Asset

Bloomberg Ticker

Imtech NV

IM NA

16.7%

Alternative Asset Opportunities

TLI LN

16.2%

Commerzbank

CBK GY

12.6%

Hargreaves Services

HSP LN

10.1%

AIG

AIG US

9.4%

MS International

MSI LN

8.0%

Dolphin Capital

DCI LN

6.3%

Pennant International

PEN LN

5.6%

B&C Speakers

BEC IM

5.2%

Plaza Centers

PLAZ LN

0.6%

GBP Cash

9.3%

Quarterly Return

Quarterly Benchmark Return

12.02%

Return Since Inception

Benchmark Return since Inception

15.90%

As I write, Pulsion Medical is up about 19% on the day, as it has received a takeover offer at €16.90, in cash.   This is the second takeover offer one of my stocks has received in a few months, as Veripos is currently the subject of a bidding war.  One of the things these events highlight is that when you buy high quality, growing small caps, there are many ways to win, and takeovers are one of them.  Often larger companies find it far easier to grow by acquisition, and Pulsion Medical would make a fine addition to a medical company’s portfolio.  There are a few problems with takeover’s, however, although admittedly they fall into the category of “nice problems to have”.  First, I manage my portfolio very carefully to try and minimise capital gains tax.  If the Pulsion takeover goes through before Q2 next year, then the resultant gain will take me over my limit for the year and I will have a tax liability, which is annoying.  I suppose there’s nothing that can be done about this.  Second, I now have to find something to replace Pulsion, which is probably the highest quality company I own, if not the cheapest.  Many of the opportunities I am seeing right now aren’t the (in retrospect) easy lay ups that were available at the start of the year – FBD, B&C Speakers etc.  I guess this means I shall need to work a little harder, there’s always something to buy. 

I made a couple of changes to my portfolio in the last few days.  I sold Veripos because it is in the midst of a takeover battle, and it felt like a good time to turn the position into cash.  I sold Euromoney to make room for a new holdings - MS International.  This is a small company, that's just moved to AIM.  They aren't very good at being a public company as their disclosure is minimal.  They won't engage with me and help me learn more about the business.  But from what little information they provide, I think I know enough that the stock is cheap and sentiment could turn very quickly.  They have three divisions: 1) Defence - Lumpy earnings, decent returns on capital, and a horrible recent result, prompted (I reckon) by US defence shut downs and UK budget cuts.  There is scope for a positive surprise here.  2) Forgings - An old fashioned business which earns horrible returns but may have a few puffs left as the UK economy improves.  3) Structures - A business building and repairing petrol station canopy structures.  It sounds boring, but it is growing (helped by an Eastern European business), and has extremely high returns on capital.  There may even be some competitive advantages as the website talks about a database of old petrol station designs, which no one else has.  All in all, the company is silly cheap, probably because no one can make head nor tail of it.  It has lots of cash, a scary looking pension deficit which isn't scary when you delve into it.  Plenty of catalysts, and run by a guy who has been there for ever, owns a big chunk, and looks to be fairly competent.  I think there's a lot of scope for positive surprises when half year results come out in a few days.

Yesterday, I sold my holdings in JD Sports and Cupid, and used the funds to buy a position in Pulsion Medical.  Explaining these one by one:

JD Sports: Although it has the potential to move higher, I don't feel that this is a stock I would be comfortable holding for the long term.  On a relative basis it may be cheap, especially when compared to stratospheric Sports Direct.  However, I haven't seen any sign that it's a high quality business, with competitive advantages.  I took the opportunity when I was in Nottingham a few weeks ago to look round a shop, and was disappointed that there were at least three others in close proximity selling exactly the same sort of product.  I then went to a Milletts and was shocked at the shabby nature of the store, and how empty it was.  Is this really a business I want to own for any period of time?  Their fashion business appears to be deteriorating, and while management may be doing the best I can, and it's not really a risk I want to own.  I'm happy to take profit.

