Investor Letter - Third Quarter 2007
Issue #12
 October 2007
In This Issue
The Numbers
Bird-In-The-Hand Investing
A Recent Investment: Avid Technology
Happy Endings: DataMirror & Catalina Marketing
What To Watch For
Dear Client/Friend,
 
We're pleased to continue providing high absolute returns in a low-risk and uncorrelated fashion using our value-oriented approach. As an investment boutique, we match this performance with a high level of personal customer service. Performance and service have translated into new business; Client asset levels are up over 50% since last September. By popular demand, we've returned stock-specific commentary to the newsletter. Please keep the feedback coming.

Thanks again for your patronage. And remember, referrals are the highest form of compliments.
 
Sincerely,
 

Charles Goldblum, CFA
Average Client Account Up 15.7% Year-To-Date Versus 9.1% for the S&P 500
returns 3Q 2007

Over the first nine months of 2007, a composite of accounts managed by Hurley Capital rose 15.7% net of fees, as compared to the S&P 500, which rose 9.1%.

Client accounts sidestepped much of the recent market volatility with investments in Coca-Cola, Canadian Natural Resources and Jacada leading third quarter returns. Market sentiment bounced from ebullient to despondent and back all in the space of one quarter. When possible, we use these swings in market sentiment to provide entry points in bad times and exits in good times. We remained focused on finding investments that will succeed regardless of market sentiment as the underlying thesis depends as much on company-specific dynamics as macro-economic events.

"I think of value investing as bird-in-the-hand investing, where you measure the underlying business value of the company you're looking at to an intelligent and informed buyer who is thinking about buying the whole thing, wanting to own it indefinitely. And if you can figure out, roughly, what that person would pay, and if the stock's available at a big discount to that, then you've got a bird in the hand. It's already worth more than it's selling at..."

-         Wally Weitz, CFA, President of Wallace R. Weitz & Co., and Portfolio Manager of The Weitz Funds


 Bird-In-The-Hand Investing
Bird-In-The-Hand Investing asks, "Is a company trading at a discount to its 'private market' valuation?" These discounts occur quite often and are typically due to one or more of the following: (1) prior underperformance which leads to negative sentiment, (2) convoluted corporate structure, or, (3) poor industry outlook. If any of the above are expected to change, there is a catalyst for a recovery in the stock. We've invested in many stocks that traded at a discount for each of the above reasons. Dell stock has advanced and is poised for further growth due to continued international expansion, despite domestic underperformance and low sentiment. Discovery Holdings, a recent sale (59% gain), had both prior underperformance and a convoluted corporate structure, while Canadian Natural Resources and most other oil companies trade at a multiple assuming oil prices decline meaningfully from current levels.
 

A Recent Investment: Avid Technology

Avid Technology (AVID $27.08 on 9/30/07) is the worldwide leader in providing enterprise software for video broadcasting, and audio and video editing and production. Avid also has a consumer video production and editing business. We believe catalysts are in place to reverse Avid's discount valuation.

The good news is:
  • Avid is in a good market. As broadcasters switch from videotapes to digital editing and production, new equipment will be required from inside the stations, to remote trucks, to cameras. The trend to HDTV requires new equipment and software, too. These are inevitable changes which will take place over years creating steady business for the technology providers. 
  • Turnaround is do-able. Avid's low margins are mostly due to non-integration of acquisitions that have left company with multiple offices in various cities and non-centralized marketing, accounting and administration.
  • Activist shareholder base pushing for change. The three largest shareholders own close to half of the company, with the largest of them, Blum Capital, having a representative join the board of Avid in June 2007.
  • Company is ready to make the difficult decisions. CEO left in July 2007 making room for an as-yet-unannounced turnaround-focused CEO. Board of directors appointed Bain Capital to consult on turnaround strategy. We expect a new CEO and margin expansion/revenue growth plans to be introduced as early as this month.
  • As the market leader in all three of its divisions, they should garner a premium valuation should this turnaround work, or sell off a piece or two along the way. Large-cap companies including Thomson, Harris Interactive and Oracle are potential buyers, not to mention private-equity players.
  • Putting a market multiple on Avid's businesses assuming no revenue growth and somewhat recovered margins yields a target price in the mid $30's per share, with further execution yielding material upside from there.

The bad news is:

  • Avid is a poorly run large software company. Operating margins for its professional video division (53% of 2006 revenues) were 7% last year and are expected to be 2% this year, where industry margins are about 15%.
  • Their consumer video division, which should be capable of 10% operating margins is expected to run losses for the 2nd straight year.
  • In some of their professional video business and all of their consumer video they compete with Apple, whose Final Cut Pro software is grabbing growing market share while depressing industry pricing.
  • Revenue growth was flat over the first half of 2007 (compared with 2006) and is only expected to be up 3% for the year.
Happy Endings: Follow-Up On Recent Investments - DataMirror & Catalina Marketing

Our out-performance this year is partially attributable to the recent buyouts of DataMirror (+96% in 2007 and 184% overall) and Catalina Marketing (+18% in 2007 and 41% overall).

DataMirror, an integration software firm, is an example for corporate managers of how to combine capital markets expertise with operational success to achieve a superlative result for investors. DataMirror had uninspiring results for years. Perhaps anticipating good results, the company bought back over 30% of its stock prior to four consecutive quarters of revenue growth and out-performance of expectations. Buying back so much stock concentrates the benefits across fewer shareholders. The result was a sale of the company for a very healthy 3x revenues and 16x trailing operating earnings. Kudos to Nigel Stokes and the rest of the DataMirror team.

Catalina Marketing (see our Q106 Investor Letter) "cashed-in" on growing expectations after developing and deploying color coupon printers in supermarkets nationwide.  Catalina was able to  garner a premium price from Hellman & Friedman, a shrewd private equity firm, as  benefits from these investments were about to roll in.

What To Watch For

We continue to spend our time building and maintaining conservative, value-oriented portfolios for our clients; talking to companies, their suppliers, customers and competitors. We are pleased with the results year-to-date and look forward to providing good risk-adjusted returns for clients over the long-term. For more information on Hurley Capital, including previous newsletters, please visit our website: Hurley Capital.

Sincerely,

Charles Goldblum
Hurley Capital
 Performance Of Hurley Capital Investments


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Important Disclosure

The Hurley Capital Managed Accounts Composite represents all actual client accounts invested in this strategy for the entire year.  The Hurley Capital Managed Accounts Composite allocates client portfolios in equity and fixed income investments, weighted according to Hurley Capital's proprietary investment strategy. 

Actual client accounts utilizing the Hurley Capital Managed Accounts Composite may have varying allocations between equities and fixed income investments based on individual investment preferences.   The results of the Hurley Capital Managed Accounts Composite are net-of-fees, brokerage commissions, and other expenses.  Hurley Capital's investment advisory fees are described in the disclosure statement of Part II of the Form ADV which is available upon request.

The results of the Hurley Capital Managed Accounts Composite include the reinvestment of dividends.  Comparison of the Hurley Capital Managed Accounts Composite to the S&P 500 and NASDAQ Composite is for illustrative purposes only and the volatility of the indices used for comparison may be materially different from the volatility of the Hurley Capital Managed Accounts Composite due to varying degrees of diversification and/or other factors.

Past performance of the Hurley Capital Managed Accounts Composite may not be indicative of future results and the performance of a specific individual client account may vary substantially from the composite results above in part because client accounts may be allocated among several portfolios.  Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable.