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Follow-up on RadioShack and a new position (ZINC)

Ok, so I’m impatient. Once I’ve decided I shouldn’t have a position in my portfolio I’m in no mood to wait around for the best price. RadioShack (RSH) is now gone from the portfolio; it ‘spiked’ up to $1.03/share and I dumped it. What was so magic about the price? Nothing. I just decided that I’d had it, that the hedge funds, Standard General and Litespeed Management, that provided the needed financing to continue operations had basically taken all the upside optionality out of the common shares. In retrospect I have to say that I should have liquidated much sooner. My original hypothesis was based on bad operating performance but lots of cash, or at least enough to make it through a turnaround. Little did I foresee that not one turnaround would be needed but two.

My lesson from this investment? A reminder to me to cut your losses early (and let your winners run) when the original investment thesis doesn’t pan out. This is perhaps one of the hardest things for a value investor to do as one has to first see that the investment thesis isn’t playing out early on then acknowledge that one has been wrong with a timely sale.

Next, the new investment. I’m a bit late reporting this but then, these day’s I’m not posting nearly enough to keep up with my heavy trading (yes, tongue-in-cheek). And besides the share price of the new investment, after running up in the last week or so, has now subsided to almost that level at which I invested. The thesis around Horsehead Holdings (ZINC) is not new to the value investing community. Monish Pabrai began accumulating shares almost 2 years ago when they were in the $9/share range and its now the largest position in his portfolio. Since his initial investment the share price increased to over $20 this past Summer before swooning recently to the mid-teens. If you look around the web you can find a lot about the investment thesis so I won’t belabor it here. Basically, the company reclaims zinc from iron ore tailings. Not sure if tailings is the right word, but its the residue from the steel industry. It gets paid to dispose of this residue and then extracts the zinc and other metals, primarily silver, which it then sells on the open market. The company built a new ‘game-changing’ plant over the past several years which purportedly will reduce its costs substantially. Last Spring it and moved operations to the new facility and closed its old plant. Well, the production at the new plant hasn’t ramped up as fast as expected and thus the setback for the company shares. To me this is a typical Phil Fischer situation. The market expected the new plant to come on-line and ramp-up production seamlessly. That hasn’t happened and now Mr. Market is disappointed and is punishing the stock. I’m inclined to believe that the setback is temporary and that this operational setback has provided a nice entry point for the patient, long-term investor. It looks like there is somewhat of a competitive moat around this company as it has long-term contracts for the iron ore residue and is the only company to have invested in this next-generation plant. I wasn’t exactly fleet of foot when I purchased my starter position for around $14.50/share, as shares had dropped into the $13’s on the announcement of the operational setback. Then, of course, with the recent rally the share price spiked up to $16 and change, before falling back to around $15/share yesterday. If the share price continues to trend down I will be buying a full position.

As always, don’t mistake the above comments as investment advice. You should always do your own investment analysis!

Updates: SVVC and RSH

The good news first:

A couple of things have happened at Firsthand Technology Value Fund since my initial post: the fund announced 1) a $10 million share buyback (to be completed by year-end), 2) the sale of their position in Facebook and the return $2.99821 per share in related gains (Nov. 6). Both of these were part of the standstill agreement with Bulldog last April. To complete the other terms of the agreement they must 1) sell their position in Twitter by the end of October and the distribute the related gains to shareholders by year-end, and 2) conclude a tender offer for 10% of shares at 95% of NAV by the end of January 2015. Net asset value (NAV) at the end of September was reported at $29.70 per share of which $7.44 was in cash. The increase in cash from the end of August is consistent with the sale of Facebook shares, though we can deduce that they used some of the Facebook proceeds to invest in AliphCom, a maker of ‘wearable’ technology.
What is interesting to note is that the fund sold all of its Facebook shares in September. They didn’t gradually sell their second largest position over a couple of months, something I might have deemed the prudent thing to do. No, they sold it all at the last possible moment! This seems to portend that they will do the same thing with their Twitter stake, i.e. wait until the end of October then dump it all in the market. Sounds like a strange strategy to me but perhaps consistent with their poor performance over the past 10 years. We holders of the fund were lucky with Facebook, the market didn’t tank in September. Will we be so lucky with Twitter? So far TWTR has held up valiantly in the latest sell-off. But, as for the future, who knows? I’m looking for another distribution from the TWTR sale of about $2.50-3.00 sometime around mid-December.

