The following excerpt comes from the Reuven Capital Investments fund Q3 letter to shareholders.
This is the monthly progress report we began in 2013. Enclosed you will find the condensed statement of your month-end value and performance, provided by our 3rd party administrator, Strategic Asset Management LLC.
Many value investors have given up on their strategy over the last 15 years amid concerns that value investing no longer worked. However, some made small adjustments to their strategy but remained value investors to the core. Now all of the value investors who held fast to their investment philosophy are being rewarded as value Read More
Reuven Capital Performance Details:
The Reuven Capital Investments fund (RCI) showed a gross profit of 17.20% in the month of September, and having a gain of 29.92% in the 3rd Quarter, and a gain of 38.98 % thus far Year to Date.
The financial markets rebounded in September from last month’s decline, with the Dow, S&P 500, and NASDAQ gaining 2.16%, 2.97% and 5.06% respectively. Despite all of the political turmoil that began to poison our brain towards the end of the month/quarter, the RCI fund had its strongest monthly and quarterly gain of the year with gains of 17.20% and 29.92% respectively. The US Federal Reserve elected not to taper its $85 billion per month ($1.02 Trillion/year) for some strange reason, and we are beginning to believe that they forgot where the OFF button is. In addition to unemployment and GDP results, many financial studies have proven that the QE Infinity program the Fed has had for the last few years has had very little impact on the overall economy and employment. But, with the Fed Chief Bernanke leaving office at the end of this year, we highly doubt that any drastic changes will be made throughout the remaining months of his tenure.
As expected, the debt ceiling and budget bill impasse were too much work for our dear politicians to handle, and therefore they decided a US Government Shutdown was more appealing. The remote possibility of an actual US Government debt default hurt the market at the end of the month and led to a spike in volatility. Although the US government is still shut-down at the time of this letter, we don’t see a real US debt default as a possibility, even after they kick the can down the road. The reason is quite simple; Self Interest. As Peter Schweizer from the Hoover Institution so eloquently showed us in his book “Throw Them All Out,” many politicians accumulate significant wealth during their political tenure, despite coming into office with meager resources and salaries that can never accumulate to even a fraction of the wealth they accumulate by the time they retire from their political office. This means that in order for them to continue capitalizing on the back of the system, they must do all that’s necessary to make sure that it continues to function. This means that a real US debt default cannot even be a legitimate consideration, as it would collapse the banking system (worse than 2008) and lead to bank failures worldwide—as a result of the debt rating downgrades that would follow. These rating agency downgrades may not mean much to most people, but in the banking world, it’s the difference between being solvent, or under net capital requirements and shut down.
As much as we would all like to believe that the powers that be would not break our system because they care about us, it’s much more logical and comforting (in a strange way nonetheless) to know that they won’t break it because they care about themselves. For a more in depth discussion about how the debt ratings affect the international banking system, watch my Australian friend, and fellow fund manager, Marcel Von Pfyffer in his recent Switzer TV interview.
During the month, one of our top long positions (SunOpta) got quite a bit more coverage than it has in years. In fact, it was as if Wall Street finally decided to read the instructions I published on May 24th, 2013 about what it will take to make this solid company become the next Organic Food blockbuster stock. As SunOpta, Inc. (NASDAQ:STKL) (TSE:SOY)’s business continues to grow, their financial results have done all the talking, yet the stock is severely undervalued and underfollowed relative to its peers. The pouch division they started in the last 2 years will continue being their fastest growing business, with even higher margins than anticipated. We’re very happy that management continues to invest into it, and know that a large strategic acquisition is on management’s radar. This could be the next big game changer for the company, and Wall Street is taking notice. With 4 new analyst reports and one top fund manager at Gabelli mutual funds highlighting the company on CNBC as a top pick, in the last month, we’re please someone is finally listening to our simple instructions.
Here is the last article I published on it seekingalpha.com
Here is Beth Lilly of Gabelli Funds highlighting SunOpta, Inc. (NASDAQ:STKL) (TSE:SOY) as their top pick on CNBC
Our original full thesis published in December 21, 2012 was recently highlighted by SA as #1 performing idea. Click here seekingalpha.com
Our other top long idea (Advanced Micro Devices) got less attention during the month, albeit had bigger news the market doesn’t know what to make of. As we discussed in our July 2013 progress report, one of the biggest hidden catalysts that Advanced Micro Devices, Inc. (NYSE:AMD) has is its MicroServer division they acquired when they bought SeaMicro a couple of years ago. As cloud computing becomes more of a standard present and future plan for most large companies, Advanced Micro Devices, Inc. (NYSE:AMD) has been quietly working behind the scenes to develop new customized technologies with new partners.
