The Alpha Masters
Unlocking the Genius of the World’s Top Hedge Funds 

By Maneet Ahuja

Today I am reviewing The Alpha Masters: Unlocking the Genius of the World’s Top Hedge Funds. Read my other book reviews here.

Like greedy children we investors tend to cling to every nugget of news about top hedge fund managers, hoping to identify some glimmer of insight into their investment processes. It isn’t always easy, given the secrecy demanded of them by the securities regulators and their own natural desire to keep their secret sauce… well, secret.

So imagine my delight to find The Alpha Masters, a book by Maneet Ahuja, who managed (in some Faustian bargain perhaps) to extract in-depth interviews with eleven top hedge fund managers. Her interviews provide the desired coverage of the managers’ investments strategies, but also give insight into their management philosophies and brief biographies about how each arrived in his position. 

The result is quite a strong book. Ahuja did a good job of keeping the managers honest, avoiding platitudes in favour of concrete details that I haven’t read elsewhere. She also covers the managers’ biggest trades, both successful and otherwise and gets their personal views on what they learned from the experience. 

The managers covered are:

• Ray Dalio, Bridgewater Associates
• Pierre LaGrange and Tim Wong, Man Group / AHL
• John Paulson, Paulson & Co.
• Marc Lasry and Sonia Gardner, Avenue Capital Group
• David Tepper, Appaloosa Management
• Bill Ackman, Pershing Square Capital Management
• Daniel Loeb, Third Point
• James Chanos, Kynikos Associates
• Boaz Weinstein, Saba Capital Management

Also, The Alpha Masters includes a forward by Mohamed El-Erian of PIMCO and an excellent afterword by Myron Scholes (Nobel Laureate and contributor to the Black-Scholes-Merton option pricing model). I really have no idea how Ahuja managed to get this level of access and support, but I am pretty much in awe.

Overall, a worthwhile read that I can safely recommend. 

If you’ve read The Alpha Masters, leave your thoughts below.

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Author Disclosure: This book was provided by the publisher for review.

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The Outsiders
Eight Unconventional CEOs and Their Radically Rational Blueprint for Success

By William N. Thorndike, Jr.

Today I am reviewing The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. Read my other book reviews here.

You’ve undoubtedly heard of Jack Welch the celebrity “CEO of the Century” who generated 20.9% annualized returns for his shareholders while at the helm of General Electric. But what about Tom Murphy or Henry Singleton? No? Maybe Bill Anders, John Malone, Bill Stiritz or Dick Smith? Well, you can be forgiven if these names have escaped you; the popular media have largely ignored these CEOs despite their equally exceptional shareholder returns.

In fact, according to author William Thorndike, these CEOs’ returns should be viewed far more favourably than those of Welch who happened to preside over one of the longest bull runs in recent memory (the S&P 500 averaged 14% returns over the period). While Welch bested the market by 3.3x, lesser known Henry Singleton of Teledyne outperformed the market by 12x over an even longer period than Welch. The eight CEOs as a whole outperformed the S&P 500 by over 20x, and their peer groups by over 7x, proving that these were not just the luckiest operators in uniquely lucky sectors.

The Outsiders is a collection of eight CEOs who eschewed the prevailing wisdom, forging their own path to great returns (if not great renown). Among the CEOs profiled are two that should be well known to readers of this site (Warren Buffett and Katherine Graham), as well as six who largely operated out of the popular imagination. The list includes:

• Bill Anders, General Dynamics
• Warren Buffett, Berkshire Hathaway
• Katharine Graham, The Washington Post Company
• John Malone, TCI
• Tom Murphy, Capital Cities Broadcasting
• Henry Singleton, Teledyne
• Dick Smith, General Cinema
• Bill Stiritz, Ralston Purina 

Each chapter focuses on one of these CEOs, providing a brief biographical sketch of how he or she arrived in the top position (e.g. one was an astronaut, another was a widow without prior business experience, two were PhDs) before delving into the unconventional strategies employed in achieving market topping returns. Thorndike manages to suss out a few common characteristics of how these returns were achieved, including:

1. Focus on per-share value rather than sales or earnings
2. Decentralized operations (“Delegating to the point of anarchy”)
3. Cash flow based metrics
4. Significant stock repurchases at opportune times

Beyond these four points, there is significant divergence in their strategies which largely stems from industry conditions. This divergence allows Thorndike to keep the book interesting while reiterating the same key points. Overall, I found The Outsiders to be a quick, interesting read about many CEOs whom I had never heard of. I think there is value in seeing examples of best practices for company management, if only for informing our ideal of how our portfolio companies ought to behave.

