Monthly Archives: July 2010

Closing ValueHuntr Portfolio

We are winding down our ValueHuntr Portfolio, which we started during the depth of the financial crisis. The portfolio was created as a way to test our investment opinions in what we considered was a sea of market bargains with no willing buyers. Through the portfolio we also tested our ideas on Special Situations, consisting mostly of companies trading at a fraction of their net cash value where there was a clear catalyst for value creation, such as an activist position or a voluntary liquidation approval. Obviously, those opportunities are no longer around today. Out of 17 positions we added to the portfolio, 14 were profitable. The maximum loss among the 3 negative positions was 4%, and one of them was a hedge.

 The main reason behind our decision is that we are embarking on additional projects which make it impossible for us to hold an equities portfolio while preventing future conflicts of interest. Stocks that would have otherwise been added to the portfolio will be profiled in our monthly newsletters from now on. Aside from the portfolio section, the blog will continue to operate as normal.

Charlie Munger: “Li Lu Is Buffett’s Investment Successor”

Mr. Li, 44 years old, has emerged as a leading candidate to run a chunk of Berkshire’s $100 billion portfolio, stemming from a close friendship with Charlie Munger, Berkshire’s 86-year-old vice chairman. In an interview, Mr. Munger revealed that Mr. Li was likely to become one of the top Berkshire investment officials. “In my mind, it’s a foregone conclusion,” Mr. Munger said.

Twenty-one years ago, Li Lu was a student leader of the Tiananmen Square protests. Now a hedge-fund manager, he is in line to become a successor to Warren Buffett at Berkshire Hathaway Inc.

Mr. Li was born in 1966, the year Mao Zedong’s Cultural Revolution began. When he was nine months old, he says, his father, an engineer, was sent to a coal mine to be “re-educated.” His mother was sent to a labor camp. Mr. Li’s parents paid various families to take him in. He was shuttled from family to family for several years until moving in with an illiterate coal miner, with whom he developed a close bond, in his hometown of Tangshan. Living apart from his family as a child taught him survival skills, Mr. Li says.
He was reunited with his family, including two brothers, by age 10, when a massive earthquake hit his hometown, killing an estimated 242,000 people in the area, including the coal miner and his family. His nuclear family was spared, he says, but “most of the people I knew were killed.”

From left to right: David Sokol of MidAmerican, Warren Buffett, Wang Chuan-Fu of BYD and Mr. Li.

At the time, he says he had no direction and was fighting in the streets. Mr. Li says his grandmother, who was among the first women in her city to attend college, inspired him to begin reading and studying. He later attended Nanjing University, majoring in physics.

Mr. Li’s investing strategy represents a significant shift for Mr. Buffett: Mr. Li invests chiefly in high-technology companies in Asia. Mr. Buffett typically has ignored investments in industries he says he doesn’t understand.

Li Lu (far right) with Chinese student leaders at Tiananmen Square in June 1989.
Mr. Buffett says Berkshire’s top investing job could be filled by two or more managers who would be on equal footing and divide up responsibility for managing Berkshire’s $100 billion portfolio. David Sokol, chairman of Berkshire unit MidAmerican Energy Holdings, is considered top contender for CEO. Mr. Sokol, 53, joined MidAmerican in 1991 and is known for his tireless work ethic.
In an interview, Mr. Buffett declines to comment directly on succession plans. But he doesn’t rule out bringing in an investment manager such as Mr. Li while still at Berkshire’s helm.

Greenlight Capital, Viking Global Quarterly Letters

Hedge funds that performed poorly for the quarter are once struggling to explain to their investors why they struggled and others didn’t. The typical explanation goes like this: “It’s not us, it’s the market”. To read the most recently published letters (Viking Global and Greenlight Capital) see below.

Viking Global

Greenlight Capital

The Doom Loop

According to Roubini, for the past 40 years debt has been increasing at a rate out of all proportion to the underlying rate of economic growth. This increase in relative debt burdens is quite unhealthy and has created an ever-lower interest rates to prevent economic calamity followed by an ever-increasing severity of financial crisis, the Doom Loop.

