NOVEMBER MONTH END SUMMARY AND LOOKING AHEAD TO DECEMBER
*This is a copy of my letter to investors summarizing the month of November.
Portfolio November Performance: +1.03% Compared to benchmark S&P 500 November Performance: +0.28%
Portfolio YTD Performance: +34.90% Compared to benchmark S&P 500 YTD Performance: +12.61%
Portfolio Highlights for November
- The market neutral posture adopted early in October performed exceptionally throughout November. The portfolio was in positive performance territory for the entire month of November. This is despite the fact that November was, at one point, 400 basis points in the red as of mid-month. A substantial reduction in portfolio exposure in October, as well as a hedge utilizing TZA, made November a much less difficult month for the portfolio than the headlines and volatility would suggest.
- TZA was closed for a small profit as of November 28th. During the same period of time, portfolio long exposure increased to 75% invested, from below 50% previously. This puts the portfolio in a much more opportunistic position to take advantage of a seasonally favorable time of year. The substantial increase in net exposure was due to a mechanical, short-term trend signal that determines exposure levels.
- A position was taken in PTGI late in the month. PTGI was a portfolio position in January through April, yielding a 40% profit during that time period. Since that time, PTGI has seen a substantial decrease in share price, $2 of which can be attributed to a special dividend. At $11.34 (Friday's closing price), PTGI is selling at a 33% discount (including $2 special dividend) to the price I sold in April. This is primarily due to two factors: 1) The company has very little sell side coverage. Therefore, when the markets landscape starts becoming unfavorable, PTGI essentially leaks market cap on a daily basis. 2) The company has seen some revenue weakness due to divisions of the company that aren't performing well. On the positive side, PTGI is free cash flow machine. Continues to pay down debt, increase operating efficiency and expand margins. It is trading at a ridiculously low 3.5 times EBITDA. As with most of the equity investments I make, the downside equation is what I pay attention to first and foremost. There simply is very little in the way of downside for PTGI at these levels given both the price and fundamental outlook.
- A small position was taken in PRXI on November 19th-November 20th at 2.56-2.60 per share. Subsequently, the position was increased in size during this past week to a mid-sized position. Details of the position are in the research report. PRXI is basically an undervalued asset and operating entity play. The business model (museum exhibitions) is very easy to ignore given today's market environment. Most significantly, the company owns Titanic artifacts that have been valued at close to $200 million. The entire market cap for the company as of Friday's close was $131 million. The Titanic assets are in the process of being sold with an LOI from a group of interested investors. This is a tax advantaged sale that should net proceeds that are still in excess of the current market cap. Given the recent price, the operating entity is essentially being given away for free with some cash on top of it from the sale of the Titanic assets to boot.
- SPNS position was increased during the month as shares rose more than 7% for November. During this past week, SPNS management authorized a private buyback of shares from a large seller who acquired the shares through a merger. This was a substantial overhang for the share price that has been cleared away to a great extent. 5% of the outstanding shares were bought back by the company as a result of this private transaction. Furthermore, the company announced earnings during November that continue to be impressive despite a stock price that doesn't seem to notice what is going on at the parent company. Some highlights from their earnings: – Revenues up 67% YOY – Net income up 86% YOY – Profit margin up 200 basis points YOY – Raised guidance to $113 million in revenue for the year. Cash position has increased over $10 million YOY. The upside will eventually be realized here. In the meantime, the downside risk in SPNS is obnoxiously low due to the fact that one full year of value creation has basically been missed by the market. SPNS is sitting exactly where it was one year ago despite all of aforementioned positives.
Portfolio Lowlights For November:
- I wouldn't necessarily consider the following "lowlights" as the companies have been in a simple consolidation phase. PXLW, UPIP and WMIH were all more or less unchanged for the month. In the case of PXLW and UPIP, they seem to be licking their wounds, so to speak, following a difficult October that saw unfavorable guidance come out of PXLW and an unfavorable court ruling in the case of UPIP. PXLW continues to see insider buying by the activist hedge fund that owns a substantial position in the stock. It should also be noted that PXLW has historically had volatility in their earnings. It wouldn't at all be a surprise to see them pickup substantially during the first half of the month should we see an uptick in the semiconductor cycle, as I believe will occur.
