Inelegant Investor

From the description of Disney-MGM Studios’ Twilight Zone Tower Of Terror:

Board a phantom elevator, shoot up 13 stories and brace yourself for a thrilling plummet… but beware! The experience just got scarier. You rocket back up, only to plummet down yet again. You dare to ride once more, but wait! That’s not what happened before. That’s right, now the Tower is in control, so it’s never the same fear twice!

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Last Friday, Geoff Gannon wrote briefly about his positive opinion on Hanes Brands(HBI). Gannon noted “I’ve yet to find someone who agrees with me on Hanes. I’m not sure if that’s a good sign or a bad sign.”

Well, I’m not sure if it’s a good sign or a bad sign either, but I’ll throw my hat in the ring as agreeing with Gannon on Hanes.

The company was saddled with a large amount of debt as part of its spinoff from Sara Lee(SLE). At almost $2.5 billion,debt is roughly equivalent to its current market cap at Friday’s close of $26.10. Sara Lee was also kind enough to leave Hanes with an unfunded pension liability of over $200 million.

Despite this heavy burden, the company has begun to make strides in its first few quarters as a public company. It has funded its pension liability with over $80 million which should be sufficient for fiscal ‘07 and allow it to pay down debt over the balance of the year.

Though positive, the company’s earnings have been impacted not only by a large interest expense,but also by serial restructuring charges. Though like The Stalwart, I worry that moving out of the Dominican Republic in search of lower costs is a short term fix at best, I believe the company’s plan can be effective if it rationalizes the huge number of plants that it currently operates.

The business itself is a solid business. Hanes owns some of the most recognized brands in both innerwear(Hanes,Playtex, Bali,barely there,Wonderbra,L’eggs) and outerwear(Champion). It has excellent distribution for its products. While it will take several quarters to start seeing benefits(I don’t expect anything spectacular this Thursday), this is a company that can fairly quickly establish an accelerating virtuous cycle of increased profitability as it deleverages.

Anyone else care to agree or disagree with Mr. Gannon and I?

Disclosure: I hold a position in HBI and SLE

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“Gluttony is good”, a modern Gordon Gekko might have said, in reference to the triumphant return of the coveted mustard belt to America. Joey Chestnut, paying no heed to rising beef prices, managed to consume, quite conspicuously, 66 hot dogs in 12 minutes. Like many former high-flyers, defending six-time champion Takeru Kobayashi suffered from a late ‘reversal’, and was able to manage a mere 63 hot dogs.

Hoping to do for stock picking what eating contests have done for sport, and in honor of the holiday, I have constructed a portfolio of companies whose names contain the word ‘independence’. The portfolio consists of five companies, two insurers, two banks, and one mining concern. Any ETF provider looking for an exciting new index to use is urged to contact me for licensing rights.

Independence Holding Company(IHC) is an insurance holding company with subsidiaries operating in the medical stop loss, fully insured health, life and disability insurance businesses. The company also owns 48% of American Independence Corp, the next stock on the list. While the largest company on the list, IHC is fairly small with a market cap of $315 million. At first glance, a dividend yield of 0.2% and a P/E of 21 look fairly prosaic, but some further looking is in order given a reasonable price/book of 1.3 and recent growth in revenue and earnings. 7/3 close: 20.75

American Independence Corp(AMIC) is a small medical insurer and reinsurer with a market cap of just $93 million. It is controlled by IHC and shares its management team. While the trailing P/E of 43 makes this look pricey, the most recently reported quarter showed a large improvement both sequentially and year over year. Management has stated that last year’s poor results stemmed mainly from business written in 2004, and that performance going forward will be improved. At 1.1 times book with recovering earnings, this stock doesn’t look expensive. 7/3 close: 11.07

1st Independence Financial Group(FIFG) is a Louisville, Kentucky based bank with 8 branches in Kentucky and southern Indiana. The bank yields 1.9% and has a trailing P/E of 21. Recently, the company announced it hired an experienced team of 6 bankers in Indiana who had previously worked at Regions Bank to expand their business in Indiana, and this could conceivably lead to material growth. With a market cap of just $33 million, 1st Independence has plenty of room to grow, and as a profitable company with a price to book ratio of .88 it provides protection on the downside. 7/3 close: 16.80

Independence Federal Savings Bank(IFSB) is a small, 4 branch bank located in the Washington DC area. It has been unprofitable, beset by turmoil of a failed merger and a fight with its largest shareholder. It generally just seems like a bad idea to own.7/3 close:10.11

Independence Lead Mines(ILDM.PK) is an old mining company with no revenue to speak of. Its only asset is land with mineral deposits which were leased to Hecla Mining(HL) in 1968. Under the agreement, Hecla is allowed to recoup costs before paying royalties, and though it has been mining the area for over 9 years, it still has a substantial un-recouped project claims. These peaked at $43 million at the end of 2005, and were down to under $25 million at the end of Q1. It is conceivable that sometime 18-24 months from now, the company might start receiving royalty payments. The company has been staying solvent by executing a series of private placements which have largely funded its litigation against Hecla. As of May, it appears Independence has exhausted its legal options, so the company’s value should be a function of its discounted royalties plus any dilution necessary to get to the first checks. Hecla might have an interest here as well as it gets closer to paying royalties. In any event, this is too hard for me to figure out. 7/3 close: 3.90

Of the five stocks, only the first three seem to warrant further consideration, but for the purposes of tracking this portfolio, we’ll assume an equal weighting of each of the five.

Disclosure: I own none of the stocks mentioned, nor do I recommend any of them

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I always imagined that I’d be a subscriber to a print edition of my daily newspaper long after it passed from normal to weird to quaint. I don’t have milk or ice delivered, nor did I use cloth diapers, but the experience of retrieving the morning paper from my front steps and the feel of the paper in my hands as I read it always seemed far superior to the pale glow of my computer screen. I thought our love would last forever; I certainly didn’t stray.

My local paper, desperate to increase revenue, began to charge a premium for home delivery rather than, as had long been industry practice, offer a discount. I decided I could just as easily pick up the paper myself, but only on days I had time to read it, so I canceled. Periodically, I’d resubscribe when I received offers of 75% off cover price for 13 or 26 weeks, being careful to cancel when the special rate expired. Eventually, I found I was buying the paper less and less often and then, not at all.

Even after this, I continued to subscribe to Barron’s, excitedly bringing it in and reading it each weekend. I always turned first to Alan Abelson’s weekly column, and was never disappointed by his wit and insight. This love too began to fade. It began when I began to receive renewal notices offering me a “special” rate. Special apparently meant “twice as much as it would cost on our website and without online access.”

Last week, the Bancroft family made much noise opposing News Corp.’s(NWS) bid for Dow Jones(DJ), publisher of Barron’s and the Wall Street Journal. Despite the fact that the bid was 60% above the previous close,the deal appears dead on concerns that new ownership would threaten the paper’s integrity, independence and quality. Judging by an article appearing in this weekend’s Barron’s, a downward slide in quality has already begun.

I was quite dismayed when I began reading the article in this week’s Barron’s on Delta Airlines(DAL)’s prospects as it emerges from bankruptcy. I immediately noticed something amiss. Every ticker symbol in the article was wrong. As were multiple names. As were multiple words. PlaneBuzz has a copy of the article and a list of mistakes here. PlaneBuzz further reported Barron’s response to complaints:

“The use of an automated spellchecker resulted in a number of errors in last week’s feature story about Delta Airlines. The company’s chief executive is Gerald Grinstein, and an analyst cited was Ray Neidl of Calyon Securities. Delta’s ticker symbol is DAL, US Airways’ is LCC. American Airlines’ parent is AMR, with the ticker AMR. A variety of other words also were garbled. A fully corrected version of the story is available for free on Barron’s Online, at www.barrons.com .”

Old media claims an advantage over blogs in terms of quality, but apparently, no human looks at the final version of articles appearing in this paper. I’ll probably continue to read Barron’s for now, and may even subscribe to a daily newspaper again. But I now see a day in the future when I won’t. And if the newspaper has lost even me, its irrelevancy is not far off. Maybe they can cut a deal with the milkman.

