Iolite Partners commentary for the first half ended June 30, 2016.
For the half-year ended June 30, 2016, Iolite Partners’ unleveraged portfolio returned -14.5% in EUR (-10.4% in USD), net of all fees. Since inception on October 1, 2008, the core portfolio has generated net cumulative returns of +143.6% in EUR (+110.0% in USD) and annualized net returns of 12.2% in EUR (+10.0% in USD). In other words, a euro invested at inception has turned into €2.44 (a dollar invested at inception has turned into $2.10).
This half-year’s performance was highly unsatisfying as measured by market prices and erased all the gains of 2015. Excluding a painful 67% drop of Perion Network (a 29% position as of year-end 2015), the portfolio would have been up in what was a volatile period. I will elaborate on this investment later in this letter.
Good news came in a few days after the end of the half-year, when a large Australian holding reported very strong annual results that immediately lifted the share price by 20% and the portfolio by 6% in a day.
All in all, I consider the portfolio greatly undervalued given the underlying assets and stick with Warren Buffett: “We prefer a lumpy 15% rate of return to a smooth 12% return”.
Thoughts on the Macro Environment
On June 24, 2016, the people of the United Kingdom voted to leave the European Union (“Brexit”). Worldwide, politicians and the media were quick to condemn the voters for a “disastrous decision”.
First, I think it was great the people of the UK had the opportunity to vote on such an important matter. Most other European countries do not put so much trust, confidence and responsibility into the hands of the people (and yes, I am aware the vote was an opportunistic political move by David Cameron).
Second, I think it is presumptuous to condemn the voters. It seems the democratic majority is only welcome for as long as it is supportive of the establishment’s mainstream opinion. Instead of condemning the voters, we should be asking: “What has led to this situation?” and “Is the European Union heading in the right direction?” Personally, I don’t believe the British voted against Europe but rather against the current state of the European Union.
Third, nobody knows what the Brexit will actually look like. Therefore, it is impossible to tell what damage the Brexit will cause to the UK (aside from a possible declaration of independence by Scotland). Switzerland has never been a part of the European Union but has fared rather well being “in” with one leg and “out” with the other. The UK is a much more important strategic and economic partner to EU member states than Switzerland and currently hosts 3 million EU citizens. Therefore, I doubt the EU can play hardball with the UK. It’s also important to remember that the UK has never been a “pure” member of the EU, as it has never been a member of Schengen or the Eurozone.
Fourth, it is likely there will now be similar votes in other countries. I expect far more serious repercussions for Europe if a core Euroland country such as the Netherlands decided to exit the EU and the euro.
Case study: Perion Network (NASDAQ: PERI)
Once we realize that imperfect understanding is the human condition there is no shame in being wrong, only in failing to correct our mistakes. [George Soros]
Fellow value investor Guy Spier once pointedly remarked that there are three types of investment letters:
1) Scaremongering: “The world is a scary place but you can trust me as I have clear vision.”
2) Promotional: “Buy shares of the companies I own [and drive up their prices].”
3) Bedazzling: “Trust me, because I am so smart.”
I would like to introduce a fourth category: “lessons learned”. My goal is not to raise assets by bedazzling a large number of people or to talk my book but to compound my own money – and that of my clients – for a very long time. I believe an open and rigorous analysis of lessons learned is a very valuable tool to help me accomplish this goal.
The financially most painful investment decision in my life to date has been an investment in Perion Network (NASDAQ:PERI). I (and my clients) would be 30% wealthier had I not kept buying the company’s shares over the last few years. This is an investment in what was once Israel’s largest IT start-up, after it had fallen on hard times and looked cheap in the aftermath.
The shares’ steep decline in H1 2016 (-67%) corresponded with the end of a major lock-up period, technical selling after the company was removed from an index, as well as some troubling news from the company itself. Valued at around $2 billion just three years ago, PERI is now trading at an enterprise value of around $100 million. Through a transformative transaction in late 2015, PERI should see revenue growth of 50% as well as solid cash generation in 2016. I believe it could generate $50 million in stable annual free cash flow going forward. Analysts estimate the company is now trading at 2.5 times 2016 earnings.
Unfortunately, there are serious issues with current management: a lack of credibility, a track record of horrendous capital allocation, and an overhead structure that no longer fits the size of the business. Many of these issues only revealed themselves over time and only became obvious earlier this year. It took me too long to spot them and to act accordingly.
In early April 2016, I flew down to the company’s headquarters in Tel Aviv to meet the chairman of the board, management and major shareholders (among them the original founder of the business, an impressive serial entrepreneur who still has a large stake). Looking at the changed nature of the business, I saw a few obvious strategic and structural steps that needed to be taken, but the main goal of my meetings was to remove the CEO (Josef Mandelbaum) and CFO (Yacov Kaufman) to give way to new leadership and a leaner structure.
In the undesirable case Mandelbaum and Kaufman decide to sit it out (and they apparently benefit from the loyal support of a staggered board), I will continue to push for a change as I firmly believe it will require new leadership to realize the company’s potential and to regain the trust of the markets. Sixty percent of the shares are in the hands of five business-savvy shareholders. Their stakes are currently hugely undervalued based on the company’s potential, giving them little incentive to sell and strong incentive to change the way this company is being run.
Investment Thesis (as of June 2015)
I am presenting my investment thesis from June 2015, as this is when I really started to load up on PERI. Most people judge investments and managers based on outcome, leaving them heavily exposed to hindsight bias and outcome bias. In contrast, I believe it is crucial to focus on process and the quality of a decision based on the known facts when it