apr 2013 10:21:00 +0000

The Rise and Fall of the Third Reich is a book that all policy makers should read. It details the rise and fall of Adolf's leadership of Germany, including both the external (e.g. deficits, debt, The Depression) and internal (organization, oration, trickery) conditions that allowed him to thrive.

Hitler's rise to absolute power is all the more remarkable considering Germany was a democracy at the time. Through his popularity, his suppression of opposition, and a great deal of deception, however, he was able to knock down various institutions that were meant to separate powers. By the end of his rule, he officially *was* the law; whatever he said went, even if it contradicted what was written as law.

Unlike a lot of pieces written about this period, the author manages to stay away from offering opinions on how historical events played out, instead sticking to the facts as they are recorded in captured German documents, recorded speeches, corroborated testimony and other written communications (German generals appear to have kept extensive diaries in many cases).

Nor is the book written by an outsider whose only contact with the war is through documents. Shirer was an American reporter stationed in Germany during the war. He traveled with Germany troops at times, and was often censored. When he got word in 1940 that the Nazis were building an espionage case against him (which carries the death penalty), he left.

From the secret German documents, it is pretty clear that Hitler was bent on acquiring new territories. But in public speeches, he consistently made overtures for peace, promising his intentions were benign. At the time, this fooled British Prime Minster Chamberlain, who allowed Germany to capture territory while building up its defenses. Lesson: watch what a person does, not what he says.

The book is also a reminder of how times change quickly. The author's prejudices against homosexuality are made rather clear at certain points; this is not something a credible author/reporter could do today!

If you plan to read it, set aside a good amount of time; the book is more than 1200 pages long! But well worth it, in my opinion.

EZCorp As Pie

noreply@blogger.com (Saj Karsan) — Thu, 25 Apr 2013 10:58:00 +0000

Though the rising market has definitely made it harder to find value, some companies nevertheless are falling through the cracks. I recently read a compelling case for investing in cash advance provider EZCorp here. The company trades with a P/E of 6 and debt that is offset by minority stakes in two publicly traded companies.

While the share structure leaves a lot to be desired (publicly available shares are non-voting), it's hard to argue with the company's track record. The company sets a 20% unlevered ROIC hurdle for its investments, and it appears to deliver market-beating returns year after year. Both ROA and ROE have been in the double-digits for the last 6 consecutive years, as the company has expanded both organically and through acquisition.

In the past, I've been worried about new legislative or regulatory hurdles companies in this industry might face, as the country has shifted towards left-leaning leadership. This article does a pretty good job discussing these issues, finding that such issues don't appear to be material in the near-term. At the same time, EZCorp has diversified into more states (reducing the risk that a state in which the company has a concentrated presence can hurt results), and further internationally (e.g. Mexico), where legislators have more pressing concerns than whether to suppress the freedom of willing trading partners in the consumer loan market.

There is some question though, as to whether this type of business has benefited over the last decade simply due to the appreciation in the market price of gold. Whereas gold is used as collateral on a good percentage of the company's loans, and whereas a good percentage of this collateral is often forfeited (after all, the company is not dealing with the most responsible borrowers around), the company sees great inventory gains as the price of gold appreciates.

But what happens if/when gold retreats? The company has put forth a presentation on this topic here. While the company has done a decent job diversifying away from its reliance on gold, it is undoubtedly still a big part of its business. Moreover, I'm not sure the presentation captures how the business would be affected were the price of gold to crash, and not just trend sideways or downward. Considering what happened to the price of gold last week, we may get some of management's thoughts on this issue when the company reports next week.

This one bears watching!

Disclosure: No position

Solving the Ridley

noreply@blogger.com (Saj Karsan) — Fri, 19 Apr 2013 10:03:00 +0000

Lately, some of the longest-standing names on the Stock Ideas page have been graduating to the Value In Action page. The latest stock to make this transition is now Ridley Inc, maker and distributor of animal feed products.

This relatively obscure stock has even less liquidity than you would expect for a company trading for less than $100 million (as it did when it was first brought up on this site). That's because the company is majority-owned.