The discount to NAV appears to have shrunk from the mid 20s to around 15-16% currently. Perhaps this is the effect of the news about the distributions, the buyback and the tender. However, if the two distributions are factored in, we are still around a 25% discount on the new, lower NAV. So I still think we have a ways to go, but should handily get to my target of a 15 to 20% return on this investment by the end of January if not sooner.

Now the bad news:

Having reviewed the RadioShack situation recently I have concluded there isn’t much upside left in the stock. While there is potential for the company, it appears to me that the hedge funds have usurped most of the potential gains. Thus I will be selling off my position shortly when I see a nice little price spike. In retrospect I should have cut my losses much sooner, however I kept thinking that I might find an opportunity to double down at lower prices. But the performance of the operations and management has been just miserable and there was never a time when the risk/reward looked right. There’s a good lesson here, perhaps applicable to the Fortress Paper investment which I will be revisiting before year-end if for nothing else than an nice big tax loss.

Another Closed-end Fund play: DRA

As I noted in my last blog I’m looking for a place to park some cash that is relatively safe but will give me some kind of short-term return. No money market funds thank you! Rates at money market funds are close to or at zero and we know what a liquidity crunch could do to those guys…just think back to the Fall of 2008! I want my money available at the click of a mouse. So, as I blogged before, I’ve been looking at closed-end funds that have some catalyst for value creation (primarily discount reduction with the hopes of picking up not only a little income but maybe even a bit of capital gain). In this post I’m spotlighting a new fund, Diversified Real Asset Income Fund (DRA). Now, mind you, new closed-end funds are only for suckers; after being priced at the offering they immediately fall to or below net asset value, some 8 to 10 % below the offering price. This is because there is an underwriting fee included in the offering price and then the market usually assigns a discount to closed-end fund shares due to liquidity concerns or whatever. So why am I blogging about a new closed-end fund? This case is a bit different. To be honest, DRA is not really a new fund. Bulldog (you remember them from my last post, no?) had been pestering American Strategic Income Portfolio Funds (I, II and III) management for a couple of years to do something about the persisting double-digit discount to net asset value at which the funds shares were trading. After unsuccessfully trying to outwait the activists what fund management came up with was a 2-step plan; folding the three funds, American Strategic Income Portfolio I, II and III into one fund (creating operating savings… for the asset manager, obviously!) and a series of potentially 3 tender offers for up to 30% of the outstanding shares. In addition, the asset management contract passed to a higher class asset manager, Nuveen. The Great Amalgamation was completed last week and the newly created combined fund was (re)named, you guessed it, Diversified Real Asset Income Fund (DRA). They come up with the most meaningless names, don’t you think? I have no idea from the name what the fund actually invests in. Well, alright I did read the press release and noted that they invest in real estate stuff, infrastructure stuff and perhaps some other things. They put it this way, “The Combined Fund’s broader investment mandate is expected to result in a more liquid portfolio over time with less emphasis on whole loans and mortgage-backed securities”. Any less amorphous than my characterization? So, with the combination completed (no value creation for us shareholders yet) we should be looking for the first tender offer (at 99% of NAV) by the end of the year. That tender should be for 10% of the outstanding shares. The second tender is supposed to occur within 6 months of the first, and the third 6 months thereafter, but only if the discount to NAV remains above 10%.

So why invest? My rationale is that, despite its miserable track record, the shares may offer value as 1) there is a new, reputable asset manager, 2) shares are selling for an 11% discount to NAV, and 3) while you hold, waiting to tender your shares, you get an 8%+ yield. My macro view is that the interest rate rebound theory has been overdone and I don’t see rates rising rapidly in the next year, thus I am comfortable with holding a leveraged fixed income position. That’s right, the investment theory depends on one’s outlook in fixed-income-land. These types of funds get double-whammied when interest rates spike; once because as interest rates go up their investments decrease in price and again because their cost to borrow goes up reducing their cash flows for dividends. Now whether my macro view is right or whether the new fund manager will perform better than the previous manager (note that NAV has already dropped over 1% since the Amalgamation!) or whether the tender offers will even happen are unknowns. So don’t take my investment analysis as a way to make money.. always do your own analysis before investing!

