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Value Investing with a Contrarian BentValue Investor ConferenceMay 4, 2012Omaha, Nebraska

Lane Five Capital Management

Lane Five Capital ManagementValue Investing with a Contrarian Bent

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Lane Five Investment Approach

Disciplined, long-term value-investing Evaluate, research and invest in securities that are mispriced by the market

• Market prices diverge from long-term business values when short-term issues drive investor fear

• Exploit the psychology and behavior that create pricing anomalies• Use depth of research and long-term, strategic thinking to identify areas where the

market is pricing adverse outcomes that are unlikely Use a probabilistic framework to constantly evaluate business value Create a concentrated long portfolio of significantly undervalued, high

conviction positions Opportunistically short companies that are significantly over-valued and/or

inherently flawed


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The Role of Contrarianism at Lane Five

Two categories of portfolio investments emerge: Great businesses at great prices due to short term problems

• What we call “Compounders”• Ideal investments• Not often severely mispriced• Not always as “great” as they might have seemed

• Technological Change• Cyclical, regulatory, secular changes• Either shortens or eliminates competitive advantage

• Prices paid for these businesses rarely truly account for these risks• Low probability does not equal no probability

Out-of-favor, unloved, troubled, really cheap contrarian investments


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Benefits of Contrarian Investing

Higher expected returns• Wider range of possible outcomes

Uncorrelated with the indices• Drivers of return or loss are not market, industry or economy specific, but rather

company specific or turnaround execution related Highly differentiated return profile for portfolio Building relationships with managements Subject to acquisitions Human behavior is always searching for clarity and certainty: attractive

contrarian investments are available in almost any market


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Hunting for Contrarian Investments

Areas to search: New low list High daily percent downward price action Elevated volume Sell-side downgrades High short interest

Characteristics of potentially successful candidates: Formerly good business model Formerly high valuation Competitors with better margins, growth, efficiency exist Signs of capitulation: shareholder turnover, disgust, management credibility in

question No visibility; no catalyst Specious secular or competitive decline arguments


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Cautions in Contrarian Investing

OFTEN THE CONSENSUS IS RIGHT

Determining consensus is difficult Timing Risk management/Hedging Loneliness The Retrospect Effect Complacency vs. Patience

OFTEN THE CONSENSUS IS RIGHT !!!!!!!


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Temperament Requirements for Contrarian Investing

Patience Weirdness Ability to handle criticism Ability to stand alone Resourcefulness


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Guidance in Analyzing Contrarian Candidates

No different than any other securities analysis: understand the risks, estimate the returns Different than any other securities analysis: the risk will be easy to see, the return difficult Analyze the negative arguments

• Determine what is already discounted. Ask “If so, so what?” • Analyze the actual evidence of the negative case• Appropriately understand impact of leverage, covenants, etc.

Analyze valuation “hooks” that could limit downside• Cash• Sellable Assets: real estate, patents, money losing subsidiaries• Run-off value of cash flows• Dividends

Understand management abilities and incentives as well as potential for change in management to matter

Understand how the story unfolds: timing, shareholder changes, earnings momentum, cash flow inflection points

Ask: “What could go right?” Analyze potential recovered earnings, cash flows, likely valuation in basic scenario. Don’t

pay for what could go right Understand capacity for there to be more than just a recovery


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Current Case Study: Corinthian Colleges (COCO)

Admit it, this makes you want to throw up• For-profit education• “Low-end” vocational schools• Regulatory pressures, cyclical issues, short sellers’ playground• Negative reputations, negative press coverage

Massive mispricing due to the emotional reaction Late 2011, rumors of bankruptcy abounded. Company was generating cash, had sellable

assets, would meet covenants and likely could pay off all debt by 2012. Not a solvency issue

Two-year overhang of new Gainful Employment regulations is lifting: companies have improved, adjusted marketing, lowered price, focused on outcomes

Vocational (diploma) programs provide a huge benefit to the nation – last year Corinthian PLACED 42,000 students in jobs. Students graduate with an average of $10,000 in debt and move from minimum wage service jobs that require no skills to moderately skilled trades. The ROI is impressive, if the student can graduate

High risk students not well served by any other means. Still, graduating them is the key Tremendous free cash flow generation as company returns to a “new normal”


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Valuation: “If so, so what?”• Current valuation: @$3.87 EV = $300 million

• On consensus (bearish) June 2012 estimates: 0.25x sales, 3.10x EBITDA, 12.1x EPS• On guided numbers: 11.1x EPS, 1.7x free cash flow• On Lane Five numbers: 11x EPS, 2.7x EBITDA, 3x “normal” free cash flow of $100 million

• What is discounted? • On DCF, price implies ~$45 million in free cash flow for 10 years• No perpetuity• Half of 2012 “normalized” FCF (Actual will be ~$175 million)

• Impact of leverage, covenants immaterial• Debt free in 3 quarters

Regulatory risks still high, still reactive to headline risk, high beta, short-heavy, story oriented stocks

Valuation “hooks”?• Value of Wyotech and Heald ~ $300 million (paid $350 for Heald, monetized 5 campuses for

$45, five Wyotech automotive campuses)• Ability to close schools, shrink to maximize free cash flow


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What could go right?• Vocational abandoned by competitors• CDR’s dropped to well below risky levels• Community colleges under fiscal strain• Efficiency in financial aid expenses, bad debt management, enrollment dramatically enhanced• Operating leverage from optimizing fixed assets• Regulatory environment could be less bad

Earnings power, free cash flow under scenario analysis• Current valuation discounts seriously impaired business model, but not absolute worst case

• 90/10 rule changes• Negative growth from closing schools• Harkin/Durbin vendetta• $0.40 Earnings Power baseline

• Past regulatory jihad’s have ended with stronger businesses• With zero growth, values range from $8.50-$10.00 as OPM ranges from 5-7% ($0.90-$1.15 EP)• With modest growth, values range from $9-$25 as OPM ranges from 7-15% ($1.15-$3.00 EP)• Previous OPM high of 18.5% (would mean $4-5 EP) • Probability Weighted Value ~$10, range of $2-25• DCF based framework, triangulated with very low assumed multiples on Earnings Power

Current case for more than just recovery is low probability given regulatory risks, but is not zero probability

• It has happened before!


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Parting Thoughts

Consider contrarianism from the bottom-up level Valuable tool for portfolio construction Provides intellectual capital, firm differentiation, portfolio differentiation Remember the downside(s) Choose your battles wisely Prepare to be lonely


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May 3 - 4, 2012

Mammel HallOmaha,

Nebraska

Contact Lisa Rapuano:[email protected]

mailto:[email protected]

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