Tim Quinlisk's new value fund is trouncing its peers this year and he got there by going where few value managers dare to tread: the Nasdaq.
Quinlisk runs the young and broker-sold
John Hancock Focused Relative Value fund, which is up more than 21% so far this year compared with a 1.6% gain for its average peer, according to
Morningstar. Like value maven Bill Miller, Quinlisk is posting big gains by sifting the battered tech sector for companies with strong fundamentals that are simply getting trounced the current economic downturn. In digging through the tech bin and in other areas, Quinlisk looks for companies with a cheap stock price relative to future earnings and cash flows, only buying shares when he sees a catalyst for growth. That's led him to chip companies like
Finisar(FNSR Quote - Cramer on FNSR - Stock Picks) and
Agere, in addition to DirectTV shops like
Pegasus Communications(PGTV Quote - Cramer on PGTV - Stock Picks). He's even looking at cratered bellwethers such as
Oracle(ORCL Quote - Cramer on ORCL - Stock Picks) and
Cisco(CSCO Quote - Cramer on CSCO - Stock Picks). All in all, his digging has led him to put 65% of the fund's stake in TMT -- telecom-media-technology to you and me.
While things have worked out well so far for Quinlisk, he's quick to admit that he's probably early and that there are still plenty of ways to lose an awful lot of money in the Nasdaq -- he's seen that firsthand with his
Lucent(LU Quote - Cramer on LU - Stock Picks) position. But he also wonders why more value managers aren't buying in the tech sector where he's seeing companies that are cheap relative to their future cash flows. Given his success helping run Hancock's
(TAGRX Quote - Cramer on TAGRX - Stock Picks)Large Cap Value fund since 1998, he took the reins last year, and Miller's rejuventated love for tech, it's hard to ignore what he's got to say.
1. Given your strategy, where do you see values today? Quinlisk: My strategy has led me to a big emphasis in three key areas, for the moment: Technology, communications services and in the media area.
Really, TMT? Quinlisk: Yes, and we've been fairly aggressive.
That's interesting because after the past year's fallout, everyone's struggling with the question of whether or not there's value in the Nasdaq. Where do you see value? Quinlisk: To step back a little bit, I like what's happened in the market over the last 12 to 15 months, in the sense that we've really had a significant rotation from growth at any price or no value placed on valuation at all to one now that at least recognizes technology for what it is, which is a cyclical growth industry. Now we've got a lot of pessimism about these companies, we've got a lot of uncertainty about their fundamentals and we've got an economic backdrop that's showed a lot of weakness.
Value Proves Its, Well, Value
After a blue period in 1998 and 1999, value funds are leading their growth counterparts |
 |
| Source: Morningstar. |
We think there are a lot of good opportunities here, and what investors have to consider is that investing in some areas of technology is no different than investing in cyclical companies, whether it's an auto parts company or a steel manufacturer.
You've got to look at the profitability of companies through a full business cycle. For example, that's what you do when you're buying an auto parts company; you buy when the auto sales numbers are down or have been coming down.
So what that has led us to within technology has been some of the more cyclical names, some of the semiconductor names.
One of the chip companies in the fund is Agere Systems, which was spun out of Lucent. There are names like
Conexant(CNXT Quote - Cramer on CNXT - Stock Picks). We also have a name like Finisar -- a name we picked up at very attractive prices.
2. What's your response to someone who says "Yes, everywhere you look in the Nasdaq you find companies far down from where they were trading a year ago, but valuations, in many cases, are still awfully high"? Quinlisk: First of all, I don't confuse price declines with value, because there're a lot of stocks that peaked at valuations that didn't make any sense and there are a lot of stocks that went down 80% and still aren't a value.
What we try to do is really look at these stocks that have gotten crushed and use their models to determine whether or not there's value there, and also take a little bit more flexible approach.
I'm not going to sit here and argue to you that Agere, which is trading at $7, is a value play based on current earnings, which are probably going to be negative. My argument is, if I can buy a quality semiconductor company with very solid long-term growth prospects, with normal profitability structures that are close to 20%, and if I'm willing to look out over the next three to five years, that's the kind of value that I like.
In many cases, there's little value based on current fundamentals but you don't buy cyclical companies when they're cheap on current earnings; you buy them when they're expensive on current earnings, because the fundamentals have eroded. That's really my argument.
3. Are you worried that you're early? Quinlisk: Absolutely, I definitely worry about that. That's a big worry because I am early. I know I'm early.
I don't own Oracle, but if I don't buy Oracle in around these levels here and there's any evidence of recovery, I'm never going to be able to make a value case for Oracle again. I'm just not and I recognize that, but that's why, when you're talking about the kind of quality franchises that are on sale now because, in a large part, because of economic weakness, I've got to look at these things now, and I will.
I don't mind being early depending on the quality.
4. What are some other companies that fit that mold? Quinlisk: Well, in the Focused fund we've got a big emphasis on DirectTV providers,
General Motors Hughes(GMH Quote - Cramer on GMH - Stock Picks), and Pegasus Communications. Let's talk about Pegasus.
Pegasus is a DirectTV satellite provider in rural markets. There's a huge amount of predictability around their cash flow. Once they sign up a subscriber, they have, within a certain degree of reason, a pretty fair predictability of how long they're going to keep that subscriber, and so I love those kind of businesses where they've got a fair amount of recurring revenues.
Now the issue with Pegasus is that you can't value it on current earnings. The reason for that is because they've been in a growth mode. In many instances they're willing to pay $400 or $500 of what they call subscriber acquisition costs to get a customer.
You throw $400 or $500 out the door, but you know you're going to get it back. A subscriber is going to pay $50 a month for the next six or seven years.
So those upfront costs are big, but when you do the math on that over a six- or seven-year period, you say, holy cow. There's a fair amount of predictability there and when I look at what the market has done on a valuation basis for Pegasus, the stock's gone from literally $78 in 2000 to $20.
There's also a catalyst here, and in the DirectTV market, that's consolidation. You see all the talk out there in the press regarding the potential sale of General Motors Hughes,
News Corp (NWS Quote - Cramer on NWS - Stock Picks) having an interest, you've got
Echostar(DISH Quote - Cramer on DISH - Stock Picks) that's also interested too. Pegasus is right in the heart of that.
Pegasus is trading at around $1,800 per subscriber and we're talking about transaction values that could certainly be north of $3,000 per subscriber, and today we can buy these guys for $1,800. So that's attractive. That's good value; it's not down and dirty kind of value, but I'm owning a very good business.
5. Now, is that the time frame you typically use for this fund when you're buying shares? Quinlisk: About 12 to 18 months. Now, I want to make money quicker, if I can, and so it's not unusual that the time period will be shorter. But really the basis for the ideas we're coming up with and really looking at models that are anywhere from two to five years. You have to, in this kind of environment.
A Solid Streak
Quinlisk started working on the Hancock Large Cap Value fund in 1998 and took the reins last year |
| Returns | John Hancock Large Cap Value | Rank vs. Peers(1=Best, 100=Worst) |
| YTD | 8.3% | 1% |
| 1-Year Return | 2.5 | 4 |
| 3-Year Return | 14.9 | 3 |
| Source: Source: Morningstar. |
6. A few weeks ago veteran value manager Bill Miller
explained his rising interest in TMT by saying that investors were assuming the current weakness for these companies would continue for years, ignoring a potential earnings recoveries next year. Does that make sense to you? Quinlisk: Absolutely. That's exactly what I'm saying. If you're talking about cyclical companies, you've got to buy them when the news is God-awful, everybody hates them and thinks the world's ending. I don't understand why a lot of value guys aren't looking at more tech because it's first and foremost, it's a combination of a couple things that I really like, right?
I mean, ultimately, as a value guy, you want to buy growth. You want to buy companies that can grow. Tech gives you that. Second, you want to buy good businesses. Well, when I strip away a lot of the names in technology and look at the software models, for example, or even some of these semiconductor companies, they've got good business models, which are hugely profitable.
So the third part of what you're looking for when you're buying cyclical companies is operating leverage. That's huge in these kind of companies. Yes, I admit Agere is not cheap on current fundamentals, because they have no visibility and the business sucks.
