APM Quarterly 
Q3 2012 

a publication of Applied Portfolio Management, KU School of Business
In This Issue:
APM golf tournament
Bidding Jeff Morrison adieu
Cash delivered, looking to Shandong?
Plains in the Gulf
Mining for value
Portfolio Performance
Links:
APM Alumni Updates:

 

Alumni, send us your updates. I've heard from many of you that this is your favorite part of the newsletter. Everyone wants to know what you've been up to - jobs, weddings, births, any type of significant event you'd like to share!

 

Mike Yeggy (APM F08) has relocated to Kansas City and accepted an offer of Investment Manager in a commercial real estate investment sales group at Colliers International.

 

Chris Brito (APM S11) has accepted an offer in investment banking with Southwest Securities in Dallas.

 

James Sumaya (APM F07) manages a hospitality industry investment portfolio for Canyon Capital Realty Advisors in Century City, CA. He recently passed level III of the CFA.

 

Chet Batson (APM S09) is pricing manager at Wesco Distribution in San Francisco.

 

Adam Ryan (APM S06) is an analyst at Eminence Capital in New York. He is responsible for all non-U.S. coverage.

 

Michael Raupp (APM F06) is a law clerk for Honorable Duane Benton, U.S. Court of Appeals in Kansas City.

 

Ryan Mandl (APM F09) has been promoted to head of business development at Five Elms Capital in Kansas City.

 

Scott Baker (APM F06) has accepted a position at Highland Capital Management in Dallas.

 

Tim Burger (APM S05) and Laura Kuhlein are engaged and married on November 10, in Kansas City.

 

Allie Atwood (APM F07) has accepted an associate position with VMG Health in Dallas.

 

Anthony Marnell (APM S06) has founded a new company, concertKarma, in Chicago.

Donate to APM

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KU School of Business

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Lawrence, KS 66045-7601

 
Thanks to our donors

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NIC Inc

Five Elms Capital Management

 

More than $9,000 raised at 8th annual APM golf tournament for new building 

 

by Ben Gaydess-Hodgins

The 8th annual Applied Portfolio Management golf tournament was held at the Lawrence Country Club on Friday, Sept. 14, 2012. The tournament drew 48 University of Kansas APM alumni, supporters and students for a beautiful, mid-70 degree afternoon of golf.   Through the generous support of the tournament sponsors and players, more than $9,000 was raised for the new KU School of Business building.

 

This year's tournament proved to be especially competitive with the winning team of Jack Hannah (APM F07), Rob Ralston (APM F07), Michael Weber  (APM F07) and Ryan Peschka (APM F07) finishing with a round of 56.   This slightly edged the second place team of Matt Mayer, Shane Parr (APM F96), Frank Sciara (APM S00) and Cathy Shenoy, who shot a 57, and the third place team of Burke Beeler, Al Simmons, Pete Rieg and Jeff Morrison (APM F98, S05) who shot a 58.  Jack Hannah had the longest drive and Robby Moriarty shot closest to the pin. 

 

The raffle winners were announced after the tournament and Aaron DeRee received a basketball signed by the KU men's basketball team. Mark Drietzler and Shane Parr each won a pair of tickets to the Kansas vs. Iowa State football game from the KU Touchdown Club.

 

We would like to send our most sincere thank you to all our sponsors and participants for making both this tournament and the APM program possible through your ongoing support and generosity.  We hope that everyone enjoyed the 8th annual golf tournament and we are excited to see everyone back next year for another great afternoon of fun and golf!

 

 

Just until he's back for the fourth round: Bidding Jeff Morrison adieu

 

by Daniel LaGree

The Applied Portfolio Management program is sad to announce the departure of instructor, Jeffrey Morrison (APM F98, S05).  This fall, Morrison announced he became the new Chief Financial Officer for CritiTech, a Lawrence company specializing in pharmaceutical technology.  Morrison, also a former student of the class, is in his third semester as an instructor with Professor Cathy Shenoy.

When asked about the benefits obtained as an instructor for APM, Morrison responded, "As an instructor for APM,  I have a new perspective on the effort level required by the class as a whole, a new respect for the KU School of Business faculty, and the reward of witnessing the relationships developed through students, mentors, and guest speakers." 

 

As Morrison begins his journey as CFO for CritiTech, his experience in APM will assist him in the business decisions he will face.

"My experience in APM has given me a unique perspective on how a company functions and the critical components that drive the business," Morrison stated.  While in the class, Morrison not only taught students the importance of financial modeling and research, but also stressed the importance of the ability to convey that message through concise, written communication.  Morrison was engaged in the APM program for the past 15 years and will continue to support APM and its importance to the KU School of Business.  The APM staff wishes him the best of luck with his new endeavors and looks forward to seeing yet another APM alumnus excel using the knowledge gained through the class.   

Tying off the cord: Cash delivered, looking to Shandong?

 

by Boone Bradley

APM expanded its position in China Cord Blood (NYSE: CO) this quarter.  Because of raising capital from selling convertible notes to Kohlberg Kravis Roberts, $65 million, and Golden Meditech Holdings, $50 million, in addition to generating between $10 and $15 million in cash each quarter, China Cord has pro forma cash holdings of between $220 and $230 million against a market cap of $200 million. Dilution from the convertible notes is certainly an issue, but we believe China Cord, after a roughly $40 million investment program to complete expansion in Guangdong and Zhejiang provinces, is gearing up to make a run at China's second most populous province, Shandong. The cord blood bank in Shandong is already in operation and completed financing in April at a $200 million valuation. Thus, the implied value of the Shandong operation not already owned by China Cord is $152 million, slightly below the unallocated cash on China Cord's balance sheet.

