Monday, November 28, 2005

Regarding the (underperforming) Initiative

It's no news that the initiative has been negative compared to the S&P 500 over the past couple of weeks (5% as of today). It gives me no pleasure to have to report these dismal results to you, and I am very worried myself at these seemingly horrible results. But I am nevertheless optimistic about the future performance of the portfolio. Let me first explain some of the things that have killed the initiative over the past couple of weeks:

Eternal Technologies Group (ETLT) came out with third-quarter earnings... and the results were less than satisfactory. Only five million dollars in revenue compared to the ten to fifteen that they enjoyed in the same quarter of last year. Market expectations have been disappointed and the stock was punished... hard. We went from our $0.75 high to a low today of $0.43. Ouch.

Big Sky Energy Corporation (BSKO) had some issues with Fraud from a former employee. He had tried to conspire with another company, pretending to be the president of Big Sky, and had tried to deal with the government in signing the rights of Big Sky's oil rights to him. In dealing with situation, the company has missed the filing of their 10-Q, and the stock took a huge hit, from about $1.20 to the current $0.96. Ouch again.

Those two were perhaps the most damaging to the performance of the portfolio. We lost around 300 basis points on these downfalls. The other 200 basis points was due to the fact that the markets have gained momentum and overtook the portfolio over the past couple of weeks.

But rest assured, all is not lost. I am going to say something that you guys probably hear everybody say when they are down, and that is: THIS IS SHORT-TERM. Except, I mean it. I can promise with a 95% certainty that the portfolio will eventually rebound. Let me explain:

The problem that Eternal Technology faced was that it had missed market expectations for the quarter. A very daunting press release came out, saying that its earnings and profits both were down some 50% over the same quarter last year. But please keep in mind that the earnings on the company is very volatile, and that whatever they don't make in Q3, they will make up in Q4--and that is just what we are expecting. I've gotten in touch with the firm in charge of investor relations for the company, and they have specifically stated that this quarter, and the year as a whole, is expected to over-perform last year's, and that due to the unexpected extension of warm weather, they had to delay fulfilling some of their Q3 contracts into Q4. What this means is, all else aside, fourth quarter earnings is expected to make up for all the underperformance of Q3. This means that despite some short term volatility with the realization of earnings, this company is ultimately still growing and turning a profit every quarter. And maybe we can expect to see that same degree of upside that we saw when we were at around 70 cents when the markets realize the potential again.

To tell you guys the truth, I actually plan to add more into the position if the stock drops any lower (anything below 40 to 41 cents). If you have any questions or big objections, please feel free to contact me. I am quite certain that the stock's drop is only temporary... although, that's only because none of the facts about the company's great performance has changed (the minute something changes, you can rely on me to be the first one out).

Now, for the other killer. Big Sky Energy Corporation (BSKO) has been very generous in giving me information regarding the current fraud issues that it is facing. I got on the phone with one of the board members today, and she has told me some things and assured me of some facts that have given some confidence to me regarding the future of the company. After all, how do you deal with fraud, and how should the markets discount for this sort of thing?

The board member kindly assured me that the fraud is not on Big Sky's part (thank heavens); they were actually the victims of it and is fighting to the death to defend their rights as victims (albeit in a Kazakh environment). Second, the whole fiasco has been a terribly embarrassing situation for the Kazakh government as a whole, and this is very advantageous to the firm because if they don't reinforce the laws and rule in favor of BSKO then it looks very bad on the international scene, and would scare away future investors which the government definitely does not want. Third, Big Sky is very confident that this issue will be resolved, although they declined to give a time-line. They don't feel that this impediment is too important to the production capabilities of the company in the long-run, and in the long-long run, this is but a blip in the stock ticker. They have also assured me that the non-timely filing will be filed sometime this week--that made me more comfortable holding the stock.

Again, I might even add more to Big Sky depending on where its stock takes us tomorrow. I will definitely add more before Thursday or Friday's end to take advantage of the upside we might derive from the 10-Q coming out which will probably reassure some investors of the company's solidity. When I do add, this stock will be no more than an 8% position, as the risk of Kazakhstan is still rather large.

So... why did I sell out of TransMontaigne and Bonso Electronics? To be completely honest with you guys, I haven't felt comfortable about these two stocks ever since I started owning them. Bonso wasn't that big of a position so I could still sleep at night, but TransMontaigne kept me awake pretty much this whole thanksgiving break. Both were pretty much bets on commodity sales and prices, and they both traded at pretty good multiples that I was comfortable when I first looked at it. But as the lack of "certainty" dawned upon me. TransMontaigne, for one, had all the things a value investor could want: 4x current earnings, near-monopoly in the southern oil pipeline transmissions, very high sales volume, but the thing that bothers me is the slim margins. A wrong bet in the derivatives markets can kill this company and tank it to the ground because they are literally holding all the inventory risk in the highly volatile oil markets. So I said fuck it. With BNSO it's the same ordeal, they have many inventories and production capabilities, except demand is slowly dying, and there are just way too many players out on the markets that do the same thing they do.

With both these companies, I reiterate, multiples are VERY attractive, but the certainty of the cash-flows were grossly miscalculated on my part, and I should have looked at the qualitative side of things more and discovered some really disgusting things that should have kept me away.

The initiative team has been working extra hard to mitigate these results and bring future performance upside all the while the portfolio has been hit. Please bear with the short-term underperformance, as we truly do not believe that this is permanent. While expecting ETLT and BSKO to normalize, we are continuously on the lookout for ideas that could benefit our portfolio. And we are sticking to our vision at the beginning of the semester: 10%+ overperformance by the end of the school-year.

Thank you all for your time and consideration. Again, if any of you have any questions or comments, or suggestions, please feel free to give me an e-mail or a ring.

No comments: