Kase capital-q1-2013


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Kase capital-q1-2013

  1. 1. Whitney R. Tilson phone: 212 277 5606Managing Partner WTilson@KaseCapital.comApril 3, 2013Dear Partner:Our fund is off to a solid start to the year, rising 6.7% in the first quarter vs. 10.6% for the S&Pand 11.9% for the Dow.The fund s returns were driven by nice gains across most of the long portfolio, with a specialmention for Netflix, which more than doubled. Here is the Q1 performance of all 11 long stockpositions in the fund as of the beginning of the year (disclosed in the 2012 annual letter), plustwo new stocks I bought during the quarter (ranked in descending order of current size): 1. AIG 10.0% 2. Berkshire Hathaway 16.6% 3. Howard Hughes 14.8% 4. Deckers 34.9%* 5. Citigroup 11.8% 6. Goldman Sachs 15.4% 7. Netflix 104.4% 8. Canadian Pacific 28.4% 9. dELiA*s -15.4% 10. Iridium -10.3% 11. Grupo Prisa (B) 16.0% 12. Sears Hometown & Outlet Stores -5.2%* 13. Spark Networks -9.7%* Performance since the position was established. Note that this excludes two private placements in Spencer Holdings and theJapan side fund.The two headwinds to the portfolio during the quarter (both discussed below) were cash, whichcomprised about a third of the fund, and the short book, which averaged approximately 20% ofthe fund. The fund is currently 66% long and 22% short.Two New Long Positions: Deckers and Sears Hometown & Outlet StoresI m pleased that I was able to identify two compelling new stocks to add to our portfolio duringthe quarter a satisfactory pace in light of the complacent market in which the major indices arenear all-time highs.DeckersDeckers is best known for its UGG brand, which accounted for 95% of sales last quarter. Thebrand has been around since California surfers started wearing UGG boots in the late 1970s, butUGGs really became a fashion trend (some would say a fad) a few years ago, which resulted inthe stock soaring nearly 10-fold from early 2009 to late 2011, peaking at close to $120. And then Carnegie Hall Tower, 152 West 57th Street, 46th Floor, New York, NY 10019
  2. 2. the bottom fell out. The company reported steadily worse results as 2012 progressed and thestock plunged to under $30 by the end of last October.Even at its low point, however, the company was not only profitable, but had double-digit profitmargins, high returns on equity, and a strong balance sheet, so the question for investors was: areUGGs a fad that will largely disappear (think Heelys), as the many people who are short thestock believe (short interest was 40.5% of the float as of 3/15/13), or will UGGs prove to be anenduring brand that s simply encountered some short-term turbulence? If so, then the stockwhich was around $40 when I was analyzing the company two months ago trading at just over10x depressed earnings, was a bargain.The company attributed its weak results to three primary factors: 1. One of the warmest winters ever in 2011; 2. The price of sheepskin (the primary raw material in UGG boots) rising 80% due to floods in Australia that decimated sheep herds; and 3. The economic weakness in Europe.These are all true statements but was the company just making excuses to cover up the fact thatthe fad had passed and nobody wanted to wear UGGs anymore? To answer this question, Idesigned a survey (click here to see it) and sent it out to my various email lists. The 274responses (posted here) I received were very revealing: 60% of respondents owned UGGs classic sheepskin boots, 48% owned more than one UGGs product, and 78% had owned an UGGs product for at least two years. When asked how highly they would recommend UGGs to a friend (on a scale of 1-10), 25% gave UGGs a perfect 10 and an additional 45% rated UGGs 7-9. 70% said they were certain (25%) or likely (35%) to buy UGGs again. These are satisfied customers. When asked whether they view their Uggs more as a fashion product or a utilitarian/functional product, 74% said the latter, and when asked how their views about Uggs changed over the past year, 65% said no change, 20% said more positive, and only 15% said more negative. These responses are not consistent with a fad product that s going away.The comments in the open response part of the survey also reinforced my thesis that mostcustomers love their UGGs and would continue to buy, wear, and recommend them.The survey was the final piece of evidence that confirmed my investment thesis that, whileUGGs may have become faddish for a while, the core brand and products were strong andDeckers was mostly suffering from short-term issues, so I purchased the stock, which has risen34.9% in the two months since then.Sears Hometown & Outlet StoresI also added Sears Hometown & Outlet Stores (SHOS) to the portfolio during the quarter. LastOctober, Sears Holdings spun off SHOS, which is comprised of four divisions: -2-