Added a small position in Firsthand Technology Value Fund (SVVC)

I’ve been thinking about closed-end fund investing ever since I discovered the Special Opportunity Fund run by Phil Goldstein. I find the theory of the fund theoretically attractive; if you invest in a basket of closed-end funds trading at historic discounts, then approach managements in these funds and demand some event that will narrow or close the discount such as a buy-back or dutch tender, if you’re successful you should be able to generate market beating returns. There are some practical problems with this approach, such as intransigent management and closed end funds whose performance is worse than the overall market during your holding period, which unfortunately can’t be overlooked. There are other problems as well, such as being an activist of sufficient size to get management’s attention or having a diverse enough portfolio to mimic the market’s underlying movement.

I actually did some closed-end fund investing initially for a reason other than the play on the discount to NAV. Last year in November I noticed that most fixed income funds, primarily those invested in municipals and mortgage-backed securities had had a terrible year. The underlying investments tumbled in value in the May/June timeframe when it looked like quantitative easing was about to be cut short. Funds invested in these sectors magnified the results of the underlying securities because the funds 1) tend to be leveraged and 2) traded from premiums to, in some cases, double-digit discounts. In other words they got clobbered. I like to be contrarian, and I thought the sell-off was overdone. So I did some homework and picked a couple of funds that were in the Special Opportunity Fund portfolio (you need someone to the do the dirty work for you, and, as Monish Pabrai says, one of the best ways to successful investing is to lift the ideas of successful investors). As luck would have it, what I had thought was an overreaction turned out to be just that, and the market for municipals and (to a lesser extent) mortgage-backed securities recovered this year with the result that closed-end funds invested in these sectors have done well, though discounts have not shrunk as much as I might have anticipated. As an added kicker for me, the municipal fund I chose was one of the funds coming under a standstill agreement between Bulldog Investors (Phil Goldstein’s management firm) and the fund’s manager. Under the agreement the fund will be tendering for up to 10% of the outstanding shares at 98% of NAV in the near future. When I purchased the shares they were trading at an 11% discount to NAV, so the more shares of mine that get taken under the offer the better. How well will I actually do? I don’t know yet as the tender isn’t over so I don’t know how many of my shares will be accepted. Worst case, if all shareholders tender all their shares (a very unlikely event), I will have 10% of mine accepted at 98% of NAV and can sell the balance into the market after the tender. Even in that case I will still do alright because the fund’s shares have appreciated by over 10% this year, as well as paying out a 6% tax-free dividend. However, there’s a lesson here; if the fixed income market had moved against me, despite the tender, I might have been looking at an overall loss here rather than a gain; the tender enhanced my gain but couldn’t outweigh the effects of the market over a year-long holding period.

So what does this have to do with the Firsthand Technology Value Fund (SVVC)? Not a lot except that the Special Opportunity Fund also has a significant investment in SVVC. Firsthand has had a miserable performance record under the stewardship of the current manager, Kevin Landis.  When the fund shares fell to a 20%+ discount to NAV several years ago Bulldog Investors stepped in, took a large position for several of their accounts and pressed for a liquidity event. With the threat of Bulldog running a slate of directors at this year’s annual meeting  the manager buckled under and signed a standstill agreement with Bulldog last March.  That agreement called for a payout of some capital gains and a tender offer. As of July 31 the fund had total net assets of $257 million, or $28.28 per share. Shares are now trading at $22.60, so based on NAV at the beginning of August, shares are currently trading at around a 20% discount. Of course this isn’t an exact calculation because we don’t know exactly what the NAV has done so far in August… but the market in general is up and therefore so should the net assets of the fund. It should also be remembered that SVVC is a strange creature because it has both public and non-public investments, something mutual funds rarely have. However their largest positions are in Twitter (22%) and Facebook (17%), shares which they acquired before the respective IPOs. In the standstill agreement, the fund’s manager has agreed to sell these shares by Oct 31 and Sept 30, respectively, and distribute any net realized gains to shareholders by year-end. This will shrink the size of the fund somewhat (thus increasing the discount to NAV). They also agreed to launch a tender offer for up to $20 million worth of the outstanding shares at 95% of NAV in the 4th quarter. They further agreed to a $10 million share buyback program if shares continue to trade at less than NAV. You may ask ‘what’s happened to these guys? have they suddenly got religion?”. I can assure you that this is not the case. They simply want to continue collecting the management fees they have so far been collecting for doing such a lousy job. I’m not sure how all this will pan out for me as it depends on what the market does between now and Oct 31, but I like the share’s sizeable discount to NAV and the several catalysts on the near-term horizon. My hope is that the payout and tender offer will reduce the discount significantly and result in a 10% to 20% return on my position by year-end.

A reminder that the above is not investment advice and you should always do your own analysis before investing.