While majority-ownership may normally scare investors off, in this case the majority ownership is a very good thing for minority investors. That's because the majority owner is not some manager looking to expand his empire. Nor is it some already-rich owner who cares more about prestige than generating returns. The majority owner is none other than value investing behemoth Fairfax Financial.

This kind of scenario is great for value investors! A whole bunch of things you'd normally have to worry about (e.g. excessive compensation, acquisitions at any price, questionable growth strategies) are all taken care of for you! Considering that the company traded for substantial discounts to both earnings and book value, this became a no-brainer.

Alas, Ridley now trades above its book value, having recently issued a giant special dividend. I would love to find more investments with the same characteristics as this one.

Disclosure: No position

Canam: Sold

noreply@blogger.com (Saj Karsan) — Mon, 15 Apr 2013 10:11:00 +0000

One of the longest-standing members of the Stock Ideas page is Canadian manufacturer Canam Group. Today, Canam trades near multi-year highs, and so I've sold out of my position.

Though I didn't lose money in Canam, I didn't make much either. But I sold because it has become increasingly difficult to value. And if I can't value it, I can't be sure that I'm owning it at a discount to what it's worth. A few events over the past few years made it increasingly difficult to value.

First, the company's debt has ballooned. As the company has high fixed costs, downturns can have dramatic effects on the bottom line. Canam has had to plug this gap by increasing debt from just $68 million in 2009 to $250 million today. Along with increasing risk, large amounts of debt also increase uncertainty of net worth: a small change in asset values makes for a pronounced change in equity values when leverage is involved.

The company also went on a bit of a buying binge, picking up some troubled US assets. In effect, this makes Canam difficult to value on a historical basis, as significant new assets with their own margin and return expectations were added to the company.

As the downturn picked up steam for a while, Canam also took on a number of competitively priced (i.e. money-losing) jobs just to keep the lights on. But it didn't tell investors it was doing this until after the losses came to light. Now how are we supposed to trust the reliability of backlog and other forward-looking numbers? Are backlog numbers reasonable only because management is goosing revenue by bidding below market, or are they reasonable for the right reasons? Having been kicked once, how is an investor to know?

Finally, Canam has undergone a CEO change, in replacing a guy that was at the helm for many years. Add this change to the many discussed above, and one is left with a situation where there is absolutely no predictability in how the company will perform.

Canam is up almost 20% since I first wrote about it in 2009. I'm torn about whether it belongs on the Value In Action page or the Value Fail page. While the stock is up, it has been almost four years, and therefore its returns certainly wouldn't be meeting its ex-ante hurdle rate. But at the same time it somehow didn't violate the first two rules of value investing despite an eventful four years. What do you think; in which category does Canam belong? Disclosure: No position

Barbarians at the Gate

noreply@blogger.com (Saj Karsan) — Wed, 10 Apr 2013 10:03:00 +0000

The LBO craze of the 1980s culminated in the massive buyout of RJR Nabisco in 1989. Barbarians at the Gate takes the reader through the twists and turns that finally led to the consummation of this deal.

The first one-hundred and fifty pages or so had me snoozing, and wondering what the hype around this book is all about. These early pages tell the story of how Nabisco and RJR came to be, including their respective cultures (including a dual-culture at Nabsico, thanks to a recent merger with Standard Brands, and the small-town, conservative culture at tobacco company RJ Reynolds).

But the next few hundred pages were highly entertaining. The authors do a masterful job at keeping the reader in suspense with respect to how it all plays out. The dramatic turns make the book read like fiction. But the story is 100% real, as chronicled by these Wall Street Journal writers turned author.

One of the striking lessons for an amateur investor will be the lack of shareholder consideration exhibited by all parties, including bankers, managers and directors, in dealing with this buyout. All stakeholders were clearly in it for themselves, and paid only lip-service to "shareholder value". Bankers wanted prestige, power and money; managers wanted to keep their jobs or vault into jobs of higher importance; directors sought to avoid liability while hanging onto their lucrative gigs. Investors should keep these incentives in mind when attempting to determine how various stakeholder groups will respond to future events.

Enjoy!

