Distressed Debt Conference: 2011 Wharton Restructuring Conference

Each year, I try to highlight some of the best distressed debt conferences I come across. This year we are starting the year off right highlighting the 7th Annual Wharton Restructuring and Turnaround Conference. Panelists from a number of the best and brightest distressed debt funds including Brigade, SVP, and Avenue (Marc Lasry is a keynote speaker) will be speaking on a number of fascinating topics (GGP case study looks particularly interesting).

For all those interested and want more details, please follow the link below:

And if you have a restructuring or distressed debt conference you think would be of interest to our readers, please contact me: hunter [at] distressed-debt-investing.com



Distressed Research - HNDUS (Harry & David f/k/a Bear Creek Holdings)

Before I get to today's post, I wanted to make two quick announcements. 1) I've been very busy with the complete redesign of the Distressed Debt Investors Club. The new site is leaps and bounds above the old one in terms of user friendliness, better forum, ease of navigation, as well as the ability to add functionality in the future. I suggest all that are curious about the site to join as a guest (Just write guest in the idea synopsis and idea write up area). If you have any questions regarding the site, please contact me. 2) With that said, once the new site is up and running I will be upping my number of posts dramatically. I have a plethora of material ready to post - just need to find time to get it done.

A month or so ago, I wrote a post about my predictions for high yield and default rates in 2011. I did note that there are still enough situations for the average distressed investor to stay busy throughout the year, despite my opinion that default rates will approach 2% this year. In January 2011, we've seen a few defaults (Orchard Brands - Highland, Canyon, and Aladdin involved, ). In addition, we've seen announcements of new fund launches targeting the distressed debt strategy (Daniel Posner at Golub - who I would like to get in contact with FYI). And of course, we've seen some bonds fall like rocks:

The above chart references Harry and David's 9% notes due 2013 (HNDUS for all those on Bloomberg). As of today, this is the worst performing bond in the U.S. high yield / stressed / distressed market that I am aware of - please correct me if I'm wrong. What caused such a dramatic drop?

Before we get to that, what is Harry and David? Harry and David is a specialty retailer. And to give you a sense of what they sell, you can go to these websites:
  • www.harryanddavid.com
  • www.wolfermans.com
  • www.honeybell.com
In addition, the company operates approximately 120 stores across the United States. For quick reference, the total number of stores has declined each year since 2007.

On January 18th, Harry and David issued a press release titled "Harry & David Reports Disappointing Holiday Results - Hires Advisors to Explore Recapitalization Alternatives" ... With a title like that, no wonder the bonds dropped. And boy did they drop. Traders from across the street were making comical markets - UBS was making a 25-40 1x1 market. They promptly tightened it up to 30-40 1x1 (you guys stay solid!)... Things stayed active, UBS stopped trying to poach the weak holders, and bonds settled around 40 at the end of the day. As of Friday night, the market was probably 43.5-44.5 on the 9s of 13.

The press release also disclosed the hiring of Rothschild as financial advisor and Jones Day as legal advisor to explore recapitalization alternatives. In addition, the jugular, as it were, of the press release, was this gem:
"While the Company believes cash on hand is sufficient to fund short-term operations, based on the Company’s current working capital and anticipated working capital requirements and results of operations, the Company will not be able to finance continuing operations without securing new capital and restructuring its obligations. The Company intends to conduct discussions with its revolving credit lenders, bondholders, other creditors and owners in an effort to recapitalize. There can be no assurance that these discussions will be successful."
Net/Net, things seem pretty dire. To give you a sense of the miss, see below (Note 2Q ends 12/31):

In addition, and this could be the first time I've seen this, on the press release, the contact for the "Investment Community" was a restructuring banker at Rothschild.

As can be seen on the chart above, EBITDA for the quarter was down 46%. In addition, in the disclosure, the company noted that EBITDA for the 12 month ended 12/31/2010 was -$17M vs. $21M last year. Going into the quarter (i.e. looking at 9/30 inventory over the past few years), it does not seem like inventory was out of wack:

Sept 2005 Inventory: $117M
Sept 2006 Inventory: $124M
Sept 2007 Inventory: $106M
Sept 2008 Inventory: $100M
Sept 2009 Inventory: $83M
Sept 2010 Inventory: $83M

Comparing inventory / sq foot and inventory / stores presents a slightly worse picture:

As can be seen above, it looks like inventory was 10% higher on an apples to apples basis for Harry and David's footprint. This leads me to believe heavy discounts were put in place to move inventory out the door - hence the lower cash flow margins.

