Compounding Life

*NOTE: I was not taking notes during the meeting so these notes are entirely reconstructed from memory, in addition I am paraphrasing what was said not directly quoting people. It is possible that information is not entirely accurate. I know for certain the order of the information below in NO way reflects the order of the actual conversations.

Location: Itex headquarters, Bellevue, WA

Attendance: 12 or 13 people including the ITEX board and company operators.

A representative of the Polonitza Group was in attendance, to see who the Polonitza Group represents view this 13D filling. The Polonitza Group among others includes David Polonitza who according to this letter has been an ITEX holder since 2004. Most of the questions were asked by The Polonitza Group. Some specific questions that were asked:

What was the reason for removing from the company by laws the ability for shareholders to call a special meeting? Is there any plan to re-instate this in the future?

They essentially said that this was done as a result of the WEST situation and at the recommendation of the counsel that was helping them during that time period. They believe it is in the interest of shareholders because it prevents management from getting blindsided with issues that have to suddenly take them away from running the business. They also noted that there processes for shareholders to voice concerns and have items brought up at the annual meeting. In addition they noted that they are always available to communicate with shareholders.

It sounded like they have no plans of reinstating the provision to call a special meeting however they did solicit feedback.

Steve White thought the bylaws were amended two years ago, but the Polonitza Group noted that this happened in the past year or at least not publicly disclosed until the past year.

I have yet to go through and track down the filling where the bylaw change is mentioned.

The Polonitza group voiced concerns over the lack of perceived independence in the board and compensation committee. As a publicly company they do not feel ITEX is doing enough to maintain proper independence on the board. They would like to see someone on the board that does not have existing relationships with the board members and they would like that entity to be a shareholder who has a reasonable position in ITEX. The Polonitza group offered up any of its members to sit on the board with no compensation required. It should also be noted that while The Polonitza Group expressed concerns about the lack of independence on the compensation committee they did state that they feel Steve White is properly compensated if not undercompensated.

The board in general tried to emphasize that while they have working relationships they are not very close friends and maintain independent thoughts and ideas.

They wanted to express that felt the board is more independent than the Polonitza Group was implying. They mentioned that while they have known each other and worked with each other for quite some time, they do not frequent each other’s houses or family events.

The Polonitza Group expressed concerns about the track record of return on capital deployed recently by ITEX. They also noted that the having an independent board member with capital allocation experience could be beneficial.

Steve mentioned that ITEX expects to see future returns on capital they have deployed.

The Polonitza Group asked if they would comment on the performance of the “SuperTrader” exchange launched by Idearc Media which is powered by ITEX.

Steve said that they are not disclosing details on this at the moment. I believe he did note that they expect it could be around 10% of revenue.

The Polonitza Group asked if the Idearc Media’s bankruptcy has any effect on deal between Idearc and ITEX, and if they expect that Idearc would attempt to renegotiate or back out.

Steve said that Idearc has been a great partner, they have always paid invoices quickly and after entering bankruptcy they had a small outstanding balance which they have assured ITEX will be paid as soon as they emerge from the bankruptcy. There was no indication that Idearc plans to renegotiate or back out of the deal.

The Polonitza Group asked if the company has thought about paying a dividend in the future.

Steve asked the shareholders for their thoughts on this. I happen to be the first one asked and was caught a little off guard. My response was that I would not opposed to the idea of returning some of the cash back to share holders, however I want to the company to maintain a strong position and be able to take advantage of opportunities to reinvest earnings at decent rates of return should opportunities become available. Most of the shareholders agreed with my statement, The Polonitza Group specifically said they were not interested in dividends being paid, specifically they pointed out the double taxation that happens when you receive dividends in taxable account, meaning the company is taxed on earnings and then the shareholder is taxed as well on the portion of earnings that gets distributed in the form a dividend.

During the dividend discussion the Polonitza Group brought up capital allocation and stated that they believe ITEX would be a good candidate for a holding company structure where the business units return free cash flow up to the parent level and the parent level manages the deployment of capital.