If you’ve read The Outsiders, leave your thoughts below.

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Author Disclosure: This book was provided by the publisher for review.

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Frank’s Disclosure: No position in any of the securities mentioned.

———————————-

IS PHOTOMEDEX POISED FOR A SHORT SQUEEZE?

SUMMARY

Photomedex (“PHMD”) is a heavily shorted stock which we think is a compelling long, especially considering the possibility of a major short squeeze.  Despite the large short position (25%+ of float, ~20% cost to borrow), PHMD is actually an undervalued (5.1x 2013E Adj EBITDA) , unlevered (20% of its market cap is in net cash), growing (revenue and EBITDA should increase organically in 2013),  high free cash flow company (D&A significantly higher than maintenance capex,  an nol reduces cash taxes and non-recurring items distort LTM results) with a buyback waiting to be used (the company has been restricted from repurchasing stock for many months but the window reopens in May) and a management team which owns ~30% of the company and is incentivized to create shareholder value.  

BUSINESS DESCRIPTION

The current PHMD was formed in December 2011 with the merger of Radiancy (which makes a number of products including the no!no!) with Photomedex (which has a strong proprietary consumer marketing engine based upon the direct to consumer sales model).  PHMD’s largest product (~85% of revenue) is the no!no! hair removal product, which is short for No Hair, No Pain.  The product is for home use and unlike other products that use methods that are painful, have side effects or are limited in body areas that can be treated,  the no!no! is based on a proprietary heat-based technology and therefore can be used for all hair colors and skin types, can be used on all body areas, and is virtually painless.  

PHMD’s revenue is derived 61% by direct to consumers (infomercials, radio and newsprint), 23% by distributors (primarily in Japan) and 16% via Home Shopping network and select retailers including Bed Bath and Beyond (which, after a test run, recently decided to sell the product at ~950 of its stores nationwide), and  Bergdorf Goodman.    

PHMD outsources most of its fulfillment and manufacturing.  This enables the company to minimize its capital expenditures and to locate its operations (call centers, manufacturing) in the most advantageous (based on cost, proximity to customers, etc.) locations.  

VALUATION

Note: the $48.7 million 2013 Adj. EBITDA estimate is our own, based on an 8% increase in revenue and zero margin improvement, both assumptions we consider to be conservative.  Canaccord’s estimate is approximately $50 million (after adding back the stock comp).  

WHY IS THE STOCK MISUNDERSTOOD

1. Misunderstood financials causing stock not to screen well – Many data sources show 2012 EBITDA to be $32.9 million (implying a 7.5x EBITDA multiple).  However, this figure includes a $6.1 million non-recurring expense and $6.2 million of non-cash stock compensation.  Adding back these two items would yield an adjusted EBITDA of $45.1 million and reduce the EV/EBITDA to 5.5x.

2. Cash flow greater than it may appear :

   1. PHMD’s D&A is significantly higher than its maintenance capex.  Last year, D&A was $5.6 million and capex was only $0.5 million (again, the company outsources most of its manufacturing and has limited PP&E).  Last year the company did spend $3.2mm for lasers placed into service, which we consider growth capex.  This relates to the Xtrac laser to treat psoriasis which PHMD places in a physician’s office and then charges the physician a fee per treatment.  This Xtrac business is currently small (less than 5% of PHMD’s revenue) and due to the payback time required for these laser investments, the money spent last year to install the lasers (which is large relative to maintenance capex) yielded little contribution to PHMD’s overall profitability.   
   2. The company has an NOL which will reduce its cash taxes for many years to come.  The company estimates its cash tax rate in 2013 will be 28% – 30%.
   3. Last year PHMD generated $25.1mm of cash flow from operations.  However, this figure was negatively impacted by approximately $8mm of taxes that the company essentially prepaid, so a more normalized cash flow figure would have been closer to $33 million.
   4. Limited analyst coverage – the stock is currently covered only by Maxim, Ascendiant and Canaccord.
   5. Limited guidance – Management is very conservative and provides only limited formal guidance (revenue for the following quarter).  This lack of guidance makes it harder for investors to understand the company.
   6. Management doesn’t do a great job telling its story to investors –we feel they could do a better job of explaining to investors why the stock is such an attractive investment (instead of just explaining what the company does), and expect management will learn to do a much better job of doing this.