Karsan Value Funds: 2013 Q1 Results

noreply@blogger.com (Saj Karsan) — Fri, 05 Apr 2013 10:16:00 +0000

Karsan Value Funds (KVF) is a value-oriented fund, as described here. Due to securities regulations, the fund is not open to the public at this time. Should that change in the future, there will be an announcement on this site.

For the first quarter ended March 31st, 2013, KVF earned $1.96 per share, increasing the value of each share to $14.08. This was a record quarter for the fund, as performance handily outpaced both that of the flat Canadian markets and that of the buoyant US markets.

Helping the fund achieve this out-performance were broad-based gains throughout most of the portfolio. Gains in TAT Technologies, Artio, Dell and G. Willi-Food (discussed here, here, here and here, respectively) were strong enough such that the fund is now completely sold out of its positions in these names.

This quarter, the fund also exited a losing position in shares of SuperValu, which turned out to be a poor investment decision on my part that cost us all money. All mistakes are easy to see in retrospect, but I'm convinced this was one which I probably should have foreseen, as discussed here.

Unlike in previous quarters where results have been strong, this time currency effects did not drag down performance. Had the CAD/USD exchange rate finished the quarter at the same level at which it started the quarter, earnings per share would have been lower by 24 cents.

Despite the fund's performance this quarter, it's worth mentioning that results over small sample periods (and in this business, quarterly and even annual periods constitute *very* small sample sizes) are not to be extrapolated. Particularly as the US market has become more expensive, it has become more difficult to identify bargains, making a repeat of this quarter's results all the less likely.

KVF's income statement and balance sheet are included below (click to enlarge). Note that securities are marked to market value, and amounts are in $CAD:

GameStop: Still In Business?

noreply@blogger.com (Saj Karsan) — Thu, 04 Apr 2013 10:55:00 +0000

GameStop (GME) has been one of the more controversial stock ideas I've written up. Today, however, the stock is up almost 70% since it was first written up on this site. As such, GameStop becomes the latest company to join this site's Value In Action page.

Right from my first article on this company some three years ago (all of them are browse-able here), I began to receive a number of bearish comments on the stock. Short interest on this stock has reached upwards of 50%, with the very smart Jim Chanos among them. As a result, I think this investment illustrates some very important lessons that every value investor should remember.

First, predicting the future is hard, even when it seems obvious. Shorts saw the demise of Blockbuster, and saw the same fate awaiting bricks and mortar retailer GameStop. But predicting the timing of such events is wrought with failure. This is why low P/E investing works: today's cash flows turn out to be worth more than the future predictions.

Second, do your own research. Jumping in on the trades of other notable investors (in this case Chanos), no matter how smart they are, isn't smart investing. Even Warren Buffett has made a ton of mistakes, and will readily admit that he's right barely more often than he's wrong. If you have done your research and believe you are right, don't be afraid to go against a large number of shorts, either. It's not just longs that are subject to herding.

Third, quality management can make all the difference. If GameStop had had the same managers as Best Buy or RadioShack for the past few years, my opinion is the company would be facing a lot more trouble. Instead, GameStop's management excelled in two ways compared to its bricks and mortar peers: operations and capital allocation.

While competitors Wal-Mart and Best Buy tried to commoditize this industry by competing on price, GameStop sought other ways to add value for customers, and created itself a moat in the process. GameStop's used game business could not be replicated thanks to the network effects created by successfully executing on its first-mover advantage. (This is very similar to why eBay can dominate its market: buyers have to go there since that's where the supply is, and sellers have to go there since that's where the demand is, creating a positive feedback loop that provides pricing power and protection against competition). Management has since sought to expand on this moat by taking advantage of data gleaned from its rewards program, and by expanding the type of used product (e.g. phones, tablets) that can be sold.

Other management teams are good operationally, but then blow cash on iffy projects in an attempt to build an empire. Not so with this disciplined management team. The vast majority of free cash flow generated has been used to pay off debt and buy back shares at very cheap prices. Some technology platforms were purchased in order to hedge the company against online competition, but none of these acquisitions "bet the company" on such uncertainties. As a result, shareholders have been the chief beneficiaries of the company's performance, an occurrence which is probably not as frequent as one would expect.