One shareholder asked about a $500,000 bad debt expense recorded on the balance sheet.

This was attributed to unpaid accounts receivable, Steve mentioned that they have an extremely low percentage of monies that go uncollected. I believe the number was 2%. They also mentioned that no commission gets paid until money is received. He also mentioned that franchisees are empowered to collect this money from members which attributes to the high recovery rate.

The Polonitza Group asked the board to comment on the lack of insider purchases by the board during the market turmoil which left ITEX selling at extremely cheap prices.

The board gave some reasons for not buying, Eric Best said he was very tied up in his startup “Mercent”, and was not necessarily financially comfortable or able to deploy cash for stock purchases during these times. Steve commented that he already has a large position in ITEX and stock purchases generally don’t cross his mind. Another board member pointed out that no one on the board has sold any stock in years. The Polonitza Group pointed out that Eric was the last to sell, Steve pointed out that he bought the shares Eric sold.

The Polonitza Group said that they understand people have personal reasons for not buying stocks during this time period, but they noted that even some smaller purchase by the board would go a long way. I pointed out that when ITEX was selling at bargain basement prices and no insiders were buying this is generally interpreted in a negative light because people will often take this as a sign that management does not think the stock is a good deal.

The Polonitza Group expressed that they felt ITEX should have been buying back stock when the stock was cheap and said they felt stock buy backs would yield better returns then their acquisitions.

Steve mentioned that they have the ability to buy back stock without the need for seeking approval, I believe the number was up to 2 million but I can’t be certain. Steve mentioned that thought it might be better to leave stock in the market for investors who want to buy more ITEX instead of reducing the liquidity of the stock and making it less available.

One of the ITEX folks, not sure if he a board member or the CFO mentioned that he has tried to find compelling evidence that stock buy backs provide any benefit or value to shareholders and he said most reports he found say they do not work. Myself and the Polonitza group both commented on the fact that most companies buy back stock at a price that is too high to provide value to their shareholders. It should be a very simple exercise for them to determine at what prices they should consider buying back stock.

That’s all I can remember for now. If I think of anything else I will update it.

Disclosure:
I own ITEX stock at the time of this writing.

At CGI Las Vegas I listened to presentation by John Del Vecchio from Ranger Alternatives. John manages the Ranger short book and has a strong background in accounting forensics. Specifically finding companies with low earnings quality before the market does and building “short” positions based on that information.

In his presentation he referenced some stats from a Blackstar Funds paper on the Russell 3000 index between years 1983-2006.

Russell 3000 stats 1983-2006

39% of stocks were unprofitable investments

18.5% of stocks lost at least 75% of their value

64% of stocks underperformed the Russell 3000

25% of stocks were responsible for all of the market’s gains

Well obviously an enterprising investor after reading this would be diligently researching looking for the %25. If you only invest in those companies you are sure to outperform the market. Well not always…

What a difference a day makes

The paper also gives us a sampling of some of the best performing stocks during that time period and their performance after the peak:

Thoughts

It would be interesting to see of the %25 that made up %100 of the gain in 1983-2006, how many companies would still be worth owning today. Looking at that list there are a couple. Of course there are some that would have resulted in a permanent loss of capital and some that are not permanent losses yet but for which the immediate future is not bright. Lets take a quick look at a couple…

GE

If you had bought GE on 01/03/83 at its closing price of 91.75, split adjusted (48:1) each share would be worth around $670 today. I figure thats about %8.3 compounded annual gain. If you had sold that share before the market drop you would have approximately 3x that amount somewhere around %12.5 compounded annually. Not including dividend payments. While GE is a mess today, its fair to say you could of done worse things than buying a share of GE in 1983.

MSFT

If you had bought MSFT when they went public on 03/13/86 at $28, split adjusted (288:1) each share would be worth around $8000 today. Around %29.3 compounded annually. Not including dividend payments.

