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Owen Bernard
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Planning / Managing Risk / Accumulating, Preserving & Distributing Wealth http://www.linkedin.com/pub/owen-i-l-bernard-ii/12/658/575
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  • Book Review: You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed

    How would another life form view our financial market system? In his book, "You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed," author Harry Long puts you front seat of his intergalactic space travel in order to answer this question. He peers inside the mind of this rational Spoc-like unearthly being and debunks the mystery of contextual thinking in the investment space.

    I found myself wildly impressed with the book and the strategy laid out. If anyone has read Edward O. Thorpe's "Beat the Market: A Scientific Stock Market System" you immediately see similarities between the strategies. The strategy is not as obvious as you might think until you sit down and dig into this book. Harry was kind enough to have a conversation and discuss his recent book.

    A Conversation with the Harry Long, author of You're Welcome Planet Earth: The Most Powerful Trading System Ever Publicly Revealed

    O.B.: What got you started?

    H.L.: As a teenager in 1998, my father allowed me to make trades in his brokerage account. In effect, the deal was that he was loaning me money at an exorbitant interest rate, so if I lost money, or didn't make steady profits, I would have to repay him a large sum (for a teenager!). He effectively let me learn by telling his broker in advance to accept my orders and in essence extended me margin, rather than equity seed capital.

    Dad was actually quite shrewd. I think he expected that I would lose it all and have to get a serious summer job. It ended up being a great learning experience and a very funny story to tell at parties. I ended up doing so well, that when I sold the positions and had quite a princely profit after repaying him with interest, he ended up telling me, "You can't have the money, that is waaay too much for a teenager to have!" And I wasn't upset at all, because that was his way of telling me that he was incredibly proud and that I had succeeded beyond his wildest expectations.

    And my father was right, too. I love that story. And I never did get a Summer job in 1998.

    O.B.: What is the story behind the title?

    H.L.: The joke behind the title is that I really wrote the book from the perspective of an advanced life form from another planet who created a cool systematic trading strategy and is sharing it with some lucky human. It's really tongue in cheek, but I will be highly disappointed if readers don't conclude that it's the simplest and best strategy ever shared in the public domain. As you can see, the alien does not suffer from humility.

    O.B.: Who are some investors who have directly and indirectly influenced you?

    H.L.: Paul Tudor Jones was incredibly generous with his insights when I was just starting out in the business, as was Edwin Schloss. They have two totally different perspectives on markets, but they were both very kind to a young kid who was long theory and short experience. I think that long/short mix is the starting point for most young investors' mental portfolios.

    O.B.: In terms of portfolio allocation, how have you looked at this question in terms of the Kelly Capital Growth Criterion?

    H.L.: I appreciate the theoretical elegance of the Kelly Criterion, but make no mistake, at my age if I have a drawdown on greater than 10%, I am taking massive corrective action. Heck, if I drawdown 7%, I had better move my feet. I do not subscribe to the pain theory of investing. The notion that one has to bear massive amounts of pain to enjoy a decent return is stupid, lazy, unethical, wrong-headed, statistically incorrect, and insipid. Did I mention that my life goal was to enter diplomatic corps?

    O.B.: Tell me about Contrarian Industries, LLC.

    H.L.: Our main business is managing proprietary capital, but private equity firms increasingly approach us to use our technology to find companies to acquire. Increasingly, they approach us to establish liquid trading operations. I think it has evolved that way, because most hedge funds already have a research department and traders think of our technology as a threat to their jobs.

    Private equity firms that wish to establish trading operations, in contrast, want to leverage technology to avoid hiring an army of new people and the associated expenses. And it goes without saying that they have no pre-existing traders who feel that our technology is a threat to their jobs, so systematic methods are much easier for them to accept culturally. With each new insider trading debacle, they are increasingly attracted to systematic methods which avoid the incentives discretionary traders have to break laws in search of profit.

    And they also realize that systematic investment strategies allow them to establish a trading operation which has very low fixed costs in relation to those of running discretionary trading desks. They love to have multiple systems which give them even greater diversification than teams of traders, but without the emotional, financial, and legal risks of having to hire and fire real living, breathing humans. If a system isn't working as expected, one simply turns it off and shuts it down. Humans who lose money, by contrast, often use emotional manipulation to over-ride well established risk management protocols.

    O.B.: What books do you recommend?

    H.L.: When Things Start to Think by Neil Gershenfeld is excellent.

    O.B.: Do you hold any opinions/concerns of the U.S. markets?

