Street Capitalist: Event Driven Value Investments

I found the following article very interesting:

Can money buy happiness? Since the invention of money, or nearly enough, people have been telling one another that it can’t. Philosophers and gurus, holy books and self-help manuals have all warned of the futility of equating material gain with true well-being…

But starting to emerge now is a different answer to that age-old question. A few researchers are looking again at whether happiness can be bought, and they are discovering that quite possibly it can – it’s just that some strategies are a lot better than others. Taking a friend to lunch, it turns out, makes us happier than buying a new outfit. Splurging on a vacation makes us happy in a way that splurging on a car may not…

Another theme that has emerged in similar research is that money spent on experiences – vacations or theater tickets or meals out – makes you happier than money spent on material goods. Leaf Van Boven, an associate psychology professor at the University of Colorado, and Thomas Gilovich, chair of the psychology department at Cornell University, have run surveys asking people about past purchases and how happy they made them.

Happiness: A buyer’s guide (Boston Globe)

Learning about money’s affect on our brains is always fascinating. I highly suggest reading the entire article.

David J. Reynolds of the WSJ reports that Sardar Biglari purchased $1.1M in Steak N Shake (NYSE:SNS) shares last week:

Steak n Shake recently disclosed plans to purchase Western Sizzlin, a steak restaurant chain that Mr. Biglari also heads.

The young activist — he is listed as 31 in a recent regulatory filing — became chief executive of Western Sizzlin in 2007 after buying shares and agitating for change at the company.

Ben Silverman, director of research at InsiderScore.com, said Mr. Biglari’s purchase showed his confidence in the outlook for the combined company. “The buying here is bullish,” Mr. Silverman said.

Mr. Biglari is “a value guy,” who has had plenty of opportunity to assess the worth of the business combination, Mr. Silverman added. “The proposed transaction seems to be the culmination of a two-plus year plan” to take control of both companies and combine their operations…

Mr. West said the proposed buyout was a “liquidity grab” by Mr. Biglari, a 33% holder of Western Sizzlin — more attractive for Western Sizzlin holders because those shares trade relatively infrequently.

Activist CEO Builds His Stake in Steak n Shake (WSJ)

Be sure to read the full article, it’s short.

Charlie Munger is a huge proponent of studying psychology and understanding how incentives affect individuals and their decisions. The video below offers some new insights on how incentives may be a little more complicated than we normally think:

Looks like this is Warren Buffett’s second Op-Ed in the NYTimes. Remember, this isn’t the first time that Buffett’s been worried about the amount of money that’s being printed. He’s also interviewed extensively in the documentary film IOUSA which also takes a concerned look at America’s alarming deficit:

To understand this threat, we need to look at where we stand historically. If we leave aside the war-impacted years of 1942 to 1946, the largest annual deficit the United States has incurred since 1920 was 6 percent of gross domestic product. This fiscal year, though, the deficit will rise to about 13 percent of G.D.P., more than twice the non-wartime record. In dollars, that equates to a staggering $1.8 trillion. Fiscally, we are in uncharted territory.

Because of this gigantic deficit, our country’s “net debt” (that is, the amount held publicly) is mushrooming. During this fiscal year, it will increase more than one percentage point per month, climbing to about 56 percent of G.D.P. from 41 percent. Admittedly, other countries, like Japan and Italy, have far higher ratios and no one can know the precise level of net debt to G.D.P. at which the United States will lose its reputation for financial integrity. But a few more years like this one and we will find out…

Our immediate problem is to get our country back on its feet and flourishing — “whatever it takes” still makes sense. Once recovery is gained, however, Congress must end the rise in the debt-to-G.D.P. ratio and keep our growth in obligations in line with our growth in resources.

Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress.

Warren Buffett – The Greenback Effect (NYTimes)

Interesting relationship:

(The Deal)

(The Economist)

A year ago, I remember thinking about this exact possibility, that Steak N Shake (NYSE:SNS) and Western Sizzlin (NASDAQ:WEST) could merge.

Here’s what I said:

One thing I’m wondering is whether we’ll see a merger between Steak N Shake (SNS) and Western Sizzlin (WEST). It would be a little similar to what Eddie Lampert did with Kmart and Sears. The same could happen with Steak N Shake with Western Sizzlin since both are in the restaurant industry, we could see some cost savings and synergies achieved by merging. Although getting the financials to work out, especially currently, would be a major stretch.