Conclusion

This data reinforces a couple of points that I sometimes temporarily forget.

1. If you own a sub par company because it was undervalued when you bought it, sell it when it reaches intrinsic value and take your profit. There is no reason to hold it afterwards because it is likely to fall into the %64 that under perform the market. If you sell it and move on to the next value you will be on your way to out performing the market.

2. Paying a little bit of a premium for a a great business with a great moat and great management can pay off big time.

3. I think people should really call “buy and hold” “due diligence, buy and due diligence hold, rinse repeat”.

Heading to Vegas today for Complete Growth Investor. If you are going to be there send me an email or DM on twitter so we can meet up.

As I mentioned in my earlier post I recently read One Up On Wall Street : How To Use What You Already Know To Make Money In The Market by Peter Lynch. Peter Lynch took over the Fidelity Magellan Fund in 1977 when it had $18 million in assets. When he stepped down from managing the fund in 1990 he achieved an averaged %29.2 return and the funds assets sat at $14 billion in assets.

Lynch’s investment style varies quite a bit from the traditional super value investors. Lynch seems more likely to invest in public offerings or companies that have little operating history if he feels they have potential for serious growth. Lynch is willing to take a little risk on situations where there is some uncertainty so some people might call him a “growth” investor. That being said I try to ignore categorizing investors into buckets like “growth” and “value”. Instead I categorize them into two buckets “good” and “not so good”. Looking at his record Lynch falls in the “good” bucket. I can’t imagine how much work it must be to manage a fund with billions of dollars in assets, over 1000 positions and on top of it providing returns that outperform the market.

One point that Lynch makes again and again is that you should always use whatever edge you have over Wall Street. If you work in in a particular industry and have a finger on its heart beat, you have an edge over people sitting in front of a Bloomberg terminal all day who may invest or trade in that sector. In the book Lynch mentions examples of great companies that he identified before Wall Street simply by being a typical consumer. Lynch also mentions some of his follies, such as the sandwich shop he ate lunch at that made a public offering. He bought in because he felt he had an edge on predicting the success of their business. They found out the hard way that their sandwich shop format did not go over well in other cities as the expense of the shareholders who bought the stock offering.

I walked away from Lynch’s book thinking primarily about one thing. What unconventional research tools are available to investors? When I say unconventional I mean anything that gives you information a typical investor or money manager might not get from the annual reports or SEC filings. Here are a few examples of some unconventional and some more conventional but under utilized tools that might help give you an edge.

The Phone

This is not really unconventional, but I think underutilized. I personally have not exercised this option as much as I would like to but I think after reading Lynch’s book I probably will.

Email

Same the idea here. There was a risk arbitrage situation I was interested in and I was trying to get a little more information about when the company expected to complete the transaction. I emailed investor relations at the company supposedly making the purchase and my email to their investor relations address bounced because the person who answered that address was no longer with the company. While this doesn’t give me any information about the merger it could be an indication of how much or little effort they put into informing shareholders. On the flip side I have emailed investor relations at other companies and gotten immediate responses from an actual human being, sometimes with decent answers to my questions! That is always a good sign.

Web stats

In my previous post about IGOI I mentioned that I went to a local retailer to see what their in store marketing and placement looked like. Another bit of research I did was related to their online store. In their conference call from last quarter the CEO mentioned that they are engaging in a more direct to customer marketing campaign. They launched a new online store where customers can buy product directly from the company cutting out the middle man and resulting in higher margins for IGO. When I heard that I decided to go to Alexa and see what they said about traffic going to the IGO website.

