Sahm Adrangi's Kerrisdale Capital has achieved a quarterly return, net to investors, of 5.4% for the quarter ended December 31, 2012, according to a shareholder letter obtained by ValueWalk. The S&P 500 index returned -0.4% during that same time period.
kerrisdale capital gained fame as one of the first firms to identify and short fraudulent Chinese revere mergers. During the full year of 2012, Kerrisdale returned 29.0% net to investors. The S&P 500 index returned 16.0% during that time.
Since inception, the hedge fund has achieved a return, net to investors, of 787.3%. The S&P 500 index has returned 67.1% during that time.
The top five positive contributors for the hedge fund were Short A, long Herbalife Ltd. (NYSE:HLF), long AMERCO (NASDAQ:UHAL) , short Mellanox Technologies, Ltd. (NASDAQ:MLNX) and long True Religion Apparel, Inc. (NASDAQ:TRLG).
Kerrisdale Capital strongly defends the number two holding, Herbalife. The long thesis for Herbalife is discussed in the letter, excerpts can be found below:
Let’s talk about Herbalife. But before we begin, it’s important to mention that Herbalife is one of numerous long investments in our portfolio and if our analysis turns out to be faulty, the loss to our investors will be manageable. We’ve never had a 100% hit rate and don’t expect to; rather, we size positions appropriately so that in the aggregate, a mix of uncorrelated ideas produces attractive returns over the long-term. We may find new information in the future that causes us to change our mind on HLF, leading us to close our position. We will trade around certain events and may hedge our downside to protect us from tail or headline risk. Sometimes our highest conviction ideas turn out to be our worst, and HLF isn’t even our highest conviction idea. But we like the stock, and disagree with the shorts on key points. Given that Herbalife has been hotly debated recently, we’d like to provide our views on the company.
We built a long position in Herbalife (HLF) in late December after the stock suffered a significant decline due to a short-focused presentation by Bill Ackman’s Pershing Square Capital. We remain long today and unless we see reason to revise our thesis based on new information or analysis, we’ve developed sufficient conviction to make it a long-term holding at the current price level.
Since we regularly seek out new investment opportunities afforded by temporary market dislocations, the dramatic decline in HLF piqued our interest to delve into the global multi-level marketing (MLM) sector further. Over the second half of 2012, the valuation multiples of these companies contracted materially due to public criticisms by Greenlight, Citron Research and finally Pershing Square. These declines in valuations reached a fever pitch after Pershing Square’s presentation on December 20th, which triggered 10%+ drops in the shares of HLF, Nu Skin (NUS) and Usana (USNA). Given the companies’ rapid and consistent historical growth and attractive capital allocation policies, there seemed to be potential for an opportunity on the long side, if the shorts were overstating their case or the market had overreacted.
After our research, we came to believe that the market had overreacted to the shorts’ criticisms, and we purchased shares of both NUS and HLF. In the following discussion, we’ll focus on HLF.
Let’s first review certain financial metrics for HLF. Since 2001, the company has grown sales from $1.0bn to $3.9bn as of LTM 9/30/11, achieving positive growth each year and achieving a compounded annual growth rate (CAGR) of 13%. EBITDA has grown each year, from $87m in 2011 to $709m in the most recent twelve months, at a CAGR of 22%. Free Cash Flow, defined simply as Cash Flow From Operations less CapEx, has grown from $85m to $428m, a CAGR of 16%.
Altogether, since 2001, HLF has generated $1,864m of Free Cash Flow Less Acquisitions. What has HLF done with all that cash? It has spent $738m repurchasing shares and $353m paying dividends. Its dividend has tripled over the past three years.
How is the business doing today? Year-to-date through 3Q 2012, revenue grew 21% over the prior year. Operating income grew 17%. Diluted EPS grew 23%. The share count has been reduced by 7% since the last fiscal year end due to aggressive share buybacks.
The company is generating $400m+ of FCF each year, and has demonstrated a clear commitment to using that cash to retire shares and pay dividends.
At $40, the stock trades at 10x 2012E P/E and EV/FCF. The company has an enterprise value of $4.7bn, but generated $400m to $450m of free cash flow in the last twelve months as well as FY 2011. For a company growing 15% to 20% a year, generating substantial free cash flow and using the cash flow to repurchase shares and pay a dividend, these are relatively low valuation multiples.
The shorts argue that these historical numbers are irrelevant because past performance is not a predictor of future performance for HLF, since they believe that Herbalife’s business momentum will reverse course in the near- to intermediate-term and collapse. We disagree. In particular, we think HLF’s business model is quite resilient, despite its ponzi-esque MLM underpinnings, because it is very geographically diversified.