Sardar Biglari is CEO of Steak N Shake! (Street Capitalist)

At the time it seemed highly unlikely because Steak N Shake had a number of issues relating to debt and management that needed to be worked out. The common thread here is value investor Sardar Biglari, who manages the Lion Fund. As chairman of both companies, Biglari has implemented a holding company structure in both of them.

The real benefit here is simplification in the organization structure. Merging both companies will preserve the benefits and reduce the redundancies of running two different holding companies.

So let’s look at the transaction and figure this out. For shareholders, the changes are on the WEST side rather than the SNS side.

The Letter of Intent contemplates that on or prior to closing Western will distribute to its stockholders all of the SNS shares beneficially owned by Western. Further, under the terms of the Letter of Intent, the consideration payable to Western’s stockholders will be based on a net transaction valuation of approximately $22,959,000.00. At closing, each share of Western’s common stock would be converted into the right to receive an amount equal to approximately $8.11 in the principal amount of debentures issued by SNS. It is anticipated that the SNS debentures will have a term of five (5) years, will bear interest at the rate of 14 percent per annum and will be pre-payable without penalty at the option of SNS after one (1) year from the date of issuance.

The Steak n Shake Company and Western Sizzlin Corporation Announce Intent to Merge

From Western Sizzlin’s 10Q we know that Western Acquisitions owns 1,5553,545 shares of SNS. Shareholders of WEST own 85.1% of Western Acquisitions. So this means that WEST shareholders control 1,322,066.79 shares of SNS. There are 2.38M shares of Western Sizzlin outstanding.

1 share of WEST = 0.466 shares of SNS + $8.11 in SNS debenture.

The debentures pay a rate of 14% per annum, creating an added incentive for WEST shareholders. For SNS shareholders, I think the real question is going to be whether or not the integration of WEST adds any real benefit to justify the debentures. I would guess that there is a long term benefit from owned Western Sizzlin. Western Sizzlin’s restaurant operations alone will likely add about $2.2M per year in FCF which could be used for accretive investments which would benefit shareholders of Steak N Shake.

Today is the Western Sizzlin annual meeting in New York. I expect that we’ll see some interesting conversations come out there. I’ll be sure to link to any blogs that post up notes from the meeting. I’m sure more details surrounding the proposed merger will be out by then so we can do a more comprehensive analysis.

Lloyd’s of London is fascinating for anyone with an interest in catastrophe risk insurance. Something most shareholders of Berkshire Hathaway are probably well acquainted with. Their syndicate writes policies on everything from terrorist attacks to Ugly Betty’s smile!

Click Here for the Interview transcript. The video appears to be down temporarily.

I liked the following quote, related to AIG on the benefits of being boring:

CHARLIE ROSE: OK, but then how do we have two different opinions? What made you sure it was not right and they thought it was right?

PETER LEVENE: Well, I cannot get inside what their thinking was. But I can tell you what our thinking has been. Our thinking has been that years gone by, Lloyds got itself into serious trouble.

CHARLIE ROSE: Right, exactly.

PETER LEVENE: Fortunately we got out of that mess and we are in a very strong position. And we said, we’re not getting into that position again. Therefore, any risky proposals that come along, no, thank you very much. For the last three or four years, we have had various finance houses come along and saying, you’re sitting on a lot of cash, we have got some great ideas for you as to how to use that cash, and they would be quite complex. And we would look at them and say, that’s very kind of you, but no, thank you very much. And they would say you know what, you are really boring. And I have to say.

CHARLIE ROSE: And you are missing your chance to make a lot of money.

PETER LEVENE: Yes. Well, I have to say today, being a little bit self-satisfied about it, we can say boring is beautiful.

Also, Here’s a great introduction to Lloyd’s, via Warren Buffett:

Our tale begins around 1688, when Edward Lloyd opened a small coffee house in London. Though no Starbucks, his shop was destined to achieve worldwide fame because of the commercialactivities of its clientele – shipowners, merchants and venturesome British capitalists. As these parties sipped Edward’s brew, they began to write contracts transferring the risk of a disaster at sea from theowners of ships and their cargo to the capitalists, who wagered that a given voyage would be completed without incident. These capitalists eventually became known as “underwriters at Lloyd’s.”

Though many people believe Lloyd’s to be an insurance company, that is not the case. It is instead a place where many member-insurers transact business, just as they did centuries ago. Over time, the underwriters solicited passive investors to join in syndicates. Additionally, the business broadened beyond marine risks into every imaginable form of insurance, including exoticcoverages that spread the fame of Lloyd’s far and wide. The underwriters left the coffee house, found grander quarters and formalized some rules of association. And those persons who passively backed the underwriters became known as “names”.