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In Warren Buffett’s 2006 annual letter to Berkshire Hathaway shareholders, released today, he comments on two different struggling industries. One, he believes, will once again see great days. The other, is doomed to growing irrelevance and shrinking profitability.

Though Buffett was rumored to be a buyer of newspapers, perhaps by desperate sellers who hoped he might be, he makes clear that he sees a grim future for the industry. Buffett writes:

Not all of our businesses are destined to increase profits. When an industry’s underlying
economics are crumbling, talented management may slow the rate of decline. Eventually, though,
eroding fundamentals will overwhelm managerial brilliance. (As a wise friend told me long ago,
“If you want to get a reputation as a good businessman, be sure to get into a good business.”) And
fundamentals are definitely eroding in the newspaper industry, a trend that has caused the profits
of our Buffalo News to decline. The skid will almost certainly continue.

Buffett describes the factors that served to make newspapers huge cash cows for many years and describes the irreversible changes that are rocking the industry:

Now, however, almost all newspaper owners realize that they are constantly losing ground in the
battle for eyeballs. Simply put, if cable and satellite broadcasting, as well as the internet, had
come along first, newspapers as we know them probably would never have existed.

Finally, he suggests who the likely buyers for newspapers are:

For a local resident, ownership of a city’s paper, like ownership of a sports team, still produces
instant prominence. With it typically comes power and influence. These are ruboffs that appeal to
many people with money. Beyond that, civic-minded, wealthy individuals may feel that local
ownership will serve their community well. That’s why Peter Kiewit bought the Omaha paper
more than 40 years ago.
We are likely therefore to see non-economic individual buyers of newspapers emerge, just as we
have seen such buyers acquire major sports franchises. Aspiring press lords should be careful,
however: There’s no rule that says a newspaper’s revenues can’t fall below its expenses and that
losses can’t mushroom. Fixed costs are high in the newspaper business, and that’s bad news when
unit volume heads south. As the importance of newspapers diminishes, moreover, the “psychic”
value of possessing one will wane, whereas owning a sports franchise will likely retain its cachet.

Newspapers, Buffett believes, are to be reduced to mere trophies, symbols of the great wealth of their owners. But like the great works of Ozymandias, in time, nothing will be left but remnants of shattered printing presses.

Later in the letter, Buffett speaks about HomeServices of America, the second largest real estate broker in the U.S. With the weakening of the U.S. real estate market, HomeServices’ revenue and earnings dropped 9% and 50%, respectively, despite having made several acquisitions. Despite these negative trends, he remains optimistic:

Nevertheless, we will be seeking to purchase additional brokerage operations. A decade from now, HomeServices will almost certainly be much larger.

The difference between the newspaper industry and the real estate brokerage industry is a lesson at the core of value investing. Newspapers represent a dreaded value trap- cheap this year, cheaper next year, and still cheaper the year after. Buffett experienced value traps firsthand with Berkshire’s textile business. On the other hand, real estate brokers are cheap based on short term expectations, but will, he believes, recover and grow once again. It is often unclear which group cheap stocks fall into. The ability to properly discern is indeed the hallmark of successful investors.

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Matrixx Initiatives(MTXX) believes that its Zicam line of homeopathic cold remedies will relieve your cold symptoms. Jove Partners believes that it knows how to solve Matrixx’s own ailments: a sale of the company to a strategic investor.

Jove filed a 13D today, disclosing a 5.1% ownership stake and declaring that

The Reporting Persons appreciate the job that management has done and is
doing to build the Zicam brand. However, they believe that the value created to
date has not been appropriately recognized by the market and will not be fully
realizable as long as Zicam remains a stand-alone brand. In particular, the
Reporting Persons believe that the Issuer’s profit margins have been depressed
and should normalize over the next several years. The Reporting Persons believe
that this normalization could be meaningfully enhanced if the Issuer were
acquired by a strategic investor.

Matrixx fell far short of estimates for 2006, blaming a late cold season. Jove’s thesis, that Zicam would be a more profitable product as part of a larger company rings true. The difficulty of competing for pharmacy shelf space with behemoths like Johnson & Johnson(JNJ), which recently expanded its girth with its purchase of Pfizer’s(PFE) consumer products division, is great. Improvements in distribution and manufacturing from being part of a larger company could be substantial as well.