Harry and David is owned by funds by Wasserstein Partners, Highfields Capital, and certain members of current and former management. It was acquired in 2004 for ~$250M ($85M of capital committed with the balance financed with debt). In FY 2005, the company issued the aforementioned senior notes to refinance LBO debt and fund a dividend of $82M meaning that sponsors were effectively playing with "house money." They also paid themselves an annual "sponsor fee" and a few dividends a long the way. After weakening results, a failed IPO, and a covenant amendment, Wasserstein's Chairman Steve Heyer was appointed Chairman and CEO of HNDUS.

So what is this thing worth? Well, before we get to that, we have to point out one salient fact rolling around the markets. For your reference, please see this disclosure from the most recent 10K:
"We own approximately 3,400 acres of land in Oregon, of which approximately 1,900 acres are planted orchards geographically dispersed throughout the Rogue Valley of Southern Oregon at varying elevations and micro-climates. This dispersion has historically allowed us to successfully mitigate the risks associated with frost, wind, hail, storm damage and other inclement weather as well as dependence on any single water source. Also included in our 3,400 acres is our 93-acre campus in Medford, Oregon, which houses our 54,000 square foot bakery, confectionery and chocolate complex dedicated to the production of baked goods, chocolates and confections, our 646,000 square foot fruit packing and gift assembly complex including cold storage, our 72,000 square foot year-round call center and various other distribution and storage facilities. Our owned acreage also includes housing for our seasonal agricultural workforce. We also own a 51-acre campus in Hebron, Ohio, which houses our 275,000 square foot fruit packing and gift assembly complex including cold storage and our 55,000 square foot call center and office space. In the fourth quarter of fiscal 2010, we initiated a plan to shut down our Hebron call center and utilize a third party service provider to complement our Medford call center. The shut down of the Hebron call center was completed during the first quarter of fiscal 2011 and the transition to a third party service provider is in progress. The building which included the call center will still be utilized to support our Hebron distribution operation."
So this company has real estates versus most specialty retailers. Its hard to get a sense for what this acreage is worth. I called a few brokers and Oregan orchard acreage is going for $7500-$10,000/acre but that only gets your to $10-$20M of value. And then you also have to value the Medford and Hebron Campus as well as the non orchard acreage. I find this a very difficult analysis.

On the flip side, you can try to figure out a run rate EBITDA estimate for this company and then apply a conservative multiple. Given that EBITDA margins for this company are all over the place, this too is a difficult analysis. But let's give it a stab.

Before that though, let's figure out our claims pool assuming no leases are rejected in bankruptcy.

Admin Claims:
  • Legal / restructuring fees at 3% of total debt = $6M
  • DIP to continue operations at average AP through a fiscal year = ~$20M
Unsecured Claims:
  • 9% Notes due 2013 = $140M * 1.045 [to account for accrued...i.e 1 missed payment] = $145
  • FNRs due 2012 = $59M * 1.025 [to account for accrued based on last floating data ] = $61M
  • Underfunded Pension = Underfunded by $30M in June 2010. Assume cap market appreciation in excess of service costs = Pension claim of $25M
  • Other GUC = $20M = eyeballing guesstimate.
Some people will ask why I've included underfunded pension. If you do some research on this company you will see vital it its to its community. I do not think they full reject the pension to the PBGC.

You will also remember from above that the company is entering its 3rd quarter with $67M of cash. In each of the last 3 years, the company used a significant amount of cash its its 3rd and 4th quarter - AP is paid down, unearned revenue flows through, etc. I would give the company credit for 50% of its cash balance so say $35M entering bankruptcy.

Using various run rate sales figures and EBITDA margins, we can forecast EBITDA going forward:

As you see I've highlighted the "lower quadrant" of cash flows given my concerns for this business. The average of those numbers are $18M. Specialty retailers trade all over the place right now, but for this type of business I think using 4-5x cash flow makes sense. This translates into the below waterfall:

At these levels, unless I find out the the company is going Chapter 7 and its hard asset value is worth a substantial amount, its hard to get comfortable at these levels. If bonds dropped to the high 20s it would pique my interest. I will keep you all updated as events unfold in this distressed debt case.



