The fund was up 17.6% in the quarter ended 12/31/11 net of fees, comprised of monthly returns of 10.0%,
5.3% and 1.5% for October, November and December, respectively. In comparison, the S&P 500 was up
11.8% over the quarter, comprised of monthly returns of 10.9%, -0.2% and 1.0%. The Barclay Hedge Fund
Index was up 1.7% over the quarter, comprised of monthly returns of 3.5%, -1.3% and -0.3%.
Since inception, the fund is up 588.0% net of fees. In comparison, the S&P 500 is up 44.0% and the Barclay
Hedge Fund Index is up 17.1% during that time.
As in previous quarters, we continued to benefit from the share price declines in U.S.-listed Chinese
companies that in our opinion are falsifying their public financial statements. This sector has been an integral
contributor to our returns over the past six quarters.
Our top five positive contributors were four shorts in Chinese companies that we believe are defrauding
investors, and our long position in Aeropostale Inc. Our top five negative contributors were shorts in three
Chinese-based companies, as well as long positions in Activision Blizzard Inc. (ATVI) and the gold
exchange-traded fund GLD. Our top five negative contributors included ChinaCast Education Corp., which we
wrote about in our report here. The ChinaCast saga, most recently the subject of this DealBook article, is still
Attractive investment opportunities come in all shapes and sizes. Often, we find ourselves investing in areas
we would not have expected to venture into, but which we haven’t been able to resist after careful analysis. As
such, we typically don’t expect a top long holding to be one of the largest companies in the world, let alone the
second largest company in the world by market capitalization. Yet after examining AAPL, we decided that the
stock presented an attractive long opportunity and it comprised one of our largest positions as of year-end.
Apple, at today’s prices, is an unusual stock. Fuelled by two products that have been around less than a
decade, it nearly matches Exxon Mobil as the world’s highest valued business. Yet when looking at its
financials and the company’s near-term growth outlook, the company is atypically undervalued. It trades at 15x
trailing FY 2011 earnings and 12x expected FY 2012 earnings. Yet that excludes the $81bn of cash and
marketable securities on the company’s balance sheet as of 9/30/11 (and which will probably be more than
$90bn when the company reports its 12/31/11 financials). This cash and securities hoard comprises 20% of
the company’s market capitalization. Netting out the cash and securities, the company trades at 12x trailing FY
2011 earnings and 9x expected FY 2012 earnings. APPL has excellent earnings quality, in that its GAAP
income very much approximates the company’s cash flow from operations less capital expenditures.
Yet despite these low valuation multiples, AAPL is experiencing rapid near-term growth. In the last twelve
months, Apple sold 72 million iPhones, 32 million iPads, 43 million iPods, and 17 million computers. Gartner
forecasts 2012 sales totaling 119 million iPhones and 48 million iPads, implying 50%-60% growth rates in the
company’s two largest segments which constituted a combined 60% of FY 2011 sales. On top of this, there are
computer sales growing at 20%+, iTunes growing at 30%+, the potential release of an Apple TV, and a more
efficient use of Apple’s huge cash reserves for dividends or repurchases. Fuelling part of the growth is the
Asia-Pacific market (i.e. China), which experienced 174% revenue growth from 2010 to 2011. The Asia Pacific
region may surpass the Americas in sales during 2012 and comprise more than 30% of the company’s FY
The bear case for Apple is that at some point, its products will go out of fashion and/or become surpassed
technologically. We recognize this and there is somewhat of a short-term orientation to our investment. But we
doubt that such troubles will befall Apple over the next 6-12 months, and currently, Apple is gaining market
share because it is the only manufacturer with complete control over how hardware and software are
packaged together. On platforms where battery life is of utmost importance, the ability to efficiently design
software and hardware that work together is a long-term sustainable competitive advantage that no other
At today’s valuation and with the current operating momentum, we have been able to get sufficiently
comfortable with making AAPL one of our largest longs.
Sterling Shoes – RIP
In November 2010, we prepared a writeup on Sterling Shoes in which we explained why we were long the
stock. In October 2011, less than a year later, the company filed for bankruptcy.
This is the second time since launching our fund in July 2009 that we have seen a long position file for
bankruptcy. In both cases, the companies have operated the same type of business: mediocre retailers with
tired products and too many stores. Sterling also had debt, which accelerated its decline. Our other bankrupt
retailer was Jennifer Convertibles, and we wrote about our experience in our letter for the third quarter of 2010.
It is clear that we need to be more careful investing in struggling retailers with same-store sales declines and
deteriorating margins. Sometimes they turn around, but usually they don’t. The hidden leverage of operating
leases continually catches us unaware.
Kerrisdale Capital Management, LLC | 1212 Avenue of the Americas, 3rd Floor | New York, NY 10036 | Tel: 212.792.7999 | Fax: 212.531.6153 3
At least, the monetary damage was not especially material because the position had become quite small over
time, as we saw the operating metrics continue to deteriorate.
End of Year Remarks
We ended the year with a nearly 200% return net to investors, generating positive returns in 11 out of 12
months. We beat the market in each quarter. Since inception, our returns have substantially exceeded the
market’s returns, and we have outperformed the S&P 500 in 8 of 10 quarters. Out of thirty months since
launching the fund, we have had a negative performance in only three of them and generated returns higher
than 10% in seven of them.
More than anyone, we recognize that our unusually high and consistently positive returns are misleading. First,
much of our gains were generated off of a small capital base. We ended the year with approximately $60
million under management.
Second, the consistency of our positive returns is an aspect I would have not predicted when launching the
fund. We are directional investors, and make most of our returns by predicting whether security prices go up or
down, rather than exploiting small discrepancies between them. Directional investing typically lends itself to
lumpier returns than those we’ve seen.
We continue to be confident about the investments in our portfolio. Regardless of how the overall market
performs, we expect our holdings to fare well over the long-term.
Thank you and please don’t hesitate to contact me with any questions.
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