WHAT SOME SHORTS ARE CLAIMING

1. Some shorts claim PHMD is a one product company whose main product has peaked.  However, the no!no! has not peaked and will likely grow in 2013 (Q1 revenue guidance for the entire company is 13%+).  Furthermore, as evidenced by last quarter’s results, the company is beginning to experience growth in some of its other products, although the no!no! likely will be PHMD’s  major product for some time.  Some of the factors that will drive PHMD’s growth are:  

   1. No!no! domestic revenue should continue to increase as the company further penetrates the US market and introduces new products such as the no!no! pro (a higher margin, high priced product).
   2. Domestic no!no! sales should also benefit as the company broadens its advertising (using shorter commercials during the day in addition to the current longer late night commercials), and begins to advertise in Spanish to market to the large Spanish speaking population in the USA.
   3. International sales (currently ~ 30% of revenue) should increase as the company continues to penetrate existing markets and, importantly, enters new markets such as Brazil (a very large market), German and South Korea.

As illustrated below, no!no!’s revenues do not appear to have peaked.  Q1 and Q2 showed sequential growth.  In Q3 advertising rates were unusually high (due to the elections and summer Olympics), so management reduced marketing expenditures for that quarter which resulted in a decrease in Direct sales, but an increase in overall profitability.  The company could have spent more money on marketing (and thus increased revenue) but felt it would not have generated a high enough ROI.  This demonstrates that management is focused on long term profitability, not driving revenue growth just for the sake of growth.  Q4 reflected additional growth, except for revenues from Distributors (primarily Japan) which is always seasonally weak that quarter.  In addition, we believe Q4 Direct revenues were hampered by the closure of the distribution facility for a few days for the holidays at year end (but that those sales were not lost, they slipped into Q1 2013).  

The following table shows the 2012 revenue ($MM) for the Consumer segment (which is primarily no!no!).

2. Some shorts also claim the company does not reserve adequately for returns.  There are many ways to assess a company’s reserves, but the below table from the 10k seems to illustrate the company has not under-reserved for sales returns or doubtful accounts.  

Valuation and Qualifying Accounts:

3. Some shorts also claim the no!no! does not work and they point to some negative online reviews for the product.   In its defense, PHMD has some studies that demonstrate the product does work.  We generally take negative online reviews with a grain of salt as we believe people are more likely to post a negative review than a positive review for any product.  While the return rate for the no!no! is high, we note the company adequately reserves for such returns.  Management claims most of the returns occur because people are not using the product properly and that it offers a 70 day full return policy.  Management is also attempting to better educate consumers about the proper way of using the product. We also note the product is sold by some well-known retailers and we doubt they would want to jeopardize their relationship with their customers by selling a product that was really terrible.  Finally and most importantly, we are suggesting you buy PHMD’s stock, not its product.   

4. Some shorts have also complained about the company’s auditor Fahn Kanne & Co. Grant Thornton Israel, which is a member firm within Grant Thornton.  To address this concern, in 2013 PHMD will pay extra to have Grant Thornton USA also sign the audit.

CATALYSTS

1. Strong Q1 results – PHMD will report Q1 results in early May.  
   1. They have guided to revenue of at least $57 million which would be a year over year organic increase of at least 13% (and they tend to be conservative on guidance).  
   2. Q1 2013 results also won’t be hurt by the $2.7mm litigation expense that hurt Q1 2012 results
2. As the following table illustrates, Management has been very conservative regarding its revenue guidance and typically exceeds guidance :   
3. Resumption of buyback – the company has $14.3 million left on a $25 million buyback announced last August.  The company has been in a blackout period since mid-December due to the timing of its 10k and Q1 releases.  The company’s window to repurchase stock opens 2 days after it files the 10q (which should be early/mid May) and we expect the company to be active in the market.  On the last earnings call, when the stock was at higher prices than today, management said “The Board is committed to continuing to execute this program as the trading windows permit.”
4. Short squeeze/capitulation – We are not sure what the catalyst is for the shorts to maintain their expensive short position, but at some point they may just move on to better opportunities.
5. Increased IR – Management is becoming more proactive and effective regarding speaking to the investment community and will be doing more conferences and non-deal roadshows.

OTHER CONSIDERATIONS

1. Insiders have sold stock and have a 10b5 plan in place.  While we never like to see insider selling, the market seems to be digesting these sales (it’s a hard for large institutions to buy this illiquid stock so they are happy to buy blocks insiders are selling) and despite these sales, management retains a significant interest in the company.  

The site acts as an aggregator of conference call transcripts from sources all over the web. Users sign up for free, add companies to a personal list, and then receive immediate alerts when a conference call transcript is posted online for one of those companies.

Saj has recently expanded the site beyond conference calls to also include each company’s filings, so users are alerted when, for example, an 8-K is filed at 5pm on a Friday when few are paying attention. Very useful!

Having conference calls and filings all in one place with free updates is pretty handy, but I think the real value of this site comes in the form of Saj’s inclusion of Canadian companies. The Canadian SEDAR system (similar to the SEC’s EDGAR system) does not have any system for alerting users of new filings (and is, in pretty much every other way, a downright terrible system for investors). Saj has built a proprietary system for getting these updates so users can be updated when Canadian-listed companies file new documents with SEDAR. This is the only system that I am aware of that has this capability and I find it extremely useful.

Head over to ConferenceCallTranscripts.org and check it out for yourself.

Frank’s Disclosure: No position in any of the securities mentioned.

***

Last week Vince Martin wrote a Seeking Alpha article on Perion Network (PERI) which seemed to cast a negative view on the company.  We have been following the company for a while and are far more optimistic about its prospects.  It’s unclear if Mr. Martin even bothered to speak with PERI or Google before publishing his widely circulated article, but we have serious concerns about some of his statements which we believe present an incomplete and inaccurate picture of the situation. Importantly, we believe Martin’s article has created an attractive opportunity for investors to buy the stock that has been beaten down by questionable journalism and undue concerns about the Google contract renewal.

Below are some of the issues we have with Martin’s article: 

