Maybe you know Lisa Rapuano's name and maybe you don't. You should, though.
A halo of deserved praise surrounds her boss Bill Miller, who manages the
Legg Mason Value Trust fund, among others, and who is the only fund manager to top the
over each of the past 11 years. But not much of that light is shed on his team, including Rapuano, who started covering tech stocks for him in 1994.
Fund: Legg Mason Special Investment
Managed Since: January 2001
Assets: $2.2 billion
YTD-Year Return: -0.9%/Beats 65% of Peers
1-Year Return: -5.2%/Beats 58% of Peers
Expense Ratio: 1.79% vs. 1.38% category avg.
Sources: Morningstar and Legg Mason. Returns through Feb. 3.
She helped him analyze some of his most controversial and successful picks, such as
in its unprofitable days. More recently she and her colleagues have cobbled together an idea of what
is now the online store's biggest bondholder and stockholder. She calls herself "Amazon girl."
Since the start of last year, Rapuano has run the
Legg Mason Special Investment fund. In a tough year she managed to gain 2.3%, topping more than 80% of her peers. Like Miller, she shops for companies that are unloved and underappreciated. How much is Amazon.com worth? What tech stocks does she think are undervalued, and what has she learned during the past two ugly years? Read on.
1. What do you look for in a company before you buy shares?
I look for a low valuation, but that in and of itself is not enough. My ideal investment is a company whose stock price has been temporarily depressed by either a cyclical
downturn or news events, where expectations have been smushed dramatically, but management has proven trustworthy in the past. Ideally, if or when they recover, they have the opportunity to have multiyear growth through margin expansion or capital efficiency. So what I'm really looking for is not just a temporarily depressed stock price, but a temporarily depressed stock price on a really good company. I'm always looking over a three-year time frame, but I'd love to be able to own something for 10 years.
2. An example?
A good example is
, which I bought on its initial public offering
in July and later added to below the IPO price, which was $14 to $15. Because the IPO market was really depressed and because technology consulting and technology spending was...
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... in a nuclear winter.
Exactly, nobody cared. Meanwhile you have a company that nobody would deny is the leader in their industry. It has amazing returns on capital that were improving. They were generating gobs of free cash flow, so much free cash flow that I don't know what they're going to do with it, and still nobody cared. It was
trading at 14 to 15 times its earnings, and now it's 25 times earnings
the stock is up 51% over the past 90 days. That was a rare example of what I'm looking for.
3. Your fund has a bigger bet on tech stocks than its average peer. What are you seeing there?
I have always had a penchant for technology in this fund.
Because you were a tech analyst working with Bill's team?
Yes, I was AOL girl and now I'm Amazon girl. Lucky me, right? So technology. The Special Investment fund had about 35% or 38% in technology at the end of 1999. We reduced it to the mid-20s in 2000 and took it back up to the high 20s in the beginning of 2001. Now I'm back down to the low 20s and waiting.
I like technology because it gets knocked down very easily. A product misstep, a lost sale, a missed quarter -- stupid short-term things -- get suddenly capitalized into the stock price as if they're long-term value destroyers. So if you have the courage to go in when these things are down in technology, these things can be especially rewarding.
4. What are a couple of tech companies that look cheap from where you sit?
Here's a classic one that no one would ever say anything good about except me:
. It's a software company, a perennial also-ran in the database business that generates really good cash flow. I like the management there because they've done all the right things. They've bought back shares, made a really cheap acquisition that seems to be integrated really well, and managed their cash extremely well. It has recovered to nearly 18 times earnings right now for this year, but it got down earlier in the year to 8. No one can see any reason to own it, because it doesn't have a 25% top-line growth rate. Not many people are going to have a 25% growth rate going forward.
Another one is
, which sells marketing data and offers a software product that integrates marketing data across databases for companies. This is a small company that didn't miss quarters for years. Last year, with the launch of this new software product, they ran into the economic downturn and a lot of controversy around the way they accounted for the software's revenues. So they changed the way they did their accounting. Today they have a much higher quality of earnings. They're recognizing lower revenues, but they've begun to grow revenue again. The stock is depressed down below two times next year's sales, while management's execution has improved dramatically over the past three quarters, and the cash generation of the company has improved by leaps and bounds. The stock price has not reacted yet.
How long has the fund held those two names?
Acxiom I've held for more than a year. I added to it all the way down which is my general protocol. Sybase I've held forever, and I bought a lot more of it in 2001.
Sources: Morningstar. Returns through Feb. 3.
5. When I looked at additions to your portfolio over the past two quarters, some names that stood out were Providian (PVN) and Calpine (CPN) , which some managers think are teetering on collapse. What do you see with Providian?
I love issues. I purchased Providian
down 94% over the past 12 months recently at these low prices, and it's basically a turnaround situation. It crashed because they just tried too hard to grow for too long. Their balance sheet wouldn't hold it anymore. What I like is that, if Providian survives, it's worth at least double its current price. It looks to us like there's more ways it will survive than it won't.
