Entries categorized as ‘Investing’

The Best Company in America

January 5, 2010 · 5 Comments

We typically post investment ideas that we like enough to add to our portfolio. However, we have not been able to find a lot of bargains out there lately, so we’ll start posting ideas that are close to meeting our requirements.

A Valuehuntr near miss is Church & Dwight Co. Inc. (CHD). CHD is one of those boring companies we would love to own. It also happens to be the largest producer of sodium bicarbonate (baking soda) in the world, and likely one of the best run companies in America.  The company was founded in 1846, and (as Coca Cola) it still uses the original company formula today.

The company develops, manufactures, and markets a range of household, personal care, and specialty products under various brand names in the United States and internationally.  Its top brands include ARM & HAMMER, TROJAN, and OXICLEAN.  The company meets a lot of the characteristics we look for when searching for good businesses, such as wide barriers to entry and great management, but the stock seems overvalued, which is the reason why it has not been added to the Valuehuntr Portfolio. Although CHD is not being added to our portfolio, we will like to highlight the company anyway.


The company operates in three segments: Consumer Domestic, Consumer International, and Specialty Products.

The Consumer Domestic segment offers household products for deodorizing, such as ARM & HAMMER baking soda, cat litter products, laundry/cleaning products, and consumer care products such as TROJAN condoms and ARM & HAMMER deodorants and toothpaste.  The Consumer International segment sells the personal care products highlighted above in international markets, including France, the United Kingdom, Canada, Mexico, Australia, Brazil, and China. Finally, the Specialty Products segment produces sodium bicarbonate, which it sells together with other specialty inorganic chemicals for a range of industrial, institutional, medical, and food applications. This segment also sells a range of animal nutrition and specialty cleaning products. Operating data for FY 2004-2008 is shown below.



The core product of the company has historically been baking soda, which is used in products within every business segment. The main advantage of baking soda is in its versatility of use. For instance, it is estimated that 95% of US households have a product containing baking soda at their home. Baking soda is not only used for cooking, but it is also an active ingredient in tooth paste, laundry detergents, pool cleaners, fire extinguishers, chemotherapy machines, deodorants, among many others.

(For more information about the versatility of baking soda, we recommend reading: “75 Extraordinary uses of Baking Soda”)


  • Market share gains:  Throughout the financial crisis, CHD has been the only company in the home and personal care products sector that has seen its weighted average market share increase, according to ACNielsen.
  • Better manufacturing: new $170m plant is slated to open in York, PA, by the start of 2009 Q4, replacing an older factory in Brunswick, NJ. It’s expected to be at least 25% more efficient than the old location.


  • Manufacturing Advantage: The baking soda manufactured by CHD is more than 99% pure, which requires proper materials, equipment, and personnel training.
  • Government Regulation: baking soda must meet the requirements specified by the FDA as a substance that is Generally Recognized as Safe (GRAS). Distribution of baking soda is prohibited unless the product meets the GRAS specifications.
  • Supply Advantage:  soda ash deposits at the Green River Basin are large enough to meet the entire world’s needs for baking soda for thousands of years.
  • Cost Efficient: mining operation in the Green River is less expensive for production of soda ash than the synthetic soda ash process that predominates in the rest of the world.


We could use DCF to come up with company value estimates for the next few years to perpetuity. Instead, we’ll make our lives simpler by assuming the company will be able to generate earnings equal to at least its 3-year average EPS. The two quick calculations we show are the value of CHD with no growth, and its value with growth assuming terminal growth roughly equal to historical U.S. GDP.

PV = (Avg. 3-Yr EPS)/WACC = $35/share

EPV= (Avg. 3-Yr EPS)(1+G)/(WACC-G) = $63/share

(Assuming WACC~7%, G=3%)

Currently trading at $61/share, these quick calculations show the company may be currently trading at the top of its valuation range. Additionally, the stock price implies a 5.3% earnings yield, which is only slightly higher than the 4.6% 30-Year T-bill. Based on this price, there are likely other opportunities where investors could get a better return for their money. This is mainly the reason why CHD has not been added to our portfolio.


In our view, there are two things every potential investor should take a closer look at before investing in CHD.

1)     Cost of Raw Materials: the cost of soda ash, surfactants, diesel fuel, corrugated paper, liner board and oil-based raw and packaging materials used in the household and specialty products businesses  are not hedged (only diesel fuel costs for transportation are).

2)      Off-Balance Sheet Liabilities: Pension Plan was underfunded by USD -14mm in 2008 based on a discount rate of 6.58%. Company’s Post Retirement Benefits Plan was also underfunded by USD -22mm (We were not able to find 2009 numbers).


CHD has one of the best independent boards in America. This is evident in the governance policies the company has developed over the years for executive compensation.  Over the years, the rewards given to company executives have been highly correlated with the stock price, as shown below.



Church & Dwight operates and manages some of the most trusted brands in the world. Although the company is not trading at a bargain price, the earnings generated from its assets are protected by wide competitive advantages expected to continue in the future. The level of usage and versatility that CHD baking soda enjoys is hard to replicate, but because the stock is a bit too pricy we are not adding CHD to our portfolio.


Categories: Analysis · Investing · Value Investing
Tagged: america, arm & hammer, barriers to entry, best company, CHD, church & dwight, compensation, competitive advantage, moat, obama, sarah palin, Value Investing

For Global Investors, ‘Microfinance’ Funds Pay Off — So Far

August 13, 2009 · Leave a Comment

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By Rob Copeland (WSJ)

Investing in funds that make small loans to third-world borrowers has been lucrative the past 12 months. But the weak global economy has some investors worried about trouble ahead.