One potential concern are claims that Zicam has caused users to lose their sense of smell. The company has already settled several lawsuits, but it is unclear what potential future exposure might be. This would clearly be a concern of a potential buyer.

I previously noted Jove when they filed a 13D on Lifetime Brands(LCUT) and some background information on them can be found in that post.

Jove’s filing led to a 12% jump in Matrixx’s shares today(2/22) as investors seem to believe that the company is now likely to be acquired above the current price. With no debt, and a market cap minus cash of less than two times sales, Matrixx may indeed be a good fit for buyer who can grow sales and margins.

Disclosure: I hold no postion in MTXX

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Recently, Jove Partners disclosed a 5.2% stake in Lifetime Brands(LCUT). In its 13D filing, Jove reported that:

The Reporting Persons believe that the Issuer would benefit from additional marketing and industry expertise on its board of directors, and have suggested
individuals for consideration by the board.

Lifetime CEO Jeffrey Siegel was quoted as saying “Jove Partners is a [Lifetime Brands] shareholder who has been advising us at our request. They have tremendous expertise in e-commerce.”

Who is Jove Partners and what particular expertise might they bring to the table?

A search of SEC filings reveals no other filings by Jove Partners. However, reading the 13D reveals that Joel Tomas Citron is the managing member of Jove Partners. Mr. Citron is the Chairman of Oxigene(OXGN). More relevant, he was Chairman of Provide Commerce, parent company of ProFlowers, before its sale to Liberty Media. The similarly named Jovian Holdings was a major holder of Provide Commerce, with a 29% stake at the time of the acquisition. Citron was a director of Jovian Holdings as were Jared Polis, who was a principal of Blue Mountain Arts, guiding it to a $900 million buyout by Excite, and Arthur Laffer, famous for the Laffer Curve.

Based on Siegel’s quote and the experience of the three, I think it is likely that the board candidate(s) proposed include some combination of Citron, Polis and Laffer. Lifetime has significantly stepped up their online presence, adding products from their other brands to pfaltzgraff.com, and the background that Jove Partners has in ecommerce could be helpful in growing direct sales to be a significant part of Lifetime’s business.

Back in September, I wrote about Lifetime Brands. At the time, the stock was trading at $20.10 and the company had projected 2006 EPS of $1.50-$1.70. The company lowered that to $1.45-$1.55 with the release of 3rd quarter earnings, and on December 21, lowered it further to $1.10-$1.15, below 2005 earnings of $1.23. Though the company has not yet released 2006 numbers, on January 25, it stated that it expected 2007 EPS of $1.40-$1.70. The end result of all of this is that on February 15, the stock closed at 19.54, not far from where it was in September.

The particular problems that Lifetime has faced have been largely related to its direct to consumer business. The experience and expertise that Jove brings could indeed be helpful in helping the company resolve these problems and get back on the path to consistent, strong growth. In the meantime, I believe the shares remain a good value.

Disclosure: I hold a position in LCUT

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You may recall my December post regarding Nuvelo(NUVO). The company reported that a pivotal trial for its lead compound, alfimeprase, had failed to meet its endpoints. On the release of this news, the stock fell 80%, and has continued to float downwards since.

Nuvelo began 2006 trading at $8.11 and quickly jumped above $17 when the company partnered with Bayer on alfimeprase. After December’s failed trial results, the stock closed the year at $4 and by February 7, has dropped to $3.33. For shareholders and the company, not a particularly good year.