Eventually, the names came to include many thousands of people from around the world, who joined expecting to pick up some extra change without effort or serious risk. True, prospective names were always solemnly told that they would have unlimited and everlasting liability for the consequences of their syndicate’s underwriting – “down to the last cufflink,” as the quaint description went. But that warning came to be viewed as perfunctory. Three hundred years of retained cufflinks acted as a powerful sedative to the names poised to sign up.

Berkshire Hathaway – Chairman’s Letter (2006)

Paul Sonkin, manager of the Hummingbird Value Fund, is an awesome investor and a great guy. I’m extremely grateful that Sonkin was willing to contribute his time to this interview (the first interview here at Street Capitalist). I wanted to interview Sonkin in particular because his fund employs a strategy accessible to all of us small investors. Some of the companies are absolutely tiny on a market cap basis and he goes after arbitrage situations that most investors will never hear of. This style of investing embraces the advantages of a small investor and allows you to exploit greater inefficiencies in the market, as many of these neglected companies are too small for the big Wall Street firms to cover or invest in. I hope you enjoy the interview and let me know if you think I should do more of these.

Flickr / Peasap

Tariq Ali: Could you give us your brief career history?

Paul Sonkin: I bought my first stock with my bar mitzvah money. I went to college and when I graduated it was when Drexel had just went belly up and I was looking for sell side research positions. I couldn’t really find any because all the assistant positions got taken up by those ex-Drexel people, so I worked at the Securities and Exchange Commission. It was a lot of fun spending a year and a half there and spending a year and half at Goldman Sachs. My career was going in one direction and my interests were going in another, so I went back to business school and I graduated in 1995. I worked for Chuck Royce for 3 years and then worked for First Manhattan which is Sandy Gottesman’s firm for a year and then I started Hummingbird about 10 years ago. That’s sort of a nutshell.

Tariq Ali: You often hunt in the nano-cap space, how do you find out about these companies? Is it like Buffett said, that you need to just “Start with the A’s” or do you use things like screens or local news periodicals?

Paul Sonkin: You know I’d say that most of my ideas come off of the new lows list. I take that that’s sort of the best hunting ground. And then the other thing that I do is I have these lists of companies i’ve owned before or am interested in. And then I get the news headlines for them on a daily basis and then I do a lot of keyword searches for like spinoffs, liquidations, merger arbitrage, stuff like that. And then I go to conferences I source my ideas pretty much from everywhere. The only place where I don’t source my ideas from is Wall Street. Not a lot of Wall Street research at all.

Tariq Ali: Yeah, that 52 weeks low list really exploded a few months ago.

Paul Sonkin: Yeah. And I guess that in times like that there’s so much to look at you can almost close your eyes and buy anything.

Tariq Ali: A lot of the companies you invest in are pretty small. Do you ever interact with the management of companies you invest in? How receptive are they to your ideas? Many of these companies have small shareholder bases, do you ever have to work with them to help promote changes in these companies?

Paul Sonkin: I guess. Yes and no. Sometimes they are very receptive sometimes they’re not receptive. I would say that we always talk to management over the phone and we’ll sort of have them walk us through the story and we’ll discuss their capital allocation decisions and just you know, go through various things like that.

Tariq Ali: And one thing I noticed is that some of the companies in this size range may have an incredibly small shareholder base. Do you ever work with these shareholder bases?

Paul Sonkin: Yeah, it’s very common.

Tariq Ali: And the other thing I noticed with some of them is they don’t register with the SEC, is this ever a problem for you? Do you ever have issues trusting their financial statements?

Paul Sonkin: No, I’d say that usually the financial statements are pretty good with the ones that don’t file. Sometimes they just file once a year. But it’s sort of like how the old pink sheets used to be.

Tariq Ali: You teach students value investing at Columbia Business School. When analyzing securities in the micro-cap/nano-cap space, are the methods different than researching mid-caps / large caps?

Paul Sonkin: Well yeah. You know it’s always easier to analyze something that’s simpler than something thats more complicated. So think of it as if you were dissecting a human body as opposed to an amoeba. You know when you have a company where there are just fewer moving parts it’s just easier to do the analysis. So that’s why we’ll keep track of 100 different companies and it’s pretty easy to do that because there’s just less to analyze.

