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This is written with serious investors in mind, though sometimes they're just drafts in progress. I'm a former reporter, private investigator and institutional equity analyst who digs deep to find niche undervalued and undiscovered securities. I manage money for individuals, institutions and family offices via my business Long Cast Advisers. This blog is part decision-diary, part investment observations and part general musings about Philadelphia sports. It should not be viewed as a solicitation for business or a recommendation to buy or sell securities.

Thursday, February 19, 2015

On the "wonderous future" sold to investors and 76ers fans

There's often a conflict in sports around trade deadlines, when a fans' emotional attachment to their team bumps up against the unemotional "dumping" and "asset gathering" of mgmt.

I'm speaking of course about the overlap between sports and investing and the "promises of a bright future" for a team in turnaround. When it comes to the 76ers at this year's deadline its' a real crashing prism; The Sixers just traded away 2/5th of their starting team - PG Michael Carter Williams and F KJ McDaniels - in return they got a development league PG, a future 1st round and a future 2nd pick.

In investing parlance, they divested productive assets that reflected at least 1/3rd of their offense (or revenues) for future - albeit unknown and uncertain - assets. The media gives them a pass and calls it genius but it pains this fan to no end.

What makes the comparison between sports and investing so obvious in this case is the owner of the Sixers, Josh Harris, who is also the co-founder of Apollo Global Mgmt (along with Leon Black, with whom we own ESWW). Harris bought the team with two friends from Wharton, David Blitzer now at Blackstone, and another PM before the 2011/2012 season.

Their general manager, Sam Hinkie, isn't a "baller" but a former Bain consultant with a Stanford MBA and he is at the forefront of the "analytics" trend in the NBA, which ranks players on efficiency not points and assists.

Hinkie shuns the media and seemingly any urge to win today. Or tomorrow. This is just his latest trade of starting players for future draft picks. Indeed, they have more than 10 draft picks over the next two years including likely two first round picks this year and next. A shirt seen at an MLK day game: "I have a dream, but the 76ers traded it for a 2nd round draft pick."

If you think about the equivalent of owning these draft picks to investment analysis you might say the balance sheet is undervalued b/c it doesn't appropriately reflect the future draft assets. Where does its value sit, this player to be named later? We know the cost is the league minimum, perhaps that is its liability, but the rest is unknown. But we know what they gave up and there is no certainty they will do better in the future.

So what does this losing team have? A lot of draft picks and a spirited coach with a great attitude half-way into a four-year contract, and lots of young players to teach. And they spend little for these players. The 76ers are actually 20% below the salary minimum that teams are required to spend each year.

So the present stinks and the media calls Hinkie "the mad genius". The team on the court, is meaningless. Over the span of the 3 2/3 seasons that Josh Harris owns the team, its winning % is just 35%. Year one, they inexplicably made it to within one game of the finals, winning playoff games against teams with hurt stars.

So they blew up the team, these owners but with the prior GM, going the traditional route of trading away their star F and a 7' C (now a reliable starter for a bad team) in exchange for a change maker, an all star, who happened to be the aging damaged C Andrew Bynum who had bad knees and never played for them.

So they changed GM and are now running in the other direction, eschewing long term all star talent for draft picks. And the record has declined. This year its 23%, as it was last, but undoubtedly after these trades it will get worse.

It is what they call a "turnaround."

So what skill is this ownership showing as it progresses through this plan? How do we even gauge progress?

I'm reminded of Stanley Furniture (STLY), a furniture manufacturer also in "turnaround". The company has in the last 12-mos embarked on a "new" strategy away from manufacturing in the US to an "asset light" strategy using only its design capabilities and distribution channels and simply outsourcing all the manufacturing to overseas subcontractors.

The shift is the work of the current CEO Glenn Prillaman. Glenn worked his way up the company since joining as a sales agent in 1993, but this is no "bootstrapper" story; his father Albert was the CEO and Chairman.

And this new change in strategy? It reverses the one he did in 2010, when he took over as CEO and embarked on then "contrarian strategy" to on-shore manufacturing of "high end" youth furniture. He invested $9M into a manufacturing plant in NC over three years, and burned shareholder equity from $93M in 2009 to $75M. And in 2014, they just shut down the plant. Same CEO, new strategy, but with shareholder equity now down to $50M. It's not just out with the old, it's also out 50% of its value. And the old CEO still remains.

I, a new shareholder, am along with the plan under the assumption that the new board - including activist investors and a former colleague of mine from CSFB - can make the right changes and extract the right value from the company even if the CEO has been a value destroyer. I have money at stake in this investment, but I have done my homework and it has thus far paid off. The risks that most concern me are how the company can manage its distribution channels after selling it one idea (US made) and now another (no manufacturing). But the issue of the stewardship of the guy who got us here in the first place, that is a hard nut to swallow. But I can sell at any time, currently with a profit.

The point is, as everyone knows, CEO's can screw up. And when they do - and it sadly happens often - it damages investors and employees and brands and communities. We don't give them a pass when they screw up in corporate America, why give them a pass now? I know Knicks fans could sympathize.

What does the fan do here? We cannot sell. We are captive. In some respects, we are like investors in a fund with a lockup. Perhaps so to speak, like an investor in a PE fund, like Apollo. What is it that these guys do so well that makes them rich? B/c clearly their track record as basketball investors is rather weak.

So I imagine momentarily the comptroller of a municipality or a treasurer of a pension fund or CIO of an endowment who is sold on the idea of the wonderous future by someone like Josh Harris. Perhaps these people - the comptroller or the CFO - are the same folks who invested with Apollo in the convertible debt of a company called "Environmental Solutions Worldwide," which makes diesel particulate filters.

In 2010, back when California regulations called for widespread use of DPF's, such an investment had a wonderous future. But looking ahead, investors would have lost 99% of their money; in 2010 the stock traded at $1,200 / share. I own it and have written about it here at a $60 / share.

And now imagine our same imprudent investors sold by the same institutional madness the same promise of a wonderous future, in say MBS in 2007 or a transaction hedged by oil at $100 or the Swiss Franc at 1.2 to the Euro.

Promises of a wonderous future come cheap only to those selling it, not to the buyers.

And that appears to be the sad point I've learned about the owner of my team today and what we should all keep in mind about these wall street mavens who get pass after pass after pass for being "masters of the universe."

These owners behind the trades today, and trades in prior years, and trades in oil or debt of distressed companies, they are not always the good stewards of capital we hope them to be, but they are simply selling a wonderful future. And it dawns on me that's where institutional "wall street" really excels - where it captivates investors - who allow themselves to be sold on the promises but not the risks of uncertainty.

Every part of me is opposed to the Wall Street principle of "selling the wonderful future" and I try to avoid it at all costs. Unfortunately, I can't avoid it with my basketball team. But I can warn readers that these guys are not mad geniuses. This is their second turnaround and its prolonged.

They are not rich because of the great investments they've made - they have a number of bad investments - but they are rich b/c they are good at selling people on the "wonderous future." That's what they are doing here.

There is nothing to do as a fan but I remind all investors there is no easy money nor is there an easy draft pick. And I caution anyone sold on the idea of the wonderous future or the "easy money" to do their homework or find and entrust people who can do it for them, prudently, honestly and with integrity.

Just please don't hold it against them if they root for the 76ers.

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