If they survive, we think we have a company with a shrunken balance sheet, lower growth prospects and an ability to earn a high-teens return on equity vs. the 40% they used to earn when everybody loved them, which was clearly not sustainable.
For a company with, let's say, 10%
earnings growth, high-teens return on equity, and a solid balance sheet going forward, we think it should trade for at least its book value. That's in the high single digits vs. the low single digits we're buying it for now. ... There's still a chance that it's worth nothing, and we acknowledge that.
What is Providian's fair value?
In our analysis, we have an estimate of $9 or $10
6. What's the thesis with Calpine?
The thing I like about Calpine
down 84% over the past 12 months is that psychological and cyclical issues are depressing the stock so much that I'm fairly confident it's mispriced in the one- to three-year time horizon. ... It looks to me that their comment that they can earn $1.70 this year is true; that the assumptions behind it make sense.
I think the company is currently in a depressed environment, which I don't think will continue. The psychological issue ... is that they have Enron dust on them. They're automatically thrown out
because nobody wants to own these companies, so that increases the probability that things are mispriced. Calpine was ... going to be this new-age power generation company of the future. I don't know if that ever comes back. It probably doesn't.
If they just stop building
plants altogether, and just use their maintenance capital expenditure, I believe it would be worth 10 times that free cash flow, which I believe is $18 or $19 right now. My analyst thinks it's worth $25, but I don't really agree with him yet.
7. Another controversial holding is Level 3 Communications (LVLT) , which is down 94% over the past 12 months, and some would say it's a dead duck. What are you seeing there?
We're fatally attracted to things that are down significantly and are out of favor. I personally believe that Level 3's liquidity situation is fine. I have gone through it with a fine-toothed comb and I believe them when they say that they won't run out of money before they're cash-flow positive. That is the most important issue as to whether or not this thing has any value.
I believe the broadband data area suffers from a mostly cyclical issue complicated by the great big glut of fiber that's believed to be out there. I don't believe that can last forever. It depends on if you believe that end demand will grow or not. The worst estimate of end demand that I've seen was
40%. If you have an end demand growth rate, it is inevitable that this oversupply can't continue indefinitely.
So you have Level 3 with what I believe is the lowest-cost network out there, significant competitive advantage and a management that has responded extremely well despite being in this terrible area. Sure they put on too much debt and grew too fast, but I didn't own them then. They've done a lot of things right in this downturn. They're running the business right now to maintain cash and expenses, which is very hard. They're executing it well.
Where did you buy the stock?
Well, I bought my first share probably at $15. Then I bought a little tiny bit when it went down into the high single digits. I loaded up on it when it went under $5. I bought some more two weeks ago.
What do you think the stock is worth?
I'm using $10 right now. When it got up to $6 or $7, I didn't sell any because I'm not looking for a trade. ... It's not for the faint of heart, and it's a 2% position in my portfolio.
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8. Now let's talk about the elephant in the room: Amazon.com. Legg Mason is the biggest stockholder and the biggest bondholder. What do you see there?
I see a company that just reported a profit any way you measure it, made unbelievable operational strides this year, and whose goal of operating cash-flow positive and free cash-flow positive is very attainable. I wholeheartedly believe that they can do that based on the current environment.
fewer loud and wrong proclamations that they're going to run out of cash. This last quarter -- with the Moody's
credit upgrade and the profit -- is a really big deal in terms of fleshing out the future scenario for Amazon.
I think Amazon is probably the company where you really have to look long-term to understand what you have and why you would be buying this thing at this price. Amazon has created this giant store that people like and people want to go to. That makes it more sustainable than your traditional manufacturing companies.
And there are very few companies that earn really high returns on their capital. The big question mark is the sales growth rate. We don't know what it is. Anybody who says they do is crazy. I believe at a 10% sales growth rate with triple-digit returns on capital, Amazon is worth at least $20
per share. What is the chance that they grow more than 10%? Well, since they didn't grow very much in 2001, everybody says, "Oh they'll never do that." We get the economy picking up, and people not hating e-commerce anymore, and strategic use of promotion and price, we could see sales start to grow again, and it could be worth more than that.
9. Where did you start buying Amazon?
With Amazon in this fund, I started buying in the mid- to high $20s and bought it all the way down. I bought most of my shares in the mid- to low teens. That's where I really got aggressive on it.
10. Given their management, growth prospects and current valuation, what are three companies you'd be most confident in holding for the next five years?
I'd probably pick
because they've executed for so long and their valuation is so low that I think I could earn 20% a year for five years based just on their return on equity, even with no expansion on valuation, which I think they deserve. I'd pick Amazon too, because I have a high degree of confidence in their business model, their opportunities are vast, and I now have evidence that the company can execute their vision. Third I'd pick
. That's something that I've owned forever, and the valuation is reasonable. They're a worldwide leader in advertising, and advertising is a growth business over time. Even though it's cyclical, it's grown 7% to 10% a year over time. I like the management and I have a high degree of confidence that in five years that they will be significantly higher than they are today.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.