What is the doom loop? It is the unstable, crash-prone boom-bust lifestyle we have now been living for some 40 years, where a cycle of cheap financing and lax regulation leads to excess risk and credit growth followed by huge losses and bailouts. With interest rates near zero everywhere, the doom loop seems to have hit a terminal state where debt deflation and depression are the only end game unless serious reform measures are taken. Recovery or not, weak consumer spending will last for years.

Bruce Berkowitz Places Big Bets On Financials

(Dow Jones)

Well-known mutual-fund manager Bruce Berkowitz is still betting on the U.S. financial sector, saying he recently accumulated a stake in Morgan Stanley (MS).

Berkowitz told Dow Jones Newswires on Wednesday that he started buying shares of the investment bank in the second quarter and now holds a stake amounting to just under 2%. That makes his Fairholme Fund (FAIRX) a Top 10 holder in the company with slightly more than 25 million shares.

“It’s a powerful franchise…that has been under the weather with most other financials in the United States,” Berkowitz said. “It’s a company that’s well run and is resuscitating itself with a significant global presence. And the price was right.”

A spokesperson from Morgan Stanley wasn’t able to confirm the stock purchases and declined to comment further.

Morgan Stanley shares closed up 6 cents to $27.01. It shares have dropped 11% over the past three months and are down a little more than 1.5% over the past 12.

Berkowitz recently has been betting on stocks often seen as risky–ones that are undervalued and preferably throw off a lot of cash. He is best-known as manager of the Fairholme Fund, which has $14.7 billion in assets and holdings that also include Citigroup Inc. (C) and Bank of America Corp. (BAC). His investment in Morgan Stanley, worth about $700 million, makes up about 4% to 5% of the fund.

Earlier this month, Berkowitz disclosed a boosted stake in American International Group Inc. (AIG), as well as a hefty holding in MBIA Inc. (MBI). Both companies’ shares jumped on the news, taken by other investors as a sign of continued confidence in the U.S. financial sector.

“While we don’t know how much money we will make for shareholders, we believe we aren’t going to lose money with these institutions,” Berkowitz said, adding he’s investing in financial stocks for the long haul.

Berkowitz said Wednesday that while a double-dip recession is possible, it’s not probable and that it’s the “nature of recovery to have fits and starts.”

He added that “it has never been a good idea to bet against the United States and its people.”

Berkowitz also expressed confidence in MBIA’s management team and said the company still provides a valuable service as a municipal bond insurer–something that’s necessary despite the investment community’s doubts.

“MBIA still, in my opinion, has a franchise, and it has the right people to lead the company back to past glory,” Berkowitz said. “And most importantly for [Fairholme's] 400,000 shareholders, we believe it has the cash to sustain the business.”

Berkowitz also said MBIA’s transformation plan appears to be progressing on track and that the company’s separation of divisions was the right choice.

MBIA split off National Public Finance Guarantee, its public-finance business, as part of an attempt to restart its business of selling financial guarantees on bonds issued by cities, water authorities and other public-finance entities. Its main unit was left with fewer claims-paying resources for its troubled mortgage exposures, which caused banks, investment funds and other policy holders to balk at the plan and file litigation against MBIA.

Still, Berkowitz said he expects the restructuring litigation to be resolved by the end of the year. He also said he would “love to find ways to further help the company beyond buying shares in the open market,” including taking actions to strengthen MBIA’s balance sheet.

As for AIG, Berkowitz said he continues to believe the government can eventually sell its stake in the troubled insurer, and a clear exit path should be established by the end of 2011.

“The history of our country and the history of capitalism is not a smooth, easy path,” he said. “Given what the country has just been through, I can see and feel the recovery. But it’s still going to take some time.”

