Lloyd Khaner on "Wall of Worries" and CDNS

Author's Avatar
Jul 15, 2011
Lloyd Khaner is the General Partner of Khaner Capital L.P, a long-short hedge fund. He selects stocks for the portfolio, sets the Fund’s investment strategy, oversees the Fund’s portfolio and directs its resources.


Khaner Capital L.P. has recorded positive absolute results for 16 out of the last 19 years. Without the use of leverage and after all fees the fund has outperformed the S&P 500 for the following standard comparable periods: three years, five years, ten years, fifteen years and nineteen years.


Lloyd is a member of the Intelligent Investing Forbes.com Investor Team. His most recent speaking engagements include the Value Investing Congress 2009 in New York City and the Value Investing Seminar 2009 in Italy. Previously, Lloyd wrote a monthly stock market column for Institutional Investor magazine titled “Lloyd’s Wall of Worry.” Lloyd was featured in Value Investing Insight in May 2006 and has been quoted in news sources including The Wall Street Journal, DSN Retailing Today and The Financial Times.


20% outperformed S&P500 or 20 years, no leverage. We have not had too many down years, so it makes it easier for us to have good returns, since we do not have.


We have over 50 turn around, of every industry, every size; except bio-tech which I will never understand, and do not invest in.


Every week I list my wall of worries like QE2, China, oil prices, Libya, ECB. I wanted to apply it to the world turn around.


I am not going to list all my concerns of every single country, but I came up with 38 countries, which all have numerous risks facing their economies.


Things will turn around is the good news.


The bad news is that has not started.


America has more problems than anyone else.


We have debt; state, municipal, financial market regulation, we are also significant inflation, the misery index is at a 28-year high. Our political system is completely dysfunctional, we have no energy policy; it really is buy as much energy as you can and use it.


Europe:


The Euro, the EU, The ECB and inflation.


Greece is the biggest problem as far as headline. They have a union problem and people are very demoralized


Ireland, Italy, all these countries have problems that must be taken care of.


Spain has a large RE crisis and banking crisis.


Germany also has problems. They own lots of debt in the EU; they have lower wages, pensions and job losses.


France: Libya war and the list will get larger.


UK: LIBOR investigation for manipulation, it might hurt their credibility.


China No. 2 worst after US: wage inflation, general inflation, food inflation. I do not think China will be a disaster, but they have significant problems.


Japan has to completely restructure everything, even before the earthquake they had a whole list of problems.


In the Middle East there are significant problems.


Africa is moving into the revolution problem, it will be tough for whole world to solve this problem.


India has problems with corruption, accounting, inflation, and tensions with Pakistan.


Brazil: RE bubble, their currency is too strong. They are too hooked to China, and if China crashes it will be bad for Brazil.


Chile: too big in mining and if get hit with earthquake, could cause huge damage.


Venezuela: are putting Iranian missiles facing US, nationalization of companies, which Chavez does not like.


Mexico: drug wars


North Korea: people are starting to starve.


Somalia: pirates, there is a stock exchange in Somalia where you can invest in pirating operations.


South Korea: Doing well except inflation.


Russia: economy is starting to slip, and selling gold to pay off deficit.


High frequency trading caused the flash crash. The ETFs are causing a lot of problems.


There are trillions of CDSs, and are completely unregulated. This could be THE TRIGGER.


Food inflation is maybe the biggest concern.


Everyone is kicking the can down the road.


Extended and procrastination, delay and play, dope and hope. Eventually these problems must be dealt with.


The possible triggers:


US debt ceiling problems.


Destabilization in top five GDP companies; inflation, deflation.


Then the turnaround will start, when countries admit their mistakes and problems will start to get solved.


People look forward and accept things will get worse before it gets better.


World GDP goes below 5% growth, US enters recession. Deflation of wages and RE and inflation of staples rise.


S&P500 drops to a single multiple like '80s, '30s, and early 1900s.


Trade wars will get worse, there will be defaults.


Uncertainty and fear peak.


But then debt level goes down, governments lose their short termism


There is real regulation, probably there will be over-regulation.


The pain will last the first three years, and the economic gain will last two years, which will be a five-year cycle.


The other alternative is to continue to kick the can down the road.


How to get through this as a portfolio manager:


No leverage, maintain liquidity.


Focus on company fundamentals.


Accept that market multiples will decline.


You can make money but you have to be careful, and recognize things get a lot cheaper. I am having trouble putting valuation on companies, because they might become lower value.


Average PE in single digit, asset bubbles will be gone, and company fundamentals will trump macro concerns. This is the best time for the value investor, when this happens.


CDNS: Ipads, mobile computing, iphones etc. CDNS creates software which they license to the chip markets. EPS and FCF should increase significantly in 11 and 12.


13x multiple of FCF in 1.25 would give the company a valuation of 17. The company is a turnaround is hard to evaluate, but I used conservative valuation.


CDNS basically offers the software and hardware makers the ability to stimulate and test out a product before the company actually develops it.


CEO has been in industry for decades, and the CEO has been buying a lot recently. He owns a significant amount of stock .


The company refocused R&D, restructures, they have subscription model so they know what their revenue will be.


They are in oligopoly,


Balance sheet $612 million in cash should be $800 million by end of year, debt is $600 million but most in convertible shares, which should be out of money soon.


Operating margins should rise over 30%.


FCF is higher than earnings because they spend double the amount on R&D than capex.


Risks:


Some of the things above which I mentioned happen.


Semiconductor industry goes into bear market.


CEO leaves.


The company does have debt.


Japan could be a problem with its lead in manufacturing electronic components.


Q&A


With turnaround how do you catch a falling knife?


An industry in a secular decline, like newspapers should be avoid, additionally companies that have a huge amount of debt. Blockbuster would be a company I would avoid.


Their acquisitions tend to be small because they are just looking for intellectual problems. The risk of a large acquisition is very unlikely.


Disclosure: None


http://www.valuewalk.com