Profile on Distressed Debt Fund Canyon Partners

Last week, Bloomberg has penned an amazing piece on Canyon Partners. I know a few of the analysts at Canyon Partners and it really is an amazing organization. Canyon is and has been involved in a number of very high profile bankruptcies in the past years. Off the top of my head, they are / have played Lehman Brothers (through the Paulson Group), Tribune, Americredit, Charter, Univision, and many others. From looking at their 13F, they were involved in CIT and Spansion on the post - reorg side.

One quick point: I have respect and know a number of people that have come off the Drexel desk (Founds of Canyon Capital: Mitch Julis and Josh Friedman are former Drexel guys). For whatever its worth, in my opinion, if Mike Milken wasn't burned at the stake and barred from the securities industry, he would be one of the world's wealthiest investors with capital accumulated on par with (dare I say it) WEB.

In addition, to the Bloomberg piece, I have found the Value Investor Insight article on Mitch Julis of Canyon Capital on the web:

Here are some of my favorite quotes from the VII interview:
"The credit culture of Drexel gave me an important way to frame investment opportunities. The idea is to combine a full understanding of whether a company will be able to pay back its obligations, in sort of a ratings-agency sense, with a focus on whether the company has a business model or competitive advantage that builds long-term value. Drexel was unique in looking at credit quality this way and we think it’s a great way to think about any investment in a business"
So often today I still find that many high yield and credit guys could care less about the business quality. While it is a different game in the sense that the "cigar butt" strategy is more viable in a restructuring, some of the best performing post-re org opportunities comes from great companies with terrible capital structures that happen to have maturities / covenant defaults at the wrong time.

On selling:
"We grew up in an environment at Drexel where the head trader always reminded us that you never went bankrupt by taking a profit. We’re not immune to the common mistakes of being overly risk averse on winning positions by not letting them run and taking on excess risk with losing positions by holding on.

We’ve gotten better at letting our winners run. Part of that comes from really understanding what we’re betting on. Say you bought something at $5 that’s now at $20. If $15 of that $20 is just the cash the company has accumulated since you bought in, the bet on the future business is still only $5. Absent a change in your thesis, why would you sell in a case like this just because you’ve already made a bunch of money"
As most value investors contend, I believe that selling is the hardest part of this business. To me, it really stems from the behavioral concept of anchoring. What I mean is when I look at a position, I will do my initial work and come up with a valuation of a security. I am then anchored to that valuation. And because we are intelligent, yet biased species, it is hard for me to get beyond that anchor even if the business prospects have improved dramatically. I think one antidote is consistently updating your numbers and your thesis based on a set of conservative assumptions. If you valued the business at 10x cash flow a year ago, you would be hard pressed to tell me that business is worth 20x cash flow today. 12x cash flow would not be out of the realm of possibilities if the company was spending its capital more wisely, or gaining market share, or permanently reducing costs.

By the way, before I conclude, during the interview Mitch Julis mentioned he was writing a book: "Beyond Graham and Dodd: A Multi-asset, Multi-strategy Approach to Value Investing" Says it is unreleased...can someone maybe nudge Mitch to get this done. I'll buy the first ten copies to get the orders started! :)



Distressed Debt Investing: 2010 Review and Defaults/Bankruptcies in 2010

2010 is in the record books. Last year, in a post entitled "2009 - What a Year for Distressed Debt!" I wrote:

"2009 was such a great year for distressed debt and debt investing, but the math alone makes it hard to justify another return like this. Here's to hoping its one-half, or even a quarter, or even a tenth of 2009's return..."
All the numbers for various distressed debt funds have yet to be released. I am hearing high teens returns as being a fairly common occurrence. Of course I have heard of some outliers on either side, but that is typical for the distressed debt strategy. Distressed Securities (as defined in the CSFB High Yield Index) was up 17.6% on the year. In the same index, bonds priced less than 80, were up 25.4% during the year.

In the past, we have shown you a chart with the aggregate number of issuers with bonds carrying a spread of 1000 bps over the benchmark. Here is that chart for 2010 alone:

2010 - Number of Distressed Debt Issuers

And long term...

