Manager Commentary-Archive-Deleted
Manager Commentary, 3rd Quarter 2010
Q:It is widely discussed that large companies currently have record-high levels of cash on their balance sheets… but what are small companies doing with their cash?
A: According to our analysis, more than 50% of the companies in the Russell 2000 hold more than 10% of their respective market capitalization in cash. This compares to just over 30% of the companies in the S&P 500 Index. The level of cash held by large companies has been widely discussed because they hold the largest amount of absolute cash on their balance sheets. What may be less known is the fact that small companies actually have higher cash levels and stronger balance sheets relative to their respective market capitalization. Small companies have been using their cash to buy other companies, buy their own stock and pay dividends. One example from our portfolios is Omnova (OMN), a company that not only used their cash but actually took advantage of low-interest rates to borrow additional money for a strong acquisition. We also have companies such as Landec (LNDC) that has used their cash to buy back stock. Lastly, several companies in our portfolios have been paying nice dividends while we’re waiting for potential performance from the underlying stock. Examples include American Service Group (ASGR) and American Software (AMSWA).
Performance as of 9/30/10 (Annualized %)*
Q: How is the way you approach discussions with small company CEO’s and CFO’s different today than ten years ago?
A: Because we are often one of the first institutional investors in a company, small company executives tend to make themselves very accessible to us. Each week we have 3-5 companies meet in our offices to discuss their business process and approach. Thishas always been a key element in our investment process and that has not changed. What has changed is that we now make more suggestions to management teams about their business decisions than we have made in the past. We don’t consider ourselves shareholder activists and we don’t intend to run other companies’ businesses. However, with twenty years of experience talking to CEOs and CFOs, we believe that we have seen enough to know what works and what doesn’t. Monitoring past examples of management mistakes has led us to be more vocal to CEO’s and CFO’s about our suggestions. For example, Gilat Satellite Networks (GILT) is a company that had an excessive amount of cash on their balance sheet. The company held $160 million of cash in the bank, in addition to a building worth $50-60 million that they planned to sell in a reverse-lease transaction. With a market capitalization of $220 million Gilat was, in effect, trading for less than its cash value. We made a strong suggestion to the management team that something should be done with the excess cash. The company went on to acquire Wavestream, a provider of high-power amplifiers, for $130 million in cash. We are satisfied that the company was able to acquire new technology without diluting shareholders or taking on any debt.
Q: Third Quarter Attribution Analysis – What Happened?
A: While both funds were up in the quarter, our attribution analysis shows that company size detracted from positive performance in both Funds.
The largest companies in the Russell 2000 Index were the quarter’s best performers. As ranked by market capitalization, companies in the top quartile of the Russell 2000 Index (between $870 million – $3.2 billion) returned 12.5% in the quarter, while bottom quartile companies ($21 – $223 million) returned just 9.1%. The MicroCap Opportunities Fund attribution analysis shows that more than 80% of the portfolio’s holdings lie in the 3rd and 4th quartile of the Russell 2000 Index. These companies contributed 2.0% and 5.2% to the Fund’s quarterly performance, respectively, which was not enough to make up for the strong performance of the Russell 2000 Index’s largest companies. The fund did return 8.57% for the quarter, and is up 8.07% YTD, through September 30, 2010. The Emerging Opportunities Fund attribution analysis shows that 81.2% of the portfolio’s holding lie in the 3rd and 4th quartile of the Russell MicroCap Index. These companies contributed 2.7% and 4.4% to the Fund’s quarterly performance, respectively, which was not enough to make up for the strong performance of the Russell MicroCap Index’s largest companies. The fund did return 8.39% for the quarter, and is up 19.68% YTD, through September 30, 2010.
Russell 2000 Market Capitalization Quartiles*