Doom & Fear

We are delighted to introduce our latest monthy newsletter: Doom & Fear. Our most exclusive monthly report, the newsletter is ideal for sophisticated investors. It focuses on market-driven fears, panics, black swans, and doomsday scenarios playing out in the market. In a world where abnormal has become normal, the report provides investors with the clarity needed to take advantage of irrational market fears. As an added bonus, the report includes our own Doom & Fear Index, which aims to provide investors with a unique trading and market-timing tool.



Newsletter Preview

Our monthly newsletters ValueFocus and ValueEdge will be published a week from today. The 14th Issue of ValueFocus will have the following content:













The Gold Pandemic: From Fever to Malaise

A Ticking Time Bomb

The Lost Decade of 2010-2020

Old-Timers Do It Best

Top Activist Opportunities

Top Arbitrage Opportunities


Rocky Mountain Chocolate Factory (RMCF) – Valuation & Strategy Update

Rocky Mountain Chocolate Factory (RMCF), one of the stocks still part of the ValueHuntr Portfolio,  also one of our favorite investments, recently held an earnings call where management updated shareholders on the company’s future plans and strategy. Some of the updates, along with an updated valuation, are posted below.

Revenues and Earnings

For the three months ended February 28, 2010, revenues increased 13.6 percent to approximately $8.8 million, compared with approximately $7.7 million in the fourth quarter of the previous fiscal year. Same-store sales at franchised retail locations increased 1.4 percent in the fourth quarter of FY2010, while same-store pounds of factory products purchased by franchisees increased approximately 0.3 percent, when compared with the fourth quarter of FY2009.

The Company reported net income of $1,200,000 in the fourth quarter of FY2010, which represented an increase of 15.4 percent when compared with net income of $1,040,000 in the fourth quarter of FY2009.

Basic earnings per share rose 17.6 percent in the fourth quarter of FY2010 to $0.20, while diluted earnings per share increased 11.8 percent in the fourth quarter of FY2010 to $0.19, when compared with $0.17 and $0.17, respectively, during the fourth quarter of FY2009.

Although net income declined 3.7 percent for the fiscal year, we still generated an after-tax return on beginning shareholders’ equity (ROE) of approximately 27.0 percent – well above the ROE of the typical U.S. Corporation. Simply put, this company is a cash-generating machine.

Co-Branding With Cold Stone Creamery

During the past year, Cold Stone and Rocky Mountain Chocolate Factory have partnered to create co-branded stores that have increased sales and franchise owner profitability.

According to Dam Beem, CEO of Cold Stone Creamery, the co-branding partnership with Rocky Mountain Chocolate Factory was designed to leverage the complementary seasonality of both brands and maximize store operations throughout the year. The partnership drove same-store sales increases of 14% to 16% during the colder and typically slower winter months and outpaced industry averages during the down economy. Because the initial 13 Cold Stone and Rocky Mountain Chocolate Factory co-branded locations exceeded projected profitability, the program was expanded to additional Cold Stone franchisees to incorporate the premier confectionery brand into their stores.

Co-Branding Expansion

On the latest call, Rocky Mountain management indicated that the pace of co-branded store openings had accelerated from 1 store during the first fiscal quarter of 2010 to 7 in the first quarter of fiscal year 2011. According to Franklin Crail, Rocky Mountain CEO, the pace of co-branded openings will accelerate even more in the quarters to come.

To date, 25 stores have either opened or been converted to the Rocky Mountain Chocolate Factory/Cold Stone Creamery co-branded concept, and management has identified several hundred CSC stores that they believe have the potential to be converted in coming years. The increase in cash flow generated by incremental sales at the co-branded stores appears to provide a return on investment sufficient to attract a growing number of CSC franchisees to the co-branding opportunity, and the number of cobranded stores is expected to increase significantly in the current fiscal year. At the end of fiscal 2010, RMCF’s retail store network consisted of 313 franchised Rocky Mountain Stores, 11 company-owned stores, and 19 stores cobranded with CSC.

