Monthly Archives: February 2012

GTIV – a long over due explanation and criticism

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GTIV is a provider of home health care services and hospice care in the US. I first bought the stock in mid August, when the entire world was hating the company for around $7.40/share.

The stock was down more than 50% in the last few weeks and about 70% since its March highs.

The sell off was caused by a flurry of headlines related to medicare/caid cuts as the government struggled with its budget issues. More specifically, there were allegations that GTIV staff had geared patient treatment in a manner that would ensure maximum reimbursement, regardless of whether or not treatments were necessary.

The high debt load further contributed to the sell off as investors questioned if reduced margins resulting from government crackdowns would prevent the company from servicing its debt.

While these concerns were valid, i decided to buy the stock for three reasons.

First, i think the long term defensibility of the industry is sound. It is a demographic fact that the US has an aging population, and this population will need care.

Second, while quantitatively I was intimidated by the debt load, qualitatively I reasoned that lenders would work with the company to adjust the terms of the debt rather than allowing the company to default. My thinking was that financial institutions were in the cross hairs of EVERYONE – politicians, talking heads, occupiers etc. There was no way that a lender would want to see a front page headlines saying, “Bank Forces Seniors to Give Up Care” or something like that. Basically, there was headline risk for the banks if they did anything other than work with GTIV and its contemporaries.

Third, since its founding, GTIV has rolled up several smaller businesses. In a crunch, these businesses could likely be sold off in order to meet debt servicing needs.

I felt reasonably confident in the above analysis, so I initiated a small position with plans to dive deeper into the industry. Initially the stock began to drift higher, causing me to delay digging deeper and reinforce my hypothesis.

However, within a few weeks the stock had dropped another 50% to a low of $3.02 and the airwaves were alive with talk of a potential bankruptcy.

While i was strong enough to not panic and sell my shares, i was not strong enough to back up the truck and really start aggressively buying shares… a costly mistake considering that the stock has since rallied more than 150%.

In summary – while I agree with Klarman’s comments that if you wait until you have done 100% of the analysis before buying you may lose the opportunity, in this case not following up on my original analysis prevented me from having the strength to buy when it really mattered. A mistake that I won’t be making again.

Buffett Partnership Letters – January 1965

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http://www.ticonline.com/buffett.partner.letters/1965.01.18.pdf

In 1964, the Dow was up 18.7% while the partnership was up 27.8% – this was the poorest out performance since 1959, a year that saw similar returns for the Dow. It is always harder to outperform a rising market.

As always, Buffett compares his performance to the largest mutual funds. He goes on to list possible reasons that these institutions are seemingly unable to outperform the Dow.

1) group decision making may limit the ability to out perform
2) there may be a desire to conform to what other portfolio managers are doing – (ie no one ever got fired buying IBM)
3) “average” is safe – the rewards for independent action are not commensurate with the risk attached to this action
4) adhering to irrational diversification practices
5) inertia

He goes on to discuss the difference between “conventional” and “conservative.”

True conservatism comes from intelligent hypotheses, correct facts, and sound reasoning. This may lead to conventional action, but many times it will lead to unorthodoxy.

A public opinion poll is no substitute for thought – “we derive no comfort because important people, vocal people, or great numbers of people agree with us.”

Decides to go to 4 investment categories rather than 3 – “Generals” are no split into “Generals – Private Owner Basis” and “Generals – Relatively Undervalued.”

Generals – Private Owner Basis – Quantitatively identified and qualitatively justified. He likes good management, he likes a decent industry, and he likes a certain amount of “ferment” in a previously dormant management or shareholder group. There is often nothing to indicated immediate market improvement. The main qualification is bargain price.

These securities are expected to appreciate either by external forces or by taking a control position.

Generals – Relatively Undervalued – securities selling at prices relatively cheap to compared to securities of the same general quality. Because of large size (usually) the idea of value to a private owner is not a meaningful concept.

Apples to apples comparisons are essential.

Tries to buy something at 12x earnings when comparable or poorer quality companies sell at 20x.

Mentions that he has found a way to minimize the risk that an overall change in valuation standards takes place…. could this be just a spread trade? ie shorting the 20x and buying the 12x?

Taxes – more detailed discussion than usual – taxes are a part of life – you have to either pay taxes, give stocks away, or hope that you lose your gains.

Buffett Partnership Letters – July 1964

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http://www.ticonline.com/buffett.partner.letters/1964.07.08.pdf

The first half of 1964 saw the Dow return 10.9% – the partnership returned about the same. As always, Buffett reminds us that it is more difficult to outperform rising markets.

The first half was an active buying period – Buffett considers the buying end to be about 90% of the business – ie – price matters!

The general category includes three positions where the partnership is the largest owner. 1 of these they have been buying for 18 months – the other 2 they have been buying for a year. “It would not surprise me if we continued to patiently buy these securities week after week for at least another year, and perhaps even two years or more.

side note: They started the year with ~$17M – or approximately $120M in today’s dollars. Assuming the 3 positions were large – 20% positions even though they likely weren’t – means $24M per investment in today’s dollars – means that investments like this today would likely be less than $100M market cap.

Buffett goes on to say that best case in situations like above the company makes progress in terms of improving earnings, increasing asset values etc, but the market price of the stock does nothing while he continues to acquire it.

This doesn’t help short term performance – especially relative to a rising market – but it produces long term profits.

Buffett Partnership Letters – January 1964

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http://www.ticonline.com/buffett.partner.letters/1963.12.26.pdf

Partnership was up 38.7% vs 20.7% for the Dow.

Buffett reminds us that it would have still been a good year if the partnership was down 20% but the Dow was down 30%.

After 7 years, the partnership has beaten the Dow by a 17.7% margin. Buffett emphasizes that this spread is not attainable over any long period of time. A 10% edge would be very satisfactory, and we can expect years when the spread is much narrower and even negative.

To illustrate the power of compounding, Buffett uses an example of the Mona Lisa, which was originally commissioned for $20,000 in 1540. If this $20,000 had been put in an investment with a 6% after tax yield, it would now be worth $1,000,000,000,000,000.00 or $1 Quadrillion dollars.

This is intended to end all discussion of buying a painting as an “investment.”

To illustrate the power of compounding and the importance of time and rate of return:

Buffett believes that the Dow itself has returned higher than can be expected over the last several years, and cautions that his own returns will likely be lower – however, as the table demonstrates, even lower returns can be very profitable when allowed to compound.

Goes through the 3 categories – generals, workouts, controls – once again.

Generals – quantitative first, but qualitative important. Will likely track the market during down years, and outperform during up years.

Workouts – getting the last nickel after .95 has been made, but they are reasonably predictable.

Control – do not want to be active merely for the sake of being active. However, when an active role is necessary to optimize the employment of capital, you can be sure we will not be standing in the wings.
Active or passive, in a control there should be a built in profit – this comes from an attractive purchase price. Once control is achieved, the value of the investment comes from the value of the enterprise, not the irrationalities of the market place.
If the market changes its opinion for the better, the security will advance in price. If it doesn’t, we will continue to acquire stock until we can look to the business itself rather than the market for vindication of our judgement.
Controls must be viewed the basis of at least several years – for this reason, a wide margin of profit is essential.

If anything, Buffett thinks that controls will take up a larger portion of the portfolio – they are currently the smallest part.

WATCHLIST – SUMR

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With revenues growing from 68.1M to 194.5M in FY10 and 182.8M YTD11 SUMR has been a rapidly growing designer and distributor of branded infant health, safety, and wellness products. Spending on infants is a retail segment less likely to be impacted by any downturn in consumer spending, although a quick google search shows that SUMR’s products appear to be priced at the high end.

The company’s growth has been primarily fueled through acquisition as laid out below:

4/1/08 6.5M for Basic Comfort 4/21/08 12.4M for Kiddopotamus 7/22/09 for Butterfly Living 12/8/09 for Classy Kid Inc 3/28/11 for Bornfree Holdings

The acquisitions were paid for with borrowed money and company stock, which resulted in shares outstanding growing from 11.2M to 15.5M and long term debt growing from 4M to 52M from 2005-2010.

This externally funded growth and accumulation of debt may be explained by the fact that management’s discretionary bonus is based on EBITDA – with an extra emphasis on “before interest.”

