APRIL MONTH END PERFORMANCE SUMMARY AND LOOKING AHEAD TO MAY

Posted By admin on May 3, 2013 | 0 comments

*This is a copy of my letter to investors summarizing the month of April.

March monthly report can be found here.

2012 Return: +58.61%

2013 Return: -7.36%

Portfolio April Performance: -6.86% S&P 500 April Performance: +1.81%

Portfolio YTD Performance: -7.36% S&P 500 YTD Performance: +12.02%

Total Return Since Inception (1/1/12): +47.80% vs. S&P 500 +27.03%

Portfolio Highlights For April

- SPNS ended March as the largest position in the portfolios. Throughout April the stock steadily rose, finishing the month up 6.43%. Given the performance of the portfolios thus far in 2013, the strategy employed is siding towards conservatism taking precedence over aggression. SPNS has gained some 40% since being initiated nearly 12 months ago, fluctuating between a mid to large sized position the entire time. Although I believe the company continues to have upside potential into the second half of the year, better opportunities on a purely risk/reward basis exist. SPNS was reduced throughout the month of April, ending the month as a small position. I will strongly consider adding to the position if prices become more advantageous in the months ahead.

- CIDM is a new position in the portfolios. The research report was published on April 23rd and can be found here. It was made a mid-sized position from the start given the advantageous setup for the company at this junctures of its existence. To highlight a few points from the research report for CIDM:

• A restructured business model focused on two segments: 1) Cinema software, where CIDM enjoys 70% of the market on the distributor side 2) Content distribution, where CIDM is the #1 digital aggregator and distributor of independent film content, with major partnerships that include Netflix, Walmart, Amazon and Hulu.
• Management that includes an experienced former hedge fund manager who specialized in small-cap restructuring situations and a CEO who is a veteran of the movie business including being the COO of MGM before it was sold for $5 billion to a consortium of investors.
• A completely restructured debt picture that essentially absolves the equity investor base of any responsibility with the debt now being collateralized by existing equipment. The debt restructuring also saves the company substantial interest payments and extends maturities of the outstanding debt.
• This is an extremely "buzzworthy" opportunity in a digital content company that is selling at valuations that create as well defined a risk/reward equation as possible. What I mean by "buzzworthy" is that it is in the right industry at the exact right time. Any earnings momentum resulting in price appreciation has the potential to see the company appreciate 3-4 times in a relatively quick manner.

Portfolio Lowlights For April

- WMIH continues to adversely affect performance as it has been trickling down in a relatively steady manner since the the middle of January. WMIH was the largest position in the portfolios coming into 2013. It has been steadily reduced due to the performance, now sitting at a mid-sized position. Overall, WMIH has been a winner since being initiated in late-July. It is up roughly 20% since that time. However, in 2013 it is down 29%, being responsible for the negative performance experienced thus far in 2013.

I have been involved in several restructuring/reemergence opportunities over the past several years. The bankruptcy and subsequent rights offering in GSI Group is one successful example. The saga of telecom company PTGI is another. CPSS was one that initially in the portfolios throughout much of 2011, but liquidated much too early. In the midst all these examples, WMIH is by far the most fascinating, complicated and potentially lucrative opportunity. There are a ton of moving pieces and possible variables involved here that are difficult to value properly. The difficulty in valuation is what creates the opportunity, however. In other words, if the outcome was apparent there would be no opportunity or certainly not an opportunity as great.

What can be ascertained is that the company has in the vicinity of .35 cents per share in net cash, leaving the price of the "assets" at roughly .25 cents per share (or $50 million) for an interested buyer. The assets in this case are: 1) NOLS worth some $6 billion 2) WMMRC a captive (captive is formed to basically isolate risk from a parent company within a defined structure) reinsurance company being operated in runoff (runoff pays existing policies, without writing any new policies until expiration of all liabilities in the form of outstanding policies). There is a substantial question mark regarding the appropriate value for such an entity. In the court hearings the value of WMMRC alone was estimated at a mid-point of $125 million. It should be mentioned that prospects for reinsurance in the current M&A environment are exceedingly opportunistic in nature. Reinsurance as an industry is getting quite a bit of attention due to many high profile hedge funds using offshore tax loopholes created through reinsurance companies being domiciled in tax havens to create lucrative, tax efficient investment vehicles. There is increasing governmental pressure and scrutiny into these offshore tax havens,creating an increased repatriation from offshore structures. Furthermore, captive reinsurance companies that are being operated in runoff certainly have an acquisition value that seems to be enticing for financial firms that know how to utilize the structure properly. There is, in fact, increased competition taking place in the reinsurance market place for captives. This is, perhaps, one of the reasons the process for WMIH is taking as long as it is. A hot M&A environment involving their sole existing business could be creating increased competition for an entity that has so many restrictions involved with a potential acquisition. It is my opinion that WMIH will eventually capitalize on this trend towards reinsurance, merging or capitalizing with an entity that allows the company to become a legitimate revenue producing financial company that can utilize the NOLs involved properly.

In the meantime, there is a $50 million valuation being given to a company (WMMRC) that was given a a $125 million mid-point value by expert witnesses in court. The NOLs here are basically being valued at zero with such a deep discount being given to the reinsurance entity here.

What is the problem then? The problem is the uncertainty of a potentially hostile situation involving hedge funds (David Tepper and co.) and the equity committee that controls the company here. There is a possibility of the current board could be replaced with a board that is more friendly towards the interests of the hedge funds. In that case, there could be an increasing hostile stance taken towards equity investors that are essentially being given a free ride on the back of what will ultimately be the hedge funds capital infusion. What form that hostility will take is difficult to ascertain here and now. My goal is to figure out the potential risks that I may be missing in the overall picture.