Here is what they had to say:

The one thing this tells me is that traffic to their online store is not growing. For a company attempting to reach customers directly I don’t find this encouraging. Another thing I looked at is their online advertising. If I do a google search for IGO, I see an sponsored link for IGO’s website. They are paying to show advertisements for people who search for “igo” even though their site is the first organic (non advertisement) search result. Now if I do a search for “universal laptop power supply” I don’t see an ad for IGO. I refresh a couple of times, still no IGO ad. This makes me wonder if they have a handle on their online advertising campaign. Next I do a search for “netbook power supply” and first time I don’t see an IGO ad, I refresh and I start seeing their ads. At least they are going after netbook customers, but I still get the feeling that if they are really trying to reach more customers directly their online advertising strategy might need some refinement. Any one of these things on their own don’t provide a ton of data, but as you start to add them up you can start to draw a picture of how well the company is aligned with their mission. It is possible that they are just gearing up their online business, in which case now that I have this information I can monitor it accordingly and this can give me an edge on how the company is doing. We already know that they are loosing their biggest customer (Targus) and they need to make revenue up some where. If their Alexa stats start growing this might be an indication that they are on the right track.

Street View

In some cases Google Street View can be a good tool for checking out the company headquarters of smaller companies. Is it a fancy building? Is it a dump? Does it even exist? Unfortunately street view only works in major US cities and this information in a lot of cases could be of minimal use, but you never know what you may find.

Here is the Vaxgen (VXGN) office (I liquidation situation I had a position in):

View Larger Map

Here is a Berkshire Hathaway in Omaha, Nebraska:

View Larger Map

LinkedIn

LinkedIn is a professional social network. Facebook for corporate America. One of the ideas I had for LinkedIn was using it as a tool research company management. If a CEO or other executive is on LinkedIn there is a good chance his or her employment history is on their profile. Are their previous companies still around or did they run them into the ground? This could be a good starting point for finding out more about executives in small companies.

Obviously these tools on their own will not tell you what stocks to buy or sell. However they can potentially provide some value when used in conjunction with your normal investment research.

IGO (symbol IGOI) devlops and markets power accessories for electronic devices such as laptops, mp3 players and mobile phones. See their corporate website for a more detailed company description.

I initially learned about IGO from an excellent post on OldSchoolValue.com. At the time it was trading below its liquidation value making it a cigar butt with at least one good puff left as long as the management did not blow all the cash. The management has shown good signs of cost containment and even increased it cash position despite dwindling revenues.

I bought IGOI at $0.58 and while it has traded above my cost basis for the majority of the time I held it, it recently jumped up as high $1.30. Looking at almost %120 gain in 6 months I decided to reevaluate my position and see if I should continue to hold to this company now that it’s trading at a premium to what I believe to be its liquidation value.

I decided to evaluate the pros, cons and facts:

Update: Thanks to Daniel for pointing out another post on this topic.

Yesteday the Reuters Blog posted an article by Rolfe Winkler called “Buffett’s Betrayal”.

Rolfe goes on to say

Today, Buffett remains famous for investing The Right Way…

…But it turns out much of the story is fiction. A good chunk of his fortune is dependent on taxpayer largess. Were it not for government bailouts, for which Buffett lobbied hard, many of his company’s stock holdings would have been wiped out.

The gist of the article is while backing companies like GE and Goldman Sachs with debt, Berkshire Hathaway holding stocks like Well’s Fargo, Bank of America, and US Bank, Buffett has used his weight to save Berkshire Hathaways and hence his own investments. As a result he is a major benefactor of the bailout. The take away for me is that the author feels that Buffett’s skin in the game makes his support of the bail outs unethical.

Then he goes on to say…

Yeah, Buffett TALKS a lot about derivatives, about leverage, but what does he DO? He trades derivatives and, if I recall correctly, has said he doesn’t want to see more substantial margin requirements.

…

And I didn’t even mention the accounting shenanigans these guys are playing. Buffett SAYS a lot about accounting integrity, but his businesses are engaged in some very shady number fudgery.

And what about the General Re case? Everyone forgets that now too.

People give Buffett a free pass because they think, deep down, he really cares about their interests. I think he does too. Just not when they conflict with his own.

I spent about 30 minutes working a response to this article. To argue what I believe some misleading statements. Then I noticed this morning that the article has been picked up on Seeking Alpha. Browsing through the comments I found someone that resonated most of my thoughts which you can read here.