On the bright side and probably outweighing management’s questionable bonus incentive is the fact that insiders own more than 21% of the company – specifically the CEO owns almost 20%.

The company sold off hard in early January when they provided updated guidance for FY11 of $238M in revenues and EPS in the range of .42 – .44 / share, a disappointed vs. 2010 FY earnings of .46/share and a clear disruption of the company’s growth trajectory.

So. The question becomes – is this temporary setback in growth an opportunity to pick up a growing retailer at a discount?

A steady state business probably deserves a valuation of 10x EPS, and SUMR is hardly a steady state business despite recent performance. At current prices of 4.80/share it is trading at ~11x the midpoint of FY guidance – cheap at a glance.

A quick over view of the company shows attention to innovation which is attractive as well.

However, the company is facing wage and cost inflation, and while they are attempting to build a moat through brand recognition, it is not there yet. They have a limited amount of distribution through a hand full of retailers, and any change in status w/ one of those retailers could really hurt the top line.

Furthermore, the company is not producing FCF in any reliable way – although if you back their acquisitions out of the FCF the story changes a bit.

I do find roll ups with increasing debt loads interesting however because at some point the market begins to price in a default due to the debt, while the nature of the roll up provides assets / business lines that could be potentially sold off to pay off the debt. I don’t think this is overly likely at this point, but if the company stumbles through next year, it will be worth taking a look.

For now, I’ll put the name on my watch list with a $4 wake up and maybe take a deeper look as the company approaches 9x 2011 expected eps.

JNGW – Special Situation

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On 2/16 JNGW announced that their Chairman and CEO would like to take the company private. In order to de-list the shares, JNGW must reduce its number of share holders to below 300. In order to accomplish this, there will be a 1 for 20,000 reverse split. Shareholders owning less than 20,000 shares will be cashed out for $2.20 / share.

I was able to buy 5,000 shares at $1.90/share on the day the transaction was announced.

Assuming that all goes according to plan, I will receive .30 / share or $1,500 on my $9,500 investment – an almost 16% return.

Not bad for a relatively low risk situation.

The company anticipates the transaction will be completed sometime in the 2nd quarter.

RSH earnings

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RSH announced earnings pretty much in line with their disappointing guidance from 3 weeks ago. Not really much new although the company did comment that they anticipate Q1 2012 will be more challenging than Q4 2011.

They continue to deal with margin compression as their sales blend rotates toward lower margin smart phones and mobility as a whole, and they continue to point to changes in the way Sprint finances their phone upgrades as a drag on performance.

Also of note was a question on why the dividend hasn’t been cut – something I have wondered myself. The company has a strong history of returning capital to shareholders through dividends and buybacks, but recently cut their buybacks only months after raising their dividend. Personally, at these prices I’d rather see buy backs than dividends. Regardless, the company danced around the question and said they had no plans to cut the dividend as of now, but I have to believe (hope?) that it is a very real possibility.

I’m still optimistically hoping the company can turn its self around.

KSWS earnings.

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KSWS reported -.70 vs -.42 estimate but is not comparable as there is some junk in there related to writing down goodwill etc. Q4 revs were way coming in at 50.2M vs 41.4M expected. 2012 rev guidance is lower than expected at $240-$250M vs estimates of $270M.

My immediate reaction is that I wish I had sold at $4 a few weeks ago and locked in a 23% gain – that is what Burry would have done.. but my inner Pabrai tells me that turn arounds take time, the brand has value, liquidity is not a concern, and I need to hear the con call to understand what is happening with the Palladium brand… not to mention it is worth holding on for the long term tax rate.

Side note – I have been thinking more about the importance of moats and margins of safety lately – it is probably inappropriate to mention Pabrai’s name in the context of this investment.

I have been thinking more about how I want my portfolio to look (eventually – assuming I am able to dedicate more time looking for investments rather than playing the chicken w/ no head game as a sales trader) and I am starting to like the idea of 5% for initial investments, with room to average down into a 10% investment if the stock sells off more than 33%. This would be only for companies with strong earnings history, low debt levels, and identifiable moats.

I would still like to leave some room for companies like KSWS – companies with less predictability stuck in some sort of turn around situation etc – but they should be more 1-2% positions combining to be no more than 10-15% of the portfolio.

Much to think about as always.