Hedge funds have been having a pretty bad year. Here is one you likely are not familiar with which is killing it. Rand Strategic Value is a value based hedge fund run by Todd Sullivan. Rand strategic value continued the good results from Q1 and expanded on them in Q2 of 2014. For the quarter Rand Strategic Value advanced 42.3% (net) vs 3.6% for the S&P 500. Since inception (12/10) Rand Strategic Value has advanced 91.3% (net) vs 35.5% for the S&P (.INX).
Since Todd took sole responsibility for all investment decisions of Rand Strategic Value in January 2012, the fund has returned 211% vs 27.7% for the S&P 500.
Below are some highlights from Rand Strategic Value on two of its top holdings; American International Group Inc (NYSE:AIG) and Howard Hughes Corp (NYSE:HHC), followed by commentary on the largest short, salesforce.com, inc. (NYSE:CRM). The full letter from Rand Strategic Value can be found below embedded in scribd.
Rand Strategic Value on American International Group Inc (NYSE:AIG)
American International Group Inc (NYSE:AIG) continues to be our largest position and continues to be materially undervalued. We own a very large position in the warrants that have more than doubled in price since we purchased them last January and also long dated call options. The option pricing on the calls was most advantageous when we decided to purchase. There are two main components to the pricing of an option, the volatility of the underlying stock and the time to expiration. Typically the longer the time to expiration the larger the time premium one must pay. That means that as time goes by, the value of that option decays in the amount of the time premium.
For the options we bought in AIG recently, we were able to do so with virtually no time premium. For example, the long dated Jan 2015 $35 calls were purchased for $12.25 each. That means our break even stock price on Jan 2015 would be $47.25. That is the price in which the value of the option would be the same then as it is now. The great thing about this is that when we bought the calls, the stock was trading at just over $46 dollars a share meaning we were only paying $1 and change per option for the time value of it or roughly $.05 a month. Because of that we were able to take a decent sized option position, that had an over $10 margin of safety and pay just over 1/4 of the then current stock price. Given the options were in the money, we will have near dollar for dollar participation in the upside of the stock making our percentage gains from the trade far greater.
Now the downside to all of this is of course our potential percentage downside is greater. But, with the options we can cap dollar loss to cost of the options. I view this as a low risk and very high reward trade for us. An earlier trade very similar to this expires in Jan 2014 and is currently up 247%. AIG currently trades well below its ~$65 BV and is seeing fundamental improvements across the board. It is poised to return tens of billions of dollars to shareholders over the next few years in both dividends or stock repurchases. In short I expect the share price to be well north of its current level comes Jan 2015 and these options another substantial winner for us. Should the stock fall to the $35 share price that would endanger the investment in the options, in my opinion that would be because of a major shock to the US economy or a major catastrophe that would be multiples of the scale of Sandy. I view both events while possible, as very unlikely in the next 18 months. While the position is of a decent size for our portfolio, it is by no means so large that should any of those instances occur I could not exit the position in a matter of moments.
It is important to note here that this options are not a main part of the investment strategy I have. However, when you are offered mispriced securities (as I view them) it behooves you to take advantage of that pricing when you can as it typically does not last indefinitely. The investment strategy is buying assets for less than what I view to be their intrinsic value while controlling risk (defined as permanent loss, not price movement). There are times when either a company’s equity, debt, warrants or options (or a combination of them) will present the best option and I will look to exploit that.
Rand Strategic Value on Howard Hughes Corp (NYSE:HHC)
We own the common stock of the Howard Hughes Corp (NYSE:HHC) and it is our second largest position. We have owned this since it was spun off to us in 12/2010 from General Growth Properties Inc (NYSE:GGP) at $38. We purchased additional shares in the low $50’s in 2011 when the then “scare of the moment” was the EU. Currently shares sit north of $100 each and in my opinion are worth at least an additional $100 from here over time (this excludes any potential effects from share repurchases).
HHC is the dominant landowner/MPC builder in the Houston, Las Vegas and Hawaii markets. They are entitled to build over 4,000 waterfront condos in Hawaii in the Al Moana/Ward Center area and the value of those and the retail location that will accompany them in my opinion is worth over 75% of the current market cap of the company. The Houston and Vegas MPC’s cannot sell lots fast enough and the refurbishment of NYC’s South Street Seaport is well underway. The activity in Houston is so great the company is adding office space and retail locations there due to demand that were “not even on the drawing board” a year ago according to management. Exxon moving to the Woodlands (one of HHC’s MPC’s) and bringing 10,000 workers. For more on their properties follow this link Down the road expect the company to spin off their operating properties to shareholders in the form of a REIT once they burn through their NOL’s.
CEO David Weinreb and CFO Andrew Richardson paid a combined $17M of their own funds for the right to work for and run the company. They purchased 7 year warrants on 2.7M shares in 2010 that cannot be hedged or sold in anyway before expiration. Weinreb said in Feb of this year “if they would have let me, I would have bought much, much more”.
Weinreb recently bought more shares on the open market at just over $100 a share.
Director Mary Ann Tighe made an open market purchase of nearly $1M at $105.
I feel this could easily be a $10B company over the next few years… it is currently a $4B company.
Rand Strategic Value salesforce.com, inc. (NYSE:CRM)
Our largest short position remains salesforce.com, inc. (NYSE:CRM). My view of this company is it is a leader in web-based customer management applications. It is also a leader is excessive executive compensation, questionable accounting practices, misleading reported financials and grossly overpriced acquisitions. To date we are showing a moderate loss here.
Insiders have such high confidence in this company that they have sold >$500M in stock during the last three years and have promised more selling this year. When the FY ‘14 is completed next January the company will have completed its third straight year of losing increasing amounts of money, will have lost over $400M combined in the last 5 years and will tell shareholders they will lose money yet again in FY ‘15. In fact, when FY ‘14 comes to a close, the company, in its entire history will not have made a single penny…….
For some inexplicable reason this company is valued at over $22B
If I gave you $22B and told you to buy any one company you wanted to, I’d dare say this would not even be on your radar. To quote Warren Buffett, “If you would not buy the whole company if you had the ability to, why then would you buy a single share?”
The company recently borrowed and then paid $3.5B for ExactTarget, a company that, you guessed it, is also unprofitable. In fact that company has paid well over $4B the last few years for companies that are, you guessed it, unprofitable. But, they all have increasing revenues.
They then followed that up with an acquisition of Edgespring that was done for stock (yes, they are losing money also). The neat thing about this is the folks at Edgespring then immediately turned around and filed to sell virtually every share they received from Salesforce, over 2 million of them.
We’ve seen this “revenue growth through acquisition” play before. It always ends badly for those holding the stock. I would guess management realizes this and this is why they are reducing their holdings so precipitously. CFO Graham Smith for example has sold $51M in stock the last three years and based on that pace ought to be near $65M when the year is over. He has never purchase a single share. Vice-Chairman Frank van Veenendaal has sold $39M in the last three years with $23M of that coming in the last twelve month alone. Here also has not bought a single share over that time frame. There is plenty more of this but I think the point is made.
Eventually Wall St emerges from its fantasy world slumber and collectively wonders “um, just how are they ever going to make money?”. When no answer is forthcoming (it is hard to argue you will when after a decade you haven’t) shares begin to reprice with that reality.
Revenues without profits are like cake without icing. It’s ok for a bit but then people will demand icing, when none is forthcoming, they will no longer want the cake.