Stock Gumshoe

Apologies for those who were unable to get in to the site this morning — some technical problems with my host really messed things up. I hope to be able to fix it soon so that doesn’t happen again.

Anyway, on with the work at hand:

This teaser has been circulating for a few months, but I’m still seeing it pretty frequently so I thought I’d take a little stab at it here. As we’ll see in a moment, this is actually probably a more interesting time to look at most of these companies than a couple months ago, though that doesn’t necessarily mean there’s anything worth buying here (that’s up to you, of course, the Gumshoe just digs — he can’t tell you what to do with your own money … and if he could, you probably shouldn’t listen).

But anyway, this is all about the secret “Phipps Stock Market” — yet another one in a long line of invented titles by newsletter publishers that obscure the names of relatively common investments. And I appreciate that, it gives a little flair to the emails and gives us something to talk about — and of course, it gives the Gumshoe something to uncover.

This one’s from The Oxford Club, a newsletter I haven’t done much snooping into in the past, though I know several folks aver at the forum have been generally complimentary of the service (if you disagree, please let us know — knowledge is power!). I believe it’s currently on sale (as are almost all newsletters, almost all the time) for $79 a year.

And along with the subscription, they’re hawking their special report: “America’s Private Stock Market: How to Make 2,441% this Year from the Coming Private Equity Boom.”

That is, clearly, what the Phipps Stock Market is — the private equity market. Steelmaker Henry Phipps, a contemporary of Andrew Carnegie, is the Phipps discussed in the letter (and the Phipps fortune is still around, for whatever that’s worth). His “private equity” fund, the Bessemer Trust funded by J.P. Morgan’s buyout of their company, U.S. Steel, for a then-unimaginable amount of money, acted not unlike the buyout firms of today (though maybe a little more like Berkshire Hathaway than the LBO flippers of the 1980s, I suppose). That’s mostly in the ad letter, so no big secret there.

The crux of the argument in favor of private equity, according to the Oxford Club in this ad, is that these companies can proceed without regard for public market pressures, can keep all their capital gains or distribute them as they see fit, can issue large dividends to owners if they want to, etc. … all the same arguments that I’m sure the private equity guys still use when trying to convince a public company to accept a private buyout today. Certainly, being a private company is easier in most respects.

The Oxford Club’s promise is that, “while these private funds generally require investment minimums well into the millions, you could soon sidestep all the red tape and grab 2,441% in combined gains over the next 12 months… not including dividends … starting with just a few hundred dollars.”

And they’ve got four investments to allow you to participate in the private equity market. As we’ll see in a moment, if you’re someone who bought into these even last month you’re probably a little grumpy about it, but who knows, maybe we’ve got some bargains here. Just to warn you, this is a little bit of an atypical Gumshoe writeup — the clues are very sparse, so I’m only really sure about two of these, the first and last ones may be worth discussing but I don’t know if we can pin them down exactly (or at least, not without lots more work by the already beleaguered Gumshoe).

Of course, I can already hear your complaints — “private equity is dead!” … “Hedge funds are ripoffs” … “moribund debt markets mean an inexorable decline for highly leveraged private market transactions”

That last one was an accountant sneaking in … sorry. I don’t necessarily disagree that this isn’t the right time to buy private equity firms or targets, though I think those who “know” that timing is perfectly wrong are, themselves, often perfectly wrong. I will note that James Stewart has a good article on the Ivy League endowments in the latest SmartMoney (sorry, I don’t think the article is available for free online yet), and those big guys continue to emphasize alternative investments, including real estate, timber, energy etc, but they also still put a lot of money into market neutral investments (hedge funds) and private equity, especially compared to their holdings in the more prosaic stocks and bonds that the rest of us typically favor. So, maybe in the long term a little private equity could be good for us even at these prices … I dunno.

So what are the four investments?

“PHIPPS STOCK #1 - The ‘Fund of Funds’”

They call this a conservative fund that invests in 27 “Phipps Market” investments. From the description, it has to be either a closed end fund or an ETF. Priced at “less than $50.”