While I still think the world of this management team, I sold my shares because I no longer see a margin of safety in the price. Mr. Market's sentiment appears to have turned positive on this company, which is my signal to look elsewhere!

Disclosure: No position

iGo Buy This Stock; Where Do You Go?

noreply@blogger.com (Saj Karsan) — Wed, 03 Apr 2013 10:06:00 +0000

Shares of iGo (IGOI) fell a whopping 35% yesterday, as the market soured on the company's latest financials and an announcement that a partnership with Texas Instruments (TXN) will not go forward. Value investors who are sitting on bloated cash positions thanks to the market's runup should probably take a close look at this one.

iGo generates most of its revenue selling power supplies for mobile devices. Its two largest customers, Wal-Mart (WMT) and RadioShack (RSH), account for over 40% of revenues. There doesn't appear to be anything special about iGo's products; fads do occur in this industry, but in general iGo's margins will be determined by how cheaply/efficiently it can source its products vs the competition.

There's nothing particularly attractive about this industry. Customers will mostly be interested in buying products at the lowest price possible, so all industry players basically try to source their products from Asia's most efficient producers. Expecting to earn even marginally above one's cost of capital in this business over the long-term is probably reaching.

But while the business' prospects may stink, its price is very attractive. Thanks in part to the massive panic yesterday, the company trades at an enormous 64% discount to its net current assets. That is, while the company trades for just over $7 million, it has net current assets of almost $20 million. This kind of discount to net current assets is very rare for a Nasdaq-listed company in today's exuberant market.

Of course, the company is losing money and has generated negative free cash flow in each of the last three years. But because of the large discount to liquid assets, investors who buy in at the current price are protected to some extent. Included in the net current assets is a cash balance of over $10 million against no debt and little in the way of purchase obligations (including leases).

Upside potential, on the other hand, is quite high. If the company's steps to reduce costs to be in line with lower revenues are successful (announced in early Feb), the company will probably trade closer to the level of its net current assets, resulting in substantial appreciation in the price of the stock.

To be sure, iGo faces substantial company-specific risks. If you're an investor who likes the idea of buying a net-net in this space but want some diversification, consider spreading your investment between both iGo and battery-supplier Universal Power Group (UPG). Universal Power breaks even, but also trades at a 50%+ discount to its net current assets.

Interestingly, one of iGo's chief competitors is one of its customers. RadioShack has been shifting towards private-label products to increase its own margins, and has thus replaced shelf-space previously occupied by iGo with its own products. RadioShack has been going through its own difficulties; it currently trades close to net-net territory itself. If RadioShack is able to earn anywhere close to its 2011 level, it too would see substantial price appreciation.

iGo is not for the fainthearted. It's entirely possible the company will continue to burn cash until there is nothing left. But from a risk/reward perspective, the odds look to be on the side of the investor. With such a large discount to net current assets, it wouldn't take much to go right for investors to generate a whole lot of upside, while the downside risk is priced in. As part of a diversified portfolio of similar companies, the odds would firmly be planted in the investor's favour.

Disclosure: Author has a long position in IGOI, UPG and RSH

Edumacation

noreply@blogger.com (Saj Karsan) — Wed, 27 Mar 2013 10:44:00 +0000

As for-profit education stocks have continued to fall in the face of market strength, I have become more and more interested in this sector. But every company I've come across in this space seems to have a at least one risk I'm not comfortable with. For example, Career Education Corp is dirt cheap, but could face huge liabilities from a previous life. Corinthian Colleges is also dirt cheap, but may have to seriously dilute its shareholders if a regulatory decision doesn't go its way.

As a result, I've decided to take a basket approach to this industry. Instead of picking one or two favourites, I've taken small positions in a few companies. If the industry is cheap (which I think it is), then the portfolio will probably do well even if a few falter. I would use this same approach if I was interested in the pharma space (because you don't know which company will come up with the successful drugs and which will fail) and financials (when discounts to book values are large across the industry, I couldn't tell you which banks are likely to fail and which aren't), for example.

Because many of the players in this industry have a lot of cash without a lot of debt, have beaten down valuations, and have single-digit P/E ratios despite big drops in revenue (while the cost-cutting has only just begun), I want exposure to for-profit education. I figured this was the lowest-risk way to do it.