The only other thing I think worth mentioning is the derivatives statement. People love to poke at Buffett, going on about how he has said they are “Dangerous” and “financial weapons of mass destruction”. Well you don’t have to dig to deep to hear his explanation of those contracts. This years shareholder meeting someone asked him about this and (forgive my memory these are not exact quotes) his answer was basically, “yes they are dangerous. Cars are dangerous too when not used properly. ” “We felt these contracts were missed priced and we feel we will make some money on them in the long term, in interim we have premiums to invest today”.

Things that are complicated can be dangerous, especially depending on who is employing them. This is also means they can be mispriced.

Disclosure: I own shares of Berkshire Hathaway at the time of this writing.

The past year has been an interesting one thats for sure. I started seriously investing in August of 2008, meaning I started managing my own investments in stocks and bonds where as previously I had only invested in employer retirement accounts with some choices limited to a few funds.

It has been exciting times since then and while I really wish I had started earlier, to be honest I feel very lucky to have started in a time when stocks are cheap and Mr. Market is manic.

I figured I would disclose a few of the positions I have which have done pretty well. Of course I also have some positions which have been flat or lost value to date, but the gains out pace the losses and I think in the long run most of the losers will be winners.

Value Vision (VVTV): Multiple entries with an average price of $0.563
Current gain of 428.27%

I initially discovered VVTV by reading OldSchoolValue, there was some concern about the off balance sheet commitments they had which no longer made it a net-net, but the stock was so beaten down that I actually increased my position even after that news. So far that has paid off but Value Vision is far from out of the woods. I have been seriously considering exiting this position lately.

Ford Preferred Series S (F.PR.S or F-S): Purchase price of $6.17 current gain of 353.91%

These are shares of a trust that holds Ford bonds. While they are preferred shares, the shares are of the trust not Ford. So in the event of liquidation you are essentially a bond holder. The coupon is 6.5% on $50 face value. The coupon payment is in arrears, meaning they are currently not paying it and previous coupon payments are owed with interest. Who ever holds the shares when they pay the owed coupons will get all payments regardless of how long you have owned it. Upon maturity (2032) the holder would get face value $50. When I first found these they were trading at $4 a share but I had already invested all my excess cash. By the time I was ready they were up to about $6.
I decided I would stop buying if the price went over $10 which it did very quickly after it was obvious Ford was not going bankrupt in the near future. Today they are trading at $29 which is little over 0.50 cents on the dollar.

There is some discussion going on about diversification at Oldschoolvalue a site that I read regularly. Like most things investment related you can find opinions telling you to do almost anything. Buffett is known historically as a non diversified investor, meaning a generous amount of his capital are tied up in small number of investments. Does that mean you should have a concentrated portfolio? Here are Buffet’s thoughts he delivered to an MBA class.

If you are not a professional investor, if your goal is not to manage money in such a way to get signifigantly better return than the rest of the world, then I believe in extreme diversification. I believe that maybe 98, 99 or maybe more than 99 percent of people who invest should extensively diversifiy and not trade. So that leads them to an index fund type of decision with very low cost. Because all they are going to do is own a part of America and they have made a decision that owning part of America is worth while. I don’t quarel with that at all and that is the way they should approach it… Unless they want to bring an intensity to the game and make a decision to start evaluating businesses. Once your in the business of evaluating businesses and you decide that you are going to bring the effort and intensity… and time involved to get that job done, Then I think that diversification is a terrible mistake…

If you really know businesses you probably shouldn’t own more than six of them, if you can identify six wonderfull businesses , that is all the diversification you need. You are going to make alot of money and I guarantee you that going into a 7th one instead of putting more money into your first one has got to be a terrible mistake. Very few people have gotten rich on their 7th best idea, but alot of people have gotten rich on their best idea.

But to quote Buffett again…

A public-opinion poll is no substitute for thought.

Regardless of what experts or friends say. Ultimately you have to decide whats best for you. You are the one that has to sleep at night with your investment decisions.

Arbitrage in the purest sense exists when there are multiple markets for something and one of the markets prices said something lower than the other. For a real simple example lets say that a certain collectible baseball card sells for $30 in California over the counter. You can take the same baseball card to a card shop in Boston and sell it $50. There is a very low risk opportunity to make a $20 profit per card if you can buy them in California and sell them in Boston. So you buy a bunch of these cards in California and ship them to your old friend from High School who lives in Boston. The shipping averages out to $1 per card and you cut your friend in at $5 per card. 

  $50  Market price in Boston

- $30  Market price in California

______

  $20  Spread

  -$1  Shipping 

  -$5  Comission 

  $14  Total profit per card

What you are doing here is a form of arbitrage.

Some people might call this
scalping; it won’t surprise you that practitioners opted for the
French term, arbitrage.

- Buffett in the 1988 Berkshire Letter to Shareholders

There are many different forms of arbitrage. People sometimes engage in arbitrage on sports betting, where they can place bets at different books at different odds in such a way that no matter what the outcome of the game or race they are guaranteed a profit. Casinos practice “statistical” arbitrage. All the games they offer have a statistical advantage in favor of the house that guarantees over time they will profit. 

Warren Buffet was engaged in a unique arbitrage situation involving cocao beans while working for Ben Graham’s Graham-Newman Corp. Buffett writes about in the 1988 Berkshire Letter to Shareholders:

 
Some offbeat opportunities occasionally arise in the arbitrage field.  I participated in one of these when I was 24 and working in New York for Graham-Newman Corporation.  Rockwood & Co., a Brooklyn based chocolate products company of limited profitability, had adopted LIFO inventory valuation in 1941 when cocoa was selling for 50 cents per pound.  In 1954 a temporary shortage of cocoa caused the price to soar to over 60 cents.  Consequently Rockwood wished to unload its valuable inventory – quickly, before the price dropped.  But if the cocoa had simply been sold off, the company would have owed close to a 50% tax on the proceeds.

     The 1954 Tax Code came to the rescue.  It contained an arcane provision that eliminated the tax otherwise due on LIFO profits if inventory was distributed to shareholders as part of a plan reducing the scope of a corporation’s business.  Rockwood decided to terminate one of its businesses, the sale of cocoa butter, and said 13 million pounds of its cocoa bean inventory was attributable to that activity.  Accordingly, the company offered to repurchase its stock in exchange for the cocoa beans it no longer needed, paying 80 pounds of beans for each share.  

     For several weeks I busily bought shares, sold beans, and made periodic stops at Schroeder Trust to exchange stock certificates for warehouse receipts.  The profits were good and my only expense was subway tokens.”

 

Risk arbitrage is the most popular type of arbitrage when it comes to securities markets and involves “merger & aquisition” situations. For example Lester Floor Tiling announces it is attempting to buy out Smith Carpet Company (company names are made up) and offering $20 per share of Smith Carpet Company stock. If you purchase Smith Carpet Company stock for under $20 you can profit from this transaction when and if it happens. 

As the name implies there is risk involved in these situations. Smith Carpet shareholders may vote against the buyout, regulatory agencies might step in and say that this would create a flooring product monopoly that would not be in the interest of consumers. In M&A activities there are endless lists of things that can prevent deals from happening.

Take all of these risks and then factor in the current credit freeze and market volatility. Things can get hairy and do.  Mergers that seemed likely months ago can now fall apart quite easily.