  3. 3. Sears Outlet: 127 warehouse style stores, all but three of which are company owned, selling mostly scratched, dented, refurbished and old model appliances at steep discounts; $564 million in sales and $42.1 million in operating income in 2012; Sears Hometown Stores: 943 stores, all but one operated by franchisees, selling mostly appliances, lawn & garden, and tools, typically in small, rural markets (average store size: 8,500 sq. ft.) in all 50 states, Puerto Rico and Bermuda; Sears Hardware Stores: 90 stores in 16 states, 33 company owned, 57 franchised, selling similar merchandise as Hometown stores, but in bigger markets (average store size: 28,000 sq. ft.), similar to ACE Hardware; Sears Home Appliance Showrooms: 85 stores in 22 states, 27 company owned, 58 franchised, selling strictly appliances in a 5,000 sq. ft. showroom.The latter three, under the Sears Hometown and Hardware segment, had sales of $1.9 billion andoperating income of $57.4 million in 2012.This might not sound like a good business, but keep in mind that 85% of the company s 1,245total stores are franchised, meaning the franchisees put up the money and do the hard work,while the SHOS simply collects a royalty on all this effort an excellent business.SHOS has strong growth potential management has indicated that the company could morethan double its store count to 3,000 stores. As an independent company, management now hasappropriate incentives, and SHOS is also benefitting from Sears closing large numbers of itsmainline stores (it closed 1,462 stores in FY 2012, 36% of its total). In fact, given that Sears scontrolling shareholder and CEO, Eddie Lampert, owns a 62% stake in SHOS (larger thanLampert s 56% stake in Sears itself), it appears that Lampert may be quietly adopting a strategyof closing unprofitable full-size Sears stores and effectively transferring to SHOS the sales (andprofits) of Sears s best businesses, its appliances and other hard goods sold under top brands likeKenmore and Craftsman. If so, this will provide a substantial long-term tailwind to SHOS, asSears had $40 billion in sales in 2012 vs. only $2.5 billion for SHOS.If SHOS is such an attractive company, why is it only my 12th largest position (approximately2%)? The answer is valuation. By the time I discovered this investment, the stock had run upfrom under $30 at the time of the spinoff to over $40, leaving less margin of safety. At its currentprice of $40, the company has an enterprise value of around $1 billion vs. 2012 operating incomeof $99.5 million and adjusted EBITDA of $109.8 million. I think earnings will growsubstantially in years to come, so 9x trailing EBITDA is a reasonable multiple, but it s not cheapenough to make it a full position so I ve established a starter position and am hoping the marketgives me the opportunity at some point to buy a lot more at a better price.Short BookHere is the first quarter performance of the three shorts I disclosed in my 2012 annual letter: 1. InterOil 37.1% 2. K-12 18.0% 3. Nokia -17.0% -3-