 

Even without acquisition of Shandong's operations, China Cord looks undervalued. Cash on hand represents $3.14 per share, $2.01 assuming full dilution, and the company creates massive amounts of "hidden" cash each quarter through deferred revenue from its upfront payment plans. Something simply must give: share appreciation, a private equity event, or large acquisition. Even with three quarters of slightly negative cash flow regarding capex spending, we project cash per fully diluted share to exceed current market valuation in the next six or seven quarters. Shares may not move in the meantime, but we believe a thesis-defining event is in sight. We maintain our buy rating with a price target for existing operations of $5.50. 

Plains in the Gulf: PXP looks to avoid drowning in debt 

  

by Austin Trees

In recent weeks, Plains Exploration and Production (NYSE: PXP) made headlines. The Houston-based natural gas and oil company made a large bet on assets in the Gulf of Mexico. British Petroleum (NYSE: BP) agreed to sell $6.11 billion worth of deep water fields to PXP as part of its $38 billion divestment program. In order to finance the acquisition, PXP took on $7 billion in debt, which is more than their current market cap, $4.78 billion. This risky move has investors biting their nails, but PXP executive and University of Kansas alumnus Mark Hensel (APM S96) is confident about the recent transaction. He believes the new Gulf assets will provide the necessary infrastructure for increased productivity of PXP's existing Gulf operations.

 

The new assets will triple PXP's oil production in the next twelve months. Moreover, a newly instated hedging program has locked in oil prices at $100 per barrel until December 2013. PXP seems very bullish on domestic oil production. With additional transactions, they plan to be 90 percent oil by the end of 2013. All in all, PXP is expected to double its EBITDA within the next 18 months.

 

PXP is currently 1.4 percent of the APM portfolio. We are sitting on our position with hopes that these assets are as productive as PXP believes and prove to be relatively low cost.

Mining for value: Scouring the hills, the plains and especially the VALE

 

by Boone Bradley

A new name in the portfolio is Brazilian miner Vale S.A. (NYSE: VALE). We began investigating Vale as iron ore prices collapsed in August to less than $90 per ton. We purchased VALE just before Chinese stimulus sent prices back to more than $100 per ton. Management believes the long-run trading range of iron ore should be between $120 and $180 and we don't see a reason to argue. Much of our thesis here is similar to that of ArcelorMittal; global construction and steel demand is at or near a cyclical low and these names will return to favor as the industry rebounds in the coming years.  Furthermore, we approve of Vale's moves into the Brazilian fertilizer/phosphates market and its continued development of the Salobo copper mines to diversify income streams. However, Vale faces headwinds of increased capex spending after paring back investment during the past few years, hurting near-term free-cash flow. Thus, new management is divesting non-performing assets, strategically optimizing their development portfolio and, we expect, likely to cut the 2013 dividend. The market is discounting shares with these headwinds, but we are happy to build a position during a few below-average quarters and collect dividends while we wait for growth-producing investment and higher commodity prices to propel shares to a cyclical high. Foreign exchange rates are a concern because revenues and debts are largely denominated in USD, while the majority of costs are incurred in BRL. The Brazilian government has been wary of a strengthening currency and will monitor it, but we still believe Vale is a long-term buy, especially if shares return to our $16 entry point level or below. Assuming elevated capex spending continues longer than expected and there is only a modest recovery in commodity pricing, we believe shares are worth between $22 and $25 today.

APM portfolio performance and rebalancing 

APM liquidated a number of names from the portfolio over the summer. Some had reached our fair value estimates, but many represented significant overlap with other holdings or were less liquid. The sales were well timed for the early summer doldrums, but we have missed much of the quiet bull run of the market in Q3. As we gear up for the Spring 2013 class, many of the sold positions continue to be on our radar and we are actively looking for new names, offering learning opportunities outside of our current holdings. We'd love to hear from you with any suggestions at apm@ku.edu and our portfolio managers are already researching an idea from Shane Parr (APM F96) and will be reaching out for suggestions shortly.


 

Current

Quarter

Last 4

Quarters

Last 3

Years

SP5006.3
30.145.0
SP6005.4
33.352.6
NASDAQ6.5
30.651.6
APM3.3
19.517.1

 

With our large cash holding, the APM portfolio missed Q3's positive move in expectation of QE3.  However, we still managed a 3.3 percent return as assets under management grew to $1,028,656, and we continue to focus on positioning the portfolio for future outperformance.  Clearly, the portfolio holds a larger cash position than preferred as we refocus and redeploy capital. However, at the end of Q3, we remain nervous about the general market's prospects as prices balance between the global slowdown in trade (see sidebar, courtesy Morgan Stanley's Sep 24 Strategy Forum) and the onset of bullish QE3 and global stimulus plans. Our feeling is that the market is on an upward trend expecting QE3, but is priced expecting good news, potentially exaggerating the downside of negative events, at which point we hope to be buyers. 

 

The APM portfolio managers are also working to upload new and old research reports to an updated website for distribution. It should be completed in Q4 2012.  In the meantime, feel free to contact us at apm@ku.edu with questions or to discuss our thoughts.