This one is, unfortunately, a little tough — the most likely candidate here, the relatively new (less than a year old) Powershares Listed Private Equity ETF (PSP), doesn’t quite fit the clues — it’s priced around $25, so the $50 clue doesn’t make much sense, and it actually holds 30 stocks (as does the index it is designed to track, the Listed Private Equity index by Red Rock Capital Management).

So that’s out there, for folks who believe that private equity is the wave of future profits … and it’s quite a bit cheaper than it was last month, down roughly 15% at the moment.

So I suppose that’s a possibility — I don’t think the fund had exactly 27 investments in it at any earlier point in its existence, either, though that’s possible, so I suppose we may be dealing instead with some kind of Closed End Fund. Unfortunately, there are at least dozens of these thanks to the popularity of hedge funds in recent years — there are 30 or 40 in London alone. There are also quite a few mutual funds that offer hedge fund like strategies or that buy hedge funds as part of their portfolio, and some Rydex ETF products that attempt to mimic hedge fund strategies without buying hedge funds (their Sphinx ETF, which was more of a hedge fund of funds product if I remember correctly, got smoked by the Refco scandal and I believe no longer exists).

So, I hate to say it, but if you want to track down all the various fund of funds CEFs, you’re on your own on this one — that’s far too boring for the Gumshoe. If that’s what you want, probably the Powershares ETF is more liquid and offers the kind of diversification that’s being teased here, whether or not it’s the investment they had in mind. I expect the expense ratio is likely much smaller, too. The ETF holds the big guys like Fortress Investment, as well as the non-Hedge fund private equity companies like Leucadia and American Capital, and some other interesting investments — including Affiliated Managers Group, which owns Third Avenue and a bunch of other small, well respected money managers, including some who advise or run private equity and hedge funds. I expect they probably hold Blackstone by now, too.

“PHIPPS STOCK #2 - Invest Like a Barbarian”

This is a fund that’s a child of a “specialty financing firm”a behemoth of the private equity world.

The parent “put modern private equity on the map with its buyout of RJR Nabisco on the “Phipps Stock Market” for $36 billion back in 1989.”

This is a spin-off of that well known parent.

“Toys R Us, Sealy Mattress and Neilsen Ratings are churning out profits for investors in this fund”

8.10% dividends.

They call this a perfect pure investment in the private equity market … so what is it?

Well, clearly the parent is Kohlberg Kravis Roberts, of “Barbarians at the Gate” fame. And the spinoff publicly traded fund must be …

KKR Financial (KFN).

That counts as an “oops” as far as July recommendations go, since KKR Financial is pretty heavily into residential mortgages and also has a REIT subsidiary (or something like that), and therefore fell just like all its compatriots pretty dramatically in recent weeks. The shares plummeted to about $10 (from $25) very briefly, and are now trading around $15. The dividend last year was just over a dollar, so the indicated dividend of 8.1% makes sense.

So, what else have we got?

“PHIPPS STOCK #3 - Make 1,118% on the IPO of the Decade”

This is a private equity company that went public “not long ago.” They’ve at least updated the teaser, since when I first saw this one they were saying it was “about to go” public.

“We love the fundamentals here, and this offering is unique: It gives you a cut from the enormous dividends this fund collects from its holdings every year.”

They say that they’ve “discovered a simple, safe way to play it for swift capital gains of 1,118%. plus dividends.”

I have no idea what kind of time frame they’re talking about, or whether their “simple, safe way” includes options, but 1,118% is a pretty stiff promise to make to investors.

They also say that “some investors will likely get clobbered by playing it the wrong way.” Whatever that means.

So, they may have some kind of mysterious trading strategy around this investment, but it’s pretty clear that, given the time frame for when it went public, that they’re talking about …

Blackstone (BX).

I have no idea what they mean by “playing it” the right way. It is certainly much cheaper than it was back when they went public to much fanfare, thanks to the fact that private equity firms can’t sell their debt so easily these days, but it may well recover. The sentiment seems to be that Blackstone managed to sell out at the top, further burnishing the reputation of Stephen Schwarzman, but of course I have no idea if that’s true or not. They did just manage to finish funding a massive new investment pool of over $20 billion, so they’ll have plenty of fees coming their way, and they did beat earnings expectations in their first public quarter.