  4. 4. Their performance was quite representative of the 10 stocks that comprise our current short book while a few worked, most ran up along with the market. I remain highly confident that everyone of our short positions is vastly overvalued and there are catalysts that will cause the stocks totumble, but over a short period when the market is ripping upward and complacency abounds,our short book is going to be a headwind.Thoughts on Q1 Performance, Risks, and the Sustainability of Corporate Profit M arginsIn the first sentence of this letter, I describe our Q1 performance as solid. In light of the factthat our fund trailed the major indices, some might challenge this view, so allow me to explain.First and foremost, my goal is to preserve capital and, secondly, to earn a satisfactory rate ofreturn. I achieved both of these objectives in Q1 hence the word solid. In general, our fundwill likely not keep up with the market when it is rising rapidly because I usually hold some cashand always have a decent-sized short book.This is not an ideal environment for a value investor like me because to find wonderful bargainsit helps to have some distress in the market or at least some area of the market but there svery little of this today. The major indices are at or near all-time highs and, for example, theVIX, a volatility measure of the S&P 500, dropped 30% during the first quarter. Nevertheless,I spend almost all of my time doing bottoms-up analysis of companies and industries, but as Iconstruct the overall portfolio and determine how aggressively or conservatively to position thefund, I am guided by Buffett s simple maxim: Be fearful when others are greedy and greedywhen others are fearful. ck market bubble (the bond market isanother matter!), but our fund is quite conservatively positioned right now because valuations arefull, complacency is high, and bargains are scarce and there are plenty of things that couldchange this. In addition to the usual risk factors (a tepid economy recovery in the U.S., possiblydependent on unsustainable money printing and deficit spending; the ongoing recession inEurope; a potential mother-of-all-real-estate/infrastructure bubbles bursting in China; and abankrupt Japan), who was even thinking about the risks associated with Cyprus or war breakingout on the Korean Peninsula until very recently? Donald Rumsfeld well.The critical question for U.S. stocks is whether corporate profit margins can remain at today sall-time-high levels. This chart shows profit margins (before depreciation, interest, and tax, as apercent of output) going back to 1929: -4-
  5. 5. As you can see, historically, when margins have peaked, they ve soon reverted to the mean. Ifthis happens again, stocks could be in for some rough sledding. If so, I believe we are wellpositioned to take advantage due to our significant cash balance and relatively low marketexposure.Privacy Policy and Updated Form ADVOnce a year, we are required to send you a copy of our Privacy Policy, so it s attached inAppendix A. In addition, our latest Form ADV is posted at: www.tilsonfunds.com/ADV.pdf.ConclusionThank you for your confidence and support. If you have any comments or questions, please callme anytime on my cell phone at (646) 258-0687.Sincerely yours,Whitney Tilson -5-
  6. 6. The unaudited return for the Kase Fund versus major benchmarks (including reinvesteddividends) is: Q1 Since InceptionKase Fund net 6.7% 124.7%S&P 500 10.6% 65.7%Dow 11.9% 121.6%Past performance is not indicative of future results. Please refer to the disclosure section at the end of this letter. The Kase Fundwas launched on 1/1/99. Kase Fund Performance (Net) Since I nception 200 180 160 140 120 100 (% ) 80 60 40 20 0 -20 -40 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Kase Fund S& P 500Past performance is not indicative of future results. Kase Fund M onthly Performance (Net) Since I nception 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Kase S& P Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500 Fund 500January 7.8 4.1 -6.3 -5.0 4.4 3.6 -1.8 -1.5 -5.5 -2.6 4.7 1.8 1.1 -2.4 1.9 2.7 2.4 1.7 1.9 -5.9 -3.6 -8.4 -1.6 -3.6 -2.8 2.4 12.6 4.5 4.5 5.2February -2.9 -3.1 6.2 -1.9 -0.6 -9.2 -1.1 -2.0 2.9 -1.6 7.0 1.5 2.1 2.0 -3.1 0.2 -3.3 -2.1 -6.9 -3.3 -8.9 -10.8 7.3 3.1 4.1 3.4 -0.8 4.3 0.8 1.4M arch 4.1 4.0 10.3 9.8 -2.6 -6.4 3.0 3.7 1.4 0.9 3.9 -1.5 3.9 -1.7 3.9 1.3 -0.8 1.1 -2.3 -0.5 2.9 9.0 4.6 6.0 -4.1 0.0 10.9 3.3 1.3 3.8April 2.1 3.7 -5.1 -3.0 5.1 7.8 -0.2 -6.0 10.5 8.2 2.4 -1.5 0.6 -1.9 2.2 1.4 4.4 4.6 -0.9 4.9 20.1 9.6 -2.1 1.6 1.9 3.0 1.3 -0.6M ay -5.7 -2.5 -2.8 -2.0 1.8 0.6 0.0 -0.8 6.6 5.3 -1.4 1.4 -2.6 3.2 1.8 -2.9 2.5 3.3 7.9 1.2 8.1 5.5 -2.6 -8.0 -1.9 -1.1 -13.6 -6.0June 2.2 5.8 4.1 2.4 4.6 -2.4 -7.3 -7.1 2.9 1.3 0.1 1.9 -3.1 0.1 -0.2 0.2 -3.0 -1.5 -1.2 -8.4 -5.0 0.2 4.5 -5.2 -2.4 -1.7 0.5 4.1July -0.7 -3.2 -3.6 -1.6 -1.1 -1.0 -5.0 -7.9 2.3 1.7 4.6 -3.4 0.5 3.7 -0.9 0.7 -5.4 -3.0 -2.5 -0.9 6.8 7.6 3.5 7.0 -4.6 -2.0 0.2 1.4August 4.1 -0.4 5.4 6.1 2.5 -6.3 -4.3 0.5 0.4 1.9 -0.9 0.4 -3.2 -1.0 2.9 2.3 1.7 1.5 -3.3 1.3 6.3 3.6 -1.5 -4.5 -13.9 -5.4 -7.2 2.3September -3.3 -2.7 -7.2 -5.3 -6.1 -8.1 -5.4 -10.9 1.7 -1.0 -1.6 1.1 -1.5 0.8 5.0 2.6 -1.1 3.6 15.9 -9.1 5.9 3.7 1.7 8.9 -9.3 -7.0 0.0 2.6October 8.1 6.4 -4.5 -0.3 -0.8 1.9 2.8 8.8 6.2 5.6 -0.4 1.5 3.5 -1.6 6.3 3.5 8.2 1.7 -12.5 -16.8 -1.9 -1.8 -1.7 3.8 7.0 10.9 1.6 -1.9November 2.8 2.0 -1.5 -7.9 2.3 7.6 4.1 5.8 2.2 0.8 0.8 4.0 3.1 3.7 1.9 1.7 -3.6 -4.2 -8.9 -7.1 -1.2 6.0 -1.9 0.0 -0.6 -0.2 -4.5 0.6December 9.8 5.9 2.3 0.5 6.5 0.9 -7.4 -5.8 -0.4 5.3 -0.2 3.4 -1.3 0.0 1.4 1.4 -4.3 -0.7 -4.0 1.1 5.5 1.9 0.5 6.7 0.1 1.0 0.1 0.9YTD 31.0 21.0 -4.5 -9.1 16.5 -11.9 -22.2 -22.1 35.1 28.6 20.6 10.9 2.6 4.9 25.2 15.8 -3.2 5.5 -18.1 -37.0 37.1 26.5 10.5 15.1 -24.9 2.1 -1.7 16.0 6.7 10.6TOTALPast performance is not indicative of future results.Note: Returns in 2001, 2003, and 2009 reflect the benefit of the high-water mark, assuming an investor at inception. -6-
  7. 7. Appendix A PRI VACY POLI CYThis privacy policy explains the manner in which the Partnership, the General Partner and theInvestment Manager (collectively, the Partnership ) collect, utilize and maintain nonpublicpersonal information about the Partnership s investors, as required under Federal legislation.Collection of I nvestor I nformationThe Partnership collects nonpublic personal information about its investors mainly through thefollowing sources: Subscription forms, investor questionnaires a nd other information providedby the investor in writing, in person, by telephone, electronically or by any other means. Thisinformation includes name, address, nationality, tax identification number and financial andinvestment qualifications; and transactions within the Partnership, including account balances,investments and withdrawals.Disclosure of Nonpublic Personal I nformationThe Partnership does not sell or rent investor information. The Partnership does not disclosenonpublic personal information about its investors to nonaffiliated third parties or to affiliatedentities, except as permitted by law. For example, the Partnership may share nonpublic personalinformation in the following situations: To service providers in connection with the administration and servicing of the Partnership, which may include attorneys, accountants, auditors and other professionals. The Partnership may also share information in connection with the servicing or processing of Partnership transactions; To 3rd party marketing firms who have been engaged by the Investment Manager to raise assets for the Partnership. Any information provided to a 3rd party marketing firm would be limited to name and basic contact information. To affiliated companies in order to provide you with ongoing personal advice and assistance with respect to the products and services you have purchased through the Partnership and to introduce you to other products and services that may be of value to you; To respond to a subpoena or court order, judicial process or regulatory authorities; To protect against fraud, unauthorized transactions (such as money laundering), claims or other liabilities; and Upon consent of an investor to release such information, including authorization to disclose such information to persons acting in a fiduciary or representative capacity on behalf of the investor.If you elect to opt-out and do not want us to share your non-public personal information otherthan when required to perform normal services or when required by law, please contact us at:Carnegie Hall Tower, 152 West 57th Street, 46th Floor, New York, New York 10019, Ph: (212) -7-
