Sunday, May 17, 2009

How did the investment gurus position themselves during Q1 2009?

Now that I have had the time to examine some of the portfolio maneuverings of the famous value investors, I thought it might be valuable to discuss some of these moves, themes evident in the portfolios and some interesting stocks that may be worth doing some more research on. I selected managers with different styles and focuses so that readers could get an idea of the diversity of strategies being employed by managers in a very difficult operating environment.

1. Pershing Square (Manager Bill Ackman): This means war!
Anyone who has been following the Pershing-Target (TGT) saga knows that Ackman has been spending a lot of his time trying to get himself and 4 other nominees on the Board of Target. On that front, I have to say he makes a pretty compelling case. In his mass email this week, my new friend Whitney Tilson of T2 Partners included the slides that Ackman used in his apparently very well attended presentation on this subject. Ackman makes the simple case that the current board is entrenched and the members have been there so long (and have other conflicts of interest that preclude them from being independent) they are not able to objectively consider changing the status quo.

There is no question that his slate of nominees has significant experience in areas in which Ackman feels the Target board is currently lacking: credit cards, real estate, and retail. He also drives home the points that the board members own an insignificant number of shares and that the number of other boards that these people also sit on has to take away from the time spent on their fiduciary duty to Target shareholders. While I understand management's contention that in the middle of a terrible recession the company does not need the distraction that Ackman's proposals have created, in the long run it might be a mistake to not get a little bit of new blood on the board.

Aside from the full frontal attack on Target, Ackman also added some significant positions in Q1. Specifically, he added Apartment Investment and Management Co. (AIV), an apartment REIT whose shares have fallen from a 52 week high of over $43 to a little under $8. He also accumulated shares of YUM Brands (YUM), owner of fast food chains such as Pizza Hut, Taco Bell and KFC. Ackman seems to betting strongly that the fast food industry will weather this storm as he also owns a significant number of Wendy's Arby's Group (WEN) shares. I think the most interesting sell in Q1 was his complete exit of Dr. Pepper Snapple (DPS) holdings. For years the sell-side argued that the confectionary business was a great business and deserved a much higher multiple than that of the bottling business. This is why Coca Cola (KO) and Pepsi (PEP) recently have not owned controlling stakes in their bottlers, as they were seen a low multiple businesses that detracted from the valuation of the confectionary business. However, with Pepsi's recent bids for two of its bottlers, maybe this conventional wisdom is being turned on its head as controlling the bottling could become an advantage. That is why this is a curious sale because DPS does control its bottling operations.

2. Pabrai Funds (Manager Mohnish Pabrai): The new strategy
Before the recent stock market debacle began, Pabrai had a very concentrated portfolio. He took as scripture Buffett's idea that you should only swing at the fattest pitches and that you should not invest in your 20th best idea. Well, 2008 was a humbling year for Pabrai and forced him to seek more diversification and pay more attention to the macroeconomic environment. Accordingly, as of 3-31-09, Pabrai held 13 separate positions in 11 companies (he owned Berkshire Hathaway A and B shares as well as common shares of Argentina-based agriculture company Cresud and Cresud warrants). I think one of the more interesting moves Pabrai made was going from a mixture of BRK-A and BRK-B shares to primarily the B shares. This may have been a liquidity-induced shift as the B shares are much more liquid than A shares. Also, Pabrai seems to be betting more and more on hard assets as he added Potash (POT) in Q1 and owns large positions in Cresud, oil and gas company Harvest Natural Resources (HNR) and zinc producer Horesheard Holdings (ZINC). In his Q1 letter to investors he said "I do believe we’ll see some heavy-duty inflation in the years ahead" so it is logical to assume that this is his way of hedging against that possibility.

3. Paulson and Co. (Manager John Paulson): The gold bug
I recently saw John Paulson speak in person at a very intimate event. I have to say he is one of the most humble, unpretentious men you will ever meet. This is a guy who has made billions over the last few years ( What was remarkable to me is the simplicity of one of the investment strategies that made him so much money over the last 2 years. I foolishly didn't take my usual great notes that night but I can give you the simple gist of the thesis and implementation.

Paulson did not believe that tranches of subprime RMBS deserved the high ratings they were assigned by the rating agencies, based on his estimates that if 5% of the loans went bad certain B-rated tranches would be completely wiped out. Prior to the wonderful emergence of CDOs, the only way to make money on this thesis was to short the RMBS themselves, a task that was very difficult and did not prove to be profitable for Paulson. But when CDOs were introduced investors then could buy the CDS on the CDOs (sorry for the alphabet soup but this is the world we live in now) and take a highly asymmetric and levered bet against the underlying RMBS mortgages. Paulson committed a measly 1.5% of his capital with what he saw as very little risk based on the deterioration he anticipated in the US housing market. Due to the huge amount of leverage inherent in the CDS, he was able to make multiples of his capital investment. I often associate huge returns with a large amount of risk but in this case there was very little risk at all. The moral of the story is to keep your investment strategy simple and when you see a hanging curveball make sure you position yourself to hit a homerun if you are right.

So, now what is Paulson doing? Well, he is betting on inflation coming online as a result of the Fed's profligate use of the printing press. In his presentation he said he did not know when inflation would come but he was very concerned about dollar debasement and inflation due to the US's huge budget deficit. Sticking to his word, he added a significant amount of gold exposure in Q1 2009. He added to his Kinross Gold (TSE: K) holdings and bought shares of Anglogold Ashanti (AU), Gold Fields (GFI), Market Vectors Gold ETF (GDX) and SPDR Gold trust (GLD). It's hard to know whether or not this will be a profitable focus, but with Paulson's success over the last few years can you really bet against him?

4. Icahn Capital (Manager Carl Icahn): Betting on consolidation in the pharmaceutical and biotech sectors?
Just a quick glance at Ichan' s portfolio as of 3-31-2009 and you are struck by the concentration of companies in the medical sector. The portfolio is filled with names such as Adventrx Pharmaceuticals (ANX), Amylin Pharmaceuticals (AMLN), Enzon Pharmaceuticals (ENZN), and Cyberonics (CYBX). Icahn has also assumed an activist role in a number of these companies with an attempt to get some on his nominees on the boards. My guess is that Icahn believes larger pharmaceutical companies with dwindling pipelines will eventually be forced to acquire some of the smaller players in order to keep growing. Personally, this is a very tough space for even knowledgeable investors to dabble in. If you don't have access to MD's and PhD's you will likely be competing with investors who understand the space much better than you do. Accordingly, despite the obvious consolidation potential, I have always stayed away from the biotech and pharmaceutical sectors.

Aside from the focus on the medical space, Icahn has maintained his large positions in certain turnaround companies: Motorola (MOT), Yahoo (YHOO), and Blockbuster (BBI-A, BBI-B). We can be sure he will do his best to push the management teams of these companies to make the best of their current circumstances and find ways to unlock shareholder value. Some additional moves of note during the quarter were the addition of shares and a note of Lion's Gate Entertainment (LGF) as well as large sales of natural gas companies Anandarko Petroleum (APC) and Williams Co. (WMB). Finally, Icahn bought 24K shares of SRS, the ProShares Ultra Short REIT ETF, likely a bet that there are still many shoes to drop in the commercial real estate space (a view that I whole-heartedly agree with).

5. Wintergreen Funds (Manager David Winters): Steady as she goes
The fantastic March 17th, 2009 edition of Outstanding Investor Digest has excerpts from Winters's comments in December regarding the equity markets and the way he was positioning his fund. In speaking about Latin American bottler Coca Cola FEMSA (COCSF), this is what Winters had to say:

"So here's a business with what we call "the trifecta"--good/improving economics, selling at a price that's low, and run by good management--which is key. It's just an incredible situation. Well, I've never seen so many trifectas in my life as I'm seeing now."

I think this quote encapsulates well the approach that Winters took in Q1 2009. He believes that the companies he owns are incredibly well positioned and was not willing to let Mr. Market and fear of an all out economic collapse force him to sell positions or materially change his investment philosophy.

"I feel a bit like a kid in a candy store with an empty stomach and a fist full of cash. So I've got to exercise discipline to figure out what sweets I want. And unlike the little kid, I want to also think about exactly which sweets should be in my stomach, hopefully, for a long time and make our shareholders a lot of money."

With these two quotes from December in mind, you would think that Winters would have taken the opportunity to add to his positions during the stock market swoon that started in January and lasted until early March. Instead, the portfolio was little changed at the end of Q1 in comparison to the end of Q4 2008. Winters sold out his positions in Mexican beverage company Fomento Economico (FMX) and casino operator Wynn resorts (WYNN) and added some shares of Coca Cola (KO). I don't know if Winters did actually buy more of his favorites such as COCSF during the quarter and then lightened up after the market bounced back sharply. If he did not, it provides a good lesson on how hard it is to be a contrarian in falling markets, regardless of how strong your convictions are and how disciplined you believe your strategy is.

Finally, I thought I would just mention some stocks that certain managers were holding that might be interesting (but obviously would require substantially more research):

1. Fomento Economico (FMX)- Even though Winters sold his shares, Cascade Investments, which includes the holdings of Bill Gates, owns over 22M shares. I think this and Coca Cola FEMSA could be interesting to look into. While both have bounced recently, according to Winters there are concerns about the impurity of water in Latin America that could provide secular tailwinds for these companies.

2. SLM Corp. (SLM): In Q1 both Glenview Capital and Lone Pine added large positions in SLM. From what I have read many of the other players in the student lending business have gone away and the bulls believe that Congress is going to have do something to make sure that students can get stable financing to go to school, a fact that will eventually benefit SLM. At under $6 a share SLM could be a real bargain if the company's market share ultimately increases as a result of the credit crisis.

3. Teradata (TDC): In Q1 both Third Point and Lone Pine sold out their entire positions in TDC. TDC is an Ohio-based enterprise data warehousing company. The stock has risen sharply (what hasn't?) off its 52 week low around $11 and now trades at about $20. It could be interesting to see if TDC is having issues that may be more permanent than temporary in nature.

4. Blank Check Companies: Third Point owns a number of these, including Triplecrown Acquisition Corp. (TCW), Trian Acquisition Corp. (TUX) and Hicks Acquisition Corp. (TOH). Are the managers of Third Point betting that these blank check companies will be able to make cheap acquisitions in this depressed environment? While these stocks are quite illiquid, it is very possible that this is the ideal environment for the managers of these companies. If I had to pick one to do some research on, I would choose TUX because of its associated with Nelson Peltz.

5. Otter Tail Corp. (OTTR): I had never even heard of this company until I saw it in the portfolio of Cascade Investments. The company has a number of diverse segments, including electrics, plastics, manufacturing, health services and food ingredient processing. The stock has fallen sharply from its 52 week high over $46 and now trades around $19. The company appears to have remained profitable over the past few quarters and may be worth digging into a bit. Knowing how close Gates and Buffett are, could this be a company that is too small for Berkshire to own but that Buffett has pitched to Gates?