Note that this only diversifies away company-specific risks. Overall risks, such as very stringent gainful employment regulations, will negatively affect all companies in this space. That's a risk one just has to take if one wants to benefit from the potential upside in this space.

Disclosure: Author has a long position in a few for-profit education companies

Chocolates On The Pillow Aren't Enough

noreply@blogger.com (Saj Karsan) — Fri, 22 Mar 2013 10:58:00 +0000

The Chairman of Loews Hotels tells the reader how to please the customer in Chocolates On The Pillow Aren't Enough. As the long-time chief executive of the luxury hotel chain, Tisch likely has a number of insights he can share about how Loews has identified ways to further connect with its customers and their wallets.

Unfortunately, these insights are not in this book. I was hoping for some depth on a number of innovations Loews has pioneered: how they came up with them, how they tested them, how they measured the results. This book contains none of that. Instead, the book is wide on breadth and low on depth.

Tisch briefly discusses a number of companies that have tried and succeeded (in most cases) to improve the customer experience. He uses these examples to illustrate a number of lessons for the reader, from how to welcome customers to how to provide security in a non-intrusive way to how to customize. Each lesson is summarized with a number of suggestions on improving a business' relationship with its customers, derived from these case studies.

There just wasn't a lot to these lessons in my opinion. They appeared to be mostly made up of derivations of "Do things that are successful" and "Don't do things that fail". Unfortunately, one can't tell what's going to be successful and what isn't, and in my opinion this book does not help one improve on that process. For example, Starbucks' foray into non-core activities is discussed as a method to keep its business growing. Some of these initiatives have failed, and some have succeeded. Tisch's lessons are (with my critiques below):

"The world's biggest brands are about more than just a great product" - Well, yes, but how is one to determine which new categories fit and which don't?

"It takes time, money, and a willingness to gamble to expand into a brand new business arena" - Not exactly great insight here.

"One key to success on a new business frontier may be buying the experience you need" - Yes, it may. Or, it may be a colossal failure. How about some thoughts on when M&A is appropriate?

"The perfect delivery system for one product may or may not work for a different product" - Shoot me.

If there are readers like me who are interested in a book heavy on experimentation with respect to what works on customers and what doesn't, I strongly recommend the book Why We Buy by Underhill. Note that Underhill's book is only focused on retailers, however.

Happy reading!

G. Willi Rises

noreply@blogger.com (Saj Karsan) — Tue, 19 Mar 2013 10:20:00 +0000

Just six months ago, G. Willi-Food was brought up on this site as a potential value investment. The stock has since rallied some 65%, offering investors an excellent exit opportunity.

There's nothing flashy about this company. It's not on the cutting edge of cloud computing, nor is it on the cusp of a biotech breakthrough. And yet an incredible 65% return over just six months was available for investors in this little-known developer and distributor of Kosher groceries.

Moreover, unlike investors in the hottest industries, I would argue that investors weren't even taking a big risk in this company either. If sales hadn't improved or gross margins hadn't returned to normal, investors were still protected on the downside by a sizable cash position, suggesting the return profile of this company was asymmetric (i.e. heads I win, tails I don't lose much).

Following the big price move, the company now trades at around its book value. You could make the case that the company is still undervalued, but that's just quibbling; the easiest, least risky returns have already been made.

Why do such opportunities exist? I don't really know. But they do! G. Willi becomes the latest stock from the Stock Ideas list to move to the Value In Action list.

Happy investing!

Disclosure: No position

Repeatability by Zook

noreply@blogger.com (Saj Karsan) — Thu, 14 Mar 2013 10:36:00 +0000

Chris Zook's Repeatability may be the worst business book I've ever read. It's not that this book about building enduring businesses did not make sense. Just the opposite, in fact; it made perfect sense. But to me that's why it is so potentially dangerous. It draws its conclusions (and therefore its advice) erroneously, in my opinion. But by making its conclusions plausible, it can probably convince a lot of readers to follow courses that may not be justified.

