Aaron Edelheit of Sabre Value Management presents “Small Cap Diamonds in a Rough Market.” Sabre is generating 19% annualized returns.

How has the small cap value sector outperform so long? Edelheit argues this is because there are periods of illiquidity and volatility. Edelheit focuses on insider buying, spin-offs and restructuring.

Photochannel (PNWIF) is now at $2 or 7 times earnings. They managing front and back end of photo sites. Clients include Costco, CVS, Tesco and Wal-Mart Canada. It is an excellent recurring revenue model. Revenue is suppose to grow 100%. They are creating a wide economic moat with high switching costs. It took Costco 9 months to move their photos. By storing so many images online it will cost a lot to move to another system.

Why not just have retail customers upload it from their computer? It is just a matter of education. As customers upload online, Photochannel grows.

People keep printing photos even in a recession. New customers of Costco, Sam’s Club and Kodak China. Digital prints are up 27%. Print orders online grew 64% online. Home printing is declining, lost 12% of its market share. Home printing is expensive.

There is optionality value of the potential Kodak China and Kodak India income, 25000 kiosks.

They will receive 5% of everything that goes through the kiosks. Each kiosk does $3 a day at 25,000 locations with no expenses to Photochannel.

Why so cheap? Not covered by sell side analysts, small cap Canadian index down over 44% YTD. A few funds have been forced to sell. Its at the lowest price in two years while it added customers and now making money. The company is growing revenues at 80% selling at 7 times earnings is unheard of.

Hemisphere GPS (Toronto: HEM)

Precision agriculture including GPS guidance and auto-steering becomes best proctices on the farm. Payback can be 6 months or less thanks to soaring input costs.

Sold their first product to China yesterday. They grew revenues by 59% in Q2 and should grow revenue 50% plus in 2008. They are raising prices and the grain bull market typically last 10-14 year and we are in year 2.

Why is it cheap? A rival company won business to Agco but HEM still with them as a customer. Rivals product doesn’t work yet.

Only 9 times this years earnings. Insiders are buying shares. They have called for a 5% buyback. There is IP value here that there are only 4-5 companies with the technology. New markets include autonomous mining vehicles. The mining companies don’t have this technology.

Limoneira (LMNR)

Producer of avocados that owns 7,000 acres of prime California real estate. They just got 500 acres to get entitled for residential development. The weather is amazing at this location.

The also own a rectangle of land in Ventura that overlooks the Pacific ocean. It is only one of 2 project to be built in Ventura in the next 10 years.

They also own water rights going back to 1893. They have 5 million acre feet in Santa Paula Basin and another 10 million un-adjudicated in Fillmore Basin. They also own their own mutual water company shares worth $100 million. They also have their own pipeline conduit to Ventura that waters avocado trees that could be used to sell water to Ventura and Oxand

Digimarc (DMRC/D)

It has strong patent portfolio according to WSJ Patent Scoreboard, 21st strongest. The company is not trading yet since it is a spinoff. They do digital watermarking. They are used on picture, audio, and data files.

They have $13 million of revenue in 2007 and expected to grow to $20 million in 2008. 77% gross margins and profitable. Can be used to scan YouTube video for watermarks and even to help monetize that content when it is identified.

How does the 21st strongest patent portfolio in information technology in the world equal a $50 million EV?

Edelheit closed the presentation with a call for participants to be a mentor. I can’t argue with his value claim with that.

A question noted that it is important to look at how many years the patents have left in the Digimarc portfolio of patents.

George
www.fatpitchfinancials.com

Kian Ghazi is with Hawkshaw Capital Management. He starts up by discussing previous picks in Wesco and Learning Tree and how they have played out.

Hawkshaw is a long/short U.S. equity investment partnership. There is a heavy emphasis on research investigation.

How do we invest with conviction?

Value investors identifying high quality one of a kind franchises that are financially strong. Then they kick the tires and uncover the land minds. Ask what could send the stock down 30% or more that would cause us not to want to buy substantially more stock.

Financially strong companies have rock solid balance sheets, positive free cash flows, and monetizeable assets.

Universal Technical Institute (UTI) is a technical school that trains mechanics, primarily auto mechanics. It trades around $15 right now.

What hit this stock? A perfect storm. The company increased capacity by 35% from 2005 to year-end 2006. Company-wide students starts turned negative shortly therafter (2Q06). This pressured margins. The strong labor market and student loan problems this year has really impacted the company.

Ghazi argues enrollment growth is poised to re-accelerate meaningfully through increased demand and improved operations. Analysts are not appreciating this. There is over concern about student loan market. He thinks normalized earnings power is about $2, which is twice the consensus.

