Blog@Motiwala Capital

Dec 2011 Report

Dear Friends,

This is our quarterly letter to clients for the period from October 2011 to December 2011. Global equity markets remained extremely volatile during this period just like the rest of the year.

Portfolio activity

We had a very busy quarter by our standards. We took on twelve new positions in the quarter – 3 regular positions and 9 special situations. We discuss all these positions below. Two portfolio companies (Bolt and Vodafone) declared special dividends. Bolt paid out a spectacular $1 per share special dividend on a $10 stock at the time. Shares appreciated nicely since the dividend was announced. We reduced our position size in Microsoft and also reduced our position in Western Digital as the stock appreciated significantly from the lows and allowed us to scale down this position to a more regular size. After these trades, we feel comfortable with the sizing of all existing positions.

Generals: 3 new positions

Becton, Dickinson and Company (BDX) is a medical technology company. It develops, manufactures and sells medical devices, instrument systems and reagents worldwide. BDX had sales of $7.8 billion and generated free cash flow (FCF) of $1.2 billion. BDX had a market cap of $15.2 billion and traded at around 12x trailing twelve month FCF.

CSG International (CSGS) provides outsourced customer care and billing solutions to the cable, satellite and telecommunication industry worldwide. CSGS had sales of $700 million and generated $90 million in annual FCF over the last five years. While CSGS has about $200 million in net debt, it is well covered with its recurring revenue base and profitability. In two years, CSGS should have the ability to pay down the debt. CSGS trades at a 7x normalized FCF multiple.

Gravity (GRVY) is a tiny Korean game developer that offers multiplayer online games, casual and social games. The main game is Ragnarok Online that was a success but its next generation game has been delayed for several years now. While investors have been disappointed, at the price we took the position we feel there is limited downside. Shares trade significantly below cash and securities held on the balance sheet.

Merger arbitrage

We did not participate in any new merger arbitrage positions in the quarter. We closed the existing positions in KCI and MMI for 4% and 3% gains respectively. We also received cash for our arbitrage position initiated in the 2nd Quarter in SHMR. While there was extra paper work and delay involved in this position, the end result was a 5% gain.

Closed end fund tenders – 3 positions, all closed.

Closed end funds Asia Pacific Fund (APF) and Malaysia Fund (MAY) allowed us a second chance to tender shares in the year. We participated again and earned 8.8% and 3.2% for tendering our shares. We participated in a third tender for Neuberger Berman Real Estate (NRO) and earned 10% for the tender.

Share tenders – 4 positions, 2 closed, 2 active

Another new area of investment for us this quarter was cash tenders for shares. This is similar to the closed end fund tenders above. However, in this case the underlying investments were equity positions v/s closed end funds. We participated in four such cash tenders. We successfully tendered and received cash payment for CRFN for a 5.5% gain. We also tendered shares of MCCK and the press release indicates a 13.6% gain on our position, for which we await payment. Two other tenders are in progress and we will disclose their outcome in our next report.

Dual share Class arbitrage – 2 positions, both closed.

Some companies have multiple share classes listed in the market. Differences between them are usually related to the number of votes per share and liquidity differences. This was a new area for us and we experimented with long short positions in the dual classes of Viacom and Heico Corp. The cost of borrowing for Viacom was much higher than we would have liked and we closed the position for a 2.5% loss. On the other hand, we closed the position in Heico for a 4% gain.

2011 performance

Out of the total 13 general investments, we only had one real disappointment in Aeropostale (-37%). Our biggest winners were GameStop (22%), Gravity (+21%), Big Lots (+17%), Conrad Industries (14%), Abbott Labs (12%) and Vodafone (11%). The rest of our positions have small gains or losses. In addition, 13 of the 14 special situation investments were profitable and positively impacted our portfolio returns.

We would like to thank each of you for placing your trust in us. I wish everyone a prosperous and happy new year.

Adib Motiwala
Portfolio Manager
Motiwala Capital

September 2011 Report

Dear Friends,

This is our second quarterly letter to our clients for the period from July 2011 to September 2011.
Global equity markets remained extremely volatile during the period. Events such as the delay in raising the US debt ceiling, speculation about the potential default by Greece, contagion worries in other European countries and a slowing US economy were at the fore front of investors’ minds.

Portfolio activity

We made seven new purchases in the quarter – 3 regular positions and 4 merger arbitrage positions. We also added to our position in Vodafone. We closed 2 of the 4 merger positions by the end of the quarter as discussed below.