Value investing blog Oldschoolvalue has been dilligently following a risk arbitrage opportunity regarding Emageon Inc. (symbol EMAG) and Health Systems Solutions Inc. (symbol HSSO). HSSO made an offer to purchase EMAG at 2.85 share. HSSO had a hard time meeting deadlines for the deal but ultimately ponied up $9 million in an escrow account to be paid to EMAG in the event that they could not follow through on the deal. $9 million may not seem like a lot, but put it in context HSSO’s market cap as of this writing is $8.3 million and the deal value of $69 million, its a fairly substantial deposit. So when news hit the deal was going to close February 11th the stock price started soaring up to $2.60 as people started getting in on the deal. The day before the deal was supposed to close the price started droping and investors were worried. Was there insider information about the deal falling through that was causing people to sell? The market in general was taking it in the pants so a lot of people (myself included) attributed the price drop to a combination of market volatility and people selling early to lock in their profits. 

The deal fell apart.Stanford International Bank in Antigua decided not to fund HSSO’s purchase and EMAG shot down to the $1 dollar level. To make it even more interesting, the decision to not fund the purchase has brought more attention to Stanford International and there is some speculation that the bank which has had abnormally high return rates on its certificates of deposits might be up to no good. In fact they are the subject of a probe.

I am left holding EMAG shares for quite a bit less than what I paid for them as are alot of other people. After doing a mental post mortem I have a couple of lessons learned.

1. Coming off of a successfull arbitrage with Puget Sound Energy I was probably not as critical of the EMAG deal as I should of been. Had the Puget Sound Energy deal fallen through I would have been content holding my position through the current market and collecting the dividends. In assessing the deal I did not put enough weight on the fact that EMAG is not a stock I would be content with holding an extended period of time. I think looking forward, my overall feelings about holding the secuirty in question should have a heavy weight on my decision. Even if the odds look like they are 90% or greater, the quality of the stocks in question should be paramount to my decision because I do not engage in enough arb situations to balance out the losses.

2. More due dilligence on Stanford International Bank may have set off some flags that I should steer clear of the deal. The fact that they offer abnormally high returns on CDs and are based in Antigua a place where I have little knowledge of the local financial regulations might have tipped me off. But of course hindsight is 20/20. 

3. I know very little about the industry that EMAG and HSSO are involved in. One nice thing about the Puget Sound Energy deal was that I live in Puget Sound and hence was close to the pulse. In addition I know a person that had been Puget Sound Energy shareholder for a long time who gave me some valuable insight as well.

Typically those who engage in arbitrage when faced with this type of situation sell their position, take their losses and move on. I was tempted to do this but I have decided not to for the following reasons:

1. Sell off. There are alot of people closing out their positions and driving down the price. I don’t believe the current price reflects the value of the stock and I do not have an existing opportunity waiting for the funds currently invested in EMAG. 

2. EMAG recieved 9 million in cash because the deal fell through. As of this writing EMAG is trading right around their book value and a little bit over their cash per share not including the 9 million in cash they just recieved. While the cash will not bring the book value up to my purchase price, I think they are better positioned or ride it out. 

While I understand the “cut your losses and move on” way of thinking, I believe the exit much like the entrance into the position requires some thought and in this case my thought is to hold on for a little while and not let the actions of the masses sway my judgement.

Some good arbitrage related reading:

1988 Berkshire Hathaway Letter

Buffett on Valuation: Risk Arbitrage Edition

Arbitrage: Emageon (EMAG)

Updates:

1.Turns out that the Stanford International is the focus of probe and key people are facing criminal charges.

2.I ended up selling my EMAG position because I feel I have found a good investment idea that will be a much better allocation of remaining funds instead of waiting for EMAG to recover.

Lately I have been reading the quarterly and annual reports from the “Oak Value Fund”. Not because I am interested in investing in their fund but because they are well written reports that summarize the market weather from the perspective of a value investor and they go into good details about their holdings and their reasons for buying or selling their positions.  

The Oak Value reports are reminiscent of the Berkshire Hathaway annual letter to shareholders but offer yet another perspective because they do not buy entire companies and they will open and close positions more often.

I reiterate, I have no intentions of investing in this fund nor do I make any recommendation that any one else does. I just feel there is some good reading in their reports.  One interesting note is that OAKVX is a fairly small fund with only around 58 million is assets.