Document 6544831

Value-oriented Equity Investment Ideas for Sophisticated Investors
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“If our efforts can further the goals of our members by giving them a discernible edge
over other market participants, we have succeeded.”
Investing In The Tradition of
Graham, Buffett, Klarman
Year VI, Volume V
May 2013
THE
When asked how he became so
successful, Buffett answered:
“We read hundreds and hundreds
of annual reports every year.”
DEEP
VALUE I
Top Ideas In This Report
SSUE
ArcelorMittal
(NYSE: MT) ……………………… 20
► Screening for Deep Value Bargains
Bridgepoint Education
(NYSE: BPI) ……………………… 32
MFC Industrial
(NYSE: MIL) ……………………… 68
► 20 Companies Profiled by The Manual of Ideas Research Team
► Proprietary Selection of Top Three Candidates for Investment
► Exclusive Interview with John Heldman
Also Inside
► 10 Essential Screens for Value Investors
Editorial Commentary ………………. 3
Interview with John Heldman ……… 5
Screening Deep Value Equities …… 10
Profiling 20 Deep Value Ideas …… 20
10 Essential Value Screens ……….. 99
About The Manual of Ideas
Our goal is to bring you investment
ideas that are compelling on the
basis of value versus price. In our
quest for value, we analyze the top
holdings of top fund managers. We
also use a proprietary methodology
to identify stocks that are not widely
followed by institutional investors.
Our research team has extensive
experience in industry and security
analysis, equity valuation, and
investment management. We bring a
“buy side” mindset to the idea
generation process, cutting across
industries and market capitalization
ranges in our search for compelling
equity investment opportunities.
Companies profiled include ArcelorMittal (MT), Arch Coal (ACI),
AVX Corp. (AVX), Bridgepoint Education (BPI), Career Education (CECO),
Citi Trends (CTRN), EnCana (ECA), Gold Fields (GFI), Hecla Mining (HL),
IAMGOLD (IAG), Kulicke and Soffa (KLIC), Marvell Technology (MRVL),
MFC Industrial (MIL), Orbotech (ORBK), Resolute Forest (RFP),
ScanSource (SCSC), Scholastic (SCHL), STEC (STEC),
Symmetricom (SYMM), and Tellabs (TLAB).
Inside:
New Exclusive Videos Exclusive Interview
in the MOI Members Area
with
(log in at www.manualofideas.com
or email [email protected])
John

Heldman,
President,
Chuck Akre discussesTriad
his approach
to valueManagement
investing
Investment
 Adrian Warner on applying private equity principles
With compliments of
The Manual of Ideas
 Ideas: Amtek, Net Holding, AMERCO, Discovery Offshore, etc.
Register at ValueConferences.com
Copyright Warning: It is a violation of federal copyright law to reproduce all or part of this publication for any purpose without the prior written consent of
BeyondProxy LLC. Email [email protected] if you wish to have multiple copies sent to you. © 2008-2013 by BeyondProxy LLC. All rights reserved.
Value-oriented Equity Investment Ideas for Sophisticated Investors
Exclusive Interview with John Heldman
We recently had the pleasure of interviewing fellow value investment manager
John Heldman, President of Newport Beach, California-based Triad Investment
Management. The firm was established in 2008 and has $117 million in assets
under management. John brings decades of experience to the management of
investment portfolios. Prior to founding Triad, he was a Senior Vice President
and Portfolio Manager with Neuberger Berman. John has also managed
investment portfolios for Deutsche Bank, Scudder Investments and Bank of
America, including managing equity funds and serving on the Equity Strategy
Committee. He obtained his BS degree in Finance and MBA from California
State University, Long Beach. John is a CFA charterholder.
The Manual of Ideas: Please tell us about your background and the genesis of
your firm. What motivated you to set up Triad and what operating principles
have guided you since then?
“If we can understand the
business, it demonstrates
growth and durability, has
above-average profitability
and shareholder-oriented
management, it becomes part
of our roughly 250 company
universe. Once a business
makes the qualitative cut,
then we focus on valuation.”
John Heldman: I have been in the industry over 27 years, having worked at a
handful of large firms, including Bank of America, Scudder Investments,
Deutsche Bank, and most recently, Neuberger Berman, which I left in early
2008 to form Triad Investment Management. It was the best career decision I’ve
made, not just for me but also for our clients. I appreciate the opportunity to be
entrepreneurial and the autonomy of running my own firm. We have much
greater investment flexibility. And we have terrific, loyal long-term
relationships with clients who give us the latitude to do what’s best and have the
necessary patience to allow our process to work. Our principles are staying
focused on the investing process, keeping other distractions to a minimum, and
communicating clearly and candidly to our clients.