Long Term - Number of Distressed Debt Issuers

As one can see in the first chart above, distressed really rallied in the last two months of the year as the "risk on" trade was on the go. What is also interesting about the above charts is that they only reference corporate "Traceable" bonds. According to JPM and LCD, over 10% of bank debt is trading at a price of less than $80. Seemingly, there are currently more opportunities in bank debt land relative to bonds.

In my experience through the year, and talking with various traders, analysts, and PMs at a number of shops, the two money making trades of 2010 (outside of just "Long Risk") were:
  1. Long structured credit: Whether it be BB CLO liabilities, MAV notes, the 0-3% loss piece of synthetic structures (thank you mortgage insurers!), or subordinated tranches of CMBS, long distressed structured credit was a huge winner in 2010.
  2. Grabbing your sack and buying post re-org equities in the summer: So many trades to name here but the ones that really jump out at you (and seemingly many people were long): LYB, LEA, CIT, SOA, SIX, Delphi (traded privately off the distressed desks), etc.
Of course, a number of vanilla distressed strategies did remarkable through the year. And that list includes things like litigation plays in Tribune and Capmarks' bonds, long stressed financials, long GM (despite the government squeezing all the juice out) and other "on-the-run" distressed like Tronox, ATP (after the oil spill), Airline credit, etc.

Which names defaulted in 2010?

EnviroSolutions Holdings (Bank Debt)
FGIC Corp (Bond)
FGIC Corp (Bank Debt)
Gateway Casino (Bank Debt)
Graceway Pharmaceuticals (Bank Debt)
Great Atlantic (Bond)
Green Valley Ranch (Bank Debt)
Indianapolois Downs (Bond)
Insight Health (Bond)
International Aluminum (Bank Debt)
Jacuzzi Brands (Bank Debt)
Local Insight (Bond)
Local Insight (Bank Debt)
Loehman's Capital (Bond)
Medical Staffing (Bank Debt)
Mega Brands (Bank Debt)
Movie Gallery (Bank Debt)
National Envelope (Bank Debt)
Natural Products (Bank Debt)
Neenah Foundry (Bond)
Neff Rental (Bond)
Neff Rental (Bank Debt)
Network Communications (Bond)
Network Communications (Bank Debt)
Oriental Trading (Bank Debt)
Penhall International (Bond)
Penton Media (Bank Debt)
Regent Broadcasting (Bank Debt)
RHI Entertainment (Bank Debt)
Spheris (Bond)
Spheris Operating (Bank Debt)
TerreStar Networks (Bond)
TerreStar Networks (Bank Debt)
Truvo USA (Bond)
Uno Restaurant (Bond)
US Concrete (Bond)
Vertis (Bank Debt)
Vertis Holdings (Bond)
White Birch (Bank Debt)
Wolverine Tube (Bond)
Workflow Management (Bank Debt)
Xerium Technologies (Bank Debt)

There's a number of names on this list that have already emerged and are trading on a when-issued or post re-org equity basis. Some have yet to file. It is indeed good hunting ground for those inclined to look at distressed debt (Local Insight should get interesting). Unfortunately, for you that love to see companies file: the outlook for default rates is to go even lower in 2011.

In my estimation, there is still a handful of opportunities to keep distressed investors busy in 2011 though definitely less than in the beginning of 2010. I think this is going to be very interesting year where returns among distressed funds will be significantly more varied than in 2010. Here's to hoping you (and I) are on the right side of the trade.


Random Request: Graphic Designer

I know many people, from a variety of buy and sell side organizations, read this site. Would any of you know or happen to work with a fantastic graphic designer at your relevant shops that have developed templates for research pieces? Thanks!



Great Atlantic Bankruptcy and Adequate Protection

Adequate Protection is always as an interesting issue when it comes to investing in distressed bonds and bank debt secured by various assets. Because a creditor's interest is secured by those same assets, it is assumed that the debtor will set up a mechanism to preserve the value of that collateral. Generally speaking, adequate protection comes from periodic post-petition cash payments (i.e. post-petition interest) or granting of additional liens.

A few weeks ago, we introduced The Great Atlantic & Pacific Tea Company's Bankruptcy. Bonds are currently up from our recommended price and are trading in the low 90s context. With that said, we have been following the docket closely and saw an objection coming from a group calling themselves "the Ad Hoc Consortium of Certain Holders of A&P 11 3/8% Senior Secured Notes."

