Investment Report - May 2011: Opportunistic Levered

*Note this investment report specifically outlines the trades and returns of the Opportunistic Arbitrage model on though the results will be similar to anybody invested directly with Stone Fox Capital using the Opportunistic Levered portfolio. 

This model had a difficult month as it underperformed the SP500 by a disappointing margin (-1.6% versus 2.85%). The model was hit very hard from concerns over Chinese stocks and specifically the fraud allegation against Puda Coal (PUDA). PUDA contributed nearly 3% to the underperformance and along with the other Chinese stocks in the model contributed the majority of the disappointment. Most other stocks and sectors performed well.

Concerns abounded over Chinese Reverse Mergers including the two such stocks held in the model: PUDA and Lihua International (LIWA). Allegations surfaced (See blog post) during the month that led to a 51% decline in the stock price of PUDA and the halting of the stock. An investigation on the supposed illegal transfer of ownership by the Chairman is on going. In the meantime, the Chairman has proposed a buyout at $12 or 100% above the halted price. This price matches the recent secondary offering and roughly equals the price prior to the fraud reports. While this offer solidifies our opinion that PUDA shareholders still maintain significant value and could be made whole, no guarantee exists that the buyout will be completed. Our opinion remains that PUDA has a value north of the buyout offer and the potential exists that the investigations surrounding the fraud could help remove any questions surrounding the stock once resolved. Naturally assuming shareholders don't lose a large ownership position in the company in the process.

LIWA lost over 8% in the month mostly due to the fraud fears pushing all such stocks down. They continue to report solid growth and earnings in addition to starting a stock buyback program that hopefully helps support the stock. China Cache International was also down roughly 8% and though they were a legitimate IPO, it hasn't kept them from feeling the downside pressure as well.

Trading was limited this month to the selling of Cephalon (CEPH) and the purchase of NuVasive (NUVA) in order to maintain exposure to the healthcare sector. At the time, CEPH was trading above the offering price of a buyout hence the decision to the sell the stock. Since then, they've had a higher offer from Teva Pharma (TEVA), but even that upside didn't justify the risk of holding the stock. In addition, NUVA was up 16% in April with plenty of remaining upside proving that the risk/return ratio favored the switch even if the model didn't catch the highest bid in the CEPH buyout.

Top Performers
The model had numerous big winner this month, but unfortunately they were all overshadowed by the PUDA losses. The main gainers were in the healthcare sector with Rigel Pharma (RIGL) up over 28%, NUVA up 16%, and Savient Pharma (SVNT) up 9.6%. They mainly benefited from a shift to the underperforming sector as emerging markets struggled. Other gainers were AerCap Holdings (AER) up nearly 14% and Liz Claiborne up nearly 17%. Though LIZ struggled during Q1 it is becoming more apparent that they might have finally turned the corner. They've struggled for a couple of years to turn popular brands like Lucky Brands, Juicy Couture, and kate spade around and it might finally have taken hold especially as we go into the fall.

Bottom Performers
In addition to the China disasters, United States Steel (X) and Limelight Networks (LLNW) both lost around 11%. X had disappointing earnings yet again, but could finally hit the sweet spot with Q2 earnings. The stock traded above $180 back in 2008 and yet only trades in the upper $40s now providing excellent upside potential as global growth continues. LLNW got hit from competitors Akamai's (AKAM) weak report. Considering the content delivery network (CDN) sector remains under immense margin pressure and the company is still losing money, the position was exited in early May.

The model remains under extreme volatility even though a majority of the companies have extremely attractive valuations. The fear in China appears greatly overblown and provides some attractive investment opportunities either via commodity stocks or China based companies.

Disclaimer: Long all stocks mentioned in client and personal accounts. Please review the disclaimer page. 


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