1. Martin correctly mentions the risk that GOOG may not renew the contract which expires later this month; however, he never explains some other highly plausible reasons why the renewal process may be taking so long.  Anyone who has been closely following the company understands that PERI completed a major acquisition of Sweetpacks only last month.  This acquisition may be complicating the renewal process because it significantly increases PERI’s size and alters its business mix.  Furthermore, (as PERI has repeatedly told investors) Sweetpacks has its own GOOG contract which does not expire until May 2013, so PERI/GOOG may be trying to structure a contract that combines the existing PERI and Sweetpacks agreements.  Finally, one must consider the calendar impact on PERI’s ability to get a deal done with Google.  In many industries it is often difficult to finalize a deal towards the end of a calendar year because people often take vacations in December and when they return in January they are often focused on other things.  So, while we doubt the calendar was the sole factor in holding up the GOOG renewal, we believe it likely contributed to it. 
2. Martin fails to mention that it is not uncommon for contract renewals to occur at the last minute.  Anyone familiar with PERI’s industry knows that one of its competitors, AVG Technologies (AVG) recently had to renew its Google contract.  AVG’s contract was scheduled to expire on September 30, 2012, but it was not until September 27^th (three days before the expiration) that AVG announced it had agreed with Google to extend the agreement until Oct. 31, 2013.  Then, on Oct. 31 (the day the extension was scheduled to expire), AVG announced the agreement had again been temporarily extended.  Then, on November 28, AVG announced a new two year agreement with Google.
3. Investors should study what happened with AVG so they can understand what may happen with PERI’s stock price.  AVG’s stock price traded down to below $10 towards the end of September as investors panicked that the Google deal would not be renewed.  However, the stock traded up every time AVG announced an extension.  When AVG finally announced the new 2 year deal in November, the stock traded close to $14.  So, investors who bought stock during the time of panic made over 35% in only two months. 
4. Martin claims that “even if a deal gets done, there may be some concern on Google’s end about Perion’s software….”   This is a rather damaging statement for which the author provides little support.   He doesn’t provide any recent comment by Google relating specifically to PERI nor does he even indicate if he spoke to Google.  Instead, Martin references language from an outdated SEC filing (PERI’s 2009 20-F) and then throws more fuel on the fire by claiming Google had “some distrust of ” PERI’s business model.  Again, he offers no real support to justify this highlycontroversial claim.  I think a reasonable person would wonder why if Google (a multibillion dollar company) really had “distrust” of PERI (a relatively tiny and insignificant customer) why GOOG renewed its contract after the 2009 and appears ready to renew its contract again.
5. Martin also states that it appears that Google has “real concerns about Perion’s behavior – and have for some time.”  We wonder why the author feels the need to repeatedly make such damaging statements, especially since he provides no proof to support his comments. 
6. Martin notes there have been “a number of complaints” about Smilebox on sites such as CNET.  While indeed there are some complaints, Martin fails to even attempt to put the magnitude of the complaints into perspective by not telling readers how many people have downloaded Smilebox. Without informing readers how many people have used the product, it is difficult to objectively understand how significant of a problem these complaints are.   
7. Martin says “ Mandelbaum’s effort to blame ignorant and/or difficult customers seems insincere.” We certainly hope Martin isn’t implying that Mandelbaum called his customers “ignorant” which we believe is a rather insulting phrase.  Perhaps Martin believes these people are“ignorant,” but we highly doubt Mandelbaum does.  Regarding Mandelbaum’s sincerity, we again question the basis for Martin’s accusation.  We have known Mandelbaum for a while and have always found him to be honest and straight forward.  Sadly, Martin fails to explain why he considers Mandelbaum to be insincere.
8. Martin states the segments in which the company competes “peaked in 2001.”  Again, he provides no facts or data to support this statement.  However, anyone who reviews PERI’s or Sweetpacks’ financials, or does some basic analysis of the company’s 2013 guidance can easily see that their business is actually growing organically.  It’s unclear to us why someone who is criticizing the future of PERI’s business model would fail to mention the company’s attractive organic growth.  Note: if the combined company generated LTM revenue of $81 million and 2013 guidance is at least $110 million, this implies organic growth of at least 35%. 
9. Martin makes some questionable comments about PERI’s customer acquisition costs (CAC).  Importantly, he also fails to adequately explain how these highly variable expenses work and how the company can increase or decrease such costs depending on their success. PERI spends CAC inone quarter but doesn’t reap the full benefit of such investments in that particular quarter.  PERI targets a very high return on investment (ROI) for its CAC.  The key is that if the company is not generating a sufficient ROI in a particular quarter, it can easily reduce its CAC which would result in an increase in profitability during that period. Similarly if the CAC is generating better than expected ROI, the company can increase its investment, which may result in lower profitability in that quarter but higher long- term profitability.  So, CAC is a variable cost and anyone who has researched the company or spoken with management should know that last year PERI very prudently and successfully invested in CAC and that in some quarters it spent less (because it wasn’t generating a high enough ROI) and in other quarters it spent more in an effort to capitalize on the high ROI it was generating.
10. Martin has also makes several comments that might lead one to question the credibility of PERI’s management.  We wonder why anyone would doubt Mandelbaum who, since he became CEO, has done exactly what he has promised and has created significant shareholder value.  Anyone who has spoken with him will realize he is actually quite open and honest about the company.  Mandelbaum is also rather conservative and understands the importance of under-promising and over-delivering.  Anyone who doubts that may wish to examine the company’s earnings guidance history last year, during which the company increased guidance three times.  

We could highlight numerous other “issues” with Martin’s article but we think we’ve made our point.  We are not sure what motivated Martin to write his article. He appears to have spent a fair amount of time writing it yet we believe he fails to present basic and critical information that would have made his article more accurate and informative.  Considering his strong views of the company, we also wonder if Martin even spoke with PERI or Google, and if he didn’t, why not.  If he doesn’t have the common courtesy to at least allow a company to respond to his damaging claims before they are broadcast throughout the investment universe, doesn’t he at least believe his readers would be interested in hearing PERI’s response so they could make a more educated decision on the situation? 

It appears to us (based on our conversations with Mandelbaum and our reading of Martin’s article) that Martin didn’t speak with PERI, which is unfortunate considering Mandelbaum speaks English fluently, and is easily accessible by phone or email or through his US-based investor relations firm. 

Martin’s bio states that he is a comedian and we watched some of his comedy routines online.  Unfortunately, we think his article is highly deceptive, filled with hyperbole, lacking basic evidence to support many of his claims and not at all funny considering the damage it has done to the company’s reputation.   

We have been buying more stock during the weakness caused by Martin’s and the questionable Bloomberg TV piece (in which the reporter, amazingly, gave incorrect information on a critical issue, the date of the Google contract expiration, despite PERI’s management telling him that his information was incorrect).  Time will tell who was right and who was wrong about PERI. 

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