I believe the best way to elaborate on this issue is through the lens of the delusions presented in Rosensweig's Halo Effect (a business book that I highly recommend). Rosenzweig presents a number of delusions from which many business books suffer, and I believe Repeatability serves as a textbook case for these delusions.

First, the authors appear to judge companies not based on their actions, but based on their successes or failures. What I mean by this is that a company that does poorly is said to have lost "focus" on its "core", while one that has done well is said to have done so because of its "focus". If the authors could define a line delineating the difference between core and non-core, perhaps such a distinction could be drawn. Sadly, the line appears arbitrary; where companies are successful it's because they focused on their core, and when they weren't it's because they didn't!

A great example of this is Lego during the early 2000's. Lego's new CEO tried a bunch of stuff (e.g. Harry Potter figurines) roughly related to Lego's core of toy building blocks for children. This strategy failed, the CEO was dismissed, and executives, the media and authors like Zook blame the downfall on things like a lack of focus. On the other hand, had Lego not tried to expand, it likely would have seen flat/declining sales and been accused of not being innovative. There simply wasn't enough information to determine what should have been done; authors that conclude otherwise are not giving uncertainty enough credit, and are thus probably leading their readers down a faulty path.

Other delusions from which this book suffers (in my humble opinion only, of course) include attributing causation where only correlation has been established, relying on a couple of explanations when there are likely many, connecting the winning dots, and believing company performance/predictability can be boiled down to something like immutable laws of organizational physics.

Don't be fooled by books like Repeatability. Arm yourself by reading the Halo Effect if you haven't already.

Distressed Debt Analysis

noreply@blogger.com (Saj Karsan) — Wed, 13 Mar 2013 10:28:00 +0000

Equities are not the only area in which the principles of value investing apply. Investors of a value mindset can also take part in the debt market. But for most of the public debt that's out there, potential upside is low (how much above par can a company's debt trade? Not much). The situation is different for distressed debt, where securities can trade well below par. An investor who finds mis-priced distressed debt securities can therefore profit to a similar extent as an equity investor.

But distressed debt investing appears much more complicated than equity investing. Not only does one have to understand the business well enough to estimate its earnings power (as the equity investor must do), one must also understand the legal issues and motives of various other stakeholders. To help me understand these and other issues related to investing in debt from a value point of view, I recently read Distressed Debt Analysis by Moyer, which is kind of like a Securities Analysis for debt investors.

The writer compares distressed debt investing to chess, but with several opponents at once. This is because anticipating the actions of the other players is of the utmost importance. Moyer walks the reader through what the players (both large and small, and comprised of all stakeholders from employees to suppliers to debt and equity holders) can and can't do, both pre- and post-bankruptcy. In many cases, the incentives for stakeholders will be such that a court bankruptcy is undesirable. In other cases, certain stakeholders may force lengthy and costly court proceedings. Determining the future course of events (or the probabilities thereof) is crucial to being able to accurately value a distressed security.

Having read the book, I'm not sure distressed debt investing is for me. I'd much rather focus on understanding a business, determining its value, and buying and selling that business when Mr. Market offers favourable pricing. Figuring out whether supplier payables will rank ahead of my securities, or whether other securities holders within the capital structure will force bankruptcy, or what other securities holders will value a company post-bankruptcy sounds entirely too complex for me. But of course, the complexity of this area may also lead to inefficient pricing. The investor who understands this area well may be able to profit as a result.

I wouldn't call this a light read, but I would call it highly informative. Happy reading!

Value Fail: SuperValu

noreply@blogger.com (Saj Karsan) — Fri, 08 Mar 2013 11:02:00 +0000

When I brought up SuperValu (SVU) as a potential value investment a few years ago, many of you warned me against it. I wish I had listened! The grocer got squeezed on all fronts, including but not limited to: food inflation, competition, and perhaps most importantly, debt.

Given time, most problems facing a company can be handled. Food inflation hurting margins? Wait it out; figure out where you can pass on costs and where you can't; shift consumers to private label "value" products. Getting beat up by the competition? Figure out what they're doing well and copy them and close unprofitable stores.