Tariq Ali: I saw in another interview, you mentioned how the portfolio works at Hummingbird where you almost allocate 50% of the portfolio to arbitrage situations. Could you talk a little bit about position sizing — does your firm put limits, do you have a hard formula for that kind of thing?

Paul Sonkin: You know I’d say that we used to have much more stringent limits but what we’ve found is that lately there aren’t that many interesting arbitrage deals. So we have allocated a lot more money to the general portfolio. So its become a little bit overweighted in that respect.

Tariq Ali: About the arbitrage part of the portfolio, with my own portfolio I’ve participated in a few small, odd-lot tender kinds of things. Does your firm deviate from small micro-caps/nanocaps for arbitrage or do you stick in the same space?

Paul Sonkin: We do a lot of small odd-lots and other forms of arbitrage. We really don’t deviate because the competition there are the big arb funds and they have a mandate to put a lot of capital to work so the spreads and risk/reward scenarios aren’t appealing. With these larger deals you can do these odd-lots, like if they’re tender but they’re going to do it on a pro-forma basis if you own less than 99 shares usually you can tender into that. So it’s possible to do odd-lots with larger tender offers but it’s not an area of our focus.

Tariq Ali: In another interview, you mentioned Seth Klarman as an investment hero. Reading Margin of Safety, he talks a lot about looking at investments with potential catalysts. Is this a case for you to, do you look out for certain catalysts or is it more of buying low and eventually the market will figure it out?

Paul Sonkin: You always want to look for a catalyst but sometimes there is no catalyst. So with Steinway (NYSE:LVB) there’s no real catalyst there. Earnings will recover and that will be the catalyst but the catalyst isn’t obvious and when it is obvious it’s too late.

Tariq Ali: Do you think you could walk us through a failed past investment?

Paul Sonkin: I guess like other value investors, we’ve paid homage to newspaper stocks. We had one called American Community Newspapers (OTC:ACNIQ) which we thought they had a little bit of a different business model because while they were dependent upon advertising they weren’t really dependent on subscription revenue. What happened was that business just completely imploded. So I think that all value investors have paid homage to old media companies and that was one failed investment that we had.

Occasionally we’re going to get caught in other situations where you get involved and the problems are more than you thought. So a company like that was Meade Instruments (NASDAQ:MEAD) where we were an activist and got a board seat. By the time we got inside we realized that the business was in much worse shape than we would have thought. We would have done fine except the economy was the kind of nail in the coffin.

Tariq Ali: Could you talk a little bit then about shareholder activism. Is it a strategy you actively utilize at Hummingbird or is it more of a strategy of last resort?

Paul Sonkin: We don’t go into any situations with the intention of being activists. There are some people who do that and it’s just not a focus for us. I guess there are cases where we felt as though they weren’t being fair for shareholders and we stuck up for our rights but I don’t see us going on boards in the future.

Tariq Ali: Since you told us about a failed/disappointing past investment, could you walk us through one you’ve been pleased with?

Paul Sonkin: There are some we have now that we think will do quite well going forward. Rand Logistics (NASDAQ:RAND) is a large position for us. The interesting thing about Rand is they’re embarking on doing an acquistion of a company that’s in bankruptcy. So we expect that acquisition, if they complete it, will be an accretive acquistion even though they’re going to have to issue quite a few shares. But just looking at the business on a standalone basis you figure that they’re projected to do $16M of EBITDA this year. They’ll have $6M of CapEx, $4M of interest, and $1M of preferred dividends, which leaves you with about $5M dollars. If you take that and divide that by 12.7 million shares you get about $.40 per share of FCF for March 2010. For March of 2011 we think they’ll do $0.75 of FCF and for March of 2012 we think they’ll do about $1.00 of FCF and the stock is currently trading below $3.00 so we think that’s extremely attractive.

Another company we have a significant investment in is Southpeak Interactive (OTC:SOPK). I think the video gaming companies have had a lot of pressure because some believe that people may just download video games off the internet for free but they can’t get the same kind of experience on a game played online as they can on a CD that they buy. That company is trading at $0.60 and they have about 51 million shares outstanding so figures about a $31M market value with about $5M of interest bearing debt. So you’re talking about $36M, this is a company that could easily do north of $100M in sales at 8% operating margins. So we think that that is a pretty attractive situation. It’s in a very sexy niche and they just brought on the ex-CEO of Take Two Paul Eibeler Interactive as a board member which gives added credibility to the company. Terry Phillips is a very good manager who is very well known in the industry. They’re executing very well and we feel like we’ll make a multiple on our investment going forward.