    H.L.: I try not to hold any opinions about macro market direction, since we are fully systematic, but I do hold significant concerns periodically about market structures, regulatory regimes, and public policy. The financial survival of the United States should be firmly based upon reigning in the excesses of fractional reserve banking and upon strengthening laws requiring derivatives of all kinds to be traded and centrally cleared on bone fide futures exchanges.

    O.B: In regard to your strategy, how much importance does the no-arbitrage principle have in approach?

    H.L.: I think Economic "Laws" should best be termed Economic "tendencies". The No-Arbitrage Principle, and its closely related cousin, the Law of One Price, are strong tendencies in markets. Going back to market structure, deviations from these Economic tendencies (inefficiencies) have a strength and duration directly related to the market structures which cause those deviations.

    So when one finds a massive inefficiency, which my book empirically proves that we have, the massive inefficiency's size and persistence is directly related to the size and persistence of the market "mis"-structure which causes it.

    O.B.: Thank you Harry for your time.

    Tags: ETF Analysis
    Aug 04 1:47 PM | Link | Comment!
  • Always Yield To Individual Opportunities

    In Howard Marks most recent Chairman memo, he remarks intensively about his disdain for investment generalizations. He certainly is not wrong in his thinking because some of the biggest hazards (e.g. Long-Term Capital Management and the usual concepts behind most quant funds) come from generalizations.

    There's little I hate more than investment generaliztions. For years, for example, self-styled authorities on the high yield bond market would say "bond defaults typically tae place 2-3 years after issuance." That always set my teeth on edge.

    As he explains his viewpoints, the equity risk premium, brought up by FierceFinance that sparked the memo, gets the full brunt of what he believes is wrong with how the equity risk premium is used. It may seem petty to harp on the article's present-tense use of the term, as written in the corresponding online article in Pensions & Investments:

    The long-term equity risk premium is typically between 4.5% and 5%.

    How does one sentence gain such attention to spark a nine page assault?

    The memo is a great read to gain better perspective in thinking about markets going forward. He brings a far more appropriate line of thinking in assessing markets by using earnings yield or the inverse property of the infamous price to earnings ratio, P/E.

    I have tried to use it in a similar fashion when assessing Lender Process Services Inc., LPS, when it seemed to be destined for failure and written off by most. Howard Mark's memo has been a good reminder of what perspectives to hold when valuations, broadly speaking, gradually become richer with the passage of time.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Mar 23 9:47 PM | Link | Comment!
  • Earthlink: Mr. Market Looking through the Looking Glass
    Overview:
    - Undergoing restructuring primarily through acquisitions
    - Investment community sentiment low for company; holds balanced perception for the industry
    - Valuation range of $11.00 to $18.00

    Business:
    EarthLink, Inc. (NASDAQ:ELNK) operates in two segments, Business Services and Consumer Services. The Company’s Business Services segment provides a comprehensive suite of communications and technology services, including voice, data, managed network services, cloud hosting and equipment services, to businesses, enterprise organizations and communications carriers. The Company’s Consumer Services segment provides nationwide Internet access and related value-added services to residential customers.

    The Company’s Business Services segment earns revenue from the provision of retail services, wholesale services and other services. For the last reported nine months 2011, the Business Services segment had $675 million in sales largely attributed to the most recent acquired businesses over the past year.

    The Company’s Consumer Services segment earns revenue from the provision of access services and related value-added services. For the last reported nine months 2011, the Consumer Services segment had $288 million in sales representing a decline in sales of roughly 19% largely due to a decrease in consumer subscribers.

    The descriptions above are taken from the last 10Q reported. Click on the hyperlink above for more infomation.


    Average business with disciplined management team...
    Since Rolla P. Huff has came on board as President and Chief Executive Officer
    ,he has experienced a great amount of headwind in turning around ELNK which seemed like a sinking ship if you were standing on the beach. Mr. Huff implemented restructuring plans soon after being appointed his position. Though, it has not shown in the top-line growth, the restructuriing plan has certainly stabilized profit margins. Given the new plan for growth by acquisition, we see operating profits potentially decreasing but hold high confidence in Mr. Huff’s leadership and business acumen in stabilizing business issues as the ELNK continues its transitions.  What is found in ELNK is a disciplined and opportunistic managerial team that follows through stated plans, concentrates on quality in personnel, and conducts business as owners of the company.