The expectation is that Blackstone will indeed have the potential to pay some pretty significant dividends — but keep in mind that, as a partnership, I think it’s also possible [warning: this is not tax advice and I probably don't know what I'm talking about] for you to be taxed on earnings that you haven’t received. They can keep earnings for investment, I think, but you still have to pay your taxes on them. Might be something to investigate, as well as your tolerance for handling a whole different kind of tax form if you do your own taxes and haven’t dealt with partnership income before, but as a partner you do also certainly have some rights to ongoing earnings — which is what I expect they mean by that “gives you a cut from the enormous dividends this fund collects from its holdings every year” bit.

Time to close this out … what else is in this “Phipps Market?”

“PHIPPS STOCK #4 - The Coming 1,223% ‘Takeover Target’ Windfall”

This is a company that they expect to be taken over by private equity (though they’ve been saying that they expect this “over the next few weeks” for well over a month now).

“This takeover announcement could hand investors in the target company 10-bagger gains.” (That’s got to mean options — unless they’re insanely optimistic).

So, what’s this company that’s due to be taken over, according to the Oxford Club?

It’s a software firm that’s flooded with cash and helping Fortune 500 companies solve an extremely challenging problem: getting their “in house” software programs to talk to each other.
So, discounting for the moment the fact that many rumored buyouts — and even agreed upon buyouts — are off the table now that the market has gotten so much worse for these deals, is it possible to determine which company this is?

Maybe not precisely, since they don’t give any specifics. It could have been Affiliated Computer Services if I was writing this in 2006, since last year they agreed to a buyout by Cerberus, but folks are so pessimistic about that that the shares are trading well under the buyout price.

I’m going to have to stick to guessing on this one, I think — there are plenty of private equity rumor mills, so if someone has a better idea for us, please let us know, but I think it’s pretty likely that they’re talking about either Computer Sciences Corp (CSC) or EDS (EDS). Both are IT outsourcing companies that do pretty much what the teaser says they do, both have been rumored private equity targets in the past (for years, in the case of CSC) and are pretty richly valued already as a result, and both have quite a lot of cash (though not that much net cash, in either case).

I could easily be wrong on this, so I’d be happy to hear your thoughts on this potential takeout target … though I think the days of profitably speculating on takeout targets may have receded into the rearview mirror for at least a little while.

I don’t know if the huge backlog of investable cash that the private equity firms have on their books will be good or bad for the market, or for the firms themselves. Certainly buyouts have been expensive in the last year as the big firms have competed for the choicest companies, but even as things turned south this Summer the firms were completing massive investment funds — there remain untold billions that are held by the big private equity firms and that are not yet invested, so that’s clearly going to have some kind of impact somewhere, whether good or ill I don’t know. It’s true that the buyout firms are having trouble getting financing lately, but if that clears up there’s no telling what they might buy (and if they get desperate, I suppose they could always pay cash…).

So … I thought I should look into this one, since I’ve been seeing it flash across my screen for months now, but I’m finding this conclusion terribly dissatisfying — it’s not so fun to sleuth out companies that have fallen on hard times in between a teaser’s first occurrence and my efforts, but who knows, maybe those of you who still have a yen for private equity and hedge funds will find a bargain in this muck.

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This one came in recently from Stansberry and Associates, it’s an ad for the S&A Penny Letter from Dan Ferris, who also does the Extreme Value letter. This newsletter focuses on what they call “Penny Stocks,” though personally I think they’ve got a pretty liberal definition of that term.

They say they are looking for the “safest and most profitable penny stocks in the market – safe stocks trading under $10 per share.” I think most folks would put the cutoff for penny stocks lower, and would exclude those companies that are over a certain market cap, but that’s neither here nor there because Ferris clearly does not — one recent “penny” pick of his, Abitibi, is, while low-priced at under $3 a share, a billion dollar+ company. So that’s what we’re working with as our investing universe for this pick, essentially any stock under $10 (that pick of Abitibi, by the way, is neither up nor down so far).