The Board Of Directors, or at least the Compensation Committee appears to disagree. In an 8-K filed last week, the company reports:

On January 29, 2007, the Compensation Committee (the “Committee”) of the Board of Directors of Nuvelo, Inc. approved the bonuses for Nuvelo’s named executive officers (as defined in Item 402(a)(3) of Regulation S-K) for fiscal year 2006. The bonuses awarded are weighted and based upon internal targets as determined by the Committee. For the 2006 fiscal year, the target bonus for Nuvelo’s Chief Executive Officer was 40% of his base salary, and for officers at the senior vice president level the target bonus was 35% of their base. The Committee is vested with the authority and discretion to increase or decrease the size of the bonus pool and actual bonus amounts based on its review of each individual’s performance and achievement of corporate goals. The Committee determined that for the 2006 fiscal year the bonus pool would be funded at 92% of its target level and the named executive officers would be awarded bonuses at between 100% and 140% of their target levels, after taking into account the 92% funding of the bonus pool.

The 2006 bonuses to Nuvelo’s named executive officers are as follows:

Ted W. Love, M.D., Chairman and Chief Executive Officer: $289,248
Michael D. Levy, M.D., Senior Vice President, Research and Development: $184,828
H. Ward Wolff, Senior Vice President, Finance, and Chief Financial Officer: $50,313
Lee Bendekgey, Senior Vice President and General Counsel: $126,449

Now, I understand that the company’s management and employees worked hard, and that sometimes the science just doesn’t work. But it seems rather unseemly for the compensation committee to conduct its review regarding the “achievement of corporate goals” in a year which saw the stock drop 50% and in which the value of the company’s pipeline evaporated and determine that top executives are entitled to bonuses of 100%-140% of their target levels.

One can only imagine what the bonuses would have been had the trial been successful.

Disclosure: I hold a position in NUVO

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Charlie Munger, vice-chairman of Berkshire Hathaway and CEO of Wesco Financial recently spoke with the Los Angeles Times on the issue of executive compensation. As always, the 83 year old Munger provided colorful commentary.

Munger derided compensation consultants, declaring that “I have always said that prostitution would be a step up for these people.” Munger pointed out that the problem was not that CEOs were evil, but that “… envy-driven compensation mania … brings out the abosulte worst in good people.”

Munger points out that legislation is unlikely to fix the problem, citing a 1993 law that aimed to curb compensation above $1 million. He concedes that some CEOs are worth huge packages, but that companies with less talented CEOs are forced to match high pay packages or admit “that the company down the street has a remarkable CEO, but we have a mediocre klutz.”

What should be done to solve this problem? Munger is not afraid to conclude that it my be unsolvable:

Just because something is a serious problem doesn’t mean that you can fix it. There’s an element of tragedy in this because some very good people are acting in some very bad ways. But things are seldom so bad that you couldn’t make them worse by a dumb intervention.

Munger goes on to say that the events of the last several years have gone some way in eliminating “the garden variety of corporate fraud,” but concludes “In my opinion, not enough executives have gone to jail.”

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On November 22, after BJ’s(BJ) CEO Mike Wedge abruptly resigned and the stock jumped, I wrote expressing my concerns:

Mr. Wedge’s departure raises troubling questions about the company’s performance. Same store sales have been lackluster of late, but last week’s earnings announcement was ahead of expectations and management expressed optimism regarding Q4. I have a sinking feeling that another shoe may drop before a buyer comes along. Given the 25% runup in the past 2 months, now looks like a good time to follow Mr. Wedge out the door and say goodbye to BJ’s

Today, BJ’s dramatically lowered its guidance for the fourth quarter:

Based on management’s current forecast for fourth quarter sales and margin results and the establishment of the various reserves referred to above, the Company has lowered its earnings guidance for the fourth quarter of 2006 to a range of $.17 to $.25 per diluted share. The Company’s previous guidance for the fourth quarter, issued on November 14, 2006, was for diluted earnings per share of $.83 to $.87.

Eight days after the company provided guidance on November 14, the CEO resigned. Though we can only speculate, it seems reasonable to believe that it was already clear at that point that guidance would not be met. So we now have a pretty good idea of why Mr. Wedge left. The only question is, how many other shoes are in BJ’s closet?

Though the stock closed down 4% today(1/4/06) to $30.55, it still trades above where it was when Wedge resigned. BJ’s continued profitability, valuable real estate and strong balance sheet will continue to place a floor on share prices, but I believe it is below current levels. I sold my BJ’s shares on 11/22 and will continue to stay on the sidelines.
Disclosure: I have no position in BJ

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