Earlier this month, the SeaMicro unit signed the biggest deal in company history with the 800lbs gorilla, Verizon. The two have been working together for the last 2 years and have announced that Verizon’s Terremark unit has launched a new cloud computing infrastructure platform, using SeaMicro’s SM15000 high-density servers. This service will compete with the cloud services of the likes of Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT), and Oracle Corporation (NYSE:ORCL) etc. SeaMicro not only gives the company microserver technology not available anywhere else, but they also are able to sell these servers directly to their end customer, bypassing some of the hardware vendors. This two-punch combination should allow the company to increase its marketshare as well as profit margins. We have added to the fund’s long position in Advanced Micro Devices, and will likely continue to so long as market ignores what’s happening, and leaves the stock at the current depressed levels.
Verizon/AMD Deal Press Release:
One of our recent Short position additions to the fund is the company MercadoLibre. Mercadolibre Inc (NASDAQ:MELI) is a Latin-American e-commerce company which many bulls consider the “eBay of Latin America. “ This perception has led to the severe overvaluation of this approximately $400 million in Revenue Company— being valued at approximately $6 billion at its current price of $135 per share. eBay Inc (NASDAQ:EBAY), on the other hand:
- operates the world’s largest online marketplace in over 40 different markets,
- is expected to grow revenues 20% and generate $19 billion with $4 billion in operating income next year,
- Has a proven mainstream retail Buyer Protected platform that’s safe and unlike any other company in the world.
- Has a very transparent and clear financial statement that rarely gets questioned
- Oh, and let’s not forget they also own PayPal and a few other very lucrative businesses along with an 18.4% stake in MELI.
So let’s see how Mercadolibre Inc (NASDAQ:MELI) compares. To start, there’s a “slight” difference between eBay’s business plan and MELI’s, whereby MELI’s customer base have a significant focus on selling/buying “grey market” goods that are illegally imported. Oddly enough, this is being ignored by investors today. Since this strategy is impossible to execute with significant scale (at least not without having the feds setting up office space in the company’s headquarters), growth will hit a big wall in the near future, which could cause the growth rate of the $400 million Mercadolibre Inc (NASDAQ:MELI) to actually be lower than the $19 billion eBay Inc (NASDAQ:EBAY). This by itself should eliminate the “smaller, but faster growing” premium that is being applied to MELI shares in comparison to eBay Inc (NASDAQ:EBAY).
On the business front, we believe that bull investors are not only significantly overestimating the growth potential of this company, but also ignoring the inherent risk of doing business in countries like Argentina and Venezuela, which account to over 50% of the company’s earnings. The two countries have inflation of over 25%, and have consistently devalued their currency. The problems in Venezuela are even more troubling than Argentina in some regards. The Venezuelan government has devalued their bolivars’ currency 5 times in less than a decade. The most recent devaluation occurred in February, 2013 where the value was cut by 32%, to a fixed amount of 6.3 bolivars’/dollar. This pegged “official rate” is the one that MELI uses to report its financials. The only problem is that even this 6.3 conversion rate is imaginary. As if that weren’t enough, the Venezuelan government is also restricting MELI’s (and everyone else) ability to withdraw their money from the country’s banks. At first the government set limits to how much money can be taken out, but a complete rejection of any withdrawals has become a common event. This has led to unofficial conversion rates of as high as 45 bolivars’/dollar in some parts of the world, meaning it would take 7 times more bolivars to buy a US dollar than the rate MELI uses in their financials.
When I asked the company during one of their conference calls in February about these currency issues, the company said that they may be investing their Venezuelan currency into real estate in Venezuela. I am not sure how going from “somewhat inaccessible money that is depreciating regularly” to “completely illiquid investment that can only convert to somewhat inaccessible money that is depreciating regularly” is going to help MercadoLibre shareholders, but apparently someone thought this could work.
