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Jan 29 15

CSC Strategy Letter | Number 19 | The Great Complacency…Continued

by Cove Street Capital

CLICK HERE to download Cove Street Capital’s January 2015 Strategy Letter Number 19, “The Great Complacency…Continued”

Jan 8 15

The Reluctant Warriors

by Cove Street Capital

A friend of ours who works for a well-known activist firm summed it up perfectly when he said, “We are living in the era of the activist halo.” From 300-page PowerPoint presentations to incredible revelations about the amount of salt that should be included in pasta water to investors who own 20,000 shares asking for Board seats, there has been a proliferation of “activist” activity.

Some of this is good, some of this is bad as Wall Street is just like Hollywood – take a fundamentally good idea and ruin it with ten successively dismal iterations. As a “guideline,” it’s not for us. Successful investment is all about the “investment.” Activism is about the time horizon. We always welcome being right sooner than later, but the beauty about investing for a living is the ability to be left alone and think, pick good combinations of business model, valuation and people, and then let compounding work for you without the “need” to be public and hire lawyers. It’s solid indoor work with no heavy lifting.

But the fun thing about investment life is that it is usually better to live by guidelines—an indication or outline of policy or conduct—rather than hard rules, given that the only “rule” outside of unimpeachable ethics and integrity, is that the future remains uncertain.

So we have joined with our new partners at SpringOwl Asset Management, formed a legal “group,” and have filed what is now a very public 13-D with the SEC which includes our letter to shareholders. We now own 7% of the shares outstanding.

How in the world did we get here? Let’s start with a little background. Cove Street is unabashedly a “suggestivist” firm. That means that we do not hesitate—when it is warranted—to privately make suggestions to management teams and board members regarding the proper way to allocate shareholders’ capital. Think of it as being at a dinner party and your significant other says something flagrantly unattractive about you. The correct posture (or so I have been told) is to wait until you are in the car on the way home until you let them have it. This also applies to business.

Over the last 2 years that is exactly the strategy we used to engage with the senior management team and members of the Board of Forestar. We saw/see a very cheap stock but with serious capital allocation flaws and governance issues that are “easily” remedied. We sent a number of letters that questioned the company’s decision to become an oil and gas operating company (well before the oil price cratered) as well as a number of its corporate governance policies. We also had a number of phone discussions and face-to-face meetings in which we tried to constructively discuss Forestar’s compensation practices, real estate strategy, and capital spending plans.

We got pretty much nowhere, and in fact we lost per share value through dilutive transactions…until we filed our 13-D with SpringOwl. Then the knee-jerk reactions starting coming public with a directionally correct bias—a motion to unstagger the board (though it would take 3 years), a share repurchase (not sure if now is the time), firing the oil and gas guy and looking hard at that direction (way late and not near fast enough), and hiring Goldman Sachs (again) to review “strategic alternatives.”

But what is missing is arguably our most important point—the same group of people that have run this stock into the ground are the group that shareholders are supposed to be counting on to now make the right decisions at a crucial juncture for the company. We think that is a very low probability.

At the end of 2014, we more or less “got the Heisman” on any suggestion of change on this front…and we were essentially forced to take our message to all shareholders.

I think this letter from another investor in another company is a very long but well said version of the following: this is not what we set out to do, but it is doable and it is in the best interests of our partners. We have paired with the folks at SpringOwl who have both skin in the game and a lot of prior experience in the corporate governance arena, which minimizes our learning curve and time commitment. Judging from the overwhelming number of supportive calls and emails we have gotten since we filed, I think we are very much on the right track here.

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The opinions expressed herein are those of Cove Street Capital, LLC and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Consider the investment objectives, risks and expenses before investing. The information in this presentation should not be considered as a recommendation to buy or sell any particular security and should not be considered as investment advice of any kind. You should not assume that the security discussed in this report is or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the security discussed in this presentation. The report is based on data obtained from sources believed to be reliable but is not guaranteed as being accurate and does not purport to be a complete summary of the available data.Recommendations for the past twelve months are available upon request. In addition to clients, partners and employees or their family members may have a position in security mentioned herein. Cove Street Capital, LLC is a registered investment advisor. More information about us is located in our ADV Part 2, which is available upon request.

 

 

Dec 18 14

Reading Disorder

by Cove Street Capital

A senior member of our investment team read this transcript and couldn’t help but replace the words “investment management” in lieu of the subject being discussed. Worth reading and thinking about.

 

Dec 2 14

What a Phony, Part II

by Cove Street Capital

Click here for Part IThe Worst Piece of Corporate BS, 2/11/2013

A recent article in the Wall Street Journal penned by Michael Dell is so full of self-serving garbage it is difficult to know where to start. (Click here to go to the op-ed at WSJ.) What is clear in most companies is that the fish rots from the head and Dell’s decade of miscues—led by Michael Dell and his hand-chosen successors— brought it to a position of miserable valuation, investor apathy, and then finally investor activism…not the other way around as Mr. Dell implies.

If a company clearly delineates a course of strategic investment, provides clear accounting into how results of this investment are measured, and most importantly, provides accountability if money is wasted, then it will attract an intelligent group of long-term shareholders who will properly discount the detraction from short-term earnings. That might explain the “sage” ability of investors to value the hundreds of billions of dollars invested in life science research which are almost by definition difficult to handicap, not to mention the hundreds of billions of dollars of market value accorded to any variety of seemingly overvalued (by our standards) technology companies. While there is “bad” activism, there is equally disastrous capital allocation by entrenched management teams. The two extremes deserve each other and somehow life manages to go on.

I have listened to a dozen thoughtful CEO’s who tell me they “love” buying companies from private equity because they know that many have been starved for capital for innovation and growth and blossom once given a chance. Michael Dell apparently didn’t have enough of a tough skin to address shareholders like adults and admit any variety of corporate mistakes that plagued Dell in the midst of an admittedly tough period for his industry. Instead, he took advantage of his inside ownership and the canniness of one of the great short-term public/private traders—Silver Lake Partners—to push a short-term trade on his public investors. I dread the hubris that spews from their mouths when they file to go public again.

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The opinions expressed herein are those of Cove Street Capital, LLC and are subject to change without notice. Past performance is not a guarantee or indicator of future results. Consider the investment objectives, risks and expenses before investing. The information in this presentation should not be considered as a recommendation to buy or sell any particular security and should not be considered as investment advice of any kind. You should not assume that the security discussed in this report is or will be profitable, or that recommendations we make in the future will be profitable or equal the performance of the security discussed in this presentation. The report is based on data obtained from sources believed to be reliable but is not guaranteed as being accurate and does not purport to be a complete summary of the available data.Recommendations for the past twelve months are available upon request. In addition to clients, partners and employees or their family members may have a position in security mentioned herein. Cove Street Capital, LLC is a registered investment advisor. More information about us is located in our ADV Part 2, which is available upon request.

 

 

Nov 11 14

Does This Make it Impossible for a Value Investor to Have a Beard?

by Cove Street Capital

CLICK HERE to download “The hipster effect: When anticonformists all look the same” by Jonathan Touboul

Oct 17 14

All That is Necessary for the Triumph of Incompetence is That Good Men Do Nothing

by Cove Street Capital

This is a very nicely done and thoughtful piece about a topic that every serious long term shareholder eventually faces despite best intentions.

CLICK HERE to download PDF

Oct 2 14

CSC Strategy Letter | Number 18 | Metastability?

by Cove Street Capital

CLICK HERE to download Cove Street Capital’s September 2014 Strategy Letter Number 18, “Metastability”

Sep 29 14

Buyback BS

by Cove Street Capital

Of the myriad of reasons proffered daily as to why we are the verge of stock market doom, a “decline in share repurchase” has come up a lot. We would note the following:

As the below chart suggests, shares outstanding for most of the S&P 500 as a whole have not changed in a decade. Material share repurchase that actually reduces shares outstanding is not the majority rule. If it has been the prop for the market going up, it will not be the reason for a decline.

