Third Quarter Summary
Our third quarter performance edged our year-to-date performance higher. In today's market environment, small gains each quarter start to add up. We continue to make selective and cautious decisions resulting in a brick-by-brick style of performance of acceptable levels of return. Most importantly, we believe deeply in what we are holding and why, and remain convinced these investments will work out in due time.
Henceforth, our quarterly letters will focus on highlighting our top three purchases (by dollar amount) in order to comply with SEC guidelines requiring objective non-performance based standards when discussing specific recommendations.
RAM Performance Summary
|Annualized as of 9/30/2004|
|3Q 2004||YTD as of
|1 Year||3 Year||5 Year|
|Vanguard Bal. Index||2.16%||4.63%||12.32%||6.66%||3.59%|
|Lipper Bal. Index||0.18%||2.44%||10.59%||5.32%||3.09%|
* Please refer to performance disclosures at end of document.
Global Industries, GLBL. During the past several years I have sat with William J. Dore, Chairman and Founder of Global Industries, several times as he explained the company’s current operational challenges and opportunities. Bill is a lean man, with a rugged face honestly earned from a lifetime of building up a premier worldwide offshore-oilfield construction company that installs offshore pipelines and production platforms. I have always been impressed with this man: his candor in highlighting the good, the bad and the ugly and his willingness to appropriately honor and stand with Global’s shareholders are noteworthy.
In the past few years, we’ve witnessed corporate malfeasance and greed too often: managers who cash out before the bad news hits the street, Boards acquiescing to re-pricing out-of-the-money options and excessive pay packages that would have been embarrassing to an earlier generation of business leaders, but are now defended with the logic of a contortionist. Here’s what Bill Dore did two years ago when his family appropriately suggested he needed to diversify his wealth (about $100 million at the time) by liquidating a portion of his Global holdings: with the stock selling at about $4/share, he said he would only sell at a price at least equal to Global’s last secondary offering price, which was $9/share. In other words, he said he would not sell one single share at a dime less than what the company had most recently represented to investors as the value of the company, even though the stock would have to more than double to meet that goal. Pretty classy.
Global has long been the offshore construction leader in the Gulf of Mexico complemented by significant international work as well (particularly in North Africa and the Middle East). The Gulf has been in a construction recession for some time as the majors commit to longer-life projects outside of the Gulf and as a result Global’s earnings have been down. However, today Global’s backlog stands at the highest it has in years, and the company has over $1 billion of outstanding bids for projects that are expected to be awarded and/or completed in the 2004/05 timeframe. Additionally, the company has steadily moved forward in efficiently streamlining its worldwide operations. Moreover, its chief competitors in the Gulf are experiencing severe balance sheet challenges. At less than 6x our 2005 enterprise value to EBITDA estimate, we feel Global is a compelling value with significant opportunities ahead steadied by the hand of one honest and hard working guy, Bill Dore. (In fact, Bill not only has not sold shares, but purchased an additional 275,000 shares earlier this year in May on the open market).
SpectraLink (SLNK). SpectraLink is the leading developer and manufacturer of short-range wireless telephone systems for on-premise use. In large campus-like environments where workers need to be in regular contact, SpectraLink’s onsite solution is just the answer. Amazon.com, Citicorp, US Navy, General Motors, Lowes and over 1100 hospitals all use SpectraLink’s wireless solution to enable its workers to cost-effectively communicate over a reliable connection. Marriott recently became a client.
SpectraLink was the first US manufacturer of workplace wireless telephone systems and went public in 1996. Management has astutely positioned the company. For an in-building wireless system to work, it must connect through the PBX (phone switch). However, there are more than a dozen PBX manufacturers, and each vendor has a dozen models. SpectraLink has spent a decade “reverse engineering” all of these PBXs, while Cisco (it’s only remaining competitor) can only attach to its own PBX. Also, there is no existing standard for Quality of Service (QoS) over a WLAN, but most major Access Point vendors have been embedding SpectraLink’s protocol in their access points since 1999. The only vendor using Cisco’s QoS protocol is…Cisco.
We bought shares in this impressive emerging technology leader at a terrific price. First, SpectraLink’s balance sheet is pristine: 81% of assets equate to shareholder equity indicating few liabilities and net cash equates to over 25% of the company’s capitalization at the price we paid. Averaging the company’s free cash flow over the past three years results in a 7% plus “yield” based on the price we paid. Particularly noteworthy for an emerging technology company is management’s conviction in its earnings power as indicated in its generous $0.40 cent dividend (over 4% at the price we paid). Finally, we paid roughly 140% on an enterprise value to sales multiple for a company averaging slightly over 10% in net margins over the past three years with a five year earnings growth rate of nearly 16% (estimated through 2005). Management owns roughly 13% of the company. We like the story a lot.
Pioneer Natural Resources, PXD. Pioneer is an independent energy company, headquartered in Irving, Texas, that explores for, develops, produces, gathers, processes and markets natural gas, crude oil, and natural gas liquids. The company was born through the merger of domestic producers Parker & Parsley Petroleum Company and Mesa, Inc.