But many of these options disappear when a company is carrying a load of debt. Shrinking down can put a company in a worse position, as the large debt burden is spread over fewer revenues. What would otherwise be temporary problems can threaten bankruptcy when financial obligations come due. Finally, a company can't spend what it needs to in order to keep up with the competition (stores get old, systems outdated etc.), which can push the company into a negative feedback cycle.

It is likely that SuperValu suffered through all of these problems as a result of its debt position. My inability to recognize this ahead of time ended up costing me. I generally stay away from levered companies; for various reasons (stability of grocery business, SuperValu's traditionally strong locations and local economies of scale, diversity of businesses/platforms), I ignored that instinct invested in SVU. Unfortunately, as the quarters wore on, sales continued to deteriorate with massive impacts on the bottom line thanks to the fixed costs of leverage.

Frankly, I'm quite happy to have been able to escape from this company at above $4/share. If there hadn't been interest in a buyout, I think this situation could have ended up a lot worse for investors. The standalone company that remains after the buyout of various assets looks just as risky, while the revenue situation continues to deteriorate. It's certainly possible new management can turn this ship around; I just have no intention of putting levered money on it! Count this one as the newest member of the Value Fail page.

Disclosure: No position

Getting Schooled By Career Education Corp

noreply@blogger.com (Saj Karsan) — Wed, 06 Mar 2013 11:01:00 +0000

The for-profit education sector has been hit hard by the market, and for good reason. This industry utilized dishonest marketing practices and drove its enormous growth using massive amounts of federal funding that was rubber stamped by public servants asleep at the wheel. But the party's now over; new rules and additional oversight have pushed many companies in this sector into the red, causing massive losses. But has the market overreacted? Perhaps in some cases. For example, Career Education Corp (NASDAQ: CECO) trades at a 43% discount to its net cash position!

While CECO has produced losses over the last couple of years, it has managed to avoid burning cash at a similar rate. Many of the company's losses can be attributed to asset impairments along with Goodwill and intangible write-downs. Future losses in some of the company's segments also appear unavoidable, but consider that in a year where the company had to adjust to a much lower revenue environment (due to drastically new regulatory compliance requirements), CECO's operating cash flow used only $17 million in 2012. Compare this to the company's $320 million net cash position (all cash less all debt) and $180 million market cap!

Management appears focused on stemming the losses by cutting non-profitable programs. Cuts initiated in the fourth quarter are expected to yield savings of over $50 million per year. In addition, the company has stopped marketing a number of its programs, choosing instead only to maintain operations required to teach existing students (so-called "teach outs"). Undoubtedly, this will have an effect on revenue; but these are likely unprofitable programs that were either eating cash or not generating decent returns on capital.

Admittedly, the earnings outlook for this company is murky, and there's no growth on the horizon. But CECO may make sense as a balance sheet investment if the losses are indeed curbed. With a tangible book value of about $400 million, the equity investor is paying just $180 million for a company with a strong net cash position that has time to turn things around and is currently aggressively cutting costs. Other companies in this space are also beaten down, but don't trade at this massive discount to net cash. Apollo (NYSE: APOL), Corinthian (NASDAQ: COCO), ITT (NYSE: ESI), Strayer (NASDAQ: STRA), and DeVry (NASDAQ: DV), for example, all trade at premiums to cash, and in many cases substantially so!

There are some caveats of which investors need to be aware, however. Much of the tangible book value is made up of computer hardware/software, furniture and leasehold improvements, which are of little value if operations turn further south. But it's difficult to tell just how much these components are included as property, because depreciation numbers aren't broken down by type of capital item.

Another worry is the company's litigation situation. This company has made a lot of enemies over the years. It is being sued by students, investors, employees, the federal government, and state governments. If that wasn't enough to scare you, there is also an SEC investigation that is ongoing, and the Education Department is conducting an inquiry concerning violations of misrepresentation regulations. All of the events causing these issues occurred when this was essentially a different company; nevertheless, the liabilities are very real.

A good portion of the company's cash is also spoken for in the form of deferred revenues. As revenues fall, as they certainly will as "teach-outs" are implemented, some of this spoken-for cash will disappear and not get replaced.