Cupid: When I bought it, I thought I was buying a profitable business, and a future pile of cash.  When the recent results came out, it was clear that when Cupid sold the "adult" business, it kept the entire cost base and let most of the revenues go, leaving me with the hope of a profitable business at some point in the future.  So the facts had changed, and while I hate turning over stocks in my portfolio, I had a chance to get out with a minimal loss and took it.

But regardless of the reasons outlined above, the fact is that I think I found something better.  Pulsion Medical seems to tick all the boxes for a strong long term investment: A strong business model, where it sells medical instruments used at critical times, in a globally growing market, where sales are perhaps temporarily depressed by the economic issues in South Europe.  The number of industry players is pretty small at 4, margins are ROCE are extremely good and getting better.  The annual report is extremely impressive - the management cite Warren Buffett and are extremely aware of the shareholder and shareholder returns - they explicitly commit to buying back stock when it is undervalued.  Trading at 11* forward earnings, this is an absolute bargain, both on an absolute and relative basis and I hope to own this stock for many years.

Asset	Bloomberg Ticker
Alternative Asset Opportunities	TLI LN	18.9%
Imtech NV	IM NA	17.8%
Commerzbank	CBK GY	10.3%
AIG	AIG US	10.3%
Euromoney	ERM LN	9.3%
JD Sports	JD/ LN	8.1%
Cupid PLC	CUP LN	7.1%
Dolphin Capital	DCI LN	7.0%
B&C Speakers	BEC IM	4.8%
Veripos Inc	VPOS NO	4.3%
Plaza Centers	PLAZ LN	2.1%
GBP Cash		0.1%
Quarterly Return	Quarterly Benchmark Return
-5.80%	2.44%

Top Up Purchase

I used the small amount of cash I have to top up my holdings in Alternative Asset Opps today.  While I have one or two companies I'm interested in, I'm in no hurry to do anything.  The portfolio does need rebalancing, though.  The "headline number" of my portfolio performance this year is pretty dull, despite a few of my investments shooting out the lights.  B&C Speakers is up around 60% and still doesn't look expensive. JD is up more than 50%.  Lesson I've learned is sometimes decent companies can be cheap for no particular reason.  The other lesson I've learned is that there's not much point picking stocks that go up 60% if they're only 5% of the portfolio.  I need to be more disciplined about position sizing.  Right now, the portfolio is a complete mess, but I will take the opportunity to sort that out soon.

Markets generally seem toppy.  Klarman's returning capital, Marks is making warnings in his letter, and Buffett is talking about being unable to find stuff to buy.  Looking at my watch list, the average P/E must be about 20.  Some commentators are talking about FTSE 8000.  IPOs are going crazy, with Foxtons up 20% today.  PE firms are doing dividend recaps.  I'll stop there. 

I just bought some shares in Cupid PLC, the online dating company.  For those that aren't familiar with the story, it was a highly rated company until this year, on the back of a secular growth business, combined with a cash generative business.  Whispers about the quality of the business model turned into allegations in newspapers and in TV documentaries this year, as some journalists claimed that the company uses dummy profiles to try and entice members to subscribe to the sites.  Doubts about churn rates also came to the fore.  Oh yes, and there was a related party transaction, now closed out.
To me, online dating is not a good business. There are very few barriers to entry, and it's very hard to have a good experience, for a range of reasons.  Even the genuine users are dishonest, and upsell themselves - that's the nature of dating.  KPMG did a company commissioned investigation and concluded that Cupid wasn't being systematically fraudulent, although there are a few practices that need to be cleaned up.  Anyway, the company is now priced as a very bad business, which is probably correct, and sentiment towards it is very low.
The interesting bit is that Cupid have decided that they should get rid of their murkier operations - the "casual dating" sites, to concentrate on their more respectable ones.  They accounted for just less than 50% of EBITDA, and have been sold for approx 4.5 * EBITDA, to the co founder.  He will use the cash flow from the casual assets to pay much of the consideration, in 40 monthly installments.
Adding earnings, cash on balance sheet, and cash to be paid, the company will have approx £43 mln of cash in 2 years, with more to come. The market cap of the company is £45mln.  So in 2 years, the business will be pretty much free.  And it's a business that can possibly grow.  I think that constitutes a margin of safety, although it requires the buyer of the casual assets to keep paying his installments.