Dividends and Buybacks

Because franchise growth does not require a lot of cash, Rocky Mountain has been able to return a significant share of its earnings to shareholdelrs. RMCF began paying cash dividends in 2003 and has increased its dividend payout ten (10) times during the past six years.  The current dividend of $0.40 per share provides investors with a current yield of 4.2% based on a recent stock price of $9.55.  Additionally, the Board has approved a repurchase program of up to $3.3 million of company stock, roughly 6% of all the shares in the company.


Incorporating a lot of the provided updates in our analysis, we estimate the company is worth at least $11 per share. A range of outcomes is possible based on macroeconomic conditions and the execution of the co-branding partnership with Cold Stone. My analysis suggests a worst case scenario (stress test) of $7.7 per share, and $12.7 in the most optimistic case.


Investment Payoff

 We have concluded that our investment in RMCF is of very low risk, as the probability of a catastrophic loss of capital is remote. We have plotted the range of possible outcomes in what we call a “symmetry plot”, to evaluate whether or not the odds of positive return are in our favor. In the case of RMCF, it is evident that we would break even as long as we have a 30% or greater chance of predicting the right outcome.


 Disclosure: I own shares of RMCF in my personal portfolio

Exclusive Discount To Value Investing Congress

This is a reminder that we are  offering our readers an exclusive $1,800 discount for the 6th Annual Value Investing Congress, taking place October 12 & 13, 2010 in New York City. This offer expires in 8 days, so get your ticket now using dicount code: N10VH4

The Value Investing Congress is the place for value investors from around the world to network with other serious, sophisticated value investors and benefit from the sharing of investment wisdom. The world-renowned presenters of successful investors present timely investment ideas, examine key concepts of value investing, and reflect on past misjudgments to help you become a more successful investor.

This year’s presenters include:

  • David Einhorn, Greenlight Capital Management
  • Lee Ainslie, Maverick Capital
  • John Burbank, Passport Capital
  • J Kyle Bass, Hayman Capital
  • Mohnish Pabrai, Pabrai Investment Funds
  • Amitabh Singhi, Surefin Investments
  • J. Carlo Cannell, Cannell Capital
  • Zeke Ashton, Centaur Capital Partners
  • Whitney Tilson & Glenn Tongue, T2 Partners

…with many more to come!

The Next Great Bailout: $1 Trillion for Underfunded Pension Funds

The federal government will likely face another round of massive bailouts if the current state of pension funds persists.

A recent study by the Pew Center on the States found that at the end of fiscal year 2008, there was a $1 trillion gap between the $2.35 trillion states and participating localities had set aside to pay for employees’ retirement benefits and the $3.35 trillion price tag of those promises.

According to the study, to a significant degree, the $1 trillion gap reflects states’ own policy choices and lack of discipline: failing to make annual payments for pension systems at the levels recommended by their own actuaries and expanding benefits without fully considering their long-term price tag.

But besides all the politics, a basic problem is an assumed 8% or greater expected investment return over time – the most common assumption for state pension funds. Simply put, it is unrealistic to count on such investment yields, especially during this extended period of high unemployment and lack of global aggregate demand.

According to Bill Gross, we are in a “new normal” which consists on slow growth in the developed world, insufficiently high levels of consumption in the emerging world, and “seemingly inexplicable low total returns on investment portfolios – bonds and stocks –lie ahead”.

But just how low?

Gross says that 4-6% annualized returns for a diversified portfolio of stocks and bonds is the likely outcome. If he is correct (I presume he is) states will be forced to go to the federal government for help. The State of New Jersey’s pension fund (which assumes a 8.75% investment yield) would run out cash for benefits by 2020 if there were no new contributions. But we would first hear from the Illinois Pension Funds, as it would run out of cash by 2017.

The price of promising pensions that states cannot afford will probably lead to the federal government stepping in.  On a positive note, it may force us to move back to basics: we might only get as much money as we put into the system, and no more.