For reference, here is the case's website: GAP's Bankruptcy Docket. You can click on "Court Documents" to access the docket.

Before we get to the objection, it would be useful to explain a number of introductory proceedings on a typical bankruptcy docket. Legal counsel to debtors and creditors must file a "Motion for Admission" to the court to represent their clients. Sometimes, and especially when Ad-Hoc groups are being represented, legal counsel will list the clients they are representing. For example, "Counsel to the Ad Hoc Consortium of Certain Holders of A&P 11 3/8% Senior Secured Notes" listed Secured Note Holders in an Exhibit in Docket #309:

You will note, a number of these funds are listed on our list of distressed debt hedge funds we published late last year (we have also added a few after doing some research on these names).

Now moving to the objection, which I have uploaded below:

It is noted in the opening paragraph of the objection that the ad hoc note holders (holders listed above) own 44% of the outstanding bond issue. Needless to say, this gives them a blocking position. What I found most interesting about this disclosure was the size of this block with the entire street knowing that Yucaipa was also a holder of these bonds. A similar case would be Terrestar, where rumors that a number of bond holders took a blocking position to better the deal they expect to get from Echostar, the interested party in that case:

In essence, the ad hoc note holders are objecting to certain aspects of the DIP financing as well as use of cash collateral. They argue that before the Chapter 11 filing, they were behind approximately $330M of debt and because of the size of the DIP will now be junior to as much as `$950M ("The figure $950.5 million is equal to the sum of $331.7 million plus the $800 million DIP Financing, plus the $15 million Carve Out, less $196.2 million in letters of credit [to avoid “double-counting” them as they would otherwise arguably be included in both the $331.7 million figure as well as the $800 million figure]). And because of the potential for a material drop in the value of their security interests, the Secured Note Holders argue they are entitled to adequate protection.

Now, the Debtors have proposed adequate protection in this case including junior liens on unencumbered property as well as other replacement liens that arguable they would have gotten even if it was not party of the DIP order. But the ad-hoc group is arguing that the debtors have not shown in one way or another, that this adequate protection "cuts it" so to speak.

Outside of the adequate protection requests, the ad hoc group brings up a fascinating argument that because the intercreditor agreement was between the Secured Note Holders and the pre-petition credit facility (which has been repaid by the DIP), and not the debtors or the DIP lenders, the intercreditor agreement is also not enforceable by either the debtor or the DIP lenders.

So what is the ad hoc group of note holders asking for? Adequate Protection (reimburesement of expenses and post petition interest) among other things:
"...provide the Secured Noteholders with the same types of adequate protection that are provided to the DIP Lenders and the Pre-Petition Secured Lenders, including: (1) payment of reasonable expenses, including professional fees and expenses, of the Secured Noteholder Consortium; (2) the current payment of the semi-annual coupon amount as provided for in the Secured Notes Indenture as an adequate protection payment provided for in Bankruptcy Code Section 361(1) and (3) access to information on the same terms as provided to the DIP Lenders, including, without limitation, notice of any offer to purchase any material assets of the Debtors, including any offer to purchase the Debtors as a going concern, or any retail banner owned by the Debtors as of the Petition Date, and notice of any intention to reject any material unexpired leases or executory contracts."
...as well as consent and notice rights comparable to DIP lenders along with disclosures of fees paid to the DIP agent and DIP lenders.

Not only that - but a very interesting request: "Disclosure of Yucaipa’s debt holdings, as discussed in footnote 7 above."

Yucaipa and Footnote 7? In a footnote in the objection:
"Moreover, it has been reported that Yucaipa Cos. (“Yucaipa”), which the Debtors indicate hold a majority of their preferred stock (and control 2 board seats as a result), have recently acquired certain debt of the Debtors, including Secured Notes. Yucaipa has a history with the Debtors’ operations, having sold the Pathmark chain to the Debtors in December 2007 for $1.4 billion. Counsel to the Secured Noteholder Consortium has made a request of Yucaipa’s counsel (Latham & Watkins LLP) to disclose the amount of Yucaipa’s holdings of other Debtor debt issuances, including any Secured Notes, but as of the date hereof Yucaipa has not provided such information. The Secured Noteholder Consortium submits that Yucaipa should disclose the amount of its debt holdings (including holdings of Secured Notes) forthwith."
Very interesting.