Big Lots (BIG) is the largest closeout retailer of America. In FY 2011, sales were $4.9 billion generating free cash flow (FCF) of $200 million. BIG had $284 million cash on its balance sheet and an enterprise value of $2100 million. BIG traded at under 10x trailing twelve month FCF.

Vodafone (VOD) is the one of the largest telecommunication and mobile company in the world with more than 370 million customers in 30 countries with annual revenues of 45 billion pounds. We purchased ADRs (1 ADR = 10 shares) listed in the US. VOD owns 45% stake in Verizon wireless (Verizon Communications owns the rest). Verizon wireless produces tremendous cash flows but had not paid a dividend to its owners since 2005 as it was paying down debt from a previous acquisition. As the debt would be paid off, Verizon Wireless would have to pay a dividend to VOD which could be used to increase the dividend to VOD shareholders. Shortly after we made our purchase, Verizon Wireless declared a dividend of $10 billion ($4.5 billion to VOD) that would be payable to its owners in Jan 2012. In turn VOD intends to pay a special dividend of 2 billion pounds ($3 billion of the $4.5 billion) to shareholders in Feb 2012. VOD has an enterprise value of $186 billion. VOD generated free cash flow of $12 billion last year and paid a dividend of $6.9 billion. If we add the $4.5 billion payout from Verizon Wireless, the FCF would amount to $16.5 billion. At our average purchase price $26, VOD was trading at about 11 times FCF. The dividend (9 pence regular + 4 pence special dividend) amounts to a 7.7% yield.

Bolt Technology (BOLT) is a tiny company that makes equipment to conduct seismic surveys for the oil and gas industry. The cost of seismic surveys is a small percent of the exploration and production effort. Bolt had $32 million on its balance sheet in a market cap of $100 million. Our estimate of normalized FCF for Bolt is about $7 million. Bolt was purchased at 10 times our estimate of FCF. We feel that if oil prices remain over $70 a barrel, there would be continued spending on finding offshore oil and gas reserves which should benefit Bolt.

Conrad Industries (CNRD) operates four shipyards and constructs and repairs marine vessels for commercial and government customers. Conrad is operated by the founder family. CNRD had $31 million cash on its balance sheet in a market cap of $83 million. Sales dropped during
the recession to $139 million from a peak of $190 million in 2008. Sales and the backlog have since rebounded and CNRD produces good free cash flow. CNRD trades at around 6x 2010 FCF and at 1x tangible book value.

UFP Technologies (UFPT) engages in the design and manufacture of engineered packaging solutions for medical and scientific, automotive, aerospace and defense, computer and electronics, industrial and consumer markets. UFPT also sports a strong balance sheet with $21 million in net cash in a market cap of $105 million. UFPT produced FCF of $9 million in 2010 and trades at sub 10x FCF.

Abbott Labs (ABT) is a large diversified health care company that operates in four segments: Pharmaceuticals, Diagnostic products, Nutritional Products and Vascular products. ABT has made several acquisitions in emerging countries such as India and hopes to increase revenues from these countries dramatically over the next few years. ABT has an enterprise value of $89 billion and produced FCF of $8 billion in the last twelve months. ABT was purchased at 11x FCF and sports a 3.8% dividend yield.

Merger arbitrage: Despite a volatile and uncertain market, merger activity was strong in the quarter. We participated in 4 merger transactions.

Varian Semiconductor (VSEA) is being acquired by Applied Materials. Blackboard (BBBB) and Kinetic Concepts (KCI) are being acquired by Private Equity groups. Motorola Mobility (MMI) is being acquired by Google.

At the time of the announcements for the above deals, the spreads were much narrower and we did not participate in the transactions. However, during the extreme volatility in August and September, the spreads between the market price and the purchase price for these transactions widened considerably (from 3-4% to almost 10%). It was our good fortune that we had considerable cash in our accounts and we opportunistically took 3-5% positions in our accounts. As the spreads reduced below 2%, we exited the positions in VSEA and BBBB for 6% and 5% gains respectively (and a much higher IRR). We deployed the capital into the KCI and MMI transactions as the spreads remained attractive. We find these transactions quite attractive as they have a low correlation with the rest of the market. While each position by itself does not make a big contribution in absolute returns, due to the much shorter holding period, we can cycle many such opportunities to produce attractive returns.

Thank you for your continued support and confidence.

Adib Motiwala
Portfolio Manager
Motiwala Capital