MOI: How do you generate investment ideas?
Heldman: We annually review thousands of companies by reading corporate
annual reports, SEC filings, and reviewing Value Line reports. In addition, we
subscribe to an extensive number of newspapers, magazines, periodicals, etc.
We read extensively including general publications to understand broad
economic trends and specific periodicals to deepen our understanding of certain
industries. We are always looking for businesses that meet our criteria with the
understanding that one day we will likely get an opportunity to invest in the
business. So we have accumulated a body of knowledge about a wide range of
businesses. If we can understand the business, it demonstrates growth and
durability, has above-average profitability and shareholder-oriented
management, it becomes part of our roughly 250 company universe. Once a
business makes the qualitative cut, then we focus on valuation.
MOI: What are your key stock selection criteria, and what types of businesses
have you favored historically?
Heldman: We favor understandable businesses with durable, well-protected
moats, where we can understand how the moat was created and what is likely to
sustain it. Evidence includes high profit margins, relatively low competitive
intensity and usually free cash flow generation. Once we identify companies that
seem to have the right characteristics, we read five to ten years of annual reports,
10-K’s, company presentations and other materials that can provide further
insight into the competitive strength and durability of a business, along with
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May 2013 – Page 5 of 110
Value-oriented Equity Investment Ideas for Sophisticated Investors
management capability and culture. We must feel comfortable with the longterm economics of the business, which means the company occupies a
reasonably strong competitive position and will get a fair share of industry
growth over the next three to five years. We develop an estimated three-to-fiveyear price target and daily rank each stock on that basis. Subject to a reasonable
level of sector/industry diversification we select 20 to 30 companies with the
greatest potential.
We prefer businesses that aren’t subject to heavy government regulation, so
we avoid many areas of healthcare, and almost all utilities and
telecommunications. We also favor capital-light businesses that don’t require
high mandatory capital investment for plant and equipment, inventories and
accounts receivables. We seek businesses where the cash flow that’s generated
is in excess of what is needed to maintain and grow the business. We also like
recurring revenues and fee-based businesses where customers are locked in
contractually or otherwise for long periods of time. And we like certain cyclical
businesses because many investors have difficulty valuing them when earnings
are temporarily depressed, or where patience is in short supply, creating longterm opportunity for us.
MOI: How do you assess the quality and incentives of management, and what
CEOs do you admire most?
“We assess management
quality by analyzing their
historical decision making.
This is where having read
five or ten years of annual
reports sheds light on what
management said and what
they actually did.”
Heldman: We assess management quality by analyzing their historical decision
making. This is where having read five or ten years of annual reports sheds light
on what management said and what they actually did. Have they run the
business for long-term results? Have they maintained and better yet strengthened
the business moat over time by increasing market share, growing sales and
raising profitability? Did they make strategic, sensibly-priced acquisitions
during depressed periods, or did they acquire during boom periods at high
valuations? Were the acquisitions paid in cash or stock? If stock, did they issue
their own stock at depressed or elevated levels? Have they repurchased stock,
and if so, were the repurchases done when valuations were depressed or
elevated? We closely examine how well management has protected and grown
shareholder value.
Next we assess incentives by looking at the stock ownership of
management, board of directors and large influential shareholders. We like to
see large insider ownership, as a management team with ownership ten times the
level of their salary is probably shareholder-oriented (they can still be
incompetent or dishonest, but it’s usually a positive). Do they issue boatloads of
stock options to themselves? Do the compensation plans align management with
shareholders? Is the incentive plan aimed at growing business value and
shareholder value over time?
We admire CEOs who stay laser-focused on long-term business
management and demonstrate a history of shareholder commitment. Warren
Buffett is the gold standard. Others we really admire include Dinos Iordanou at
Arch Capital Group, Bruce Flatt of Brookfield Asset Management, Murray
Edwards and Steve Laut at Canadian Natural Resources, Phil Ryhoek at
Denbury Resources, Mike White at DirecTV, Mark Papa at EOG Resources,
Prem Watsa at Fairfax Financial, Glenn Chamandy at Gildan Activewear,
Patrick McHale at Graco Inc., Joe Pyne at Kirby Corp., Ian Cumming and
Joseph Steinberg at Leucadia National, Jim Tisch at Loews, Jeff Lorberbaum
at Mohawk Industries, Howard Marks at Oaktree Capital, Charles Fabrikant
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Value-oriented Equity Investment Ideas for Sophisticated Investors
at Seacor Holdings, Eddie Lampert at Sears, Brian Sondey at TAL
International, Carol Meyrowitz at TJX, Jim Metcalf at USG, Bill Berkley at
W.R. Berkley, John Stumpf at Wells Fargo and Raymond Barrette at White
Mountains Group. This is only a partial list. We have spent thousands of hours
analyzing management track records and feel we have a good understanding of
which management teams are highly capable and shareholder-oriented.
MOI: Would you outline the summary thesis behind one or two of your best
ideas at this time?
Heldman: Everything we do is analyzed through our three-way filter: business,
management, and valuation.
“Wells Fargo’s valuation is
attractive now, with the
common stock trading at
around ten times estimated
2013 EPS. Still elevated
credit costs and
regulatory/legal costs should
decline over the next few
years as the financial crisis
fades further from view.
Earnings growth of 8%
annually over the next five
years could result in roughly
$5.00 of earnings per share.
A reasonable multiple of 13
times earnings for a highquality business with 15%
return on equity results in a
$65 stock price in 2018. With
Wells today at $37, the
annual return would be 12%
and a 3% dividend yield
creates a potential 15% per
year.”
Our largest position at March 31, 2013 was Wells Fargo [WFC] warrants
expiring October 2018. We love Wells Fargo’s business: a very large, very lowcost, very stable consumer/business deposit base that due to its lower cost and
stability allows Wells to avoid “reaching for yield”, unlike competitors who hold
riskier loans and assets. Still, the net interest margin is among the highest of
major banks. Furthermore, good historical loan underwriting means Wells hasn’t
suffered as much as other banks during economic downturns. In fact, Wells uses
stressful periods opportunistically, such as 2008 when it was able to acquire
ailing Wachovia Bank. The Wachovia purchase extended Wells’ geographic
footprint to the East coast. In our view Wells has the best branch distribution
system in the country. Wells’ revenues derive roughly 50% each from net
interest income and fees, providing more stability than other capital marketsdriven banks such as J.P. Morgan Chase and Citigroup. It is a relatively plain
vanilla financial services company focused on serving consumers and small
businesses, with less emphasis on large corporations or volatile capital markets
activity.
Management is top notch at Wells Fargo. We’ve followed the management
for 25 years. They have taken the right steps over the years. The business is run
for long-term customer and shareholder benefit. Management has the right
culture, a blend of Wells Fargo’s historical cost control and risk management
with a strong sales culture at Norwest Bank when the two banks merged in
1998. Management is careful about capital allocation and pays attention to the
business cycle. Share buybacks are done when the stock valuation is attractive,
rather than mindless repurchases.
Wells Fargo’s valuation is attractive now, with the common stock trading at
around ten times estimated 2013 EPS. Still elevated credit costs and
regulatory/legal costs should decline over the next few years as the financial
crisis fades further from view. Earnings growth of 8% annually over the next
five years could result in roughly $5.00 of earnings per share. A reasonable
multiple of 13 times earnings for a high-quality business with 15% return on
equity results in a $65 stock price in 2018. With Wells today at $37, the annual
return would be 12% and a 3% dividend yield creates a potential 15% per year.
We aim for 15%+ returns so Wells common meets our criteria.
The warrants offer the possibility to do even better in this scenario. The
warrants were issued to the U.S. government during the financial crisis when all
banks were forced to sell stock to Uncle Sam. The exercise price of the warrants
is currently $34 per share, so today the warrants have an intrinsic value of
around $3 per warrant. Should Wells trade around our estimated 2018 price of
$65 then the warrants would be worth $65 less the $34 exercise price or $31 per
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Value-oriented Equity Investment Ideas for Sophisticated Investors
share. The warrants today trade around $12. Another kicker is a provision of the
warrants whereby each quarter that Wells Fargo pays a dividend in excess of
$.34 per share reduces the warrant exercise price by the amount of the entire
quarterly dividend. Wells recently announced its intention to raise the dividend
to $.30 per share starting with the second quarter of 2013, subject to Board
approval. We assume the dividend will rise above the $.34 trigger level
sometime next year. If Wells were to pay $.35 per quarter as of 2015 that would
reduce the warrant exercise price by another $4 or so to $30. Our potential $65
price in 2018 less the $30 exercise price would result in a warrant value of $35
or three times the current warrant price of $12, which works out to almost 24%
per year. Even better.
MOI: You have written that you compare your “estimate of future value with
the current stock price, and will invest only when a return of 15% per year over
3 to 5 years is achievable. If current prices offer expected returns under 10% we
will reduce commitments and wait until better opportunities develop.” How do
you judge prospective returns over a three- to five-year period, and what is your
view on holding cash?