There are some good trends. About 50% of qualified mechanics will retire over the next 7-10 years. UTI is twice the size of its nearest competitors. The value proposition here is compelling for the $25,000 investment. Ghazi estimates the return on this educational investment is 25% and if levered it is more like 50%. There are many OEM partners that reduces the capital outlays necessary for operating and equippling UTI campuses. The OEMS include BMW, Harley-Davidson, and many other auto manufacturers.

There exposure to the subprime market is very small. From 2003 to 2005 the company was hitting on all cylinders. Then management failed to adjust to changing employment market. The affordability of the program declined and the educational funding gap increased over time from $7,000 to over $12,000. This resulted in leads dropping by double digit rate. Those that show up after a contract went way down. In 2007, the federal government reduced the subsidies to student loan providers. UTI began funding the gap of subprime loans to students and this caused concern to the market.

As unemployment rate rise, enrollment rises. In 2006 and 2007, high school students could go into construction and make $30 an hours, so they were not finding it attractive to pay to become mechanics.

They have changed the SVP of marketing in January 2007 and the SVP of campus sales in September 2007. They also improved the marketing from infomercials to 30/60 second ads. They improved the company website and spend more time with prospective students to encourage them to enroll and stay in the program. Leads are already starting to grow in the most recent quarter (3Q2008). There was a 41% increase in leads. Modest contracts growth can lead to a high shows growth.

Under the presented scenario there is a potential value of $30 per share.

What could drive this stock down 30%? It could happen if students can’t secure financing, but it appears students still have access to prime loans. Regulatory issues could arrise if default rate spirals out of control and result in the school being cut off from federal student loans.

What you need to believe?

Contract growth: 5%
Show rate improvement: 3.5%
Starts growth: 12% for 2 years
Capacity utilization: 80%
Drop out rate: 30%
Incremental margins: ~50%
EBIT margins: 15%

With more relaxed assumptions, he could envision the stock being worth $45 per shares.

I must admit that I’m interested. My only concern is the amount of mechanics being trained by the military is probably high given the protracted war effort. The withdrawal of troops from Iraq could result in a surge of trained mechanics hitting the market.

George
www.fatpitchfinancials.com

Boykin Curry from Eagle Capital Management starts off the second day of the Value Investing Congress. His presentation is on value investing and time arbitrage.

He starts off explaining that value of a stock is the present value of its future earnings. There is a major focus by most on next year’s earnings estimate. Most questions (81%) on conference calls focus on the next 12 months. Only 19% are interested in focusing on the earnings potential beyond a year out.

Buy things that have short term problems and long term opportunities. The future is not knowable but it might be guessable.

The specific example presented is American Express (AXP). The normalized earnings beyond recession are about $4-5 per share. The secular trend is cash to plastic. American Express is the collective buying power of a pool of wealthy individuals.

Nothing has emerged to threaten their long term earnings power. Earnings in 2008, 2009, and 2010 could be potentially rough. Boykin estimates $30 billion could be gone on charge offs. If you do that for the next 3 years, earnings is estimated to go down to $2 per share for each of the next three years. How does this equate to folks only paying half as much today as they did last year for the same company.

Boykin doesn’t believe that large cap stocks are always efficiently priced. He agrees that there is not information arbitrage opportunities in these stocks. However, the time horizon of investors is often not rational. There is the wisdom of crowds but there is also madness of the crowds. With large cap stocks, one hedge fund can’t go in and move the price up and make it more rational.

Last year analysts 1-year price target went from $76.5 to $41.0 billion from 2007 to 2008. It is all based on multiples of 2009 earnings.

Why does the time arbitrage persist? Clients measure performance over relatively short periods. It makes going down 20% by being early difficult for funds. There are a also a few successful short-term strategies that also blow it up for others, since clients will pull there money and move to them. Also, short-term results are often preludes to the long-run.

Average monthly turnover has increased. Time arbitrage opportunities persist.

You can focus on long-dated call options to take advantage of time arbitrage. When they pay off they are extremely valuable. Examples right now include, Newfield Exploration (NFX), Microsoft (MSFT), and Comcast (CMCSA).

Newfield is a natural gas company. In the long-term, there is a huge incentive for the government and companies to build out natural gas filling stations. If tomorrow it is announced no one will ever use natural gas in cars, it won’t affect the stock price today.

Microsoft is being treated as a declining asset. The future for Microsoft could include their capability to provide synchronized both online and offline activity. If the company decided to stop investing in this, the stock would actually probably go up.

Comcast could in the future develop targeted television advertising, like Google provides online. Comcast’s distributed network of services might also be able to deliver customized content on demand in the future.

This strategy will make it tougher to raise capital and get started as a fund. There are also benefits, because it is intelectually stimulating. Once you are successful, you will better retain clients. It can provide a sustainable competitive advantage in an industry with very few.

Recent events hasn’t changed his strategy. There are a lot of opportunities out there. Just make sure the companies survive the recession. This could actually make the country stronger in two or three years. There is a huge shift in capital allocators from the reckless to the Warren Buffetts and Seth Klarmans of the world.

