Lisa Rapuano — PPTX - Value Investor Conference

Report
Lane Five Capital Management
Value Investing with a Contrarian Bent
Value Investor Conference
May 4, 2012
Omaha, Nebraska
Lane Five Capital Management
Value Investing with a Contrarian Bent
Lane Five Investment Approach
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Disciplined, long-term value-investing
Evaluate, research and invest in securities that are mispriced by the market
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Market prices diverge from long-term business values when short-term issues drive
investor fear
Exploit the psychology and behavior that create pricing anomalies
Use depth of research and long-term, strategic thinking to identify areas where the
market is pricing adverse outcomes that are unlikely
Use a probabilistic framework to constantly evaluate business value
Create a concentrated long portfolio of significantly undervalued, high
conviction positions
Opportunistically short companies that are significantly over-valued and/or
inherently flawed
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Lane Five Capital Management
Value Investing with a Contrarian Bent
The Role of Contrarianism at Lane Five
Two categories of portfolio investments emerge:
 Great businesses at great prices due to short term problems
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What we call “Compounders”
Ideal investments
Not often severely mispriced
Not always as “great” as they might have seemed
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Technological Change
Cyclical, regulatory, secular changes
Either shortens or eliminates competitive advantage
Prices paid for these businesses rarely truly account for these risks
Low probability does not equal no probability
Out-of-favor, unloved, troubled, really cheap contrarian investments
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Benefits of Contrarian Investing
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Higher expected returns
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Wider range of possible outcomes
Uncorrelated with the indices
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Drivers of return or loss are not market, industry or economy specific, but rather
company specific or turnaround execution related
Highly differentiated return profile for portfolio
Building relationships with managements
Subject to acquisitions
Human behavior is always searching for clarity and certainty: attractive
contrarian investments are available in almost any market
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Hunting for Contrarian Investments
Areas to search:
 New low list
 High daily percent downward price action
 Elevated volume
 Sell-side downgrades
 High short interest
Characteristics of potentially successful candidates:
 Formerly good business model
 Formerly high valuation
 Competitors with better margins, growth, efficiency exist
 Signs of capitulation: shareholder turnover, disgust, management credibility in
question
 No visibility; no catalyst
 Specious secular or competitive decline arguments
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Cautions in Contrarian Investing
 OFTEN THE
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CONSENSUS IS RIGHT
Determining consensus is difficult
Timing
Risk management/Hedging
Loneliness
The Retrospect Effect
Complacency vs. Patience
 OFTEN THE
CONSENSUS IS RIGHT
 !!!!!!!
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Temperament Requirements for Contrarian Investing
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Patience
Weirdness
Ability to handle criticism
Ability to stand alone
Resourcefulness
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Guidance in Analyzing Contrarian Candidates
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No different than any other securities analysis: understand the risks, estimate the returns
Different than any other securities analysis: the risk will be easy to see, the return difficult
Analyze the negative arguments
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Determine what is already discounted. Ask “If so, so what?”
Analyze the actual evidence of the negative case
Appropriately understand impact of leverage, covenants, etc.
Analyze valuation “hooks” that could limit downside
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Cash
Sellable Assets: real estate, patents, money losing subsidiaries
Run-off value of cash flows
Dividends
Understand management abilities and incentives as well as potential for change in
management to matter
Understand how the story unfolds: timing, shareholder changes, earnings momentum,
cash flow inflection points
Ask: “What could go right?”
Analyze potential recovered earnings, cash flows, likely valuation in basic scenario. Don’t
pay for what could go right
Understand capacity for there to be more than just a recovery
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Current Case Study: Corinthian Colleges (COCO)
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Admit it, this makes you want to throw up
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For-profit education
“Low-end” vocational schools
Regulatory pressures, cyclical issues, short sellers’ playground
Negative reputations, negative press coverage
Massive mispricing due to the emotional reaction
Late 2011, rumors of bankruptcy abounded. Company was generating cash, had sellable
assets, would meet covenants and likely could pay off all debt by 2012. Not a solvency
issue
Two-year overhang of new Gainful Employment regulations is lifting: companies have
improved, adjusted marketing, lowered price, focused on outcomes
Vocational (diploma) programs provide a huge benefit to the nation – last year Corinthian
PLACED 42,000 students in jobs. Students graduate with an average of $10,000 in debt
and move from minimum wage service jobs that require no skills to moderately skilled
trades. The ROI is impressive, if the student can graduate
High risk students not well served by any other means. Still, graduating them is the key
Tremendous free cash flow generation as company returns to a “new normal”
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Current Case Study: Corinthian Colleges (COCO)
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Valuation: “If so, so what?”
• Current valuation: @$3.87 EV = $300 million
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On consensus (bearish) June 2012 estimates: 0.25x sales, 3.10x EBITDA, 12.1x EPS
On guided numbers: 11.1x EPS, 1.7x free cash flow
On Lane Five numbers: 11x EPS, 2.7x EBITDA, 3x “normal” free cash flow of $100 million
What is discounted?
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On DCF, price implies ~$45 million in free cash flow for 10 years
No perpetuity
Half of 2012 “normalized” FCF (Actual will be ~$175 million)
Impact of leverage, covenants immaterial
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Debt free in 3 quarters
Regulatory risks still high, still reactive to headline risk, high beta, short-heavy, story
oriented stocks
Valuation “hooks”?
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Value of Wyotech and Heald ~ $300 million (paid $350 for Heald, monetized 5 campuses for
$45, five Wyotech automotive campuses)
Ability to close schools, shrink to maximize free cash flow
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Current Case Study: Corinthian Colleges (COCO)
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What could go right?
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Earnings power, free cash flow under scenario analysis
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Vocational abandoned by competitors
CDR’s dropped to well below risky levels
Community colleges under fiscal strain
Efficiency in financial aid expenses, bad debt management, enrollment dramatically enhanced
Operating leverage from optimizing fixed assets
Regulatory environment could be less bad
Current valuation discounts seriously impaired business model, but not absolute worst case
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90/10 rule changes
Negative growth from closing schools
Harkin/Durbin vendetta
$0.40 Earnings Power baseline
Past regulatory jihad’s have ended with stronger businesses
With zero growth, values range from $8.50-$10.00 as OPM ranges from 5-7% ($0.90-$1.15 EP)
With modest growth, values range from $9-$25 as OPM ranges from 7-15% ($1.15-$3.00 EP)
Previous OPM high of 18.5% (would mean $4-5 EP)
Probability Weighted Value ~$10, range of $2-25
DCF based framework, triangulated with very low assumed multiples on Earnings Power
Current case for more than just recovery is low probability given regulatory risks, but is
not zero probability
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It has happened before!
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Parting Thoughts
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Consider contrarianism from the bottom-up level
Valuable tool for portfolio construction
Provides intellectual capital, firm differentiation, portfolio differentiation
Remember the downside(s)
Choose your battles wisely
Prepare to be lonely
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Lane Five Capital Management
Value Investing with a Contrarian Bent
Contact Lisa Rapuano:
[email protected]
May 3 - 4, 2012
Mammel Hall
Omaha, Nebraska
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