The ad says that this “Secret ‘Penny Hedge Fund’ Could Double Your Net Worth [and] It costs less than $7 to get into this opportunity … there’s no managements fees.”

No management fees! That doesn’t sound like any hedge fund I know, secret or not.

He goes on to say that this is, of course, not actually a hedge fund. He thinks it is “as close to being a hedge fund as you can get, considering it’s partly owned and managed by one of the most successful and under-the-radar investors in the world”

So who is this investor? We’ll start with those clues:

“He manages $4.6 BILLION for himself and a few of his super-rich friends.”

“He has trumped the S&P 500 stock index every single year for the past five years.”

He “loves” Echostar and Canadian Natural Resources and has held them for some serious profit.

The ad also includes a chart of this investor’s performance over the past five years or so (which is indeed very impressive), and that helps me to confirm that we’re talking here about the Fairholme Fund. It has beaten the S&P as noted, and the management number is pretty close — currently, FAIRX holds $4.9 billion.

So we’re done, right? Put your money in Fairholme? Not a bad idea, probably.

But not so fast — remember, we’re talking about this great investor who has some kind of involvement with some other thingamabob that itself could conceivably be considered to be something like a “penny hedge fund.”

And by the way, that “$4.6 billion for his rich friends” bit? Kind of misleading, Fairholme is a regular ‘ol mutual fund with a $2,500 minimum investment … I’m sure some rich folks own shares, but regular Joes like you and I might, too.

Take a breath. Step two.

It’s pretty clear that they’re talking here about Bruce Berkowitz, one of the advisers and probably the most public face of the Fairholme Fund. Fairholme holds large positions in both Canadian Natural Resources and Echostar (together they make up more than 20% of the fund), and the FAIRX chart is an exact match for the chart in the teaser ad.

Fairholme is a really good mutual fund, to be sure, and one that’s often considered to have a very similar investment strategy to Warren Buffett (whose Berkshire Hathaway is also a major holding of the fund — at 16%, the only holding larger than CNQ or DISH). They have beaten the S&P for five years running, though they’ve had an average performance compared with their “mid cap mutual fund” peers, according to Morningstar. I’ll certainly concede that Fairholme is worth investing in — it even has a somewhat reasonable expense ration of 1% — and that Berkowitz is a key player in the decisionmaking for this focused mutual fund.

But it’s nowhere near $7, and it’s a stretch to say it acts at all like a hedge fund, and it’s definitely not a stock. What on earth is this “Penny Stock” managed fund operation of whatever sort that we’re talking about here?

The ad says that “right now, he’s [Berkowitz, we presume] bought up more than a $14 million stake – with his own personal money – in the small $7 ‘Penny Hedge Fund’ I’ve told you about.”

Other clues?

Profits of “around $5 million” in 2004, “almost $50 million” in 2006.

And specific dividend numbers, too — this is great! “In 2004 and 2005, it paid out around $2 million…. Last year, investors got a whopping $16 million.”

I know — you’re saying to yourself, “but Gumshoe, this is way too hard. Just give up”

To which the Gumshoe, who has recently resumed referring to himself in the third person, responds with a hearty laugh … “Nonsense!”

So … a few seconds on spin in the Researchifilizationometer, and the Gumshoe can with some confidence tell you that this “Secret Penny Hedge Fund” must be …

Winthrop Realty Trust (FUR)

FUR? That’s odd, huh? The ticker’s left over from when it used to be called First Union Real Estate Equity.

And that’s right, it is a REIT. The hedge fund thing might be a stretch, but we’ll get to that.

Here’s the confirmation:

It is right around $7 — closed at $6.97 on Wednesday, when I first saw this email.

Gross profit matches — $5,066,000 in 2004 and $49,273,000 in 2006.

The total dividend payout for 2006? $16,069,000. And 2,064,000 in both 2004 and 2005, so that’s nearly an exact match. (I think they must not be counting special dividends here, because they did have a special dividend of near $4 million at the end of 2005 … but I won’t quibble.)