    (in millions) 01 02 03 04 05 06 07 08 09 10
    Rev($) 1244.93 1357.42 1401.93 1382.20 1290.07 1301.27 1215.99 955.58 723.73 622.21
    EBITDA (16.068) 58.88 105.09 202.05 228.70 146.90 165.32 289.69 230.61 201.81
    EBIT (36.96) 45.66 80.10 172.16 194.90 108.88 111.84 284.01 217.49 177.78
    Tangible Capital Employed 623.35 507.87 412.06 423.31 364.24 376.11 250.31 506.54 717.36 815.68
    R.O.C.(%) (5.93) 8.99 19.44 40.67 53.51 28.95 44.68 56.07 30.32 21.80
    (in millions)
      01 02 03 04 05 06 07 08 09 10
    Op. CF 47.38 18.96 101.73 188.15 188.70 115.25 88.79 230.61 208.62 154.45
    Zero-Growth CapEx 20.89 13.22 24.99 29.89 33.88 38.02 53.48 5.68 13.12 24.03
    FCF 26.49 .42 76.74 158.26 154.82 77.23 35.31 224.93 195.50 130.42
    FCF/Rev (%) 2.13 nil 5.47 11.45 12.00 5.93 2.91 23.54 27.01 20.96
    Bold indicates Mr. Huff’s time served as Chairman and CEO

    Price/Value Analysis:

    ELNK’s initial rate of return and relative value to government 10 year bond better option... ELNK is estimated to earn pre-tax $1.95 to $2.09 per share for the year end 2011. Dividing $1.95 and 2.09 by our pre-tax yield based on government 10 yr. bonds for 25 Nov. 2011, approximately 1.97%, and you get a relative equity value ranging between $20 and $22 a share.

    For 2011 year-to-date you could have bought a share of ELNK for as low as $6.04 and as high as $8.95. Since estimated per share pretax earnings are $1.95 to $2.09, paying between $5.97 and $8.95 a share your pretax rate of return would be between 12.13% and 25.34%. At today’s price of $6.11 you get an initial pretax rate of return of 22.35% and 24.55%.

    So you can ask yourself: What would I rather own - government or corporate 10 year bonds with a static interest yield of 1.97% for a government bond or 3.34% for a corporate A bond versus an ELNK equity/bond with an initial earning/interest yield ranging between 22.35 and 24.55% that is undergoing restructuring to potentially improving both top and bottom-line profits?

    ELNK net asset value consideration stands around $8... For the third quarter 2011, ELNK had $910.52 million in long-term debt and lease obligations and $36.18 million in tangible shareholders’ equity. Long-term debt stands at $910 million with ITC^DeltaCom senior secured notes due April 2016. Capital lease obligations for payment up to the year 2015 average out to being $3.42 million. Aside from the portion of current long-term debt due (ample cash to cover the near maturing debt), the amount of debt incurred due the acquisition poses a large enough margin for error to allow the newly acquired businesses ample time to prove their soundness. Despite the changes in capital structure, ELNK net debt leverage ratio and gross debt leverage ratio remain relatively low against peers like TW telecom (NASDAQ:TWTC) and Level 3 Communications (NYSE:LVLT).

    A new outlook on earnings shows a bit of franchise value...backing out factors of growth, we have average EBIT margins at 15.83% of revenues over the last 10 years. Considering the last four years of what current management has done, we see margins of 24.38%. For the year end, ELNK states EBIT to range between $210 and $225 million. Using $1,112.58 million in revenues as a sustainable measure over the next three years, we estimate EBIT earnings to range between $178.01million/$1.65 per share and $327.54 million/$3.04 per share. We have free cash flow margins averaging 11.14% for the last 10 yrs. and 18.61% for the last 4 yrs. reflecting a basis of $123.94 million/$1.15per share and $207.05 million/$1.92 per share, respectively.

      01 02 03 04 05 06 07 08 09 10
    EBITDA margin (1.28) 4.34 7.60 14.61 17.72 11.28 13.60 30.31 31.86 32.43
    EBIT margin (2.97) 3.36 5.71 12.45 15.10 8.36 9.19 29.72 30.05 28.57
    FCF margin 2.13
    NIL
    5.47 11.45 12.00 5.93 2.91 23.54 27.01 20.96
    Bold indicates Mr. Huff’s time served as Chairman and CEO

    Growth is unpredictable at this point...
    For growth to be calculated at this point would prove useless until a longer time period is allotted to better assess the sustainability of the business model.

    ELNK is certainly not the same company it was prior to Mr. Rolla Huff taking the helm. Being led by a value investing CEO who understands the importance of patience, ELNK is a operating in a relatively competitive industry. Despite the challenges the company faces, the odds favor ELNK. At most, an allocation of 23% and an initial entry allocation of 3.82%. This is what I have calculated based on risk associated with my trading style as well as other macro and micro issues. This is certainly different for others.


    "Think about it a little bit more and you'll agree with me, because you're smart and I'm right" - Charlie Munger

    Disclosure: I am long ELNK.
    Tags: ELNK, TWTC, LVLT, LONG
    Dec 20 4:56 PM | Link | Comment!
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