The $30 billion industry, partly made up by small lenders on the ground financed by bigger microfinance investment funds, has been expanding its lending at a 40% to 50% annual pace over the past five years, according to the Consultative Group to Assist the Poor, a research institute hosted at the World Bank.

Those microfinance funds have returned 4.47% for investors the past 12 months, according to a benchmark index, compared with a 22% loss by the Standard & Poor’s 500-stock index.

While the inflow of funds from the Western world has allowed lending to boom to small borrowers in poor countries — from India to Bosnia to the Ukraine — it’s also sparked worries that too much money is chasing too few loans.

“As soon as we reach a certain limit, we will see more [loan] defaults,” said Jacques Grivel of the Luxembourg-based $100 million Finethic fund, which invests in microfinance world-wide.

Already more than 100 investment funds are focused on microfinance, typically accepting money from targeted individuals or institutions, usually with a minimum of $10,000. The funds then buy the bonds or stocks of small, local banks in mostly third-world countries. These banks then lend money to tiny entrepreneurs at annual interest rates up to 50%.

Not everyone is persuaded the industry is hitting a barrier. They argue that the business is still in its infancy, and $30 billion of loans is a drop in the bucket compared with the needs.

Bob Annibale, head of a Citigroup Inc. unit that advises local microfinance lenders, said his clients are “aware of what’s happening in their markets and the challenges.” They have halved their lending pace, and are taking a harder look at potential borrowers, he said.

Meantime, fund managers, spurred by the surge in investor interest, are launching new funds. Dexia Bank’s $500 million Micro-Credit Fund has added $100 million in the past year and MicroVest Capital Management, a Bethesda, Md.-based company, is starting a new fund this fall.

Alex Hartzler, a Harrisburg, Pa., entrepreneur, put $750,000 into funds run by MicroVest. “This has outperformed everything else I’ve had,” he said.

Microvest’s first fund has averaged 8% annual returns since 2003, according to the fund manager.

Microfinance is largely unregulated, and lending standards remain relatively opaque. Since most U.S.-based funds aren’t registered investment companies, they aren’t subject to Securities and Exchange Commission oversight.

It’s tough to get solid data about loan performance at microfinance firms. According to the Consultative Group to Assist the Poor, the accepted default rate is around 2%. By comparison, a U.S. subprime-mortgage default rate is closer to 30% for loans 90 days past due or in foreclosure.

However, the International Association of Microfinance Investors, which attempted to verify the 2% default rate this month, said the rate could actually already be much higher, since bookkeeping by many local lenders is incomplete.

Gustavo Moron, business manager for Financiera Edyficar, a small Peruvian bank that specializes in lending to small-business owners, said he’s being pinched between stiff competition and the flailing economy. In cities like Cusco, at the foot of the Andes Mountains, Mr. Moron is slashing monthly interest rates to 1% from 3% to salvage repayments from taxi drivers, artisans and tour guides who aren’t making money because of weak international tourism.

As returns are shrinking, he finds himself taking chances he hasn’t before. “We’re loaning to people we wouldn’t have two years ago,” Mr. Moron said in a phone interview from Lima.

Categories: Investing · News
Tagged: emerging markets, funds, Investing, microfinance, WSJ

Does Stock-Market Data Really Go Back 200 Years?

July 17, 2009 · Leave a Comment

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By Jason Zweig (WSJ)

As of June 30, U.S. stocks have underperformed long-term Treasury bonds for the past five, 10, 15, 20 and 25 years.

Still, brokers and financial planners keep reminding us, there’s almost never been a 30-year period since 1802 when stocks have underperformed bonds.

These true believers rely on the gospel of “Stocks for the Long Run,” the book by finance professor Jeremy Siegel of the Wharton School at the University of Pennsylvania that was first published in 1994.

Using data assembled by other scholars, Prof. Siegel extended the history of U.S. stock returns all the way back to 1802. He came to two conclusions that became articles of faith to millions of investors: Ever since Thomas Jefferson was in the White House, stocks have generated a “remarkably constant” average return of nearly 7% a year after inflation. (Adding inflation at 3% yields the commonly cited 10% annual stock return.) And, declared Prof. Siegel, “the risks of holding stocks decrease over time.”

There is just one problem with tracing stock performance all the way back to 1802: It isn’t really valid.

Prof. Siegel based his early numbers on data first gathered decades ago by two economists, Walter Buckingham Smith and Arthur Harrison Cole.

For the years 1802 through 1820, Profs. Smith and Cole collected prices on three dozen banking, insurance, transportation and other stocks — but ended up including only seven, all banks, in their stock-market index. Through 1845, they tracked 19 insurance stocks, but rejected 95% of them, adding only one to their index. For 1834 onward, they added a maximum of 27 railroad stocks.

To be a good measure of stock returns, an index should be comprehensive (by including many stocks) and representative (by including the stocks commonly held by investors). The Smith and Cole indexes are neither, as the professors signaled in their 1935 book, “Fluctuations in American Business.” They cherry-picked their indexes by throwing out any stock that didn’t survive for the whole period, whose share prices were too hard to find or whose returns seemed “inflexible,” “erratic,” or “non-typical.”