 

note: This post is for Dan who asked about my interest/activity in closed end funds.

Switching out Liberty Media C shares for A shares

Sorry, I’m vacationing away from my usual haunts and the beach and sun have more allure than typing away on an old laptop. Thus the lapse in blogging. I have been following the market, but don’t find anything particularly interesting happening outside of some closed-end fund tender offers (maybe I’ll go into those on a different post).

Last week when the Liberty Media C (LMCK) shares traded at a premium to the Liberty Media A (LMCA) shares I sold the C shares I had purchased/received in the ‘dividend’ transaction and purchased the same number of A shares. It wasn’t the gain that I was after, but the relative value between the two classes of shares simply didn’t make sense. Both the A shares and the C shares have the same economic interest in the Liberty Media properties. The only difference is the A shares have a vote at the annual meeting while the C shares do not. When I purchased additional C shares (after the ‘dividend’) they were trading at something like a 4% discount to the A shares. I thought that that discount didn’t make sense, as the vote didn’t seem to be that valuable (given that Malone controls the company with his B share votes). But to have the ‘vote’ be worth less than zero, a liability? That certainly didn’t make sense either.

If the C shares fall to a greater than 5% discount I may switch back again, but the current discount between the A and C shares looks just about right, less than one percent but greater than zero.

Added more Liberty Media (LMCK)

I couldn’t help myself. Yesterday was the last day Liberty Media (LMCA) was trading before the distribution of Liberty Media C shares (2 Liberty Media C shares for each Liberty Media A share). The when-issued Liberty Media C shares (LMCKV) were trading at a 3% discount to the Liberty A shares for no apparent reason that I could think of. On top of that, when a stock split happens often the post-split shares trade up in value (again for no real reason… except for human nature). So we had a discount for the when-issued C shares AND the probability that the shares would trade up when the distribution happens today (July 24)… sounds like a no brainer for me, especially because I have wanted to own Liberty Media for a while. Nothing like a discount to make this shopper bite! Yet, it has to be noted that the situation with the Liberty shares is a bit more complex because the shares being distributed are a different class (C vs. A) and have no voting rights (though they do have the same economic rights). I don’t really think that the voting rights for the class A shares have any value because Malone controls the company with his supervoting B shares, so I discounted this seeming difference and dove in. Today will tell if my short-term thesis is correct. Not that I’m that interested in the short-term, mind you. I’m really interested in the unwinding of Liberty Media into the Sirius stake on the one hand and the new Liberty Broadband (Comcast, TW etc) on the other.  That transaction will be in the form of a distribution of Liberty Broadband shares AND rights to Liberty Media A, B and C shareholders, and it should happen sometime in early fall. THAT’s the transaction I’m really interested in as it should ‘unlock some hidden value’, i.e. reprice the sum of the two parts upward. I’ll be taking a closer look at that transaction when the timing and final details are announced.

Finally!…out with the old (and in with the new)

It seems to take me a long time to admit my investing mistakes. But when I finally get around to cleaning out house, there’s a wonderful feeling of liberation! The moment after you pull the trigger you ask yourself “Why?, Why did I hand on too long to a position that I knew wasn’t living up to my investment thesis?”. That’s what happened to me with MFC Industrial (MIL); I’ve known for a while that the company wasn’t performing according to my original thesis, but I held on anyway, thinking that perhaps there was a new, better thesis with the purchase of Compton Petroleum, then with the change in control to Peter Kellogg. Anyway, earlier this week I finally looked in the mirror, saw my tergiversation for what it was and took the plunge, selling the balance of my position (sorry for the delay in reporting). I finally accepted that, indeed, there were more attractive investment options out there. So I’ve recycled part of the MIL proceeds into a starter position in LMCA.

I’ve been following the Liberty family of companies, i.e. John Malone, for a long time now. I owned Ascent Media a few years back and did well with it. I looked at Liberty Ventures when that was split off but couldn’t come up with a value proposition when it started trading. Obviously I was wrong on that one as the shares soared. Then I was evaluating a position in LMCA a couple of years ago when it was trading between $70 and $80 a share but never could get comfortable with the Sirius situation. LMCA shares have advanced considerably since then, so why purchase now? The short answer is the upcoming split and spinoff of Liberty Broadband which I think will be a value realization catalyst. This post is just a ‘heads up’. I’ll be doing a more in-depth post on the Liberty Media situation as we get closer to the split date (July 23).

Always remember that I’m not advocating any investments here; do your own analysis!

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