To me it seems like they have a pretty compelling argument - It is hard to imagine junior lines here providing true adequate protection. With that said, I am sure the company will comes up with a response and it will be up to the judge (or back door negotiating) to come up with a compromise here - especially given the size of the block here. Maybe they get adequate protection in the form of accrued interest payments at the default rate at the end of the Chapter 11 proceedings? Hard to tell at this point. We will continue to follow Great Atlantic's bankruptcy and any rulings / motions regarding adequate protection.



Hedge Fund Manager Interview Series - Ori Eyal

In November, we announced we would be conducting interviews with emerging hedge fund managers (defined as less than $250M in AUM) as a regular feature on the blog. It gives me great pleasure to bring you the second edition of those interviews.

Ori Eyal is the portfolio manager for Emerging Value Capital Management, a global value fund based in NYC with investments around the world. In a recent speech to students at NYU, he remarked "Most of my investing knowledge comes from studying Mr. Warren Buffett and his value investing philosophy." Since 2008, he has materially outperformed the S&P 500 and a comparable world index. This is a fantastic interview and we hope you enjoy it!

In addition, if you or the fund you work for would like to be interviewed for upcoming editions of the emerging manager series, please send me an email (hunter [at] distressed-debt-investing.com)

Tell us a little bit about your background and the people that influenced your investment style?

While I started out as a Computer Scientist, I was always interested in finance and economics. Around the year 2000 I read “The Essays of Warren Buffett” and became a value investing addict. Studying the writings of top value investors including Warren Buffett, Joel Greenblatt, and Seth Klarman has helped lay the foundations for my investment framework. The basic tenets of value investing make intuitive sense to me: buying something for less than its worth, investing within your circle of competence, demanding a large margin of safety, and the power of compounding over time.

Ever since, I have been on a journey to learn from the masters of value investing and to develop my global value investing framework. I earned my MBA at the University of Chicago’s Booth School of Business in 2006. I worked for Deutsche Bank as an analyst at one of their global investing funds. I also interned for several hedge funds, including Deephaven and Aquamarine.

In 2008, after a decade of developing and practicing my global value investing framework, I finally felt ready to launch my own fund, Emerging Value Capital Management (EVCM). EVCM is a long-biased global value fund. At EVCM, I strive to integrate my global value investing framework with the best practices and ideas from the value investors I have studied. My life savings are invested in EVCM fund so I “eat my own cooking.”

What were some takeaways from your experience with notable value investor Guy Spier?

I was very fortunate to work for Guy Spier at Aquamarine Fund while studying for my MBA. Guy Spier is an extremely talented and thoughtful investor who looks at the world as one global integrated market. Using his deep insights into how the world operates, and his latticework of mental models, Guy has been able to successfully identify and invest in some of the world’s greatest businesses.

At one point, Guy and I traveled to Israel together and we went to visit and research about 15 undiscovered companies in Israel. In some cases I think we were the first international investors that had ever visited them. Watching Guy interact with the management teams of these companies was a key learning event for me. He has the ability to quickly develop rapport with everyone in the room and get to the main business issues that each company faces. By the time the meeting is over, Guy has a better understanding of the business than the company management team does. Working for Guy helped me develop my global value investing framework. He taught me how to analyze great businesses and how to approach and interact with company management teams. He has been a great mentor, role model, and friend over the years. When I launched EVCM fund, Guy Spier was my biggest supporter and my first investor.

Zeke Ashton of Centaur Capital has also been a great mentor, teacher and friend. After I launched Emerging Value Capital, Zeke was kind enough to invite me to his office and has helped me further develop and refine my investment approach. Closely studying the fantastic investing framework that Zeke has developed as well as many of his specific investments, has been a tremendous learning experience for me. Particularly helpful has been studying Zeke’s excellent risk management framework and his covered call methodology.

I have also learned a lot (and continue to learn) from my interactions with great investors including Monish Pabrai, Whitney Tilson, Glenn Tongue, Mathew Richey, and Rick Reiss.

How do you balance "embracing short term volatility" and raising capital for a fund?

I don’t like volatility any more than other investors. However, I do recognize that some volatility is inevitable when investing in stocks. In general, all of my fund investors are disciplined, value oriented investors with a long term (multi-year) time horizon. Smart investors focus on the investing strategy and the logic and research behind the fund holdings while ignoring short term volatility in results. EVCM fund investors have earned a excellent return to date. Those that added capital when the fund had an occasional down month ended up earning fantastic returns.