But that's not what I'm buying it for. I don't care what they do next quarter. I just care that their franchise is intact and if it is right, I'm going to be so rewarded in the next three years, it's going to be unbelievable, because I can look out three years and look at what the business model is and it tells that the stock's worth four or five times what it's being valued at today.
7. How can people avoid traps when they're looking at the Nasdaq? It's almost like, people are very quick to say there's value there, but not everything's a value. Quinlisk: You have to look at valuation. I can't just say, gee, you know, Cisco -- I'm not, I don't mean to pick on Cisco, or whatever, Oracle -- you can't say, God, Oracle's gone from a high of $46 to $15. That doesn't necessarily mean value.
So what we try to do is look at valuation, that's the first criteria. And if it doesn't fit the model in terms of a reasonable valuation metric, then we're not going to buy it.
Now by that you mean you're looking at, are you looking at its PE relative to similar growing peers? Quinlisk: No, I'm using a combination of about six different factors. Because I think it's ultimately very important that you don't just base one metric.
People say they just use P/E multiples and I just kind of flip out because PE doesn't tell me enough about the business, about the capital intensity of the business or the cash flow. So it's really a combination of a lot of metrics we look at. That's why I've always been a big believer more of a discount in cash flow analysis and really look at what's the present value of the future revenue streams? Or earnings streams? And that's really one of the sort of intrinsic value metrics that we look at in terms of what we think businesses are worth.
So I think the trap here is buying companies that aren't values because the valuation metric doesn't work.
8. Are there any that jump out to you as being things that are probably look like low-hanging fruit, but someone should do more due diligence before they would take a position? Quinlisk: That's what I'm telling people in presentations. I'm saying Look, the most challenging part of my job right now is looking at the Oracles of the world, the Ciscos of the world, the
Dells of the world, looking at companies that, as a value manager, I haven't had the chance to buy in three years, and getting back up to speed on them."
Because Oracle is $16.17. I know the current environment stinks. There's people concerned about they're going to miss the quarter and so on and so on but what intrigues me about it when I look at my models -- Oracle has never been statistically cheaper on a price-to-cash-flow basis. It's trading at about 13 times cash flow. For a company that's probably a 20%, 25% grower, that's probably pretty attractive here.
But you don't own shares? Quinlisk: I don't. No, I don't.
9. Let's talk about a company where every value investor has an opinion: Lucent. You've said you like Agere, which Lucent spun out, but what about the mother ship? Quinlisk: Man. The mother lode. I'm concerned. What concerns me is that despite all the research that we do, the best perspective on a company is from the inside. And they've got a board/senior management team that seemed willing to do a deal with
Alcatel at a low price. This gives rise to some issues about their comfort level in the business model, going forward. And that really concerns me.
That doesn't exactly indicate that... Quinlisk: They think they can turn it around or the business is fine. That really, really concerns me.
Do you own shares currently in the large-cap fund? Quinlisk: Yes, I do. And in the Focused fund too. Here you've got a company that is trading at roughly, maybe a little over one times revenue on a book-value basis, it's trading at almost 1.5 times book.
All the profitability metrics of current valuations are wacked because of the fact that they're so under pressure now, so you can't even look at them currently.
So everything's pretty much out of whack here, but if you were to deal with some of the parts of kind of comparable valuation, it's telling you that the thing is extraordinarily cheap.
Where's the catalyst? Quinlisk: I don't see the catalyst. I'm looking for a catalyst that would get me excited about it, which is for them to first, sell off their fiber optics business to alleviate a lot of the financial concerns that surround the company in terms of their rational considerations over the next year.
I think that would effectively do that. That would be a huge positive. The second thing I'm looking for is a new management team that's going to come in and give it a shot to turn it around. And the more visible that would be, would be even better because there is value here. But I don't see the need to really rush into this without those catalysts.
10. Finally, what's your take on more traditional value sectors like energy and financials? Quinlisk: Everybody's piled into energy. That's why I don't own much energy. The fundamentals there are pretty solid, they're very solid. But everybody in the world owns it.
Like being late to the party?
It really is. And when you look at financials, they've had a great run over the last 12-15 months, on an absolute basis and certainly on a relative basis. Those valuations are looking, certainly fairly valued at this point. There's no huge undervaluation there.
Ian McDonald
RSS