The database of early U.S. securities at EH.net has so far identified more than 1,000 stocks that were listed on 10 different exchanges — including Charleston, S.C., New Orleans, and Norfolk, Va. — between 1790 and 1860. Thus the indexes relied on by Prof. Siegel exclude 97% of all the stocks that existed in the earliest years of the U.S. market, and include only the bluest of the blue-chip survivors. Never mind all of the canals, wooden turnpikes, rubber-hat companies and the other doomed stocks that investors lost millions on — and whose returns may never be reconstructed.

There is a second problem with Prof. Siegel’s data.

In an article published in 1992, he estimated the average annual dividend yield from 1802-1870 at 5.0%. Two years later in his book, it had grown to 6.4% — raising the average annual return in the early years from 5.7% to 7.0% after inflation.

Why does that matter? By using the higher number for the earlier period, Prof. Siegel appears to have raised his estimate of the rate of return for the entire period by about half a percentage point annually.

Prof. Siegel calculated in his 1992 article that $1 invested in stocks in 1802 would have grown, after inflation, to $86,100 by 1990. In his book just two years later, however, he estimated that $1 in 1802 would have mushroomed into $260,000 by 1992. But in 1991 and 1992, stocks gained 30.5% and 7.6%, respectively, which should have taken the cumulative return up to only about $121,000. Nearly all of that huge difference seems to have come from Prof. Siegel’s revised number for early dividends.

“I made an estimate of the dividend yield,” Prof. Siegel told me, “through looking at a smaller set of securities and projecting it out.” Money manager Robert Arnott of Research Affiliates LLC has recently estimated the early dividend yield at 5.2%. “Arnott has a much lower estimate, and that’s a big difference,” said Prof. Siegel. “I mean, I don’t know what more to say.”

I later called Prof. Siegel to ask him again about the difference between his original research and his book, but he didn’t get back to me by press time.

What, then, are the odds that stocks will continue to lag behind bonds for the long run? The sad truth is that history can’t tell us the answer. The 1802-to-1870 stock indexes are rotten with methodological flaws. So we have only the period since then, or four distinct and complete 30-year stretches of stock returns, to base our long-term investment decisions on.

Another emperor of the late bull market, it seems, has turned out to have no clothes.

Categories: Academic · Investing · News
Tagged: Stocks, performance, jason zweig, bonds

Dryclean USA Inc. (AMEX: DCU)

July 13, 2009 · 1 Comment

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Dryclean USA Inc. (AMEX: DCU) has been added to our ValueHuntr Portfolio. The company operates a simple laundry and dry cleaning equipment business with a market value of approximately $6 million. According to the latest SEC filings, the company has $1.9 million in excess cash with a stable earnings stream and growing revenues. We estimate that the company is worth anywhere between $7 million to $9 million, which means that the company is trading at a 20 to 50 percent discount to its intrinsic value. Though undervalued, the company’s effective corporate governance is what really attracts our attention.


Together with its subsidiaries, DCU supplies commercial and industrial laundry and dry cleaning equipment, and steam boilers in the United States, the Caribbean, and Latin America. The company distributes commercial and industrial laundry and dry cleaning machines and steam boilers manufactured by others manufacturers. It also designs and plans laundry and/or dry cleaning systems to meet the layout, volume, and budget needs of various institutional and retail customers; and supplies replacement equipment and parts to its customers.

The commercial and industrial laundry equipment distributed by the company features washers and dryers, including coin-operated machines, boilers, water reuse and heat reclamation systems, flatwork ironers, automatic folders and feeders. The Company’s dry cleaning equipment includes commercial dry cleaning machines manufactured by others under the company’s Aero-Tech®, Multi-Jet® and Green-Jet® names, as well as garment presses, finishing equipment, sorting and storage conveyors and accessories distributed for others.

The Company currently employs 33 employees on a full-time basis, of whom 3 serve in executive management capacities, 13 are engaged in sales and marketing, 9 are administrative and clerical personnel, 3 are in service, and 5 serve as warehouse support. None of the Company’s employees are subject to a collective bargaining agreement.

Quick Valuation

We believe the company is a well-managed business selling for lower than our estimates for intrinsic value. The company is currently trading at a 10 multiple relative to FY 2008 earnings. However, the company holds nearly $1.9 million in excess cash, for a normalized earnings multiple of 7, or approximately 14 percent earnings yield. Our quick estimates indicate the company could be worth anywhere between $7 to $9.4 million, which correspond to a discount of 20 to 50 percent relative to today’s market value of approximately $6 million.


Off-Balance Sheet Arrangements

The company has no off-balance sheet arrangements.

Corporate Governance

We believe the company has excellent corporate governance principles because management interests are directly aligned with the interests of shareholders. Executives and Officers of DCU own approximately 67% of all outstanding shares.  As it should be, officers have an invested interest in enhancing shareholder value: they will never make money unless shareholders do.

Furthermore, DCU has no plans or arrangements with any Executive Officers which provide for the payment of retirement benefits, or benefits that would be paid primarily following retirement, other than the Company’s participatory Section 401(k) Profit Sharing Plan which is a deferred compensation plan under which the Company matches employee contributions up to 2% of an eligible employee’s yearly compensation.  

Also, the company has no contracts, agreements, plans or arrangements that provide for the payment in the future to any company executive following or in connection with his resignation, other termination of employment or a change in control of the company.