You dedicate a substantial amount of your time and resources investing globally? Is that a function of the lower number of opportunities in the United States or more of sense that overseas markets are less efficient?

Even today, most value investing takes place in the U.S. and is applied to U.S. stocks. Having an international background, I became convinced that value investing can and should be applied to global markets. Therefore, one of the main tenets of my investment strategy at Emerging Value Fund is global value investing. I invest in various countries based on where I find the best investment opportunities. When I invest outside the U.S., I look for investment opportunities that are so attractive that they more than compensate me for bearing additional geo-political and macroeconomic risks. Portfolio construction is a bottom-up process driven by where I find the best investment opportunities at any given time. I don’t have a target allocation for any specific country. Rather, I keep my “idea radar” open for opportunities around the world in both developed and emerging countries. I search the world for the best investment opportunities and use them to construct the portfolio.

My favorite international investing theme is the growth in the number and in the wealth of emerging market consumers. It is one of the most powerful secular investment themes of which I am aware. As the emerging markets population urbanizes, it rapidly embraces capitalism, creates wealth for itself, and increases its purchasing power. To profit from this trend I seek to invest in businesses that sell to emerging market consumers. Willi-Food (discussed below) is an example of a company that is well positioned to benefit from this long term trend.

There are a few key benefits that EVCM fund expects to gain from global investing. These are currency diversification, exposure to emerging markets consumers, a larger investment opportunity set (more stocks and bonds to choose from) and less efficient asset prices (more mispriced assets to invest in). The Euro, the U.S. Dollar, the British Pound, and the Japanese Yen all face severe problems, making it difficult to determine which developed market currency is “the worst.” In general, I think that emerging market and commodity based currencies are likely to appreciate over time versus developed market currencies. Global investing allows me to diversify EVCM fund’s exposures between developed market currencies and, when possible, to shift our exposure from developed to emerging market currencies. In the best of cases, I can find investments in emerging markets where I expect to make a strong return both from the asset itself and from the local currency appreciating over time.

One of your main investment types is dubbed "Great Business at a Good Price" - can you give us an example or two today that would meet this criteria?

When evaluating potential investment opportunities, it helps to have a detailed framework or mental models for thinking about investing. My model tries to categorize investment opportunities into 4 different types:
  • Great business at a good price
  • Cheap Growth
  • Special situation
  • Global Macro
Obviously, real world investment situations are complex and don’t always exactly fit these models.

A good example of a current EVCM fund investment is Carrefour, the French retailer. It is the second largest retailer in the world, with operations in France, Spain, China, and Brazil. It is a great business, with a long history of profitability, and dividends, a strong balance sheet, a wide economic moat, and a recession resistant business model. At the same time, it is also a special situation investment. New management was instituted in 2007 by Colony Capital and Bernard Arnault and they are working hard to increase efficiency and cut costs. Also, there is a good chance they will spin off Carrefour’s significant real-estate assets into a separately listed company. I see a potential 50%+ upside when either of these 2 initiatives work out.

Do you prefer special situation investing? Where are you seeing the most opportunities amongst your various investment strategies?

Special situation investing is an attractive strategy that can provide high returns that are less correlated to the general market movement. Special situation also tend to have catalysts which unlock value when they occur. Having catalysts helps prevent the situation where you invest in an undervalued company and it remains undervalued for a long time. So yes, I like special situation, but I also like my other investment categories (great business, cheap growth, and global macro).

If you had to pick one investment today, that you had to hold for 10 years, what would it be?

That is a difficult question. The world today is changing at an accelerating rate which leads to the rapid erosion of economic moats. If forced to choose, I would pick Nestle which I believe is the world’s greatest business. Nestle is the world's leading food manufacturer with operations in more than 70 countries and with products in coffee, bottled water, milk and dietetics, prepared dishes, pet food, chocolate & confectionery and pharmaceuticals. Its brands include: Nescafe, Nestea, Nespresso, Carnation, Coffee Mate, Hot Pockets, Lean Cuisine, Kit-Kat, Dreyer’s Ice Cream, Eddy’s Ice Cream, Gerber baby food, Purina, Dog Chow and Friskies dog food. In addition, Nestle itself is an umbrella brand signifying quality and great taste to consumers around the world.

