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I’m parking some more money .. in a liquidation situation this time.

It’s hard not to fall into the trap of increasing market exposure as the market vaults to new highs and your portfolio continues to lag; You sit there with cash and, day after day, share prices keep rising. But this is exactly the wrong time to increase exposure! To give myself a little solace in my current plight I play out the most likely what-if scenario were I to give in and invest my free cash: It goes like this…so I finally capitulate and load up on all those shares I’ve been coveting….. only, the day after I invest the market stumbles and continues dropping steadily for the the next two months, dropping 10, 15, 20%, and I’m sitting there with all those coveted stocks now in my portfolio at 20, 30, 40% losses. Yes, my losses are always greater than that of the overall market; it’s Murphy’s law! So I smugly look back to the present and feel good about not jumping on the bandwagon at this point in the latest bull run. But what to do with all that idle cash then? If you’re like me it begins to burn a hole in your pocket at some point. I could just let it sit there and EARN NO INTEREST. But with a little industry maybe I can put together a low risk investment or two. I did something of the sort when I ‘parked’ some money in the Firsthand Technology Value Fund. Next I put some loose change into a closed end fund with a catalyst, Diversified Real Asset Income Fund (DRA). Those investments are still in the process of maturing and I won’t know whether I’ve reached my investment goals there for a couple of months. OK. But there’s still more change jangling around in the pocket, tempting me to ‘put it to work’ (an expression I’ve never quite understood) So what’s next?  I’ve decided to fall back on that decidedly unsexy sector of investing, liquidations. Why unsexy? Primarily because the upside in any liquidation situation is clearly limited. But then again, so is the downside, and that’s what I’m interested in here. The idea is to limit the downside so that in a market retreat I’ll have the cash ready to buy up all sorts of treasures.

I remember having looked at Winthrop Realty Trust (FUR) a number of years ago as a potential value investment. In fact, I even owned a few shares at one point as I dipped in early when I began a deep dive into their financials. It was short lived however, both the owning and the deep dive, as I quickly realized that I didn’t have the kind of real estate expertise to complete the necessary analysis. So a recent blurb in the Spinoff Monitor caught my attention, “Winthrop Realty Trust increases estimate of liquidation distributions from $18.10 to $18.35 per share.” or something like that. I was very surprised to see the company was liquidating, and even more surprised when I read up on it to see the reason behind the liquidation; management concluded that, despite their best efforts, the Market was not attributing enough value to the company and that shareholders would be best served and realize the most value by a liquidation of the assets. Wow! Management concerned about shareholders realizing value? Unheard of! I decided to dig a little deeper. Now the great thing about a liquidation is that management has to provide an estimate of what exactly they think the liquidation distributions will be (not the timing, mind you, just the total amount). So there is no need for me to have any real estate valuation expertise! In fact, who better than the management of a real estate company to provide the best valuation of the real estate they manage! The thing to remember about management’s valuation in a liquidation scenario, however, is that it is almost always CONSERVATIVE. Yes, that’s right there is no incentive for management to overpromise here… and a good many disincentives for them NOT to do so. So let’s go back and look at the proxy the company put out in June 2013 for their August special meeting to approve the liquidation. In the proxy management provides a range of value for liquidation distributions of between $13.79 and $15.79 per common share. Shares were trading in the $11-12 range before the liquidation proposal was made public at the end of April. Thereafter shares traded in the $15 range until mid October when management upped their estimate of liquidation distributions, first to $18.10 then $18.35. Have I missed the boat? Am I getting in too late? Well, of course, it would have been better if I’d invest in FUR in April before the announcement, or even in early October before they increased their estimates. But I’m looking to park money, with little downside so I can’t anticipate a huge upside, can I? I’ve bought a small position at $16.82 per share. This works out to about a 9% return if the distributions end up totaling management’s estimate of $18.35.  That doesn’t sound so great since the liquidation could take til August 2016 or beyond. Two years to get a 9% return, that might mean a return of only 4% per year! But you have to take into consideration the timing of the distributions. Management has already said that the first distribution should be in January or February 2015, and the quicker the distributions the higher the IRR on my investment. Furthermore, I think management may continue to increase their estimate of the distributions. Given their past actions I feel quite confident management will continue to put shareholder interests before everything else;  after all, management as a group is the largest shareholder with over 9% of the outstanding shares.

I haven’t finished accumulating my position as I’m contemplating a bit of year-end selling may depress the price from here over the next month (possibly mutual/pension funds that don’t invest in liquidations??). So, readers, no buying from you please until I’ve bought my fill. Thanks.

Tender results for DRA

The first part of my investment thesis for the Diversified Real Asset Income Fund (DRA) has panned out; they just completed one (out of a potential 3) self tender offers at 99% of NAV. Unfortunately, just like me, there were a number of other fund holders who tendered, and the tender offer was waaaayyy over subscribed. In fact, owners of 2/3 of the total shares outstanding tendered their shares. That means 2/3 of current fund shareholders just wanted to get their money back! I guess nobody was very happy with the historical performance of the fund!

The tender offer was structured to repurchase 10% of outstanding shares (approx. 2.5 million). With over 16 million shares tendered I was only able to sell 15% of my shares. As I said, I am comfortable holding this fund for at least the next 6 months. If over that timeframe the discount to NAV doesn’t average below 10% (today its around 11.8%) the fund will have to conduct a second tender for a further 10% of shares outstanding. In the meantime I’ll be collecting my 7% interest!

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 investment thesis was based on the loads of cash (or at least enough to make it through a turnaround) that would let new management reshape the bad operating performance. Little did I foresee that not one turnaround would be needed, but two. My lesson from this investment? A reminder to myself: cut losses early (and let winners run!) if the original investment thesis doesn’t pan out. This is perhaps one of the hardest things for a value investor to do as you have to first see that the investment thesis isn’t playing out early on, then acknowledge that you’ve 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 moved operations to the new facility and closed its old plant. Well, 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 snafu 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.

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