Finally, the company also has a number of operating leases expiring way out into the future. These total almost $640 million, though the company is working on trimming this number. Another downturn in operations, or a lack of ability to meaningfully cut costs, would make these fixed costs loom large.

Unfortunately, estimating the final cost of these liabilities is difficult to impossible. As such, this company is far from a sure thing, discount to cash or not. Nevertheless, it is clear that Mr. Market is trading this company as if it has no future. The company's substantial cash holdings, however, suggest the upside to such an investment is higher than the downside is low. Each investor will have to come to his own conclusion about the return profile of this investment.

What do *you* think?

Disclosure: No position

Heidrick & Struggles

noreply@blogger.com (Saj Karsan) — Fri, 01 Mar 2013 11:18:00 +0000

I like buying into businesses with variable cost structures. These kinds of companies have somewhat of a protected downside; when things go south, costs can be removed such that the firm may remain profitable, subject to a period of adjustment. Executive search firm Heidrick & Struggles (HSII), which saw its shares fall 20% on Tuesday, appears to have such a model.

Heidrick trades for under $250 million despite a net cash position of almost $120 million and cash flow from operations of over $100 million over the last four years. As you might expect, demand for its services (recruitment of C-level personnel) rises and falls sharply with the business cycle, which can cause heavy volatility in the stock price.

This is exactly the kind of situation in which a value investor might be interested: a volatile stock for a company whose downside is protected in the form of a flexible cost structure. The flexible cost structure is the result of fact that most of the expenses in this firm are made up of consultant labour costs. If your revenue no longer justifies carrying these consultants, they can be let go. Such is not the case when your labour costs come in the form of unions or pensions, for example, or when a large part of your costs are otherwise fixed (e.g. in the case of leases or plant machinery).

But while Heidrick may seem like an ideal stock in theory, in practice it's not exactly working out that way. The company has seen its per-share book value (adjusted for dividends) grow by just 3.8% per year over the last 10 years.

My theory for this disconnect is that the firm is run for the benefit of its employees, rather than its shareholders. The value created due to the beneficial characteristics of this industry appear to accrue to management/consultants.

The evidence is overwhelming. The company has managed to lose money in 5 of the last 11 years, despite the fact that annual revenue per consultant is over $1 million. This suggests that it is shareholders that bear the brunt of the volatile nature of this business. The share count was flat over this period, despite some heavy buybacks, as employees have benefited handsomely from options and restricted shares.

Finally, despite the poor returns on book value, the company is a serial acquirer of other businesses. Just last quarter, the company dropped 6x EBITDA on another consulting firm, spending almost one quarter of its current market cap on the transaction!

While Heidrick is undoubtedly cheap, it may not be cheap enough for a value investor to put up with such shareholder-unfriendly actions. Neither competitors Korn/Ferry (KFY) nor Insperity (NSP) seem to suffer from the same problems. Unfortunately, one currently has to pay a premium for these superior companies.

Disclosure: No position

Filings Notification (Canada and US)

noreply@blogger.com (Saj Karsan) — Wed, 27 Feb 2013 11:07:00 +0000

I'm excited to announce some new features on conferencecalltranscripts.org. The grandest new feature is the ability for users to receive notifications not just when a company has a new transcript, but when it issues a new filing as well. This applies for Canadian and US companies for now. As far as I know, this is the only place where you can get free notifications when Canadian-listed companies make regulatory filings; hopefully you find this feature as useful as I have! Click the "Get Notified" tab on the homepage to create/edit your portfolio (or click here) and select whether you want to receive notifications on filings.

In addition, some functionality was added so that you can opt to receive notifications on transcripts only when the transcript is free. Quite a few event transcripts cost more than $100 to purchase, and if you don't want to be notified when such a transcript exists, you now have that option on your portfolio page.

And finally, you can now fit (hopefully?) your entire portfolio onto the site. Restrictions have been removed such that you can now add up to 50 companies into your portfolio.

So to summarize, conferencecalltranscripts.org is now a site where you can view company filings and earnings call transcripts (no matter where they may be on the web), get notified when a new transcript/filing is issued (for up to 50 companies), and choose to receive notifications only when free content is available.

As always, if you have any more suggestions on how the site could be more useful to you, please let me know!