- WMIH continues to move sideways without much in the way of fundamental developments. The following was noted in the research report: "The question here for investors in WMIH is a question of time? My biggest concern with the company as an investment is not the potential for success but rather the length of time it will take to achieve that success." The timeline is the tricky part here. Patience will be a profitable virtue, I believe. In the meantime, the company is selling at a 25% premium to cash, with a bunch of assets that nobody knows how to value really. The courts tried and obviously failed, as the company is now trading at 50% discount to the value they gave the company as a recovery vehicle. I like the uncertainty in the valuation. That is where the opportunity lies. And my risk in waiting is cushioned by a discount that provides very little in the way of downside, with tremendous upside should clarity into the valuation of the assets be gained.
Looking Ahead
The last paragraph of the October monthly summary read as follows: "The time to sink one’s teeth into the meat of the market will come in December perhaps. For the time being, the only concern should be making sure that the market doesn’t sink its teeth into one’s nether regions." It turns out that assessment of the market could not have been more accurate. It is now December and the threat of further teeth sinking into the nether regions of investors has decreased substantially. November went a long ways towards satisfying the market's lust for creating fear within the investor class.
2012 should finish with some substantial strength despite the fears over the Fiscal Cliff and all of the "cliff" jokes that seem to accompany these fears. The market is a forward looking mechanism. With that said, it is rather obvious that November was the process that saw the markets internalize the fears over an incompetent government creating economic catastrophe. The market will now be free to look at what kind of discount has been factored into various companies that are probably undeserving of the recent slaughter.
The semiconductor sector, in particular, should drive the markets forward throughout December and January. There has been a substantial uptick in insider buying from high level semiconductor executives, who are fully aware of the cyclical nature of their industry. Furthermore, from a technical standpoint, the Semiconductor Index (SOX) has created a very noticeable pattern with respect to a key technical point that I outlined in this study posted last week.
In addition to substantial insider buying semiconductor companies, there seems to be some growing confidence among banking execs of the ability for their respective companies to perform over the long-term. The insider buying at Citigroup and Bank of America continues late in the year. It is a noticeable phenomenon because of the fact that you don't see insider buying take place in these companies as often as it has been in 2012. It is an expression by executives, I believe, of very little left in the way of downside catastrophe and growing operating efficiency allowing these companies to thrive over the long-term.
Both of these key sectors should assist in driving the markets higher over both the short and long-term. According to technical studies I have published here, the expectation for downside volatility is being OVERESTIMATED by market participants due to the trauma suffered due to a consistent pattern of market shocks and the resulting under-performance by a majority of fund managers. This overestimation of the possibility for downside results in two distinct phenomenon to take place:
1. Managers par their risk much too quickly and almost simultaneously across strategies and sectors. This leads to quick, short corrections taking place that don't last for more than 1-2 months.
2. Managers react slowly to increase risk exposure. This leads to the type of grinding up, with very little volatility and volume, that we have experienced for much of the past few years.
There will be an event or series of events that will break this trend towards the convergence of behavior among fund managers. I believe that event will come in the form of a realization that undeniable opportunity exists within a market that has tremendous inflationary pressures bubbling underneath the surface. The question is what piece of date or series of data will trigger the reaction in fund managers that causes their propensity towards fear to dissipate?
Whatever that data is, it goes without saying that there is very little original thought left in the fund management community. It can be seen from the 13F filings, all the way down to the performance numbers each quarter. The herd mentality that was the exclusive domain of retail investors has now become the palatial estate for hedge fund, mutual fund and institutional managers.
And, as usual, the only way to solve the problem of convergence of thought within a population is through extremes, whether bullish or bearish in nature. Those BULLISH extremes will come years from now. In the meantime, the Wall Street community will continue waiting for a boogie man that only exists in past returns.
Regards,
Ali Meshkati