  8. 8. 277-5606 or by email: kalires@kasecapital.com.Protection of I nvestor I nformationThe Partnership s policy is to require that all employees, financial professionals and companiesproviding services on its behalf keep client information confidential.The Partnership maintains safeguards that comply with federal standards to protect investorinformation. The Partnership restricts access to the personal and account information of investorsto those employees who need to know that information in the course of their job responsibilities.Third parties with whom the Partnership shares investor information must agree to followappropriate standards of security and confidentiality.The Partnership s privacy policy applies to both current and former investors. The Partnershipmay disclose nonpublic personal information about a former investor to the same extent as for acurrent investor.Changes to Privacy PolicyThe Partnership may make changes to its privacy policy in the future. The Partnership will notmake any change affecting you without first sending you a revised privacy policy describing thechange. -8-
  9. 9. The T2 Accredited Fund, LP (dba the Kase Fund) (the Fund ) commenced operations on January 1,1999. The Fund s investment objective is to achieve long-term after-tax capital appreciationcommensurate with moderate risk, primarily by investing with a long-term perspective in a concentratedportfolio of U.S. stocks. In carrying out the Partnership s investment objective, the Investment Manager,T2 Partners Management, LP (dba Kase Capital Management), seeks to buy stocks at a steep discount tointrinsic value such that there is low risk of capital loss and significant upside potential. The primaryfocus of the Investment Manager is on the long-term fortunes of the companies in the Partnership sportfolio or which are otherwise followed by the Investment Manager, relative to the prices of theirstocks.There is no assurance that any securities discussed herein will remain in Fund s portfolio at the time youreceive this report or that securities sold have not been repurchased. The securities discussed may notrepresent the Fund s entire portfolio and in the aggregate may represent only a small percentage of anaccount s portfolio holdings. The material presented is compiled from sources believed to be reliable andhonest, but accuracy cannot be guaranteed.It should not be assumed that any of the securities transactions, holdings or sectors discussed were or willprove to be profitable, or that the investment recommendations or decisions we make in the future will beprofitable or will equal the investment performance of the securities discussed herein. Allrecommendations within the preceding 12 months or applicable period are available upon request. Pastresults are no guarantee of future results and no representation is made that an investor will or is likely toachieve results similar to those shown. All investments involve risk including the loss of principal.Performance results shown are for the Kase Fund and are presented net of all fees, including managementand incentive fees, brokerage commissions, administrative expenses, and other operating expenses of theFund. Net performance includes the reinvestment of all dividends, interest, and capital gains.The fee schedule for the Investment Manager includes a 1.5% annual management fee and a 20%incentive fee allocation. For periods prior to June 1, 2004 and after July 1, 2012, the InvestmentManager s fee schedule included a 1% annual management fee and a 20% incentive fee allocation. Inpractice, the incentive fee is earned on an annual, not monthly, basis or upon a withdrawal from theFund. Because some investors may have different fee arrangements and depending on the timing of aspecific investment, net performance for an individual investor may vary from the net performance asstated herein.The return of the S&P 500 and other indices are included in the presentation. The volatility of theseindices may be materially different from the volatility in the Fund. In addition, the Fund s holdings differsignificantly from the securities that comprise the indices. The indices have not been selected to representappropriate benchmarks to compare an investor s performance, but rather are disclosed to allow forcomparison of the investor s performance to that of certain well-known and widely recognized indices.You cannot invest directly in these indices.This document is confidential and may not be distributed without the consent of the Investment Managerand does not constitute an offer to sell or the solicitation of an offer to purchase any security orinvestment product. Any such offer or solicitation may only be made by means of delivery of an approvedconfidential offering memorandum. -9-