What to sell?  Well after much thought, IG had to go in the bin.  It's had a decent run, and I worry a lot about lack of growth of subscriber numbers, and regulatory changes.  Today, it re announced that it would no longer offer spread betting on Italian equities, because of their financial transactions tax.  I will think more about IG and possibly rebuy at some point.  It's not an awful stock to own, it's just that I think Cupid is better.  Other candidates would be Euromoney, but I am aware of the behavioural mistake that people make of selling their best performers, and if the likes of Hargreaves and Rightmove can sell at 30 P/E plus, then it has room to go up, perhaps.  JD Sports also was a contender, but this is still undervalued on a relative sector basis, and is geared to the current UK recovery.  I'm prepared to wait a few months on this one.  That said, I had a few hours free in Nottingham yesterday and took the opportunity to walk around the shopping district.  I was horrified at the number of casual sports shops, and the shoddy state of the Millets I walked into. 

I made some changes to my portfolio today.  I sold the holdings in Munich Re and FBD Holdings.  Munich Re went because I can't really think of a good reason to own it.  It has failed to earn good returns on equity for years, and I don't see any particular prospect of it doing so in the future.  Further, I read a lot of stories about capital flooding into reinsurance from hedge funds, and from buyers of catastrophe bonds.  Two of the benchmarks that I think about when evaluating a stock are "does it have the potential to double in three years" or "is it an outstanding business that I could own forever"?  I don't think it fills either of these criteria, and it's made me some money, so it had to go.
FBD was a much trickier one.  It appears to be an outstanding business and, if I can convince myself it can steadily gain market share, as it has done, I'm sure it will make great returns over the very long term.  I sold this one simply to free up capital to allow me to buy Commerzbank with the knowledge that it's had a good run, and I can rebuy at a later date.
So ... Commerzbank.  Why?  And why didn't I pull the trigger a month ago when it was 30% cheaper?  I've got no excuse for that, I was indecisive, and greedy to see if Munich RE and FBD would squeeze a little higher.  Stupid.  Regardless, if my thesis is correct, Commerzbank is still cheap.  It's a fundamental part of the German economy, is trading at 0.4 P/B, and is repaying state assistance.  We've seen this story before.  Sure, the assets may not have been written down enough in the first place, which makes them harder to exit at a profit.  And sure, there is some real dross in there, and long dated dross at that.  But I'm now comfortable owning this stock for 5-10 years, and I'm very confident that over that time period, the range of potential outcomes are pretty good.  The risk of permanent capital loss is negligible, IMHO.
The final thing I wanted to touch on is Imtech.  What a disaster.  Probably my worst trade ever, if we exclude my attempt to use student loan money to buy into the lastiminute.com IPO.  At least I didn't know better then.  In short, I was arrogant and felt that my analysis of Imtech's finances and prospects was better than the market, which included a range of value based hedge funds, shorting the stock.  I didn't take account of the company's exposure to the economy, and the ability of its revenues to collapse.  I also looked too much to P/E, and ignored the fact that it wasn't very cheap on an EV/EBIT basis.  It will spend the next couple of years paying down debt, so FCFE will be zero at least until 2015.  I'm left owning a stock that I don't particularly want, and I have a paper loss.  I will hold, and wait for the accounts and company to normalise, and hope that the improving EU and UK economy feeds through to Imtech's numbers.  In addition, one could make an argument that it's not expensive relative to the market.  But the fact is that by owning this stock for six months, I am taking an opportunity away from a better stock to be part of my portfolio.  I look forward to next week's numbers with interest.