The company’s five directors each receive a fee of $5,000 per annum with the exception of the chairman, which receives $10,000 per annum for his services.

Finally, the Chairman role is occupied by an independent officer.

Possible Catalysts

Last December, DCU received a proposal from members of the Steiner family, the principal stockholders of the company, to acquire all of the outstanding shares of the company’s common stock for $0.85 per share. However, the Steiner family later withdrew the proposal without providing the reasons. We believe that the company will eventually merged with companies under the control of the Steiner family, but it is impossible to know just when.


We believe the company is a well-managed business selling for lower than our estimates for intrinsic value. Even if a merger with businesses under the Steiner family never occurs, we believe there is great value in DCU due to its superior management, stable earnings stream, and its low-risk operations (no leverage).

Disclosure: We own DCU shares.

Categories: Investing · Value Investing
Tagged: dryclean USA, Value Investing

Failure of a Fail-Safe Strategy Sends Investors Scrambling

July 10, 2009 · Leave a Comment

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By Tom Lauricella (WSJ)

Carl Mahler stood before a group of fellow financial advisers recently and voiced frustration and fear that a fundamental tenet of investing had been proved wrong.

“Hi. My name is Carl, and I’m a recovering asset-allocationist,” the Raymond James Financial adviser quipped.

Asset allocation, a bedrock of investing for decades, appeared to fail miserably in 2008. The conviction shared by most investors — that they should spread their money across myriad asset classes to minimize losses — was shaken as nearly all markets tumbled in unison.

The financial crisis has sent many financial advisers, academics and investors back to the drawing board. Mr. Mahler told the group he was rewriting the playbook he had followed for much of his 41 years in the markets. “Asset allocation did not work,” he says. “Everything went into the abyss.”

Many investors came away from the carnage believing that last year was an anomaly — that, in times of severe stress like that experienced in 2008, disparate markets will all tumble together as investors scramble to sell whatever they can and move into cash.

But a number of influential investors and analysts, from managers of massive funds such as Pacific Investment Management Co., or Pimco, to those at small school endowments, argue that asset-allocation strategies are fundamentally flawed. This wasn’t a one-off failure, they say, but one that’s been long in the making.

“You were increasingly seeing a breakdown” of perceived relationships between asset classes, says Mohamed El-Erian, co-chief investment officer at Pimco. “And that was way before the latest phase in the markets, which accentuated the problems.”

Investors like Mr. El-Erian contend that the problems warrant rethinking those relationships to account for broad changes in the global economy and financial innovations that change the way people invest.

Not everyone agrees. Last month, Fidelity Investments issued a report to clients defending the strategy. “Diversification didn’t fail in the recent market downturn. It worked — just to a lesser degree,” the report said.

A Simple Concept

On the surface, diversification is a simple concept: Combine investments that don’t move up or down at the same time, or at least by the same degree. The goal is to smooth out returns, to hedge portfolios against big losses on single investments, and to position investors to benefit if one corner of the market posts outsize gains.

Diversification spawned a whole range of investment options. Among the most popular are target-date mutual funds, which offer a mix of stocks and bonds tailored to the investor’s age, wealth and risk tolerance. Some investors in these funds lost so much money last year that they would have been better off putting their money into a stock-index fund.

By the time the Standard & Poor’s 500 stock index hit its recent low on March 9 — a decline of 47% from a year earlier — nearly four dozen target-date funds had done even worse, including funds from Goldman Sachs Group, OppenheimerFunds and Alliance Bernstein. At Fidelity, one of the leaders in such funds, the Freedom 2050 Fund lost 48% in the 12 months ended March 9.

The theory of asset allocation emerged in the 1950s when economists such as Harry Markowitz, who would later win a Nobel Prize for his work, developed mathematical models for ways to improve investment portfolios.

Along the way, asset allocation became ingrained in nearly every corner of Wall Street. For brokers, tinkering with asset allocations was among the basket of services for which they charged clients flat fees year after year. Pension-fund consultants built a lucrative business screening money managers.

For mutual-fund companies, asset allocation was a cornerstone of their buy-and-hold philosophy, which helped them hang onto assets. They expanded their businesses beyond plain-vanilla stocks and bonds to funds that reaped higher fees. Target-date funds have become the centerpiece of most 401(k) plans.

Yet in recent years, while Wall Street was promoting diversification and formulas that purported to capitalize on it, the relationships among asset classes were changing. Investments that weren’t supposed to move in sync, such as stock markets on opposite sides of the globe, had begun moving in similar ways. That reduced the benefits of diversification through asset allocation.

Correlation is a statistical measure of the degree to which investment returns move together. Between 1991 and 1994, the correlation between the S&P 500 index and high-yield bonds was low, at 0.2 or 0.3, according to Pimco statistics. (A correlation of 1 means returns move in perfect sync.) International stocks had a correlation with the S&P 500 of 0.3 or 0.4, and real-estate investment trusts had a correlation of 0.3, according to Pimco data. Commodities showed little correlation to U.S. stocks.

By early 2008, investment categories of just about every stripe were moving significantly more in sync with the S&P 500. The correlation on international stocks and high-yield bonds rose to 0.7 or 0.8, and real-estate investment trusts to 0.6 or 0.7, according to Pimco’s data for the previous three years. Commodities were showing a slightly negative correlation — returns were moving in opposite direction — of 0.2 or 0.3, the data indicate.

