About Me

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Avram Fisher, Founder & Portfolio Manager of Long Cast Advisers, is a former equity analyst at CSFB and BMO covering industrials and business services. He has prior experience in private equity; as a corporate governance analyst; as a writer; reporter and private investigator; and as a lifeguard and busboy (I still clear plates when my kids don't). This blog is an open book of ideas about patient investing and about starting up a small-cap focused RIA. It is part decision-diary, part investment observations and part general musings. Nothing on this blog is a solicitation for business nor a recommendation to buy or sell securities. It is simply a way to organize and share thoughts with an expanding audience of independent, patient and talented small cap investors. www.longcastadvisers.com

Tuesday, October 25, 2016

On the short term activist shaking the ARIS tree

It is an interesting observation that when one types the word "SEVEN" into google search function, it autofills "Seven Deadly Sins" a reflection I suppose on the frequency with which the people check for behavioral affirmations.

In a way, the stock market has a similar effect. Every tick in the market can be a behavioral affirmation of one kind or another that can heighten the tension between greed and charity, or diligence and sloth.

I write here however, of the tension between "wrath" (less formally known as "impatience") and its more virtuous partner "patience". I find the latter to be a stellar principle for sound investing but it can be so difficult in practice that even those who speak of "long-term value-oriented investments" find it hard to back up with actions.

This all comes to mind because of the impatience recently expressed by the investor filing a DFAN14A with the SEC on ARI Network Services (ARIS), indicating a desire to solicit the sale of the company, an action that strikes me less as the endeavor of an activist than an expression of impatience and idiocy.

What we know about ARIS need not be rehashed because I've written about it elsewhere, but I'll summarize in three bullets:
  • It is an $85M market cap company whose CEO Roy Oliver, since taking the reins in 2008, has grown shareholder equity 33% CAGR. 
  • In stewardship with his capable CFO Bill Nurthen, who joined the company in 2013, Oliver now runs a cash flow generating business that has reinvested in high return acquisitions, an attribute of a "compounding" company
  • By increasing the availability of and access to debt, the company should be able to continue to fund what has hitherto been a successful acquisition strategy into the future.
In my ~15 years in institutional finance, I've rarely seen such strong capabilities in companies above $10B market cap and here I am a shareholder of one that is still below $100M, and with a potentially long runway of growth ahead.

Taken all in, I believe the C-suite team is unusually strong and capable for a company so small (though they are not perfect). 

Yet, were the company to sell, we would lose our ownership rights to the company just as the going-got-good and we would lose the benefits of investing in a C-suite team that has performed so admirably. To break up the band, so to speak, seems premature; to nip such success in the bud seems stupid. 

Obviously, once a company has gone public it is in principle already sold; shareholders are the owners and the executives are the managers.

This missive is therefore addressed to my fellow owners who like me can see the long road ahead under present management, who don't want to pay taxes on their growth in capital to date and who know how hard it is to find well run companies that can compound growth over time, for what are well run companies but good mgmt teams allocating capital - labor, time and financial - wisely?

When we find them good companies well managed, we should hold onto them for long periods b/c they are few and far between.

I imagine all shareholders know as much as I do and see the same attributes as I see in ARIS,  but what do we know about the owner advocating for the sale? I aim here to briefly fill in that gap based on available information so we can judge for ourselves whether his suggestions reflect temperance or gluttony.

This appears to be the third activist endeavor for the owner ...

1. AdCare Health (ADK). Period of activism: 2013 until Present (he is now on the board).

Initial statement from April 2013 says he owns 750k shares at $4.01.

In July 2013 he's advocating they sell the real estate to generate $4 / share cash that they pay as a dividend to shareholders and that the remaining business would be worth $9 / share. In August 2013 he says they should split into a REIT and an operating company. July 2014, the company announces it will end operations and convert into a holding company that would make it attractive to be acquired by a REIT. In November 2015, the Vice Chair has fraud charges filed against him. (I can't keep up!).

ADK now sells for under $2 and is the subject of an activist campaign by Echo Lake Capital / Ephraim Fields. Value investors appear to like the opportunity from the NOL's and the property.

