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

Monday, April 30, 2018

IVTY Proxy: Board Compensation is Shameful

When Christopher Byron died last year, I was reminded of the years I knew him, my first two out of college, when I was an editorial assistant at the (old) New York Observer and he wrote a weekly column about executive compensation.

The obscenity of executive pay at the time was still relatively new and it was awesome to hear him talk about the issue. Now executive comp is an old obscenity, like a grandmother's curse. "Feh!"

Even in our topsy turvy world, it seems that the one thing everyone can agree on is paying themselves raises with other people's money. It is certainly the one issue on which all our government representatives tend to agree. All the more reason to continue to shed light on the practice.

For smaller companies, I typically see Board cash pay in the $10k-$25k range and a few thousand shares. Occasionally you see Boards putting skin in the game, though no examples come to mind at the moment.

Invuity's latest proxy demonstrates the wrong side of comp, a greedy, do nothing board paying itself an absurd fee justified by nothing. Here is the board comp for $75M market cap company trading at its 52-week lows, whose stock is down 65% over the last 52-weeks, 50% ytd and whose new CEO is trying to talk up better capital allocation to the street.



I'm sure Boards justify these things using comparables but the aspect of benchmarking everyone seems to forgets is adjusting plus / minus from the baseline depending on performance. So I'd be fine with them using a benchmark, just deduct 65%. Oh and by the way, granting oneself $125K worth of shares is not a form of alignment.

Here's the cash comp they intend to pay themselves next year, roughly the same as last year. That the Chairman takes a small cut infers he knows it's excessive, but the cutback isn't nearly sufficient.


The company reports quarterly earnings in a few days and based on the stock's recent performance, I guess the market expects 1Q18 sales below consensus $9.5M and / or management will lower already conservative guidance of 5% topline growth.

It would be pretty dramatic if this happens on top of plenty of drama year to date: The new CEO was announced in mid-February and there was an equity raise in March.

Whatever happens, the new CEO will have to articulate a lucid and reasonable plan, and I expect he will. As I see it, the reasons for owning the company haven't changed much: Great product, selling okay, scaling the marketing curve, with optionality to do much better under better management, and with the whole company selling for less than 2x sales.

Here we are under ostensibly better management and I have been trying to keep my head about even as the stock slides and the anonymous comments pile up on CafePharma. Obviously, I think investors will get paid or else why would I own this, but I think the aspects that I underweighted in my initial analysis, notably the prior CEO's spending ways and the excessive Board comp, takes on increasing weight under the new CEO, and I just keep thinking "The Board should contribute not detract from the new CEO's efforts by making material changes to their comp." I recommend a few changes in the letter I sent today.

***

Dear Chairman:

I was shocked and disappointed to open my Invuity proxy and observe continued excessive Board compensation.

What you pay yourselves even as you’ve overseen significant and material destruction of shareholder value should outrage Invuity’s employees and customers from whom you are effectively taking much needed resources. Furthermore, the extent at which you sell shares and the miserliness with which you personally buy them should outrage shareholders, the majority of whom have lost money on this investment to date.

No doubt, a compensation structure that exists only to enrich yourselves fit comfortably with the norms, cultures and behaviors of the prior CEO, but this has no place in the current strategy of managing capital more efficiently and effectively.

We have a new CEO who is working hard to improve so much prior mismanagement that occurred under your watch and that resulted in the evaporation of capital market credibility. The Board can help him re-establish credibility by following a sane and reasonable compensation structure.

I recommend the following two steps to show faith and confidence in his efforts and in the company in general:

Take no compensation until the firm starts earning money.

Buy shares with your own personal money until the Board effectively owns 20% of the company.

Lead by example. Stop this senseless self-enrichment. It will do right by your employees, customers and shareholders and it will materially and beneficially contribute to the company’s new efforts towards a wiser and smarter approach to capital allocation.

Sincerely

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.

Tuesday, April 17, 2018

LCA 1Q18 Letter: "On Testing An Investment Hypothesis"

I included this short piece as part of my 1Q18 letter posted on the Long Cast Advisers website.

