Vistaprint

Dear Partners:
In the third quarter of 2012, our Partnership returned 8.9% net of fees and expenses. As of September 30th, our year to date net return is 27.8%. On average, we held 17% of our assets in cash throughout this year.

There’s No Such Thing As a Free…Drug

Free options are one investment bucket to which we allocate capital. Derma Sciences (mentioned in our 2011 Q4 letter) owns a drug that accelerates the healing of diabetic foot ulcers. The drug should soon enter the final stages of the FDA approval process. Statistically, it has a 55% chance of making it to market. (Anecdotally, the odds are even higher.) Upon final FDA approval, the drug should be worth around $1 billion. We purchased Derma Sciences when it was valued at $80 million. Our attraction to the investment was that the market seemed to pay no attention to Derma Sciences’ two other business segments, one of which was growing rapidly. Those segments alone, plus the cash, were worth around $80 million. That effectively provided us the option on the potential blockbuster
drug for free.

We recently exited the investment, which generated a 64% IRR. Derma Sciences is still undervalued: the drug alone has an expected value in the hundreds of millions, yet the company’s market capitalization today is only $140 million. However, we sold because at today’s valuation, there is downside should the drug not be approved. Though Derma Sciences is clearly still a bet with a positive expected value, it no longer fits into our free options bucket.

Getting Paid to Wait for the J-Curve

Vistaprint Limited (NASDAQ:VPRT) is a new investment for our fund. Robert Keane, founder and current CEO, started with the dea to cheaply produce business cards for companies too small to order large quantities. Through the creation of printing technologies designed for low volume orders, VistaPrint Limited (NASDAQ:VPRT) significantly reduced the cost for a box of 250 business cards. The cheap prices they were able to offer small businesses enabled Vistaprint to rapidly grow from $0 to over $1 billion in annual revenues.

Today, business cards account for only 30% of Vistaprint’s sales. The company has expanded its low volume concept to sell a wide range of customizable, printed marketing materials in small quantities and at cheap prices–from brochures and signage to customized apparel and stationary. In addition, the company now targets consumers as well as small businesses, with products such as wedding invitations and photo books.

2012 Q3 Letter KCM