“Since we take a private
businessperson’s perspective,
we evaluate what a private
business buyer would pay for
the business in three to five
years.”
Heldman: We start with Value Line Investment Survey three-to-five-year
estimated sales and earnings. It’s a starting point and we modify based upon our
judgment of particular business characteristics or cyclical industry
considerations. Since we take a private businessperson’s perspective, we
evaluate what a private business buyer would pay for the business in three to
five years. We typically use multiples of several metrics including operating
earnings, owner earnings—operating cash-flow less maintenance capital
spending—and occasionally EBITDA for businesses with very low capital
spending needs. Financial services businesses typically are valued at multiples
of book value. We will also use price earnings multiples to cross check our
private business valuations. We maintain an extensive business merger and
acquisition database with hundreds of transactions over the past five years or so,
so we have a good source of objective valuation multiples.
Cash is a residual of the investment process. We are highly selective and
only include in our 250 company universe those companies that we would feel
comfortable owning should the market be closed for an extended period. So the
deciding factor for purchase is valuation. When we can find 20 to 30 candidates
within our 250 company fishing pond that meet our 15%+ return potential over
three to five years, we will be fully invested. When we have a shortage of
candidates, we maintain cash until our purchase criteria are met.
Our sell process is essentially the reverse of the buy process. We begin
selling if the current price is projected to result in appreciation potential under
10% per year, or if another stock offers significantly greater potential, or the
business competitive position weakens.
MOI: How has market volatility over the past several years affected your
investment process, and have you tweaked your approach in any way as a result?
Heldman: Over the past twelve years the stock market has experienced two
very severe market downturns, and we understand the fragile nature of investor
sentiment. We emphasize through client communications that we seek to protect
against long-term permanent loss through extensive research and thoroughly
understanding the companies we invest in. We invest in a well-researched,
concentrated portfolio of 20-30 companies, so volatility can affect us in the
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Value-oriented Equity Investment Ideas for Sophisticated Investors
short-term. We attempt to ease investor concerns by communicating clearly and
candidly during stressful periods when investor behavioral mistakes can occur.
But, we firmly believe some volatility is central to our process and results, as we
seek to benefit from other investor’s mistakes. If the market were perfectly
rational, we’d have much less to do. Underlying business value and management
change very gradually, while stock prices fluctuate dramatically in the shortterm.
MOI: You have argued that, “Investor behavior is more important than superior
intellect. Emotionally-stable investors recognize the occasionally irrational
nature of markets and maintain a disciplined focus on business value versus
market price.” What do you consider to be the worst behavioral errors investors
make, and how can investors guard against those mistakes?
“Lack of understanding and
impatience are probably the
two greatest mistakes, and
they are often intertwined.”
Heldman: Lack of understanding and impatience are probably the two greatest
mistakes, and they are often intertwined. Most investors can’t take the time to
truly understand the most important elements of investing, such as
business/competitive strength, financial statement analysis, management
capability and motivation, business valuation measures, etc. This lack of
understanding can be amplified by investor behavioral biases that cause people
to do the wrong thing at the wrong time. Therefore, lacking true understanding
of what drives a company’s valuation over long time periods, when companies
experience short-term setbacks—as almost all do at some time--investors often
get impatient and sell a stock when it’s depressed. This might lead to buying a
stock that appears to be doing better, without realizing that the better results are
usually incorporated into the current stock price. So investors can move from
one disaster to another, without really understanding the true causes. It’s the
classic case of buying high and selling low. But the cause is sometimes found by
looking in the mirror. The best way to guard against this is to invest in
companies you can understand, and pay attention to market cycles and business
valuations. A great company selling at a very inflated valuation can become a
very poor long-term investment.
MOI: Can you recommend one or two recent books that have given you new
insights into the art of investing?
Heldman: I’ve just started reading The Outsiders: Eight Unconventional CEOs
and Their Radically Rational Blueprint for Success, by William Thorndike. I’m
looking forward to finishing it as I’m very familiar with most of the profiled
CEOs, having followed them for years. I’d highly recommend learning from this
book how truly gifted CEOs manage their businesses over the long-term. As the
title implies, greatness often requires an unconventional approach. We feel the
same way about the investment business.
MOI: Thank you so much for your time and all the insights.
Diclaimer provided by Triad Investment Management: The comments by John
Heldman are not an offer to sell or the solicitation of an offer to buy any
security in any jurisdiction where such an offer or solicitation would be illegal.
His comments are intended for informational purposes only and should not be
construed as investment advice or as a recommendation to sell or buy any
security or other investment, or undertake any investment strategy.
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