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The Inoculated Investor
http://inoculatedinvestor.blogspot.com/
2010 Value Investing Congress: May 4th and 5th in Pasadena, CA
DAY 1
Speaker #1: Paul Sonkin from Hummingbird Funds
Fund Background:
Hummingbird focuses on microcap value and is modeled on Buffett-Graham Partnership. Focuses on
$200M and below--usually around $100M; could have over 100 names in the portfolio.
Tarsier Nanocap Value Fund: Focused on the wild, wild west of the investment management world. This
fund focuses on companies with market caps in the $15M range.
The micro and nanocap areas offer great opportunities for investors now. These sectors underperformed
during the nuclear winter. A decade of neglect has been compressed into 2 yrs. Private market values
exceed public market values by a large margin. Traditional managers have become too large and too scared
to take advantage of these opportunities. Therefore, people willing to look at this space are left with a
potential for superior returns with less risk. Huge premium you are getting paid for due to illiquidity--a
result of there being so few investors in this space.
Hummingbird takes larger positions (greater than 5%) because it makes it easier to influence management
and can influence the outcome of their investment. Focus on firms with a single or a small number of
niches because they are easier to evaluate than firms that are in 10-15 businesses. Also, management is
much more accessible
The goal is to maintain patience and a rational, disciplined approach to value investing. Try not to fall into
the trap of style and market cap drift. Manage risk by diversification.
5 factors they look at:
1. Potential upside (discount to intrinsic value)
2. Can you estimate intrinsic value?
3. Certainty of outcome
4. Timing-how long does it take for the gap to close?
5. Margin of safety
3 areas in which they believe they can develop an edge---these 3 are absolutely critical:
1. Information edge
2. Analysis edge
3. Trading edge
Other managers screen out (as a result of institutional constraints) the kind of stocks they look for and this
limits competition because others are looking for liquidity. This gives them a huge pond to fish in. There
are 5000 candidates that don’t file with the SEC and trade on the pink sheets that are on their radar. With
companies with market caps over $1B, there are probably only 2000 companies. So they have a lot of
stocks to look at without having to compete with hedge funds. They can get information by monitoring the
company’s website. Also, they produce simpler financial statements to look over and there are fewer buy
and sell side analysts covering the stocks. This allows them to get information that other don’t have. But,
they have to be in the market every single day because of the wide bid-ask spread. It is a very trading
oriented strategy.
Looking for catalysts- internal and external:
Internal (things that increase intrinsic value): things that increase ROIC, improving B/S
External (things that help close the gap between intrinsic value and price): takeout, new analyst coverage
Goldman Sachs:
“Having read the complaint, I think GS did do it”
The Inoculated Investor
http://inoculatedinvestor.blogspot.com/
Investment Ideas:
Steinway Musical Instruments (LVB): $17.99
•
Piano, band business, real estate are main assets
•
Stock is up 100% off of its lows but still has a
long runway to go before it is at fair value
•
Recent events:
o
Increased ROIC,
o
Reduced working cap by closing
facilities—now making more money
with less investment
o
Improved their balance sheet by taking
on an Asian partner.
•
Asian partner should help with distribution in
Asia--should be the growth driver
•
Bought back stock, debt and paid dividends
•
Great management capital allocators
•
Activist on the board
•
Piano business will improve as the economy improves along with margins
•
As margins recover then EBITDA should recover as well
•
Band business- negative competition from Asia killed margins
o
Led to negative operating margins
o
Company has outsourced production to China and has closed US operations;
Question: Does Yamaha compete with Steinway in Asia?
They are not competitors in the luxury markets-- only on the lower end of the business. If you are going to spend $100K on a piano you buy a Steinway. 30% are retrofitted as player pianos (bought by people who can’t play the piano)
Question: Pricing power for Steinway, do they have it in band or piano?
The company increases it piano prices 4% every year like clockwork. Some years they sell more pianos and some years they sell fewer. In the band business they have pricing power to some extent. Their brand name gives them some pricing power.
Question: How do they look Steinway’s real estate value?
They only place a value on it if there is an intention to sell. But they not going to sell in this market. They have excess space that they do not need and it does provide an extra margin of safety up to $50-$75M if something goes wrong.
SouthPeak Interactive Corp. (SOPK.OB):$.30
•
Develops and publishes
video games for Xbox,
Nintendo Wi, etc
•
Value investors in the video
game business
•
Was a former SPAC
•
$18M market value
•
Could do a $100M in
revenue over the next year
or two
•
Volume has picked up over
The Inoculated Investor
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the past couple of months
•
Former founder had 3M shares and was blowing out shares-- dumb seller
•
Make a lot of money on their sequels
•
Did a messy acquisition, had to take some charges, had some legal problems
•
Had poor IR until recently and no analyst coverage
•
Will introduce 20 games in the next year
•
Catalysts:
o
Earnings shine through
o
Big seller is out of the market
o
Big line up of games should drive growth
Dyna Group International (DGIX.PK):$.80
•
Make knick knacks--licensed goods
from the NFL, NBA
o
Shot glasses, spoons, belt
buckles
•
Have been in the business for 30
yrs---not fly by night and have a long
history
•
Founder owns 50% of shares
•
Dirt cheap on normalized earnings
•
Market cap (with only 7M shares)
less than $7M
o
Can earn $2M a year of with
an EV of $5M
•
Long term value-- no catalyst but the company will recover
•
They could buy back stock or the owner could decide to sell the company--that is the exit strategy
Question: What the success profile percentage in the portfolio?
Out of 10 stocks 2 blow it out, 2 crash and the ones in the middle do OK. The problem is that you don’t
know which are which ahead of time
Question: How do they go about assessing capital allocation of these firms?
Mechanically, you just look at the cash flow statement. You go to the proxy statement and look at
management compensation. They always look at the section called related party transactions.. Get into a
dialogue with mgmt at maintenance CAPEX, growth CAPEX and potential acquisitions--interviewing
management teams is an art.
Question: Market making activities--why do they do that?
Their partner makes a market for them. If they are on the bid then it is a stock they are fine buying and if they are on the offer it is a stock they willing to sell. Need to be in the market each day just in case they need the liquidity--in 4 or 5 days they can get in and out of most positions.
Question: Do they invest in roach motels? How do they stop redemptions?
Not investing in roach motels. When they are buying stock they are often competing with management who is buying back stock. So they get a surprising amount of liquidity. They were able to get liquidity and cover redemptions during the crisis. They can also sell the company back some shares directly--may not get the best price but they do get liquidity
Question: When you hold 100 stocks, how do you get comfortable about underlying advantages of each
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