Tariq Ali: Could you talk a little about Fortress International (NASDAQ:FIGI) with your take on the situation there?

Paul Sonkin: I think it’s a very very well run company. I think that they had some challenges with some of their customers getting financing but I think that long term it’s going to be a great investment because it’s a play on server farms and on these data processing facilities. Even though near term they may not put up great numbers. I think that long term they’re capable of some meaningful earnings growth and generating a lot of free cash flow. I was sitting with the CEO of the company about a month ago and if you just look at the companies that they’ve done initial build outs for I think they can get about $400M of revenue just by building out the facilities that they’ve already started to work on. Because when you put up a facility if they put up a 150,000 facility, they may only build out 20,000 feet but as more tenants come in they get that add on work.

Tariq Ali: As a teacher, do you have any advice for students of value investing right now?

Paul Sonkin: I think that it’s a great time for young people to be getting into the business. If you look, a lot of the firms were created after the aftermath of the 20′s and there were a lot of firms created after the 70′s. I think that there are a lot of firms that will be created out of the aftermath of 2008. So I think that it’s a good time to be getting into the business. Usually, the advice that I give my students is to keep your eyes open and your mouth shut. One of the pearls of wisdom that I give them is if your boss asks you for a red umbrella, don’t bring him a blue one and explain how it’s going to keep him dry. Just give your boss what he wants. I think that there are a lot of people who start working that get off on the wrong foot.

Tariq Ali: Do you have any book recommendations?

Paul Sonkin: There are several books that I really like. I like Hidden Champions by Hermann Simon. David Dreman wrote a book back in the 70′s called Psychology and the Stock Market. Another one I really like is Style Investing by Richard Bernstein. And all of the classics.

Tariq Ali: Thank you so much Paul for taking the time to do our interview.  We wish you the best of luck!

I really enjoyed having the opportunity to interview Sonkin. During the interview, I learned quite a bit about his process and I hope you did too. Here are some thoughts:

For his search strategy, It looks like following the 52 Week Lows is your best bet. In addition though, Sonkin mentions that he employs keyword searches to find things like liquidations and other special situations. There’s a few ways to do this. One, you can set up alerts with the SEC database to send you a message whenever a particular company has filed a document you’re looking out for. Different SEC filings correspond to different corporate events, there are filings for spinoffs, material events, tender offers, and so on. Or, you could rig up your own Yahoo! News Alert so that whenever a story comes with a particular trigger word, such as liquidation, you’d get notified so you can quickly act. Other things are more simple. For example, Sonkin mentioned that he keeps a list of companies that they watch. These are things you just have to do on your own, it becomes easier after you’ve analyzed more and more companies. Right now I’m throwing a number of companies in the too expensive pile, but I look at how they perform over time. Eventually maybe something will happen to cause a company to fall below its intrinsic value and because you’ve already done work on it, you’ll be able to act quickly.

I hope you noticed that when I said small companies, I meant it. Fortress International only has a market cap $13.67M, Southpeak Interactive trades at a $24.78M, Rand Logistics at $37.13M, and Steinway at about $102M. My guess is that most of these companies will have little by way of analyst coverage or attention on Wall Street or CNBC. The advantage is simple: less coverage means there’s less eyes on them and produces greater opportunities for you, the small investor. The market in these area is generally less efficient and the businesses are actually rather simple. I think that companies of this size are better for newer investors because like Sonkin says, they’re much easier to analyze. Steinway is going to have less moving parts than a company like Kraft and it means you can hone in on your analysis better.

I also thought it was interesting that Sonkin sees some of these companies as ones with great long term prospects to grow as business. I know that other investors only venture into companies of this size range in order to find net-nets or special situations, but it seems like Sokin is taking a much comprehensive approach. To find these kinds of companies you’re probably going to have to broaden your search a bit in order to find them, since they may not come up on an ordinary screen. Sonkin’s Fortress International investment is probably the best example of this.

I haven’t read any of the books that Sonkin mentioned but Hidden Champions looks to be very interesting. The book is a study on small companies (that most people may never have heard of) that are market leaders in their respective areas. Such a book could probably prove helpful for analyzing some of these tiny companies from a qualitative perspective.

Hopefully you enjoyed my first interview here at Street Capitalist, I plan on doing more of these in the near future but with readership participation. I think that they’re great learning tools for students of investing because you’re able to pick the brains of people with more experience in the field. I already know that I’ve learned a lot from this interview with Paul Sonkin.