Quarterly Update

Alternative Asset Opportunities	TLI LN	17.7%
Imtech NV	IM NA	9.8%
AIG	AIG US	9.4%
IG Group	IGG LN	8.0%
Euromoney	ERM LN	7.7%
Dolphin Capital	DCI LN	6.4%
JD Sports	JD/ LN	6.4%
FBD Holdings	FBH LN	5.3%
Munich Re	MUV2 GR	5.2%
Veripos Inc	VPOS NO	3.8%
B&C Speakers	BEC IM	3.6%
Plaza Centers	PLAZ LN	2.1%
GBP Cash		14.6%
Quarterly Return	Quarterly Benchmark Return
-2.96%	-0.02%
Return Since Inception	Benchmark Return Since Inception
9.80%	13.90%

I'm pretty satisfied with returns YTD given that my largest position is a fixed income like security that has fallen in price over the quarter.  I have added a sizeable position in Imtech NV, and will post a write up shortly.  The substantial cash position I have recorded will enable me to participate in the forthcoming rights issue.

Today, I repurchased Dolphin Capital Investors, after I made an exception in selling it after the Cyprus news.  Since then, we have seen (relative) stability in Cyprus, and the sale of Dolphin's interests in the Venus Rock resort to a Hong Kong investor.  This is a validation of the thesis that a non European market for Dolphin's assets still exists, and of course, brings a big lump of cash to the company that can be re deployed into the other developments.  Q1 NAV updated is expected next week.  This holding is now around 7.5% of my portfolio.  I will possibly be further re organising the portfolio shortly.  I am looking at a rights issue situation that looks compelling, and some of my holdings are looking a lot less attractive, in terms of potential upside.

Euromoney

Today I took a decent position in Euromoney, which I hope will be a long term holding.  I like them because their existing portfolio of high quality, niche businesses operates with a negative working capital model that generates prodigous amounts of free cash.  They use that free cash for numerous bolt on acquisitions, adding similar specialist businesses to the portfolio.  They also have long term economic tailwinds behind them, as they have the opportunity to grow in emerging markets over the coming decade.  I love stocks that have the ability to compound earnings over the long term, and one excellent way of doing so is through bolt on acquisitions.  This works when you have a steady supply of candidates, and when you have the ability not to overpay.
Euromoney should be debt free by the end of the year (if it doesn't make further acquisitions).  It has a FCF yield of around 9% (net income obscures this due to sizeable intangible amortisation).  With the ability to grow organically and use free cash well, I'm comfortable owning this for a long time.

Quarterly Update

Alternative Asset Opportunities	TLI LN	28%
AIG	AIG US	12%
IG Group	IGG LN	11%
JD Sports	JD/ LN	7%
Munich Re	MUV2 GR	8%
Veripos Inc	VPOS NO	7%
Johnson and Johnson	JNJ US	7%
FBD Holdings	FBH	6%
B&C Speakers	BEC IM	5%
Plaza Centers	PLAZ LN	3%
GBP Cash		4%
Quarterly Return	Quarterly Benchmark Return
13.17%	13.96%

After the somewhat surprising events in Cyprus over the weekend, I decided to place a stop loss on Dolphin Capital.  While I am generally not a fan of stop losses, for several reasons, this was a day when this stock was not going up, and could potentially have dropped a very long way.  So I ended up selling my position at 37.5, and do not feel compelled to re enter, though a perusal of their results, out in a day or two, might change that.

Yesterday Elbit Imaging, who own c60% of Plaza Centers, announced a debt for equity swap it had negotiated with two debt holders - both US distressed funds.  These funds will now have a roughly 90% equity stake.  Why is this good?  Well these funds aren't investing in Elbit because they like the stock as a long term business.  They will be looking to extract as much value as possible as quickly as possible.  Most of that value is in Plaza Centers.  Their interests are therefore aligned with mine, and I'm hoping for some significant positive developments in the next six months or so.