2. Resonant Inc (RESN).

Initial statement of ownership of 300,000 shares in Feb 2015 at $15.47.

Continued to buy through the spring of 2015 such that ownership stake reflects 700,000 shares and the stock is trading at $4.75. In February 2016 he's given a board seat with the stock at $1.80. As of 4/27/16 he owns 1.035M shares.

3. ARI Network Services (ARIS)

1M shares bought b/t October and December 2014 @ $3.67 / share. In December 2015 files letter that company should seek potential sale. In Oct 2016, files proxy that company should consider a sale and that he is nominating himself and some investment banker to the board.

... I dare not speak ill of other investors for it is undoubtedly a function of hubris to think that one is smarter than another.

We all see in companies values - the more divergent the value the greater the opportunity - and I hope the value this investor sees in the shares he owns can be realized. I know nothing about two of them. However, I have experienced two things in life that I can say with certainty:

1. People tend to repeat their patterns of behaviors. Conclusion: Someone who has a prior history of buying small cap companies, getting on the board and overseeing value destruction is likely to do that again. We should aim to keep those with a frequency of such behaviors from coming to near to managing the capital that investors, company employees and managers have worked so hard to produce.

2. When my children ask for things they've done nothing to deserve, I say "no". Conclusion: When your unsolicited proxy arrives, shareholders should do the same here.

-- END --

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS OR RECOMMENDATION TO BUY OR SELL SECURITIES.


Monday, October 17, 2016

The Half Truths Told About Passive Accounts, And the Whole Truth on Concentrated Patient Investing

Peter Thiel apparently likes to ask an interview question: "Tell me something that's true, that almost nobody agrees with you on."

I prefer the question "Tell me something that's false that everyone believes" and as I've grown older I've gained more confidence in those things that come to mind.

At the top of that list right now is the idea of diversification, (followed closely by Vikings not actually wearing horns on their helmets).

Diversification makes sense b/c it follows the common principle, "don't put all your eggs in one basket".

Ironically however, that principle conflicts with every single one of life's most important decisions; who you marry, what you do as a career, who you work with, etc.

In all the major commitments in life, we by nature put all your eggs in one basket.

I think everyone would do well practicing at least once in awhile putting all their eggs into one basket so they better understand the inputs to and tolerate the consequences of those actions.

Anything else is laziness.

***

This relates to the half truth that we should invest our savings in the market through a diversified basket of low cost index funds as an alternative to buying and selecting individual businesses for investment.

The whole truth is that when asset returns are correlated the presumed benefits of diversification disappear, so why is it better than individual stock selection?

***

I reckon most people don't think about the markets as individual companies. I reckon they think about it more like a flock of starlings in murmuration but those of us who analyze individual companies are like ornithologists who can pick out individual birds.

When you dig deeper into "the market" and look at its components it becomes apparent that sometimes "the market" is really just a few stocks overweighted in an index, impacting the whole.

***

There are a lot of ways to invest in the stock market beyond undifferentiated passive investing. I buy and hold small companies for long periods and limit my portfolio to a handful of what I think are terrific businesses trading at reasonable prices (or better still, unreasonably low prices).

There are plenty of other people who do what I do up and down the market cap spectrum (ie large and small companies) and then there are others who buy bankruptcies, debt, risk / arb, options. There's no lack of variety of investors. Some are more consistent and successfull than others.

Regardless of who those people are, I think I speak for all of them -

every single investor that buys individual securities 

- that the underlying trend towards blanket diversification reflects two forms of laziness - intellectual and professional - that has become nearly universally accepted but is just plain wrong.

By intellectual laziness I mean the inherent incongruency that we should prefer market exposure with market risk over business exposure with business risk.

A well researched, thoroughly analyzed, cash flow generating, under-levered and growing business acquired inexpensively should - at any point in time - be a safer investment than a basket of companies arbitrarily selected by their size or industry or valuation, especially when that basket overlaps so many others. And if properly selected it can generate a more meaningful return than that basket.