Then came the meltdown of 2008. In a year when the S&P 500 lost 37%, the MSCI index of major markets in Europe, Asia and Australia lost 45%. The MSCI emerging-markets index fell 55%. Real-estate investment trusts declined 37%, high-yield bonds lost 26% and commodities fell 37%.

At Pimco, the firm’s head of analytics, Vineer Bhansali, points to commodities as an example of how diversification strategies can break down. Even as stocks and bonds struggled in early 2008, commodity prices were in the midst of a historic rally. Wall Street rolled out research showing the lack of correlation between stocks and commodities.

But that history didn’t take an important point into consideration. Prior to this decade, investing in commodities was a complicated process due to the complexity of the futures markets. The advent of exchange-traded mutual funds, or ETFs, allowed investors to buy and sell commodities with the click of a mouse. By the summer of 2008, ETF investors had poured billions into commodities in just a few months.

As the financial crisis worsened and stock and bond prices collapsed, ETF investors who needed to raise money found it easy to bail out of commodities, too. That contributed to a 37% drop for 2008 in the Dow Jones AIG Commodities Index.

“When people start buying an asset, the act of them diversifying ultimately makes the asset less of a diversifier,” says Pimco’s Mr. Bhansali.

Louis Morrell, who until this month oversaw Wake Forest University’s entire $1 billion endowment, felt this firsthand in the school’s portfolio.

A $90 million portion of the endowment, called the Tactical Fund and still managed by Mr. Morrell, held everything from commodities to emerging-market and big-cap stocks. Mr. Morrell, involved with money management since 1968, had honed a strategy based on the idea that you could have a portfolio filled with investments ordinarily considered risky and volatile — but if they didn’t move in sync, you could have higher returns without higher risk. For many years, it worked, even during bear markets. During 2001, for example, the Tactical Fund lost 0.1% while the S&P 500 dropped 15%.


Last June, the Tactical Fund had nearly 30% invested in commodities, 16% in emerging markets, 19% in other non-U.S. stocks, and 24% in U.S. stocks — investments that historically didn’t move much in tandem.

“We got clobbered,” he says. The Tactical Fund lost 44% last year and the overall endowment fell 25%. Late last year, he and his team began working on a new allocation strategy. Rather than treating large-cap U.S. stocks, emerging-market stocks and international stocks as separate categories, the team put them under one “stocks” umbrella. They also switched their view on commodities and gold, which they felt were linked more to inflation than to stocks.

The Tactical Fund still has a healthy slug of commodities as an inflation hedge, and emerging-market stocks now make up 24%. Corporate and government bonds account for 14% of the portfolio, down from 42% at the end of March. Thus far, the new approach is paying off. The Tactical Fund is up 14% this year, through Tuesday, compared to a 2.5% drop in the S&P 500.

“The old strategies were mathematically correct and gave a sense of a lot of discipline,” Mr. Morrell says. However, “they were too backward-looking.”

At Ibbotson Associates, a Chicago firm specializing in asset-allocation strategies for big investors such as pensions and mutual funds, chief economist Michele Gambera also has gone back to the drawing board. It’s been a topic on his mind for the past two years, he says, but 2008 heightened his scrutiny. “There have been reasons to question diversification, no doubt about that,” he says. “It’s been humbling.”

Mr. Gambera says a telling picture emerges by tracking performance during extreme market moves. He found that many investments can do more damage on the way down than they do good on the way up.

Since 1973, in months where U.S. stocks rose more than 6%, European stocks rose on average by three-quarters as much, and Japanese stocks by half as much, according to Ibbotson.

But when the U.S. market fell by more than 4.5% in a month, Europe and Japan tracked the declines far more closely. Stocks in Europe on average posted declines equaling 86% of the U.S. drop, and in Japan, 66%. Real-estate investment trusts matched about half of the U.S. market gains in the best scenarios, but two-thirds of the declines.

“Even if it’s important to add an investment for diversification, people have to consider the costs,” he says. “And we’re learning that there are a lot of implicit stock-market bets in a lot of asset classes.”

As Mr. Gambera sliced and diced the numbers, he concluded that only a few asset classes besides cash proved to repeatedly help a portfolio during a sharp decline. He determined that in the 45 months since 1973 where the U.S. stock market lost more than 4.5%, gold produced positive returns 71% of the time, and intermediate-term government bonds, 67% of the time. During the 20 big monthly declines for stocks since the launch in 1997 of Treasury Inflation Protected Securities — government bonds whose payout is adjusted for inflation — TIPS provided gains 85% of the time.

As a result, Mr. Gambera says, Ibbotson is now recommending bigger holdings of U.S. Treasurys for certain clients.

Hard Lesson

At Raymond James, Mr. Mahler also has retooled the way he builds portfolios. This was no easy decision, he says. Even after the bear market that ended in 2002, he didn’t make any changes to his models.

“It’s what I lived and breathed,” he says. He is keeping the basic structure of his portfolios, but he’s adding money managers with a go-anywhere mandate, including actively betting against stocks by going short.

He is coupling that with greater cash holdings in accounts. His goal is to make a portion of clients’ portfolios more flexible, while at the same providing a greater cushion for whenever stocks next decline.

He says he is convinced there is a way to make diversification work. In fact, after the strains of last year, he says, many investments are behaving more like they did before 2008.

Asset allocation, he says, “might well have been injured….But I don’t think it’s gone forever.”