***

I like to make as few decisions as possible and react as little as possible to short-term changes in price. However, as the largest single client in the firm, I definitely feel it when stock prices go down. And when they do, as they will inevitably, I increase my research to try to better test the hypothesis, because I want to make sure I’m not missing anything while taking advantage of the opportunity to buy more.

Thinking about this, I’m reminded of a wonderful article I recently read in my alumni magazine about the physicist Andrew Ewald’s work on metastasized cancers. I recommend the entire article but this paragraph alone blew me away. It speaks to the amount of time, effort and experimentation involved in simply tracking information that might be useful:

“He reconfigured his microscopes to image hundreds of positions in quick succession while staying in perfect focus. And he replaced the light filters. Microscope designers typically enhance their instruments' resolution by blasting a sample with as much light as possible. But light that bright kills cells. "Bringing in more light looks fantastic for a few images," Ewald says. "Then the sample dies." He took a different tack: He carefully guided the scope's light beams to make each photon do more work. He managed to supercharge his resolution while keeping light levels low enough for cells to survive indefinitely. He wrote software that made the microscope take a picture every 10 to 20 minutes for up to 100 hours. He calls the technique 4-D confocal microscopy—the fourth dimension being time. He calibrated his equipment to collect not just images but numbers—quantitative measures of cells' positions, velocities, and trajectories.”

What an intense and extraordinary amount of work first identifying a problem then testing different solutions. It got me thinking about how investors test a hypothesis related to an investment idea.

All public investors have access to self-reported financial information published quarterly; macro-economic information published regularly by the government (and supplemented by private sector service providers); and their own abilities to reason. These are good primary sources to help form a hypothesis.

We also have access through Seeking Alpha, Sumzero, VIC, et al. to other people’s views on a stock. And of course, the most expedient piece of information is the stock price, which is essentially the aggregate of what everyone thinks.

There is value to knowing what everyone else thinks, but it often serves more as a “bias creating machine” than a “hypothesis testing machine”.

I recently met a PhD psychology student at Stanford who told me: “There’s lots of human error out there, that’s for sure,” which is a nice way of saying something a lot of us probably wonder from time to time. It gets to the heart of my belief that the markets, theorized as an efficient method of price discovery just as often amplifies human error.

If you want to do better than the crowd, you have to do different. With nearly two decades of investment experience, and a foundation of healthy skepticism, a little irreverence and a lot of humility, I think it is possible to sustainably and repeatedly do better than the crowd. The question is: How?

Part of my work, which was informed by my brief experience in 1996 working as a PI for BackTrack Reports, involves interviewing people. Without care, interviews can lend towards biases (small sample sizes, weak connections, etc) but a good source (customers, executives’ former colleagues, competitors who always love to dish dirt, experts in certain fields) asked the right open-ended questions can add value that is not otherwise available elsewhere. It is a sharp relief from talking with other investors who more often than not don’t want to hear or haven’t considered the bad news. (The best ones do, and most likely already know it.)

I know I’m not the only investor who interviews people and I know that as a “hypothesis testing machine” it is imperfect. But I think marrying the quantitative analysis of financial statements with the qualitative aspects of “walking around and talking to people” helps reduce some errors.

Whatever the favored method is, the key is to first figure out what we’re looking for, then try to figure out how to find it. It’s hard and it’s time consuming and you never know if what you’re going to find will add value. I start with asking “where am I wrong” in order to seek out what I don’t know so I can find ways to disprove the hypothesis. Asking the right questions is one of the hardest parts to solving any problem, investing included.

There’s no one answer and we can all find our paths to success. But following a scientific method has tremendous value. I realize that comparing the humble and greedy aspects of business valuations and investing doesn’t hold a candle to cancer research, but in taking a professional and scientific approach to the work, at least we can match the integrity of it.

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ALL RIGHTS RESERVED. PAST HISTORY IS NO GUARANTEE OF PRIOR RETURNS. THIS IS NOT A SOLICITATION FOR BUSINESS NOR A RECOMMENDATION TO BUY OR SELL SECURITIES. I HAVE NO ASSURANCES THAT INFORMATION IS CORRECT NOR DO I HAVE ANY OBLIGATION TO UPDATE READERS ON ANY CHANGES TO AN INVESTMENT THESIS IN THE COMPANIES MENTIONED HERE, WHICH I MAY OWN.