But finding those companies takes time and effort and its stressful and difficult and it gets in the way of making money that comes from accumulating assets, which is how all money managers get paid regardless of performance.

By professional laziness I mean the things that happen when people ...

1) accept intellectual laziness and call it a service.

2) do what everyone else does and call it "unique" or "proprietary"

3) take vast sums of money from endowments, pension funds, retirement funds, government entities, etc and put it into instruments that behave like index funds simply b/c it's too hard to allocate them otherwise, and with no consideration of or responsibility for those whose retirement depends on the wise allocation of said capital.

... the alternative in all cases involves work that is difficult and differentiated but could be more meaningful to clients; identifying a handful of undervalued securities and owning them.

***

I've been investing personally since the late-1990's, starting with 10 to 100 share lots when it was easy and you could read Buffett at night and still buy www.something.com during the day and be up 10x the next and none of it made sense, but it was fun.

The investing structure of Graham and Buffett resonated with me nonetheless and I fell in love with it, slowly transitioning from my prior work as a writer / reporter to institutional research (with stints as a PI and in PE in between) then working for nearly 15 years on the sell side (with an MBA squeezed in) covering mostly industrials and services related companies up until I was laid off in 2012.

Here's a small collection of books I used to teach myself about investing ...


... I have a whole other shelf of text books from my MBA plus it's incredible what's available online now (and at the library).

***

Ironically, b/c I worked on the sell side, I had little time to spend thinking about my own investments and b/c of Eliot Spitzer I couldn't own the stocks I covered, so my personal accounts (I managed three) were fairly haphazard.

I had three primary accounts: One mostly held companies where friends of ours worked (a quasi Lynchian approach), one was concentrated in micro caps I'd read about in trade journals or found on screens, and one was diversified with large companies.

I tracked returns extensively on Quicken on an early generation Macbook but i gave that up when i started working in the industry. It was okay for me that some stocks went up more than others went down.

When I was let go, and looking for work on the buying side, I figured I should start reflecting on my personal returns. I could only go back as far as the end of 2007 since E*Trade only kept returns for a certain period and here's what I did over that time period.



Nothing earth shattering ... but it dawned on me that owning a handful of random micro-caps in concentrated positions for long periods led to 2x outperformance of the major indices, and with a pretty a low correlation.

What if I just focused on that area of the market, not buying "random micro caps that sounded interesting" but fully understanding the businesses, the managers and executives, the customers, analyzing these tiny companies as I'd analyzed mid- and large-cap companies in my coverage sector, and making big bets in the best ones I could find, while saying "no" a whole lot more?

I decided that's my business, not just b/c of the outperformance over an arbitrary time period, but b/c I liked finding gems overlooked by others and most importantly b/c it would be easier to compound a small sum of money in smaller companies than it would be in larger companies.

Since that time, noting the end dates for the other two accounts which have been moved, that small cap concentrated account is up 18% CAGR. It seems to validate the thesis.



The downside of focus on small caps, which I've talked about with a few institutional PM's who run small cap funds, is that the strategy maxes out at a certain AUM, which caps compensation.

That's fine. That's why so few people do it. It is good enough for now to experience the ego gratification of investing in deliciously inexpensive well run company employing great people doing interesting work satisfying the needs of hungry customers, and doing it with integrity for myself, my clients and the companies I own.

***

This the most differentiated approach to investing requires patience. It is sometimes quick and exciting, sometimes slow and frustrating, but its always enervating and enlightening way engage the world around me.

The opposite end of the investing is the most undifferentiated mass marketed passive movement. They will charge you the least fees but you get the mass strategy. Someday this institutional passive investing will resemble the equivalent of cheap protein, including i fear, even the slaughterhouse.

-- END --

ALL RIGHTS RESERVED. THIS IS NOT A SOLICITATION FOR BUSINESS. ALL OPINIONS ARE MINE ALONE, EVEN THE ONES I SAID WERE EVERYONE ELSE'S. THESE ARE UNAUDITED TIME WEIGHTED RETURNS OF A PERSONAL INVESTOR BASED ON MONTHLY STATEMENTS AND CALCULATED IN EXCEL.