Categories: Analysis · Investing · News
Tagged: asset allocation, diversification, Value Investing

Update: Life Sciences Research (LSR) to be Acquired in Going Private Transaction; Valuehuntr Exits Position

July 9, 2009 · 2 Comments

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Life Sciences Research, Inc. (LSR) announced today that it has entered into a definitive merger agreement to be acquired by Lion Holdings, Inc., an entity controlled by LSR’s Chairman and Chief Executive Officer, Andrew Baker, for $8.50 per share in cash. Mr. Baker currently beneficially owns approximately 17.5% of the outstanding shares of LSR.

On our March 16, 2009 post, we specified that LSR was a special situations play with a high probability of realization. We also pointed out that this was not a long-term play, as its mediocre earnings power did not make it a long-term value candidate. We are now closing our position on LSR, for an absolute return of 20%.

Under the terms of the merger agreement, LSR stockholders, other than Mr. Baker and his affiliates, will receive $8.50 in cash for each outstanding share of LSR common stock, representing a premium of approximately 77 percent over LSR’s closing share price of $4.79 on March 3, 2009, the last trading day prior to public announcement of Mr. Baker’s initial March 3, 2009 proposal to acquire the Company for $7.50 per share. The $8.50 per share purchase price also represents a premium of 13% over Mr. Baker’s initial proposal, and a premium of 18% over LSR’s closing share price of $7.18 on July 8, 2009, the last full trading day prior to today’s announcement.

A Special Committee consisting of LSR’s independent directors was charged with evaluating strategic alternatives for the Company and unanimously recommended approval of the merger. Based upon this recommendation, LSR’s Board of Directors (with Andrew Baker and Brian Cass abstaining), approved the merger and resolved to recommend that LSR stockholders approve the merger.

Lion Holdings, Inc. has secured equity and debt financing commitments that provide for the necessary funds to consummate the transactions contemplated by the merger agreement. The transaction is expected to close in the fourth quarter of 2009 and is subject to certain closing conditions, including approval by LSR stockholders.


Categories: Arbitrage · Investing · Special Situations · Update
Tagged: andrew baker, LSR, Merger, ValueHuntr


April 22, 2009 · 3 Comments

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We are adding dELiA*s, Inc. to our ValueHuntr Portfolio. DLIA is a company selling for $58M, with 67% of its current assets in the form of cash or cash equivalents. The company’s net current asset value of $47M represents nearly 87% of the total shareholder equity, and it is significantly below our intrinsic value estimate of 115M.


On November 5, 2008, the DLIA completed the sale of its CCS business to Foot Locker. The company received aggregate cash consideration of $103.2 million for the sale of the CCS assets and assumption of certain related liabilities. This transaction significantly strengthened the DLIA’s balance sheet and recapitalized the company at a time when financial flexibility and liquidity is important.


The use of the sale proceeds has not been fully determined, but given the success of recent Delia’s store openings, we expect management to take advantage of retail opportunities within its core Delia’s brand and reduce general administrative expenses.



dELiA*s is a direct marketing and retail company comprised of two lifestyle brands – dELiA*s and Alloy – primarily targeting the approximately 33 million girls and young women that, according to published estimates, are between the ages of 12 and 19, a demographic that is among the fastest growing in the United States. The dELiA*s brand is a collection of apparel, sleepwear, swimwear, roomwear, footwear, outerwear and other accessories. The company currently operates 97 stores across the US, including 13 opened in 2008.





Value of Assets


At yesterday’s closing price of $1.87, the company’s working capital represented nearly 50% of the total shareholder equity. Moreover, the company’s net current asset value of $47M represents 87% of the total market price.


We estimate the company’s assets are valued at $115M, or $3.70/share, with cash representing nearly 45% of the company’s total assets.




The $103M in pre-tax earnings received from the sale of CCS assets increased the company’s equity by 18%, greatly enhancing shareholder value.





Value of Earnings


The P/E ratio of 4 analysts assign to the company is misleading, as it is clear that DLIA’s profitability in 2008 was masked by extraordinary income that would otherwise have caused the company to report a loss as in previous years.


The company was profitable in 2008 only due to the cash received from the discontinued operations of its CCS assets. If this sale is excluded, the company would have recorded a loss of nearly $13M, which is consistent with historical income results. Weinclude the cash received from this sale in our asset valuation, as equity is greatly improved due to the increase in current assets. However, we exclude the profit received from these discontinued operations in our earnings valuation.


In the 10K filed on April 16, 2009, DLIA reported a revenue growth of 7% (including both direct marketing and retail businesses) and an average same store sale growth of 2.8%, even in the challenging economic environment. However, expenses grew by 11%. The direct marketing business accounted for 102M in revenues in 2008, or 47%, while retail accounted for 53% of total revenues.


On average, DLIA has achieved an 8% annualized growth in revenues. However, these higher revenues have been offset by an average annual expense growth of 11%.




SG&A expenses have historically ranged from 61% to 66% of total sales. The company’s COGS have ranged from 42% to 45% of total sales. Our analysis indicates that the company would need to reduce general administrative expenses to 60% of total sales and COGS to 38% of total sales before the company becomes profitable. This means that the company’s management would need to significantly reduce its variable costs before we put a value on its earnings.







