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A View From Here March 2012

March 20, 2012 • Print This Article

"Go your own way. Know your names. Don't envy or chase after other investors. Recognize that time is on your side, but don't treat time as if it were only a necessary evil for a patient investor. Enjoy life while it is occurring. Value invest to enrich your life and don't subordinate your life to your portfolio." - Walter Schloss

The New Year ushered in double-digit returns for our investment accounts and the next two months have extended these gains from strong sentiment for our existing positions and the takeover offer for Flint Energy. On a performance basis, things are very good in our world.

The Wall of Worry

There's an old saying that "stocks climb a wall of worry", which seems to be the case so far this year. On the surface, the state of the world is giving the impression that we are on the verge of moral and economic collapse as global concerns matched with jobs and financial data point to continued weakness. If I learned anything in the 24 years of financial advisory, it is that we always seem to be on the cusp of collapse. It is perhaps the one constant.

Consider this quote from Time Magazine in September 1992 and ask yourself if it sounds like it could be today's headline:

"The U.S. economy remains almost comatose. The slump already ranks as the longest period sustained weakness since the Depression. The economy is staggering under many "structural" faults represent once-in-a-lifetime dislocations that will take years to work out. Among them: the job drought, the debt hangover, the banking collapse, the real estate depression, the health-care cost explosion, and the runaway federal deficit."

What many seem to have missed is that the markets are off to their best start in 25 years, and according to Bloomberg Investment Services, more than $469 billion has been pulled from US equity mutual funds over the past 5 years and share volume on major exchanges slipped to the lowest since 1999. Pessimism is taking a toll on the securities industry where more than 200,000 jobs were lost last year in the US and the moral warfare from projects such as Occupy Wall (and Bay) Street questions the integrity of the industry. On March 14th, Greg Smith, a senior vice president at Goldman Sachs tendered a very public resignation, claiming the firm (and the industry for that matter) has operated on a substandard basis. Sentiment is the worst since the early 1980's when 17 years of equity marketed stagnation gave way to the biggest rally in the history of the markets.

It may be interesting to note, that despite all of this rhetoric, markets are now almost 2x higher than the March 2009 low. It has been my observation that when markets (or a share price for that matter) reach a previous high-water mark - they tend to continue moving higher. While it has proven to be foolhardy to make predictions, we nonetheless like what we are seeing.

There Goes another One

In January 2010, we reviewed our performance of the past decade and commented how surprised we were to see so many of our investment positions that had been taken over at premium to our cost base. Investments such as Pet Valu, Intertan, Sodisco-Howden to name a few, yielded us significant profits from buyouts and contributed greatly to our long-term performance - this decade has added a new one with Flint Energy Services last month.

Flint has been good to us over the years. We originally purchased it in 2001 and built a very large position by 2004 as it became our most passionate investment. We ultimately sold it for a 300% profit in March of 2006. At the time, despite admiring the company's operations, we felt that the valuation was high relative to its growth prospects and peer-group. We continued to monitor its progress over the ensuing years and found the valuation was very attractive again last year.

As such, we began to initiate a new investment position in the fall of 2011 at roughly the same prices we first entered into the position in 2001 despite being almost two times larger and more profitable. In fact, the company's valuation was at the lowest level in the its history. It was our theory at the time that Flint's price was so depressed that they could possibly break up into three separate publicly traded vehicles that would yield values much higher than its current share price. Starting in late December we used two consecutive positive earnings releases and a better market environment to add to this position at higher prices. It should not have been a surprise when on February 20th, that the company announced that they have received an offer of $1.3 billion or $25/share - netting a return well in excess of 100%. We didn't hesitate to wait on the possibility of complications involved in closing the deal and used the market to liquidate the position and re-deploy the capital elsewhere.

It's all about Valuation

Looking back to the time we sold the position in March of 2006, the company was valued 40% higher than the $25 per share take-out price announced last month. This is the case despite growing almost 2x in size since. This reality talks of valuation and how the pendulum can swing to extremes and that we must remain cognizant of this when committing funds to investments.

The Earnings Front

Late February and March saw earnings from some of our largest investment positions and in each case companies met or exceeded our expectations. FirstService reported solid 3rd quarter results and now stands as one of the investments we believe can provide extraordinary returns over the next 5 years. As such we had been using the market malaise to accumulate more shares in recent months. Methanex reported an excellent headline number in late February and continues to be one of the positions we feel might have begun a multi-year re-valuation.

We attended the Enghouse annual meeting following the release of their 1st quarter earnings, which saw exponential growth in their underlying business as well as a 30% increase in their quarterly dividend. Enghouse is a fascinating investment. Senior management has an excellent track record building the company as well as owning a significant stake in the business with almost a third of their share price in cash. The company is well equipped to take advantage of potential acquisitions to augment their business and does so on a measured basis. There has been a period over the past 5 years where they simply sat on their growing cash position as private equity funds were paying large prices for businesses that would fit their mold. Now, that access to capital has dried up, and prices are more attractive, the company is well positioned and has been active making advantageous acquisitions to build their business. What we find so intriguing about this investment is the modest size of their acquisitions (usually below $20 million), which are expected to add to earnings in their first year. We have taken a moderate position and will look to add to make further commitments into apathy or catalyst events that we believe can unlock further value.

Softchoice reported an optically weaker 4th quarter, which included costs associated with an acquisition, an accounting charge (which had delayed the numbers for almost 3 weeks) and retirement of their remaining debt. When viewed on a normalized basis, the earnings were excellent and grew over 30% from the previous year. Simply looking at their net cash position at year-end is quite telling. In their 3rd quarter earnings release, cash (net of all debt) stood at $34.8 million. One quarter later, after retiring $10 million of debt, closing a $20 million acquisition and taking a $1.1 million accounting charge, net cash stood at $33 million, suggesting that the company had been able to increase net cash by over 40%. Management held an investor day on March 6th at their head office, which we were lucky enough to attend. Their strategy continues to be the transition to a technology services company rather than simply a distributer, which could ultimately see a significant revaluation of their business in the future. At present, it remains very cheap, despite the 50% increase in the share price over the past three months. We are encouraged that the CEO recently purchased more shares in early March.

All Time Highs

For those of us who held a position in the company, Flint once again helped our portfolio's reach new all-time highs despite some positions, which suffered in our accounts in December 2011. We remain proud of how accounts have performed thus far in 2012 and most if not all, are well into levels that the accounts have never seen before.

We are also encouraged to see that there has been an influx of new clients from referrals and we want to thank our clients. We believe that we offer excellent service and performance and genuinely appreciate this ultimate vote of confidence.

Enjoy this amazing transition into Spring and as always…

All Good Things,


Filed under: Uncategorized

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital Corporation ("MRCC"). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRCC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRCC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member-Canadian Investor Protection Fund / member-fonds canadien de protection des épargnants.

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