The Q4 of 2009 was a strong finish for a year that will go down as one of the wild one in history. From an investment perspective, we hit the bottom in early 2009. In the end of 2009, the market was brimming with optimism and was in high spirits. As someone once said, things are never as bad as they seem and never as good as they look. The fear in early 2009 was shown to be incorrect by late 2009. The optimism in late 2009 was shown to be wrong by early 2010.
For us, our investments finished strong. Our biggest holdings, CPD and GGP, moved closer to fixing the major issues hanging over the company. Whereas some of our smaller holdings, Penn Traffic and RHI Entertainment, ended the year with the least likely outcome. In all, we were extremely pleased with how 2009 ended and we look forward to an exceptionally strong 2010.
Here are the updates on our holdings:
Caraco Pharma: CPD recently announced its quarterly earnings. The quarterly numbers were a non-event for us. We were interested in the update related to the FDA compliance. CPD reported that it has started hiring back some of its former employees in expectations of receiving FDA compliance. CPD also reported that it has moved manufacturing of certain drugs to other facilities, highly likely Sun Pharma’s NJ plant. These two events are major news as it shows that the company will likely get to break even or cash flow positive shortly. Also, the rehiring of employees is a huge indication that management expects to receive FDA compliance shortly. We expect the company to be back in compliance before end of 2010. In the meanwhile, the company will likely get to cash flow positive.
General Growth Properties: The company has been an exception story in 2009. Management has done an amazing job in 2009 to get through the bankruptcy and protect/increase shareholder value. In last 2 month of 2009, the management and legal team did an amazing job in getting most of the properties out of Chp 11. We expect in 2010, the company will either get bought out or emerge from Chp 11, either as a standalone or in a joint venture. In the next 2-3 months, the route the company will likely take will become much more evident.
WellCare: Our initial investment thesis has worked out exactly as we expected. The company cleared all the major legal hurdles related to the Florida Medicaid investigation. The fines to be paid relating to these legal issues are minimal. Even with the legal issues behind them, the shares have not rebounded. As the strong earnings start showing, we expect the shares to increase substantially from the current levels.
Ternium: This company had a roller coaster year. The shares dipped to ridiculous valuation as fear ran wild that steel companies could not sell their inventory. It was true that steel companies were struggling, Ternium stood out as one of the best run steel companies in the world. Management did an exceptional job in getting $4B for its Venezuela operations. The company is on track to pay off a substantial portion of its debt and improve its Mexico operations. We believe 2010 will be a decent year for the company but the future looks exception for one of the best run steel company.
RHI Entertainment: The company has had a rough 2009. From a cash flow perspective, the company has failed on delivering the made-for-TV movies. The company has concerns about valuation of its library and whether the company will be able to stay out of default. We still believe in the management and the business model. We believe the company is going through extremely difficult economic times. If the company can delivery on the movies and create recurring revenue from the library, the company will survive. The 2009 Q4 results will show whether the company delivered the movies and the valuation of the library.
Harvest Natural Resources: We believe this is an extremely undervalued energy play. The management is shareholder friendly and has made exceptional moves to increase value. Most recently the company announced they will issue 32M of convertible debt. Although we don’t like the dilution, we believe the dilution will be very minimal. Also, the management is looking at a financing deal where it will monetize the next 5 years worth of Petrodelta dividends for $250M. We believe this will provide enough financing to explore the worldwide HNR options, a hit on anyone of these worldwide options will dramatically alter the company’s valuation. We are excited about the US Antelope potential.
PhotoChannel: We recently commented on this one in another blog entry.
Premier Exhibitions: Management has definitely turned this company around. It is no longer bleeding cash. Management has started working on creating growth and focusing on initiatives that will increase cash flow. The company is also waiting to hear the court ruling on its Titanic assets. We believe at current prices the company is extremely undervalued.
Palladon Ventures: This is a pure speculative play for us. On asset valuation basis, the company is selling at ridiculous valuation. The company’s assets in Utah are worth substantially (well over 10x) more than the current market value of the company. Although the company has many challenges ahead in getting production and shipment of its Utah assets. If the company can delivery on the shipment of the iron ore, we can easily hit a home-run (10x) return. We believe the next 3-9 months are crucial for the company to work through its debt issues, working out the agreement with China, finding a new customer, and finding a solution for production/shipment.
KVH Industries: The company’s strong recurring revenue stream and growing business bode extremely well for shareholders at current share prices. The company has a clean balance sheet, a recurring business model that will create huge cash flow, and a growing business segment. We believe the shares at current prices could be a 4-5x return in 2-3 yrs.
