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Tuesday, June 12, 2007

current thoughts

I really havent written much on the market since early in the year for two reasons. One, I really have not had much time to do much individual writing die to other projects and two, what was I going to say. Stock Markets up, film at 11?We have moved pretty much straight up all year long and there has been nothing much new to say and my core portfolio has stayed pretty much the same all year, Candian oil trusts, coal, activist stocks and spac warrants. With nothing much to say and no time to say I have been relatively quiet. That changes now however. Interest rate and inflation jitters have finally spook the stock market a little and we have seen some down days with increased volatility. The VIX is up about 50 % from January levels and it makes a little easy to fire off trades when you have some activity to take advantage of. For the first time in months I am finding puts worth writing on some undervalued stocks and I am happy to see the return of one my favorite trading methods. Puts on SHRP and PIR have looked especially attractive, although PIR is up sharp today reducing the opportunity for new positions somewhat.

The fed says that the main concern in the economy remains inflation and have pretty much eliminated the hope of a r ate cut, in fact hinting at the possibility of an increase. I think too much of an increase here whether it it imposed by the fed or the marketplace will have serious consequences. Energy costs for industry as well as consumers are already well above average and to now push borrowing costs higher will further squeeze margins, shrinking profit margins and reducing profits. Lower profits, in theory, are going to mean lower stock prices. I am not doom and gloom by any means but I think rising rates will be difficult for the stock market to contend with in the short run. In addition my main summertime economic indicator tells me the consumer is cautious. I have not encountered one back up at the by bridge this year. Not on Dover race weekend. Not on Memorial day. Not one Thursday or Friday have I even had to tap the brakes until I got to the toll booth. Im glad I don’t have a business in Ocean City this year. I suspect it is slower than usual. Having said that, it is a well know fact that I am the worst macro guy on the planet and have successfully been wrong in my prediction of market movements with something near perfect levels. So I will stick to my knitting with deep value and special situation investing.

I continue to play in the SPAC space and have recently taken an extensive look at the field We have profits in 4 of 5 positions taken over the last year in the warranst os special purpose acquisition companies, including a nine bagger in great lakes dock and dredging with only one small loss. Although this type of investing is pretty ..okay..very speculative, a small portion of capital applied here can be very rewarding, As I go through all the listings and recent events it is obvious that the biggest danger is a no vote to deal forcing the liquidation of the company and the warrants going worthless. Big firms such as fir tree and baupost own a lot of spac deals to play the arbitrage. If they like the deal, they vote yes and the stock usually goes up . If they don’t, they vote no and block the transaction and lock in a 10-12% profit in the liquidation. Win-win, unless you arelike me speculating on the warrants. To avoid this, Im only buying warrants where the deal is announced, there is insider buying and not a large institutional presence in the stock. Tough criteria but there are a couple that Pass. ITHK, EHHA and SHA pass this test. I also like ESA as there is not a large presence of arbitrage guys in the stock and Marshall Reynolds, the chairman has a long track record of successful deals. I ll add the warrants of all four to my speculative, you should buy this list.

On the pure value side I like SCX, LS Starett. This is one boring business, hand tools, saw blades and gauges but at exciting valuations. Two thirds of book, 50% of revenue, enterprise value to ebitda a takeover worthy 6 times. Debt to equity is 10% and they are profitable. When I am long stock I like to see the institutions with me and in LS Starret they are. Brandes, LSV, Bruce Sherman at Private capital and Charles Royce all have decent positions in the stock. I also like Adaptec here.The data management and storage company’s shares are trading around book value and are attracting attention. In addition, the company, trading at 3.76 a share has almost three bucks in net cash. Steel Partners filed a 13 d on the company yesterday and are getting close to the 10% ownership level. They have requested seays on the board and are very critical of current management. A s ale here would not be a huge surprise. Likewise, Educational Distributors has come under fire form the activists of late with both Robert Chapman and Daniel Loeb taking aim at the company and pushing for a sale or merger to take advantage of the over 4 bucks a share in Net Operating losses on the corporate books. To avoid change of control, it would have to be some type of reverse merger but it can and probably should be done. At 2.05. I think the hares are a good long term selection here. HDL, the music and dvd distributor alos looks very cheap here at half of book value, 10% of revenue and generating free cash flow. Marty Whitman recently bought 15% of the company and I think we should join him in owning this cheapie for the long term.

I am still long the three liquidations here and will keep them all the way through the runoff. Ecc capital, tripos and remec will, in my humble opinion, provide decent returns from these levels as they sell off the assets and give us the cash. I am looking for a chance to sell puts around here on real networks, Gencorp, Borders and BLG if I can get it done at a good price.

If you haven’t read it yet, Monsih Parabrai’s new book, the Dhando investor is out and is an excellent primer on the type of low risk high potential return investing. I attempt to practice. The central idea is if I am wrong I lose a little bit, if I am right I make a ton. The returns tend to be as Warren Buffet once said, lumpy, with gains accruing in a very frog like fashion. Periods of boring sideways followed by leaps as situations work out and are ecognized by other investors(thanks to Louis Navellier for the frog analogy. He of course was using it to refer to small stock in general but I find it an excellent analogy for seep value and special situation investing.). I think the stocks and securities mentioned above have these characteristics and have the potential for superior long term returns for patient investors.

With that it is summertime on the island and we are back to resort living. I spend most of my weekends begging and bumming for boat rides and hanging around dock bars with an great group of friends, indulging in cocktails, seafood ,conversation and of course the constant and futile search for the next incantation of the one true love of my life. It truly is a lot like being in a resort around Kent Island in the summer time and if you haven’t ever made it, it is getting to the time. The Bikini contests start at the red Eyes Dock bar this Sunday in my favorite ritual of fathers day( okay so I ll never be father of the Year but it is a good time). Also if you get the chance and inclination, the big grills will be lit and most likely so will we. The girls will be out, the bands rocking, the boats rumbling and it should be one hell of a time.

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