Berkowitz is not the Chief Investment Officer or anything akin to that as far as I can tell for Winthrop, but he is on the Board of Directors and personally owns well over two million shares, bought mostly last year in the $5-6 range, as far as I can tell with a cursory search. At today’s price of just a hair under $7 that does indeed put his holding at about $14 million. And it is his money, this isn’t Fairholme that’s invested in FUR (though they may own shares, too, for all I know).

And maybe that bears some investigation — if he likes it enough to pour tons of his own money in, why isn’t it a major holding of the Fairholme Fund? Is he shortchanging the fund, or does this stock just not fit its focus, or is he trying to save the fund from his personal folly? I don’t know.

I don’t see any indication that he has bought more shares recently, or that he is particularly active in investment decisions for the company, though as a director he may well be (and I expect it’s likely that Dan Ferris has delved significantly deeper than I on this — I haven’t even listened to the conference calls).

So … color me convinced, the “Penny Hedge Fund” looks to be Winthrop Realty Trust.

Now … is it anywhere near being a hedge fund? Well, maybe kinda sorta. They are somewhat nontraditional in the REIT space — they invest in property, in debt, they have lots of partnership agreements, and they’ve stated that they do not intend to be restricted, except to the extent legally required by their REIT status, in the types of investments they consider. They don’t just buy buildings and collect rent, nor do they just lend money to developers or homeowners, and most REITs fall into one or the other of those categories pretty perfectly.

From their webpage: “Our principal business activities include investing and making loans secured by real estate, joint venture investments with local real estate partners and acquiring equity and debt securities where the underlying assets consist of real estate.”

Check out the “Our Assets” page on the company’s site, and you’ll be convinced that they are much more diverse than the typical REIT. So that’s kind of interesting. All kinds of properties, investments in other REITs and partnerships and joint ventures, mezzanine real estate loans, etc. etc. etc.

There are certainly some hedge funds with a similar focus, so I guess if we’re feeling charitable we can let S&A get away with calling this a hedgie. Of course, after Bear Stearns’ little problems, hedge funds that get anywhere near mortgages are not all that popular these days. I have no idea whether Winthrop has anything in their portfolio that could conceivably be tarred with the “sub-prime” brush, but if they did focus on that area at all I expect we would have seen a dramatic fall this year in the stock price (and we have not).

They’re a decent size at just under a half billion dollar market cap, and are in the S&P REIT index. The indicated yield is not terribly impressive, as with most REITs these days, at about 3.5% — I have no idea if it’s likely to go up in the near future. It has recently gone down, but that’s not particularly fair to say because it has generally been quite uneven in the past and there have often been “special” dividends, including last fall.

They do have a nice profit margin; their debt is not all that high for a REIT; with Berkowitz and management it has pretty massive insider ownership of about 25%, so some smart people who should know the company certainly own shares. I ain’t that smart, and I don’t own shares, and I’d love to hear more about this firm if anyone wants to delve deeper. This is, I think, the third real estate related company I’ve looked at in recent months, and all of them have pretty massive insider ownership (and often, recent insider buying).

Given the volatility in real estate, it’s interesting to see that shares in this one are virtually unchanged on the year (though they did have a good year in 2006), so the $7 price you can buy it for today is not far off the price it changed hands at in January … which means there might not be any rush to do your research here. As of their last quarterly earnings report, earnings were up a tiny bit but funds from operations, a more typical measure of REIT performance, were down a bit. It looks like there’s only one analyst covering this one, and they’ve got a buy and a $7.50 price target.

I must say, I’m intrigued … but I still want to learn more about why I should buy this over any of the other high-insider-ownership REITs we’ve looked at here, including some other pretty sophisticated financial REITs that work with debt as well as buildings. I’m also kind of curious why, if it’s the investment expertise of Bruce Berkowitz I want, I should buy this company that he is a part owner of over shares in the much more diversified, nicely performing Fairholme Fund for which he clearly makes investing decisions.

And really … a little bit off the point … are individual investors still fascinated enough with hedge funds to bite on a “penny hedge fund” teaser? Haven’t we all seen enough evidence yet that the majority of hedge funds are underperforming, extremely high cost, illiquid investment vehicles? Just because rich people and institutions still seem eager to invest in them, doesn’t mean I aspire to.