JULY PERFORMANCE SUMMARY AND LOOKING AHEAD TO AUGUST

Posted By admin on Aug 3, 2013 | 0 comments

*This is an excerpt of my monthly letter to investors summarizing the month of July.

The full PDF version of the summary, including managed account performance data as well as a few added components is only available via email.

Return data will no longer be published as a part of the summary posted to Zenpenny.

If you would like to be added to the monthly email list, please contact me at mail@t11capital.com

Portfolio Highlights For July:

• As detailed in last month's summary, HMPR was increased from a mid-sized position to a large position in June, as continued improvements in the balance sheets of regional banking companies (HMPR included) had been greeted by a minimal amount of appreciation in the shares of the company.A relatively substantial appreciation took place in HMPR during July that saw the shares appreciate from a low of 1.22 on July 1st to a high point of 1.86, before settling in the 1.70 range to end July.

There were no fundamental developments during the month to spur such an increase in price. The sudden strength in shares of HMPR can be attributed to several things:

1. Overall strength in the financial sector
2. A recognition that regional banks are faring much better along the path to recovery than anyone thought possible just 4 years after financial Armageddon
3. HMPR, specifically, has returned to profitability in their recent quarter for the first time in years. Additionally, their net charge offs and non-performing assets have returned to pre-crisis levels.

The market has been somewhat slow in recognizing the recovery in a lot of the smaller regional banks. This is much to the joy of company insiders who have been extremely comfortable with picking up shares for themselves repeatedly throughout 2013. HMPR has not seen any insider buying to date. However, I would be surprised if that doesn't change by the end of 2013.

• WMIH is another financial sector holding that performed well during the month of July, appreciating 12.5% during the month. WMIH remains a large position in the portfolios since it was initiated in July of 2012.

During that time, WMIH has announced no relevant news to justify the 80% appreciation in the share price. It should be noted, however, that there wasn't any relevant news to justify the companies assets selling for approximately $25 million when you strip away the cash at the 2012 lows either. The stock has simply been moving in a range that has reflected the mood of the market and the mood of its shareholders, at any given time.

The mood of the markets, as we are all witnessing, has been rather jolly as of late. With that comes a certain sense of optimism that companies like WMIH will find their relevant spot within the financial economy.

The scope of attention that WMIH ends up commanding is up for great debate. It doesn't seem to be a question that anybody can answer with any accuracy. What shareholders, such as myself, can accurately surmise is what degree of risk we are taking when investing in a company that has such a wide degree of potential possibilities from both an acquisition/merger standpoint and future earnings power standpoint.

That risk, even at these levels, is negligible at best. While the potential reward remains substantial. With that said, there is no need for financial modeling of any degree. The only relevant model is the one that says you, as an investor, are risking one dollar to gain three, four or possibly ten.

WMIH qualifies as such a risk/reward tradeoff, which is why I have kept it more or less a large position since the time it was initiated.

• IWSY did lose ground for the month, shedding roughly 10% during the month of July. The reason why it deserves to be a highlight is because the investment was closed out completely during the month of July for an approximately 150% profit since inception in late-February of this year. The sale prices took place in the 2.20 range. 2.30 range. And 2.70-2.80 range.

I wouldn't at all be surprised by a continued surge in the shares of IWSY. However, it had come to a point where I could no longer accurately judge the risk in the name. I wasn't sure if I was dealing with giving up a point of downside to gain a point from here or exactly where my risk/reward trade-off lied exactly.

Whenever I reach that level of confusion in an investment, I generally greet the confusion by walking towards the nearest exit. I have found that confusion in investing ends up leading to vulnerabilities that the markets will exploit when given the first opportunity to do so.

From a purely fundamental standpoint, the management of IWSY is dealing with a large degree of execution risk at a near $200 million market cap. The markets have factored in a significant amount of future success, in the form of new partnerships that will create increased revenue. Appreciation in the share price from these levels will only take place on delivery of success, which I wouldn't at all be surprised to occur. However, the level of risk I am taking in order to see that success take place, again, was difficult to ascertain.

EVOL is a new position in the portfolios. The full research report is available on the T11 website. The Cliff Notes version of why I took a position in this name can be stripped down to three factors:

1. A mitigation of risk in the pricing of the shares brought about by unrecognized restructuring and growth in the company.
2. A management team that is aligned with shareholders in pursuing growth.
3. A knowledgeable institutional shareholder base that is quietly seizing the opportunity.

As I mentioned in the research report, these common factors is what I look for in any small-cap opportunity. In EVOL, we have a telecom software services company that has quietly put together 20 consecutive quarters of positive net income. All the meanwhile, the company generates a substantial amount of cash that they are continually returning to shareholders. Since 2010, EVOL management has returned $4.30 per share in one time special and quarterly dividends to their investor base. This type of ultra-shareholder friendly management is unusual for a small-cap company.

The company is taking on a number of cloud based initiatives that seem to be gaining traction. What these cloud initiatives are intended to provide is a high-margin, recurring revenue model that will further streamline the offerings EVOL provides. This move to the cloud is occurring as they continue to experience growth in their traditional telecom business, which is broken into three separate segments. You can read more about the segments in the research report.

There is also an interesting institutional investor that is a highly-successful telecom activist. This activist investor has been increasing her position in EVOL substantially throughout 2013.

The upside in the name is in the order of 300-400 percent over the next 12-18 months. Liquidity in the name is causing me to make it a maximum mid-sized position.

• CIDM managed to gain nearly 4% during the month of July. The position was increased to a mid-sized position during the second half of the month, as the reaction the dilutive offering the company announced last month was muted. This muted reaction confirms that there is very little risk in the shares at this price. This especially becomes true as they continue to ramp up their entertainment offerings in the form of “Over The Top” programming initiatives, as well as bolstering their already impressive library of content.

Additionally, on July 1st, board member Peter Brown made a purchase of $250,000 worth of CIDM as a participant in the share offering. It is always good to see insiders put skin in the game, especially when they have relevant experience within their respective field.

Peter Brown is the retired CEO of AMC theaters. Being in that position he probably knows a thing or two about where the industry has been and where it may be headed. In either case, his purchase of the shares can certainly be greeted as a positive.

• SPNS was reinitiated as a position in the portfolios after being sold in late-April for a 40% profit from inception. I was quite a bit more bearish on the markets when I sold the position, wanting to raise cash instead of risking excessive exposure leading to a drawdown. That stance has obviously been proven incorrect by the markets. I have no problem admitting the mistake and correcting it through a repurchase of these shares.

SPNS has been a relatively steady mover since I initiated the position more than a year ago. The lack of volatility in the shares paired with the tremendous amount of upside potential in the shares make for an attractive combination of attributes.

It should be noted that SPNS is a company that generates increased business from the prosperity in the financial sector. Their key clients are all insurance companies and various other financially related entities. A resurgence in the balance sheets of the financial sector certainly has a very strong possibility of trickling down into the bottomline of SPNS. I fully expect to see this occur into Q4.

With that said, the upside in the shares continues to warrant exposure.

Portfolio Lowlights For July

• TZA was sold at a roughly 10% loss early in the month. Much like other portfolio managers who have been experiencing difficulty with anything that has a bearish bias, I have been no different. TZA, in fact, has been the biggest single losing investment in the portfolios during 2013 after two separate attempts at hedging risk that apparently doesn't want to show its face.

I am perfectly fine with remaining in a heavily invested long position here as long as the results remain consistent. Portfolio volatility will cause me to pull back on long exposure. Keep in mind, 75% long with a 25% cash position is the portfolios default comfort level. Therefore, a 90% long position does represent a heavily invested position for the portfolios. Historically, this type of heavy involvement on the long side will not last past the 2-3 month timeframe. I would expect then, that by September-October, exposure will be reduced.

Looking Ahead To August

Following a solid July performance for the portfolios, August certainly has the potential to play the role of the spoiler as it has many times in the past. We only need to look back as recently as 2011 to see how quickly August can turn from a gorgeous mistress with a loving embrace to a jaded terrorist with nothing but blood lust on its mind. With that said, there is certainly reason to be cautious as we enter August.

This becomes especially true when considering how far we have come in the markets this year. Furthermore, the markets are starting to become lubricated to the point where investors are having a fantastic time slipping on each other in an effort to catch freely floating hundred dollar bills that are falling from heavens. In other words, things are starting to become too easy.

This is certainly no guarantee that an end is in sight over the next few weeks. Anyone who was around during the 80s or 90s bull markets can attest to the fact that markets can certainly stay easy for a period of years. The worst mistake one can make in a bull market of this caliber is sitting out simply because things have “gone up too much.”

It should also be noted that as we get closer to Q4 without a pullback within such a steady uptrend in 2013, market professionals will begin to scramble for long exposure. This will be of benefit to technology and financials first and foremost, with other sectors lagging behind in terms of performance.

The Q4 crowd who desires to catch up in terms of performance wants upside volatility without regard for anything else. You can't catch up in Colgate or Pepsi the way you can in Google or Linkedin. Those who want performance at the last minute will often times take extraordinary measures to get there.

If we are to get a substantial pullback, it is fair to say that a logical time for it to begin is between now and September 15^th. Barring some sort of surprise economic event, I wouldn't necessarily be counting on a large pullback after September. If there is a potential storm coming, the eye of it will probably begin forming in August, therefore.

While I do plan on remaining vigilant of this outcome, I don't plan on taking any preemptive action, such as moving to a substantial cash position or hedging at this point. The current portfolio positions are simply too far off the beaten path to react to a weak market in quick fashion. These are positions that depend far more on where the company is going fundamentally as opposed to where the S&P 500 is going over the next several weeks.

When the time does for defensive action, the markets usually make it fairly clear. One just has to be willing to listen.

Regards,

Ali Meshkati