George
www.fatpitchfinancials.com

Carl Icahn just joined us at the Value Investing Congress. He’s speaking on the current financial crisis and the role of shareholder activism.

According to Icahn, the real problems with these financial companies are the Boards. The Boards do not in any way hold managements accountable. They take risks when they shouldn’t. When Boards work they then can become very dangerous.

First, the CDOs were dangerous. They created tulip bulbs, and here they were houses. Then you print mortgages and then you securitize them and then place them in mortgage backed securities. Then they take the lower traunches and put them in a CDO and they became really toxic but got AAA rating for diversification. What good is this diversification if everything in it is no good. The Boards did nothing about this. They hired the fox to guard the hen house.

He is announcing United Shareholders of America to address this problem with Boards. I’m not sure if this bit of news has been announced elsewhere yet.

Then Icahn discusses the history of his first proxy fight that lead him to be added to a Board. A big guy, Don, told him there is either to either agree or resign and not say anything. Icahn stayed quiet for several meetings until there was an issue associated with the acquisition of the garbage disposal unit factory. Then another Board member asked for Icahn for his opinion. Mr. Icahn then said that this was the worst deal in the history of America. That got some laughs. Then Icahn said he was voting against it and everyone else was going to be personally liable. Don never brought up the issue again and then he sold the company.

He saves tons of money with these actions. Then he provides the example of money saved at Imclone and Federal Mogul.

“The fault falls not on the stars but ourselves,” recalls Icahn from shakespeare.

We need to change the law that requires a Board to put an issue on a ballot.

This system blew up because we allowed ourselves to do these insane derivatives. There are some investment banks that made it through this because they avoided this things. The $10 trillion out there needs to be deleveraged. Its going to take a while to work through this. The scared money can panic and pull out. The Fed is going to need to come in and in again to keep lending them money.

He saw something similar in 1990 and Mr. Icahn bought up junk bonds but its nothing like today with all these banks tied up.

Finally, he is taking questions and asking the audience go to his blog and join United Shareholders of America.

In response to the first question, he warned to invest very carefully. There is opportunity in energy companies and pipeline companies. You have to have a lot of staying power to invest right now. Cash is very important to invest right now.

Icahn doesn’t understand accounting right now in response to a question on fair value accounting. We need to allow some leeway with accounting for these companies right now to do with massive right downs.

When asked about the change in leadership, Icahn brought up the cost of proxy fights. Yahoo (YHOO) spent $36 million to fight him and it cost Icahn about $5 million to respond. The laws need to be changed. Some hedge funds come along for proxy fights but mutual funds dither on issues. It can be argued that the system is completely disfunctional at this point and needs to be changed. Mr. Icahn believes most other countries are doing a better job on corporate governance than the United States, including Canada, United Kingdom, and Australia.

Updated: 9:55 PM October 6, 2008 to incorporate some edits and remaining Q&A comments that weren’t captured earlier due to my laptop running out of power.

George
www.fatpitchfinancials.com

John Burbank of Passport Capital is the next presenter. He is being patched in via video conference, which had a rough start due to technical issues. It added comic relief, which was welcome given the depressing morning presentation and current market numbers.

Passport Capital is targeting 30% annualize returns and the word here is that he is currently generating 40% annualized returns.

The presentation is focused on looking at the big sector changes. The presentation is themed to the Wizard of Oz of all things.

The market is now at Emerald City and the curtain on the Wizard is parted and the U.S. is now exposed for what it is. Net foreign purchases of U.S. Treasuries are down. This has not been good for the wizard’s buddies, the U.S. financial banks.

Burbank believes Bernanke is making a huge policy mistake and not getting enough liquidity into the market. He believes less will be investing in the United States, foreign capital will be invested more in their own markets.

Burbank’s firm believes in peak oil. Oil exporters are highly liquid and are an area to look for opportunities.

EFG Hermes and other regional managers seem to provide great value. AUE government ownes 25% of the company. The forward P/E looks very compelling.

Another company in this sector is Shuaa Capital. Great sales growth at both of these.

Burbank also likes fertilizer minerals quite a bit, since the emerging markets need these inputs. The focus here is on Mosaic (MOS) and Potash (POT). The P/E for MOS is around 3 and the P/E for POT is around 4. Potash is like the Saudi Arabia of potash. The replacement costs for these companies’ capacity is high and not really factored into the price of stock.

Burbank is long farmers and foreigners and short a leveraged United States and General Electric. He seems to question Buffett on this.

Burbank believes the financial markets are in massive cardiac arrest. They need to cut rates tremendously and flood the market with liquidity. The rest of the world has the ability to flood the country with dollars and that is what has to happen.

George
www.fatpitchfinancials.com