So where do all these hundreds of billions of dollars of share repurchase go as a whole? It is a correct statement that many Boards and management simply don’t understand the corporate finance behind effective share repurchase and use it to disguise the very high cost of dilution to shareholders from aggressive compensation programs. See the chart again.

Boards and management are like many investors — they buy at the top when they are “confident” and freeze at the bottom when things are “uncertain.” Sad but true and very difficult in practice to change. It is tough to say en masse that share repurchase “signals” anything anymore as it has become so widely used as a PR prop.

What an intelligent share repurchase plan does is buy small pieces of a business below a reasonable estimate of intrinsic value. When pursued like this, there is no debate — how can you argue with its logic? As a secondary effect, how can you argue with using free cashflow to return cash to shareholders and enable those who stay to own more and more of a worthwhile business on a tax free basis?

After 30 years of talking to CEO’s, I am not sure I can count on one hand CEO’s that have told me they are NOT going to make a worthwhile corporate investment in order to buy stock. What I have seen hundreds of times is management pursue out and out silliness to the tune of hundreds of billions of dollars in wasted and inopportune spending on corporate acquisitions, capital spending at the top of cycles, R+D wasting ventures, and other grand scheme, consultant-driven ideas that get hatched in apparently very fertile boardrooms. THAT is the bigger destroyer of value — NOT intelligent share repurchase.

Sep 23 14

Let’s Picket for Better Global Sewage

by Cove Street Capital

Politics aside, we are regularly asked by large institutional clients, “How is Climate Change affecting the way you invest?”

Our short and practical answer is “It doesn’t.” This piece by longtime favorite economic and environmental thinker Bjorn Lomborg is a more detailed version of that answer. It also suggests some subtle moral ambiguity in what some would consider to be “conventional wisdom” on the topic.

CLICK HERE to download PDF

Sep 23 14

Leading Candidate for Worst Sell Side Piece in 2014

by Cove Street Capital

In regard to Tesla…

Having defended our more cautious stance for over a year, we find ourselves torn in upgrading as it is clear substantial risks remain. This is, in part, given (1) the lack of available data to question management’s claims with respect to battery pack durability (among other long-term warranty / residual / service / charging infrastructure related issues), and/or (2) despite lofty expectations, Tesla has never generated even one-sixth of the profitability per share based on the Street’s 2016 EPS outlook (even less based on our updated 2017 estimate), while tax incentives are waning and Gigafactory construction is looming. We have no clarity on battery input costs and take management at face value relative to the estimated $200-300/kWh (kilowatt-hour) starting point while targeting $100/kWh ICE (internal combustion engine) cost parity inside of a decade. We are also relegated to performing various mathematical gymnastics to ascertain the cadence of Model S demand in its most mature market, the U.S., each quarter.

While there are no fewer than a half-a-dozen other key concerns we share with industry purists, the reality is that these issues simply do not matter with respect to Tesla’s stock. Tesla sentiment is like a freight train, in our view, benefiting from a well-manicured growth story that has caught the eye of a much broader investor base relative to most auto stocks. Tesla has positioned itself as the smart vehicle of the future, with a glimpse into smart purchasing and smart infrastructure. Tesla has captivated a global audience, some of whom have lost interest in distinguishing horsepower ratings among the dozens of $100k-plus luxury vehicles, others that would have never considered spending six-figures on anything but a house. Like Tesla’s right place/right time purchase of the NUMMI facility, or the astounding political energy around renewables (again), our call ultimately comes down to timing. We believe our risks remain legitimate, just much further out than we anticipated. Tesla will eventually face stiffer competition from traditional OEMs, we think, and will reach a ceiling of consumer support. But it is clear from our recent factory visit and conversations with investors, customers, and management that these concerns are at the earliest, late decade issues at best.

To that end, we note our call does not hinge on Gigafactory timing, nor Model III pricing/volume expectations for 2020 and beyond. We are focused on the Model S and X alone. We are simply more optimistic of Tesla’s success as a “slightly bigger than niche” global luxury auto manufacturer, and like the head start management has carved out for the brand.

(from Stifel Nicolaus Analyst James Albertine)