We think that DLIA is a case where the sum of its parts is significantly greater than the current value the market is placing on the company. Our analysis indicates that the company could become profitable by reducing its SG&A expenses to 38% of sales and its COGS to 60% of sales over the years. Obviously this estimate is assuming that expenses continue to climb at a similar rate they have historically relative to total sales. We believe this is a conservative estimate, as revenues have the potential to increase at a faster rate after the recession ends and consumers return to their old shopping habits. But because the company is not currently profitable, we rather not take the potential of future earnings into account in our intrinsic value estimate.


We believe the company’s assets are worth at least $115M, or $3.70/share, which is more than double the current market price of $58M, or $1.87/share, and this is placing no premium on the prospects of future earnings and assuming all warrants are exercised.




Disclosure:  The ValueHuntr portfolio does not represent an actual portfolio, and it is tracked for informational and educational purposes only. We do not have an actual holding in DLIA. This is not a recommendation to either buy or sell any securities.

Categories: Investing · Valuation · Value Investing
Tagged: delias, DLIA, nasdaq, Value Investing

Pershing Square Annual Report

April 1, 2009 · Leave a Comment

Pershing Square Capital Management LLP is a value-based hedge fund with a concentrated portfolio of securities. On January 22, 2009, Pershing Square presented their investment results for 2008, and provided their investors with a confidential report, which we are now posting for our readers.


Pershing Square widely outperformed the S&P500 index for the year, and is now up 160% since 2004. Pershing Square is a great example of how a value-based strategy can be employed on both the long and short side of the trade with a concentrated portfolio.  Pershing is known for purchasing undervalued businesses and for shorting businesses whose intrinsic value is much lower than what the market reflects. For Pershing Square, shorting is not a hedging strategy, but rather a way of creating value for their investors. Pershing’s funds hold an average of 8 to 15 holdings at a time. This allows them to focus only on their best ideas, which in turn decreases their investment risk.


The report can be downloaded here.

Categories: Investing · News · Value Investing
Tagged: annual report, concentrated portfolio, long, Pershing Square, short, Value Investing

Trident Microsystems Inc. (NASDAQ:TRID)

March 31, 2009 · 14 Comments

We are adding Trident Microsystems to our ValueHuntr Portfolio. TRID is a company whose stock is trading substantially below its net-cash value. According to its latest SEC filing the company held nearly $212M in cash with $56M in total liabilities, for a net-cash value of $156M as of December 31, 2008.  However, TRID’s market price is only $95M, nearly a 60% discount to its net cash.



TRID is a leader in integrated circuits for Digital Television. While its products are used in all kinds of displays, LCD television is its most important growth market as LCD televisions take share from plasma in the market for larger screens as well as traditional CRT television sets of all sizes. Additionally, TRID designs, develops, and markets integrated circuits (ICs) and associated software for digital media applications, such as digital television (digital TV) and digital set-top boxes (STB). The company also designs cross-platform software that allows multimedia applications to run on devices in the digital living room, including digital STBs and digital TV sets.



TRID is a net cash stock that always traded above its net asset value until this year. The company follows the typical case in Wall Street where analysts tend to emphasize earnings prospects and neglect the underlying value of assets. Once Wall Street realizes that positive earning prospects are no longer sustainable, the stock is sold off on the basis of poor earnings alone. This would never happen in the private market, where businesses tend to sale at a value equal to at least their net assets, plus a premium for earnings prospects for those which are profitable.



 On its last earnings call, TRID reported net revenues of $19.2 million for the second quarter fiscal year 2009 representing a quarterly sequential decline of 45% compared with $34.8 million reported in the September 2008 quarter and a year-over-year decrease of 74% from the $75 million recorded in the same quarter of the prior year. Revenues from their top three customers represented 67% of total revenues in the second quarter. Revenues from the largest customer, headquartered in Japan, decreased by 63% from the prior quarter and represented 34% of total revenues. Amazingly, not a single analyst asked management about the company’s cash position and what their intentions are with this cash.

For the sake of conservatism, we value TRID based its cash at hand alone, assuming all other assets such as PPE and intangibles are worthless. Our analysis indicates TRID is currently trading at 60% below its net cash value, even all long-term assets are assumed to hold no value.



Spencer Capital Management LLC, a New York-based investment partnership, announced on March 2, 2009 its intention to put forth a slate of candidates for election to the company’s board. We believe Spencer Capital will be able to realize some shareholder value in the near future. Spencer Capital is a New York-based fund advisor that specializes in deep value investing and is headed by Kenneth H. Shubin Stein, whose ascent to value investing has been nothing but ordinary.

In 2000 he founded Kenshu, LLC, the predecessor to the Spencer Capital Opportunity Fund, LP, which was formed in 2003. From 2001 to 2003 Dr. Shubin Stein managed Kenshu, LLC while also working as a portfolio manager for Promethean Investment Group, LLC. He joined Promethean after completing his internship in orthopedic medicine at Mount Sinai Medical Center in New York. Before his internship, he cofounded and managed Compo Asset Management, LLC, a U.S. based value investment partnership which was merged into Promethean. Prior to founding Compo, Dr. Shubin Stein was a medical technology analyst for The Abernathy Group in New York, an investment management firm specializing in the medical and technology sectors. Dr. Shubin Stein is a graduate of the Albert Einstein College of Medicine where he completed a 5-year medical and research program with a focus on molecular genetics. He graduated with a B.A. degree from Columbia College in 1991 with dual concentrations in Premedical Studies and Political Science. Dr. Shubin Stein holds the CFA designation and teaches an advanced investment research course to second year students at Columbia Business School.