Nestle has excellent long term growth opportunities in emerging markets as the rising middle class shifts its discretionary spending to NestlĂ©’s brands.

I think Nestle is a safe way to invest in the growth of both developed and emerging market consumers and I expect that it will be larger, more dominant and more profitable 10 years from now.

Favorite long / short today? Reasons?

G. Willi-Food International (Nasdaq: WILC) is one of Israel's largest food importers with a focus on the Kosher and Health-Food segments. WILC designs, imports, manufactures, markets and distributes more than 1,000 food products. Products are sourced from 200+ suppliers throughout the world to more than 2,000 customers in Israel including all the major Israeli food retailers, wholesalers, and the Israeli defense forces. Imported products include: canned vegetables, fruits, pickles, canned fish, bakery products, lemon juice, high-quality oils, dried fruit, nuts, pasta, halva, coffee creamer, snacks, dairy products, noodles, and more. The Company adds 40-60 new products to its offerings each year.

In many cases, Willi-Food works with global food manufacturers to re-engineer both the food contents and the production lines into a kosher end-product. This end product is then imported and distributed in Israel under the Willi-Food brand. All Willi-Food products are certified Kosher according to strict rabbinical authorities, which positions Willi-Food as a strong competitor in the lucrative kosher products market. Although most of the Company’s products are sold under its own brand, Willi-Food distributes a variety of items from world-leading manufacturers, such as Completa coffee whitener (Netherlands), Zanetti cheese (Italy), Breda butter (Netherlands), Nobleza Gaucha Yerba Mate tea (Argentina), Lurpak “spreadable” butter (Denmark) and Arla Foods dairy products (Denmark). In addition, Will-Food provides some products on a private label basis.

While 80% of revenue is from Israel, the company's activities extend beyond importing into the Israeli market. Willi-Food distributes its products in both the USA and Europe and is actively working on expanding its sales in these and other international markets. The kosher food market is estimated to be over $14B/ year in the USA alone. It is growing at 15% per year and is underserved with few branded kosher products. Among others, kosher products appeal to Jews, Muslims, and Health conscious consumers. Willi-Food is actively targeting this huge international market and any success here could dramatically increase the company’s revenues and profits.

WILC is owned and managed by the Williger brothers who co-founded the company. They are conservative managers that have done a good job at slowly and steadily growing shareholder value. Under their management, revenue has grown from $30M in 1999 to $120M in 2010 while net income has grown from $1.8M in 1999 to $8M in 2010. I visited the company in Israel and I was favorably impressed by what I saw.

WILC’s market cap is $88M. The company has about half its market cap in net cash and is looking to deploy this cash to acquire a US distributor. Net of cash, WILC trades at 5X 2010 earnings, a cheap price for a profitable, growing, recession resistant business with strong competitive advantages (brand, distribution, kosher know-how, global supplier network), a team of experienced and proven owner-managers, and with an attractive growth runway (global kosher food market).

What is the greatest piece of investment advice you like to adhere to in managing a portfolio on a day-to-day basis?

The key to long-term wealth creation is not earning high returns. Rather, it is earning good returns while avoiding (or minimizing) the blow-ups. The biggest mistake that investors make is not investing in a conservative enough manner. The world is a dangerous place for capital. Inflation, expropriation, revolution, currency devaluation, industry declines, wars, natural disasters, depressions, market meltdowns, black swans, theft, fraud, and taxes all pose a constant and lurking threat to growing (or even just maintaining) wealth over time. In any given year, the probability of disaster is small. But over many years and decades anything that can go wrong eventually will.

As long as we can stay in the game, the long-term power of compounding will work in our favor. A 10% real annual return will multiply our money over 117 times in 50 years. But having even one single year with catastrophic losses undoes years of great performance. Simply put, the key to amassing wealth over time is avoiding catastrophic losses and never having to start over from scratch. When things go wrong, we can avoid catastrophic losses only by investing conservatively and without leverage. Conservative investing is like insurance—it seems like a waste of money until something bad happens and then you are glad to have it.

I see funds that use leverage (either at the portfolio level or by investing in highly levered companies), and I see funds that are too concentrated. Over the long run, leverage and excessive concentration usually end badly.



hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.