To finalize the currency issue in Venezuela, the company insists on using the 6.3 bolivars/dollar conversion rate in their earnings, which is clearly inflating earnings and revenues. This means that even their $400 million in revenues and growth generated are not what they seem, due to their selective accounting practice. Unlike hard to value assets that barters (in the picture below) use, MELI has its revenues and gross profits come in the form of cash. Therefore, the only conversion rate that should ever be used for “cash” is current conversion value. To clarify, by current conversion rate I mean how much can MELI realistically get right now if they wanted to convert all of the currency? What it should be worth, and what it could be worth is a nice gesture by management, but misguided to say the least. Just imagine if someone tried selling you a house based on some future projected value, or what I like to call “wishful thinking value.”
15 BROAD STREET, #3500, NEW YORK, NY 10005 ? DIRECT: 212.480.9175 ? TOLL FREE: 800.9.REUVEN ? FAX: 212.742.7011 ?
Another potentially problematic issue that MELI has is a pending regulatory lawsuit in Brazil—where nearly 50% of the company’s revenues come from—relating to their payment processing unit, MercadoPago (their version of PayPal). According to the company’s August 2013 10K filing, if the new law becomes enacted in its current form, it could force MELI to shut down the MercadoPago business indefinitely in order to avoid paying penalties for non compliance, as well as the infrastructure investment needed to comply with new regulation. Since the company does not have business liability or disruptions insurance coverage (per company’s Annual report filed February 2013), any litigation costs or business disruption caused by this lawsuit [or any other] could materially harm this company’s viability. Our sources tell us that over 70% of MELI buyers use MercadoPago to fund or to finance their purchases. Since the company typically deals with “subprime-type” customers, which have limited payment method options, this payment system is a critical part of the company’s infrastructure.
The more we dig into this company, the more red flags we find. In addition to competing the likes of eBay Inc (NASDAQ:EBAY) and Amazon—which is tough enough—the company has so many internal issues being ignored by investors that it’s hard to understand why the market is pricing their stock at such a premium of 12x projected sales. One thing we do know is that if trouble starts knocking on their door, none of their executives or key technical personnel will have to think twice about bailing out. Since none of them have an employment agreement with the company, and almost all option grants have become fully vested, there is little incentive for any of them to stick it out, or even keep the stock. Insider sales have run rampant by management across the board, with the CEO, Marcos Galperin, selling $37 million in stock just this past August.
To sum it up, here is what the MELI’s Venezuela & Argentina (and somewhat overall) business looks like in our minds
THE ROAD TO A SHORT SELL
To reiterate the point we made last month, despite the recent rise in the market, we still believe that there is an overwhelming amount of uncertainty and unintended consequences that could lead to a market decline of 15 to 25 percent at some point in the next 6 months. As we head into the 3rd quarter earnings season, we anticipate a large number of companies to lower earnings guidance, as the effects from the financial engineering executed in the last 12-24 months begin to wear off (see overview of financial engineering in August progress report). We are still in the early stage of this cause & effect circumstance, but believe that the market may begin to target specific large companies at first before having a market-wide effect.
Our prediction of a 15 to 25 percent decline in the US markets is something we anticipate will happen rapidly when it eventually happens. History has shown us that unlike bull markets, which tend to have incremental appreciation in prices over time, market declines (or as the politically correct media refers to as “market corrections”) usually occur in one quick swoop that feels more like running into a wall. It is because of this type of historical abrupt reaction to uncertainty that successful Short investments could provide a much larger return than a Long investment.
We believe that some of our long positions have enough catalysts, and earnings growth opportunities that will allow them to outperform the market in the long run. Irrespective of that, we continue to monitor valuation for each, and believe the discounted valuation each of these companies still has versus our estimated intrinsic value, serves as an additional hedge.
Lastly, we completed another month that helped us move in the right direction and continue to believe that our fund’s opportunity has never been better. We are here for you if or when you have any questions, and look forward to reporting to you next month.
For more information about the RCI fund, or to get our most recent presentation, please email us at info@ReuvenCapital.com or contact us at 212.480.9175.
All the best,
Reuven Capital Investments LP
THE REUVEN CAPITAL INVESTMENTS concentrated long/short equity fund with a shareholder activism focus.