In connection with their intended proxy solicitation, Spencer Capital Management, LLC and certain of its affiliates intend to file a proxy statement with the SEC to solicit TRID’s stockholders.



We have added TRID to the ValueHuntr Portfolio because it is trading significantly below its net-cash value, and we believe Spencer Capital, a fund that focuses on deep value investing, will be a catalyst to close this gap and thus increase shareholder value. With an estimated cash burn of $6-7 million per quarter, TRID’s net cash would stand at nearly $2.1/share at the end of 2009. We estimate the company is worth at least $2.54/share based on its cash alone compared to a current market price of $1.53/share.


Disclosure:  We do not have an actual holding in TRID. This is neither a recommendation to buy nor sell any securities]

Categories: Investing · Net Cash · Special Situations · Value Investing
Tagged: Kenneth Rubin Stein, Net Cash, Net Net, Spencer Capital, TRID, Trident Microsystems, Value Investing

Life Sciences Research (NYSE: LSR)

March 16, 2009 · 3 Comments

In our view, LSR is a pure Special Situations/Workout play with a high probability of realization. At a market value of $90M, the company is trading nearly 11% below the purchase price of $100M offered by Andrew Baker, who serves as Chairman and CEO of LSR. It is our view that the company’s intrinsic value is lower than Baker’s purchase price of $7.50/share, so we are adding LSR to our ValueHuntr Portfolio as an arbitrage opportunity. We do not intend to hold LSR shares beyond $100M of market capitalization ($7.50/share).


About LSR

Life Sciences Research, Inc. is a global contract research organization providing product development services to the pharmaceutical, agrochemical and biotechnology industries. LSR brings leading technology and capability to support its clients in non-clinical safety testing of new compounds in early stage development and assessment. The purpose of this work is to identify risks to humans, animals or the environment resulting from the use or manufacture of a wide range of chemicals which are essential components of LSR’s clients’ products. The Company’s services are designed to meet the regulatory requirements of governments around the world. LSR operates research facilities in the United States and the United Kingdom.




The company is currently trading at a market capitalization of nearly $90M, which is 11% lower than the $100M that Andrew Baker, the current Chairman and CEO of LSR, has proposed to purchase all of the company’s outstanding shares for. The latest balance sheet shows that as of December 31, 2008, the company had $171M of assets with $186M in liabilities. Though the company has enough cash to meet all near-term commitments, it is our view that this is a case where the private market value exceeds the company’s intrinsic value. With $15M in negative equity, any possible investment in LSR must be made having Andrew Baker’s $7.50 purchase proposal as the ceiling for the total value that could be realized by LSR stock investment. We view this as a special situations play with high prospects of near-term profitability, so we are adding LSR to our ValueHuntr Portfolio. However, we do not intend to hold the stock beyond $7.50/share.




On March 3, 2009, LSR announced that Andrew Baker, Chairman and CEO of LSR, has made a non-binding proposal to acquire all of the outstanding shares of LSR for a price of $7.50 per share pursuant to this letter dated March 3, 2009:





Andrew Baker

401 Hackensack Avenue

Hackensack, NJ  07601




                             March 3, 2009




Life Sciences Research, Inc.

P.O. Box 2360

East Millstone, NJ  08875

Attention:  Board of Directors




I am pleased to present this non-binding proposal to acquire all of the outstanding shares of common stock par value $.01 per share (the “Shares”), of Life Sciences Research, Inc.  (the “Company”) for a price of $7.50 per Share.  I intend to effect the acquisition through an entity that I will control.


The proposed purchase price represents a 57% premium over today’s closing price of the Shares and provides an attractive opportunity for the Company’s stockholders to maximize the value of their investment in the Company at a highly uncertain and volatile time in the markets and the global economy.


I welcome the opportunity to discuss this proposal with the Board of Directors and its advisors as soon as possible.  My proposal is conditioned upon satisfactory completion of due diligence, negotiation of definitive transaction documents, receipt of the requisite financing commitments and receipt of necessary board approval.  If my proposal is of interest to the Board, I am prepared to harness the resources necessary to expeditiously negotiate and document the proposed transaction.  I have already begun exploring potential financing sources, subject to satisfactory confidentiality arrangements.  While I am confident that I will be able to secure the requisite financing for this proposal, there can be no assurance of success.


This proposal does not create any binding obligation, nor will I be deemed to have any obligation whatsoever to the company relating to a proposed acquisition of the company by virtue of this letter or any written or oral expression made by or on my behalf by me or any of my affiliates, advisors or agents unless and until mutually satisfactory definitive documentation has been executed and delivered by the parties thereto.


I look forward to discussing this matter further.




s/ Andrew H. Baker

Andrew H. Baker


cc:  Mark Bibi, General Counsel


In general, we believe the likelihood of a $7.50/share purchase by Andrew Baker is high, so the probability of near-term upside to $7.50 is significant. At today’s price of $6.78/share, the company is trading at an 11% discount to Andrew Baker’s offer price.





With a negative equity, the company is not a candidate for long-term profitability. However, we believe this opportunity presents us with an attractive arbitrage with a high probability of realizing a quick 11% return. This is why LSR has been added to our ValueHuntr Portfolio.



[Full Disclosure:  We do not have a holding in LSR. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. Do your own research before investing in any security.]

Categories: Arbitrage · Investing · Special Situations · Value Investing
Tagged: Arbitrage, Special Situations, Value