2011 Portfolio Review (part I)

I’m a bit late with this post but I’ve been trying to figure out just how to handle my year-end review. My model blog portfolio has no position sizes, so I can’t really measure performance. Yes, it’s intentionally that way. I have never included position size because the purpose of the blog is to focus on the investment decision-making process, and to force me to memorialize my reasoning for each purchase so that I can review and criticize it later, avoiding ex post facto rationale drift. The goal is to improve my investment process. As I have stated elsewhere, and I’ll state it again here for the record, this blog is not about investment advice, but about exploring the investment process.

That said, I’ll give you a look at my performance anyway. I know you’re curious. Remember, since I don’t follow my own advice and thus don’t have equal size positions (sorry Monish, I just haven’t gotten there yet), the performance of my personal portfolio is not exactly reflective of what a portfolio of equally weighted positions in each of the securities in the model portfolio might have produced. Furthermore, I have a couple of legacy positions in my personal portfolio that were never added to the model portfolio. Those caveats out of the way, I can say that the performance of my personal portfolio in 2011 was disappointing, down some 4% vs. a 2% gain of the S&P 500 total return index. The main detractors to my performance were the positions in AIG, which I started accumulating in May at about $30 a share and purchased all the way down to $20 (average cost of $26.10 for a loss of 11% for the year), Bank of America A warrants (on a share price basis down 72% for the year though my position was down only 35% because I added significantly during the year), KHD Humboldt Wedag (share price down 29%), Enzon Pharmaceutical (share price down 45%). These were offset by gains in Ascent Media, my largest position going into 2011 (sold in April-June for a gain of 30% during 2011), Gyrodyne Corp. (a gain of 57% – short term…ouch!) and K-Sea Transportation (a gain of 37%).

In terms of number of positions, I went the opposite way I had hoped, increasing from 16 at the beginning of the year to 19 at year-end. Five (5) positions were sold out (ASMCA, AVTR, GYRO, KSP, HAWK), six (6) new positions added (ABH, AIG, EBIX, GKK, ITT, PDLI ) and 2 positions were added with the spinoff of Xylem and Exelis from ITT. But I’m still within my targeted maximum of 20 positions, though, as I said above, I’m not to the point of equally weighting them (Pabrai’s concept of the ‘20 best ideas’).

Let’s look at what happened during the past year for each of the positions (in order of size in my personal portfolio):

AIG: Not much to say on this one. The US Govt. still owns something like 77% of the equity in AIG after selling a tranche for $29 in June of last year. The uncertainty associated with this overhang combined with the bad taste left by the destruction of value in 2008/9 should keep a lid on the share price for the near future; I don’t anticipate the share price returning to levels of early 2011 ($60) until the Treasury is able to do another secondary offering, and that won’t happen until the price returns above its cost basis of around $27/share. So its kind of a chicken and egg situation. But watch out when consensus turns; it’ll be a stampede. Just look at what happened during the past 10 days when the shares outpaced the market upswing by 2:1.

MIL: After all the shenanigans (spinoffs, rights offerings, takeover and name change) over the past two years it’s nice to see that MIL is concentrating on investing its capital; recently they made a small purchase of an iron ore mine in Missouri. I hope they do more of that and less financial engineering, though I would like them to complete the return of capital they announced in early Fall. I increased my exposure to MIL in anticipation of the announced ROC, so I now have an outsized position because the ROC wasn’t completed in 2011, the timeframe initially indicated. Overall, I don’t see huge upside potential in the shares at the moment but I think there is a good margin of safety with the book value at $8.75/share, substantial inside share ownership and management’s track record of accretive deals.

MCF: My original investment thesis for Contango was based on the temporarily depressed stock price following its June 2010 announcement of a significant reduction in estimated reserves. The company is a low-cost  producer of oil and (mostly) gas, has an innovative operational structure (less than 20 employees), no debt and significant management ownership; overall a great company. The share price recovered in late 2010 but I opted to hold on for LTCG treatment. Shares hit a high just before the mandatory year holding period elapsed and since then have been trending downward with the price of natural gas. I think this is an exceptionally well run company and am in no hurry to sell until Mr. Market gets enthused enough to buy me out in the upper $70 range.

BBEP: I missed the boat on this one. The unit price ran up to $23 in April 2011, very close to my target sell price, but I got greedy, sold only a quarter of my position at those levels and held on for the extra dollar. Mistake! The company announced a secondary offering in May and the unit price promptly fell, exacerbated by the market tumble in May/June, into the $17-$18 range where it has languished ever since, only recently heading back above $19. Quicksilver Resources which had held a 30%+ position that it acquired in a trade for properties and leases and was subsequently in litigation with management, held a secondary offering at $16.80 a share in November, selling their remaining shares. BBEP’s quarterly distribution continued to increase in 2011, climbing 11.5%, from $.39 in Nov. 20010 to $.435 in Nov. 2011. It still remains, however, below its peak of $.52 paid out in the last quarter of 2008, before the company’s liquidity crisis and distribution suspension.  I’m in no hurry to sell before the units reach my price target as I’m receiving a 20% return on my invested capital. Patience is the key as this O&G LP seems to be doing fine.

KHDHF: After spinning off from its parent (KHD, which became Terra Nova in 2010 then became MFC Industrial in 2011) during 2010, KHD did a rights issue in early 2011. The rights issue was structured in such a way that it allowed KHD to sell a 20% ownership in the company to a Chinese firm at about 30% discount to market price; this was achieved by making the rights non-transferable and US shareholders ineligible to participate unless they were accredited investors. I found this so incredibly shareholder unfriendly, a quasi expropriation of property, that I swore to sell my shares at the earliest opportunity (at the appropriate price of course). If management could be so callous regarding shareholder rights who knows what they might be capable of. Unfortunately, that opportunity hasn’t yet presented itself. As for me, being a non-US based individual, I was able to exercise my rights, which I offset with an equal dollar sale of shares, thus lowering my cost basis.  That proved a wise move as the share price declined from $9.00 a share at the end of 2010 to the year-end 2011 level of $6.42. I’m still holding as I believe there is significant value in the company, though I continue to worry about the misalignment between shareholder and management interests.

PRXI: I’ve written about Premier Exhibitions several times during the year including a recent update, so I don’t need to review this holding here

I will examine the balance of my holdings in a subsequent blog.

Happy investing to all in 2012