I have added TLI LN and FBD Holdings to the portfolio.  TLI now makes up over 25% of the portfolio, and I'm very happy to hold an asset with fixed income like safety, and equity like returns.  During times when the market is falling, the portfolio should outperform.  If the market rises very sharply indeed, the portfolio should lag.  I think the risk/reward characteristics of TLI make it a great asset to own regardless of whether one has a view on the overall market and what that view is.

Thanks to Wexboy (http://wexboy.wordpress.com/), who alerted me to this idea:

Trading at *7.5 expected earnings, the market is discounting FBD Holdings (Irish P+C insurance) at an extremely high rate, and not giving it the benefit of any growth prospects.  This seems overly conservative considering that it has weathered one of the greatest stress tests of all time (the Irish financial collapse) with only two (ok 3, but the last one was tiny) years of losses.  It would appear that the only balance sheet mistake it made was the curious direct ownership of a hotel and leisure complex in Spain.  But there was barely anyone in Ireland who didn't have property interests in the mid 90s, so I don't hold this against them too much.  That property interest has been put into a JV, and the balance sheet is now de risked, with no debt.

What of the earnings?  Well peak after tax was €250mln pre crisis but FBD are unlikely to get back to that level any time soon.  Why?  Well their investment portfolio is now largely in cash, bunds, and high grade corporates - the investment portfolio is earning very little even if there is very little risk.  There is an argument for moving back into Irish government bonds, which I sympathise with, but let's assume they make no money on their asset portfolio going forward.  Also, the fact is that with property falling greatly in value and people having far less money to buy things, there is far less stuff in Ireland to insure. 

What are we left with?  Well the company earned €53mln on €281mln of equity in the last 12 months, post tax, unlevered.  And this is after a period of unprecedented business disruption.  Revenues were flattish to slightly down, but this is to be expected for the reasons above.  Going forward, I suppose the Irish economy and asset values could deteriorate further, but there seems to be a fair bit of that priced in.  What could happen on the upside?  Well this is a company that is uniquely focussed on Ireland, in an industry where most of the competitors are subsidiaries of multi nationals.  These are multi nationals who are struggling in their home countries, possibly retrenching, and probably not concentrating too much on Ireland.  We know how helpful an Irish focus can be, because FBD has been growing market share for ten years.  In addition, it has a competitive advantage through its chain of rural offices, and has now launched some direct selling internet platforms.  It's loss and combined ratios are outstanding.  It really is very good at what it does and it's aiming to pay out 50% of earnings in dividends.  There are no expansion plans beyond additional market share at the right price.

So we have an opportunity to buy a quality company that earns a high RoE, has competitive advantages and is focussed on one country at a time when the economy has probably troughed.  That's good enough for me.  I don't need the economy to grow, or the company to seize market share, or interest rates to go up, but this is where there is potentially significant upside.

Tomorrow I will take a position in two similar stocks - Plaza Centers and Dolphin Capital.  They are similar because they are Real Estate developers in trouble.  Both are overextended in some unfortunate parts of the world.  Consequently, they don't have enough cash, and are suffering from depressed asset valuations.  They are outstanding opportunities because they are trading at massive discounts to book value and both will probably survive - though this is not for certain.  Plays relating to a discount to book value can work well when assets can be sold, with Real Estate this is a natural part of the business.  I have done an extensive amount of reading and research on these companies, and have satisfied myself that these are great investments from a risk/reward perspective.  While I don't have time to discuss these further, I hope to do so in the future.

Asset	Bloomberg Ticker	Percentage of Portfolio
Alternative Asset Opportunities	TLI LN	17.1%
AIG	AIG US	15.5%
IG Group	IGG LN	13.3%
JD Sports	JD/ LN	10.6%
Munich Re	MUV2 GR	10.3%
Veripos Inc	VPOS NO	9.9%
Johnson and Johnson	JNJ US	7.8%
Tesco	TSCO LN	7.7%
B&C Speakers	BEC IM	5.6%
J Sainsbury	SBRY LN	1.6%
GBP Cash		0.1%