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Value Investing with a Contrarian Bent Value Investor Conference May 4, 2012 Omaha, Nebraska Lane Five Capital Management.

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Presentation on theme: "Value Investing with a Contrarian Bent Value Investor Conference May 4, 2012 Omaha, Nebraska Lane Five Capital Management."— Presentation transcript:

1 Value Investing with a Contrarian Bent Value Investor Conference May 4, 2012 Omaha, Nebraska Lane Five Capital Management

2 Value Investing with a Contrarian Bent Lane Five Investment Approach Disciplined, long-term value-investing Evaluate, research and invest in securities that are mispriced by the market Market prices diverge from long-term business values when short-term issues drive investor fear Exploit the psychology and behavior that create pricing anomalies Use depth of research and long-term, strategic thinking to identify areas where the market is pricing adverse outcomes that are unlikely Use a probabilistic framework to constantly evaluate business value Create a concentrated long portfolio of significantly undervalued, high conviction positions Opportunistically short companies that are significantly over-valued and/or inherently flawed 2

3 Lane Five Capital Management Value Investing with a Contrarian Bent The Role of Contrarianism at Lane Five Two categories of portfolio investments emerge: Great businesses at great prices due to short term problems What we call “Compounders” Ideal investments Not often severely mispriced Not always as “great” as they might have seemed Technological Change Cyclical, regulatory, secular changes Either shortens or eliminates competitive advantage Prices paid for these businesses rarely truly account for these risks Low probability does not equal no probability Out-of-favor, unloved, troubled, really cheap contrarian investments 3

4 Lane Five Capital Management Value Investing with a Contrarian Bent Benefits of Contrarian Investing Higher expected returns Wider range of possible outcomes Uncorrelated with the indices Drivers of return or loss are not market, industry or economy specific, but rather company specific or turnaround execution related Highly differentiated return profile for portfolio Building relationships with managements Subject to acquisitions Human behavior is always searching for clarity and certainty: attractive contrarian investments are available in almost any market 4

5 Lane Five Capital Management Value Investing with a Contrarian Bent Hunting for Contrarian Investments Areas to search: New low list High daily percent downward price action Elevated volume Sell-side downgrades High short interest Characteristics of potentially successful candidates: Formerly good business model Formerly high valuation Competitors with better margins, growth, efficiency exist Signs of capitulation: shareholder turnover, disgust, management credibility in question No visibility; no catalyst Specious secular or competitive decline arguments 5

6 Lane Five Capital Management Value Investing with a Contrarian Bent Cautions in Contrarian Investing OFTEN THE CONSENSUS IS RIGHT Determining consensus is difficult Timing Risk management/Hedging Loneliness The Retrospect Effect Complacency vs. Patience OFTEN THE CONSENSUS IS RIGHT !!!!!!! 6

7 Lane Five Capital Management Value Investing with a Contrarian Bent Temperament Requirements for Contrarian Investing Patience Weirdness Ability to handle criticism Ability to stand alone Resourcefulness 7

8 Lane Five Capital Management Value Investing with a Contrarian Bent Guidance in Analyzing Contrarian Candidates No different than any other securities analysis: understand the risks, estimate the returns Different than any other securities analysis: the risk will be easy to see, the return difficult Analyze the negative arguments Determine what is already discounted. Ask “If so, so what?” Analyze the actual evidence of the negative case Appropriately understand impact of leverage, covenants, etc. Analyze valuation “hooks” that could limit downside Cash Sellable Assets: real estate, patents, money losing subsidiaries Run-off value of cash flows Dividends Understand management abilities and incentives as well as potential for change in management to matter Understand how the story unfolds: timing, shareholder changes, earnings momentum, cash flow inflection points Ask: “What could go right?” Analyze potential recovered earnings, cash flows, likely valuation in basic scenario. Don’t pay for what could go right Understand capacity for there to be more than just a recovery 8

9 Lane Five Capital Management Value Investing with a Contrarian Bent Current Case Study: Corinthian Colleges (COCO) Admit it, this makes you want to throw up For-profit education “Low-end” vocational schools Regulatory pressures, cyclical issues, short sellers’ playground Negative reputations, negative press coverage Massive mispricing due to the emotional reaction Late 2011, rumors of bankruptcy abounded. Company was generating cash, had sellable assets, would meet covenants and likely could pay off all debt by Not a solvency issue Two-year overhang of new Gainful Employment regulations is lifting: companies have improved, adjusted marketing, lowered price, focused on outcomes Vocational (diploma) programs provide a huge benefit to the nation – last year Corinthian PLACED 42,000 students in jobs. Students graduate with an average of $10,000 in debt and move from minimum wage service jobs that require no skills to moderately skilled trades. The ROI is impressive, if the student can graduate High risk students not well served by any other means. Still, graduating them is the key Tremendous free cash flow generation as company returns to a “new normal” 9

10 Lane Five Capital Management Value Investing with a Contrarian Bent Current Case Study: Corinthian Colleges (COCO) Valuation: “If so, so what?” Current EV = $300 million On consensus (bearish) June 2012 estimates: 0.25x sales, 3.10x EBITDA, 12.1x EPS On guided numbers: 11.1x EPS, 1.7x free cash flow On Lane Five numbers: 11x EPS, 2.7x EBITDA, 3x “normal” free cash flow of $100 million What is discounted? On DCF, price implies ~$45 million in free cash flow for 10 years No perpetuity Half of 2012 “normalized” FCF (Actual will be ~$175 million) Impact of leverage, covenants immaterial Debt free in 3 quarters Regulatory risks still high, still reactive to headline risk, high beta, short-heavy, story oriented stocks Valuation “hooks”? Value of Wyotech and Heald ~ $300 million (paid $350 for Heald, monetized 5 campuses for $45, five Wyotech automotive campuses) Ability to close schools, shrink to maximize free cash flow 10

11 Lane Five Capital Management Value Investing with a Contrarian Bent Current Case Study: Corinthian Colleges (COCO) What could go right? Vocational abandoned by competitors CDR’s dropped to well below risky levels Community colleges under fiscal strain Efficiency in financial aid expenses, bad debt management, enrollment dramatically enhanced Operating leverage from optimizing fixed assets Regulatory environment could be less bad Earnings power, free cash flow under scenario analysis Current valuation discounts seriously impaired business model, but not absolute worst case 90/10 rule changes Negative growth from closing schools Harkin/Durbin vendetta $0.40 Earnings Power baseline Past regulatory jihad’s have ended with stronger businesses With zero growth, values range from $8.50-$10.00 as OPM ranges from 5-7% ($0.90-$1.15 EP) With modest growth, values range from $9-$25 as OPM ranges from 7-15% ($1.15-$3.00 EP) Previous OPM high of 18.5% (would mean $4-5 EP) Probability Weighted Value ~$10, range of $2-25 DCF based framework, triangulated with very low assumed multiples on Earnings Power Current case for more than just recovery is low probability given regulatory risks, but is not zero probability It has happened before! 11

12 Lane Five Capital Management Value Investing with a Contrarian Bent Parting Thoughts Consider contrarianism from the bottom-up level Valuable tool for portfolio construction Provides intellectual capital, firm differentiation, portfolio differentiation Remember the downside(s) Choose your battles wisely Prepare to be lonely 12

13 Lane Five Capital Management Value Investing with a Contrarian Bent 13 May 3 - 4, 2012 Mammel Hall Omaha, Nebraska Contact Lisa Rapuano:


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