I continue to hold a mid-sized position here for the same reasons I initiated the position at .50 cents in July of 2012: The risk is so well-defined in a business model with abundant possibility and limited observable downside.

- IWSYdeclined 12% during the month of April after a post-earnings spike that saw the stock rise above 1.30. IWSY remains a mid-sized position within the portfolios.

- MITL declined 10% during the month of April in what I consider to be an act of passing time until clarity is seen into top and bottom line numbers into the second half of the year. Given the fact that I believe technology will play a much more prominent role in any market rally from August onward, MITL should begin gaining some traction once money that is looking for increased return potential begins making its way into the US markets. For the time being, MITL remains a small position in the portfolios.

- JMBA declined nearly 7% during the month of April. JMBA is one of my favorite opportunities in the portfolios currently. However, I am waiting for the share price to begin showing some signs of life before adding. What I see in JMBA is not just a potential growth story due to an increasingly health conscious consumer. JMBA is not going to be a smashing revenue model that creates monstrous cash flow for the company causing the share price to explode due to undervaluation according to every metric available. JMBA is 100% a branding story.

In JMBA you have the most well known fresh juice company domestically, with a focused effort on creating the same type of brand consciousness overseas. You also have a management that doesn't seem as concerned with profiting from each individual franchised store as much as they do making JMBA stores as prevalent as Starbucks in neighborhoods across America. Furthermore, there is an effort to install small JMBA kiosks in universities, hospitals, school cafeterias etc. to further expand the brand recognition. Not to mention the effort that is being made to have JMBA products in grocery stores.

You can see the trend here. JMBA is a branding recognition story in an industry that is just beginning to bubble beneath the surface. Everything management seems to be doing is geared towards putting JMBA in front of the eyeballs of the consumer. Revenue growth will follow the eyeballs. Perhaps of even greater potential is the brand recognition that these efforts will create, making JMBA an eventual high value takeover target.

All of these factors together when combined with the successful restructuring efforts, debt reduction and recent return back to profitability make the $220 million market cap being assigned the company an extremely low risk proposition with substantial upside potential.

- The portfolios did end April roughly 60% invested, with a 40% cash position. This level of under-investment has everything to do with the lack of performance among the names in the portfolio causing me to trim exposure. It is not as a result of any bearish overall opinion regarding the future direction of the markets.

Looking Ahead To May

The sheer persistence of this bull market has been the most surprising aspect of market behavior thus far in 2013. There has not been a correction in excess of 4% through April of this year. What is perhaps more surprising is the fact that this rally has been led by sectors that include transportation, consumer discretionary, healthcare and utilities. Conspicuously absent are the sectors we have come to appreciate as market leaders over the past several years. Namely technology and commodities.

The SOX, as an example, has been lagging the Nasdaq greatly. This is not something that has been typical of bull markets over the past 10 years. Commodities, as a bull market leader, have completely disappeared as weakness in Emerging Markets has created defined weakness within the sector that doesn't seem to be intent on turning around with any ferocity in the near future.

Furthermore, more speculative names in the markets have yet to make their mark among the market leaders. Take for example the highly volatile social media space. There are select names, such as LNKD, that are being driven forward as a result of superior earnings. However, the market still remains selective in what it chooses to reward and what it chooses to punish.

When you take the aforementioned evidence being offered by the markets into consideration, there is only one conclusion to draw: This bull market we are experiencing has yet to see an influx of any speculative money at all. In fact, it seems to be a bull market that is being driven greatly by foreign assets looking for safe haven in well known, trusted U.S. companies that will preserve capital over the long-term.

This is surprising when contrasted against the loud voices that are calling for an end to this bull market because "there are too many bulls." The study of sentiment in today's market environment is increasingly built on indicators that have very little substance, being more anecdotal in nature as opposed to concrete evidence weighed against the actual allocation of assets.

If you look at the asset allocation picture of the markets here, it is apparent to anyone who bothers to look closely that there is very little in the way of speculative, greed driven price movement that tends to mark important market tops. There is no runaway bull market in any one sector. There remains a tendency to back and fill. There is a selective attitude towards what deserves to appreciate and what doesn't. All of these are telling of a responsible investor class that is controlling the current market environment.

You may ask, what is significant about a responsible investor class being at the reins of the market? It comes down to one concrete fact: Bull markets don't end with responsible investors being at the helm. The Warren Buffet type of investor doesn't cause blowoff tops in market averages. The Warren Brown type of investor certainly does. Who is Warren Brown? Exactly. He hasn't achieved any status, except for late payments at the gas and electric company because he is always buying speculative stocks when the market feels cozy, comfortable and he has lots of company to affirm his judgement.

The Warren Brown type of investor doesn't bid up healthcare and utility names in an orderly manner. It is a more sophisticated investor that is responsible for this type of asset allocation. This type of sophisticated investor is typically early as opposed to late.

From this vantage point, there are no signs whatsoever of speculative funds rushing back into this market. It continues to exhibit all the orderly cues of a bull market that has simply made a new all-time high after years of being stuck in the mud. That doesn't mean we won't have a 5% correction until 2016. We may have one over the summer months, in fact. When that correction comes, it will be an opportunity to increase exposure, however.

It will not be the market top that most expect it is based on sentiment indicators that have no place in the analytic arsenal of any investor who has long-term portfolio appreciation as their goal.

Regards,

Ali Meshkati