CombiMatrix: This is a wonderful heads-i-win and tails-i-don’t-lose situation. The company is selling for a slight premium to cash. The company has many valuation options that could provide a huge return at current prices. Management has been working on selling the company, either in parts or in whole. At current prices it is an easy double. If one of the many ‘options’ work out, it could be worth substantially more. On the worst case scenario, the cash protects the downside.
We are currently invested at:
Although, our cash level is much lower than we would like, our current holdings have a substantial number of event driven holdings that should materialize in the next 6 months. Roughly 40% of current holdings are in cash and ‘event-driven holdings’.
Currently we are still finding opportunities to buy solid businesses, with strong management, at cheap valuations. As our current event-driven holdings play out, we believe we will still have opportunities to capitalize.
10 responses to “Quarterly Update: Setting up for a strong year”
Could you comment more on Palladon Ventures?
Is it traded on the canadian markets?
Palladon Ventures owns iron ore mines in Utah. The value of these iron ore mines are substantial. They recently announced NI 43-101 Preliminary Economic Assessment (“PEA” or scoping study) for a portion of its Iron Mountain Project, which shows a US$766 million Net Present Value (NPV) and 24% IRR. The study was only on Palladon’s Comstock Mountain Lion (CML) deposit and stockpiles, and did not address other significant historic resources at Iron Mountain. The CML deposit and stockpiles represent only around 20% of company’s total compliant and historic resources. So the total valuation is huge.
The company has until June 2010 to find a customer. Basically they have to pay $38M in debt by June 2010. Most likely situation is the company finds a customer for its stockpile and then uses the cash from the customer to pay off the debt.
The company had management issues a for years ago. New management has come in and started the process to unlock the value. So far the new management has made good progress. The big question is how to get the stockpiles from the mines to a port and finding a customer. A Chinese company was interested in the stockpiles and could be a customer.
From the updates i read, it seem that they have an agreement with luxor capitals regarding their debt repayment of 41Mil.
In the event that the Company does not exercise the Payment Option on or before March 31, 2010, Luxor has agreed to reduce the then outstanding $41 million Loan Amount to $25 million, in exchange for transfer and assignment by the Company of 50% of the equity of Palladon Iron Corporation to Luxor (the “Luxor Equity”), subject to terms and conditions to be set out in a definitive agreement. Palladon Iron Corporation is Palladon’s wholly owned subsidiary, through which it is pursuing development of the Iron Mountain Project, an iron ore deposit located in southwest Utah, USA.
What are your comments on this? Is luxor trying to take over PLL cheaply at current valuation? Will this option be excercised?
My take is Palladon wants Luxor out. I think Luxor is willing to get out if they get their debt paid off. Back in 2008, Luxor did own 50% of PLL. So if Luxor really wanted to own Palladon they wouldn’t have sold it. I think the company is working hard to pay off Luxor and get production started. If the company is not able to get the debt paid off, they still have the right to buy back any equity from Luxor. So I think what management is hoping for is that they get a customer who will put some money upfront. The funds can be used to pay off Luxor. I think the next 3-6 months will show if management can execute.
Now that Constellation has rolled its debt a few years forward and expanded it to 350m, front month natural gas is trading 5.25 with winter next year trading a dollar over that, it seems as though this thesis is all the more compelling. Any particular reason that it isn’t part of your recent quarterly list of holdings?
I agree with you that CEP is compelling. I sold the stake in CEP because of other compelling opportunities. When you run a concentrated fund, there is only so many stocks you can hold. I still believe CEP has plenty of upside, now that the debt issue is resolved and NatGas is selling in the $5 range.
The one concern that i do have about CEP is their reserves. Currently they don’t have any growth prospects. So if the NatGas prices stay extremely low, say $2-4 range, then they are likely losing money on the unhedged and also losing reserves.
When I look at other opportunities, like ATP Gas, I see deep discount and also very solid growth prospects. I still believe CEP is worth substantially more than current prices but I’m a bit concerned for their reserves if NatGas prices stay low for a long period.
With respect to ATP, they too would potentially have issues if oil prices suffer significantly. I think that inherently in owning either one of these stocks, the investment thesis must include the belief that the respective energy product will hold at its current price levels. I do agree that ATP has great growth prospects whereas CEP does not have any at this point.
Yes ATP can also have issues if the oil prices drop. Although ATP has a large reserve and growth potential that can increase it. So with ATP if gas prices drop for a couple of years, the impact on NAV shouldn’t be extreme. Whereas with CEP, if you get couple years where NatGas prices suffer than the NAV has a big hit as their reserves are decreasing every day.
Think about two water balloons, one with a diameter of 5 and another with 15. If you poke a hole in both of them and let the water leak for a while, the one with the smaller diameter will have a dramatic decrease compared to the one w/ a larger diameter. Now image the larger diameter actually is attached to a faucet that is feeding water into the large ballon, you could end up with no major change in size.
apologies, saw that the base is 205m now.