As we have highlighted in the past, Roumell Asset Management primarily ascertains value in one of three ways: discount to a readily ascertainable net asset value; private market valuation based on merger and acquisition activity within an industry; and lastly, going-concern analysis wherein we look at the total economic benefits likely to accrue to shareholders (a proxy for owning the entire company). Pioneer is a discount to net asset value situation supported by relevant and meaningful merger and acquisition activity.
Energy and production companies (E&P) report their proven oil/gas reserves annually. Assuming an investor has confidence in the reported number (not necessarily so) a value can be placed upon the company’s reserves. For instance, at year-end of 2003, Pioneer reported 4.7 tcf (trillion cubic feet) of reserves (on a gas equivalent basis).
How are gas reserves being valued in the private marketplace? We reviewed several recent transactions: Calpine sold reserves for $2/mcf; Anadarko recently sold some of its reserves for $2.22/mcf; Encana purchased Tom Brown for $1.90/mcf; Forrest Enterprises purchased Wiser Oil for $1.73/mcf; Newfield bought privately held Inland Resources for $1.76/mcf; and Pioneer recently bought Evergreen Partners for $1.37/mcf. Reserves will be valued differently depending on such factors as the difficulty of lifting those particular reserves and the average life of those reserves. Long-life assets like Evergreen’s will be less on a per mcf basis because the income stream is being discounted back over a longer period of time. On average, competitors are paying about $1.80 per mcf (million cubic feet) for each others’ reserves.
In valuing Pioneer, we applied a $1.60 per mcf to its proven reserves providing some discount to what was occurring in the private markets. However, given that approximately 15% of Pioneer’s reserves are in Argentina where market prices are fixed, we discounted these reserves substantially. The total reserve value we estimated was $6.6 billion ($6.4 billion for non-Argentina assets and $224 million for Argentina assets). Additionally, we added $170 million for Pioneer’s undeveloped acreage and subtracted its $1.4 billion debt. The resultant value equaled roughly $5.2 billion, or $43.50/share (over 30% greater than our average purchase price). In essence, we paid about $1.20/mcf for Pioneer’s reserves at a time when industry insiders are buying reserves at higher prices.
Our Pioneer analysis is not based upon predicting the direction of commodity prices. Rather, we will take our lead from industry leaders (typically very conservative themselves in making long-term commodity projections) who are willing to pay substantially more than we did to own energy reserves. There appears to be a clear disconnect between the public and private market’s assignment of value to E & P companies…we’ll stress the latter while assuming that the discount is sufficient to keep us out of harm’s way in the event that prices move against us.
We look forward to the fourth and final quarter of this year. We will continue to do what we have always strived to do:
RAM invests, again and again, in companies/securities that we believe are significantly undervalued given relevant merger/acquisition activity, net asset value analysis, going-private transaction activity and reasonable going-concern values. RAM Quarterly Report, May 11, 2000
We are pleased to announce that Amrith Fernandes-Prabhu has joined Roumell Asset Management as an intern. Amrith is a senior at American University majoring in International Economics. In addition to her interest in investment management, Amrith is involved in several local charitable organizations.
Once again, we want to thank you for the trust and confidence you have placed in us. We will continue to watch what the market appears to make cheap, diligently research those ideas and, in the end, select our investments cautiously. If you are aware of individuals who would benefit from our approach, we would welcome the opportunity to talk with them. You can always direct such individuals to our website, www.roumellasset.com. Additionally, as we have mentioned in the past, we have lots of terrific restaurants in our neighborhood and would be happy to take you and a friend(s) to lunch to discuss our investment approach. As always, please feel free to contact us directly about your account.
Investment Strategy: Roumell Asset Management, LLC (“RAM”) employs a value investment strategy in managing client portfolios. RAM Equity accounts can have up to 100% of assets invested in stocks; RAM Balanced Accounts typically have 35% of their assets allocated to fixed income investments (though the figure can range from 50% to 80% depending upon the needs of the client).
Calculation of Rates of Returns: First and foremost, readers of this letter should recognize: past performance is no guarantee of future results. Returns are reported net of all fees and applicable trading costs; returns are from only those accounts present for the entire period; returns are time-weighted. These returns are based on a composite of Roumell Asset Management’s accounts (present for the entire quarter) and therefore were not necessarily duplicated in any specific client account. These figures include an insignificant amount of short positions. These consolidated performance numbers include all of RAM’s fully discretionary accounts within each category. Discretion is defined as the ability of the firm to implement its intended investment strategy without restriction.
Inclusion of Accounts: In the performance calculations for RAM equity, there are 84 equity portfolios totaling $29.8 million. This represents 34.4% of total portfolios and 30.9% of total dollars under management. In the performance calculations for RAM balanced, there are 110 balanced portfolios totaling $52.5 million. This represents 45.1% of total portfolios and 54.5% of total dollars under management. A complete list and description of the firm’s composites is available upon request.
The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients and the reader should not assume that investments in the securities identified and discussed were or will be profitable.