Interview: Ryan Morris (Meson Capital Partners) Part 2

Member: Ryan Morris
Title: Portfolio Manager
Firm: Meson Capital Partners
Focus: Deep Value
Location: Los Angeles, CA
Undergrad: Cornell University
Post Grad: Cornell University
Notable Stock Expertise: FMD, PNCL, INFU, ATPG, ZAGG

(part two of the continued interview with Ryan Morris)

SumZero: What companies today fetch an undeserved premium?

Ryan Morris: I am not actively short them, but I don’t understand why people are valuing so many cyclical stocks like Caterpillar (NYSE: CAT) as if they are not cyclical.  I think the market has become more superficially focused than ever as evidenced by, for example, dividend stocks being the highest performing category last year.  The current dividend on a stock is nearly meaningless but if the market just prices things that are immediately apparent then it explains this kind of behavior.  It creates a good buying environment for my “bad perception/good reality” style of investing but it also means that things that appear ugly will get cheaper for a while.

SumZero: What segments of the market are you most eager to avoid?

Ryan Morris: Whatever segment is most popular. I generally don’t like businesses that change really fast such as a lot of technology companies.  I’d rather start an Internet company than invest in one in the current pricing environment there.  If there isn’t a very recurring element to the revenue or hard asset value I’m usually less interested.  I don’t want to pay up for growth, I’m just trying to buy cheap enough that if a business doesn’t fail completely then it will be a good return.

SumZero: What's one new position you've established recently?

Ryan Morris: Just about two months ago I established a large position in Pinnacle Airlines and filed a 13D.  Considering that Warren Buffett has been my hero since childhood and he swears off of airlines after his US Airways mistake in 1989, at least I get points for independent thinking.  The stock was down 90% last year and it’s not actually an airline in the normal sense as they don’t pay for fuel, sell tickets, or have pensions.  I actually did very well investing in aircraft leasing companies in 2009 where people were conflating them with other near-bankruptcy financial companies based on their GAAP numbers but the reality was very different.  With Pinnacle, analysts – that is those that still have the stomach to even look at it after being down 90% – are being incorrectly superficial about Pinnacle’s true liabilities and future prospects.

To reduce risk, I have formed a 13D group with another large shareholder to get a voice for shareholders.  Hopefully that voice is on the board that currently owns a mere 1% of the company, or if necessary through an equity committee should they decide to file chapter 11.  As was the case with HearUSA, chapter 11 is not the same as equity being wiped out.  Pinnacle is definitely more messy and less certain than the aircraft lessor situation in 2009 but I am also more sophisticated an investor and don’t make the position size as big.  It definitely fits the criteria that I like where most everyone else is panic selling for reasons that look valid at first glance, but metaphorically once you do some real research you find yourself alone in the library and that the covers of the books are very different than the contents.

SumZero: What's the most troubling market risk today that people aren't talking about?

Ryan Morris: I feel like all the risk people are talking about today is overall market risk. Every tail insurance type policy seems overpriced to me – every bird in the sky is a black swan with a fat tail!  With respect to risks that come up with all individual investments – particularly in the small cap universe where I focus - I’d say that the biggest risk that I don’t hear talked about is the governance side.  The quality of corporate governance for smaller companies is just such a mixed bag and I don’t think people pay enough attention to it.  Almost all of my investment mistakes have been related to that and it’s a fairly subtle thing until you have some experience with it.  I know a lot of people who buy stocks based on profit guidance but they really need to take a closer look at the accounting and keeping track of how closely CEOs do what they say and how intellectually honest they are about their mistakes.

SumZero: What was the worst trade you ever made and what did you learn from it?

Ryan Morris: My worst investment ever was in a Chinese truck-cab manufacturer, Tongxin (txic.pk).  It was a very large position that declined 80% in 2010.  As I mentioned, I try to find “babies being thrown out with the bathwater” that appear to be painted with the same brush as some bad category and thus receive the same low valuation, but the reality is much different.  Something like 90% of small cap US-listed Chinese companies are not real and misrepresent their financials.  After extensive research into Chinese tax filings, channel checks, and visiting China, Tongxin appeared to be one of the few exceptions to this broad statement and thus fit the bill for things I usually like.  It was extremely cheap at about 3X earnings and 1/3 of book for a growing business that had been around for 25 years.

I write about it in more detail in my Year end 2010 letter to investors but what essentially happened was that the Chinese founder got annoyed with the US holding company CEO and decided that he would simply disregard the fact that he had American partners.  He stopped cooperating with sending them financial reports which caused them to be delisted and though they haven’t completely “gone dark”, it is still unresolved today nearly two years later.

This was actually how I was introduced to activism as I attempted to lead a proxy battle at the time to get some board representation to stop this internal coup.  As the Chinese controlled the board, there was no actual confrontation or rule being broken, the board just sort of made a decision “it is in the best interests of shareholders to no longer be bothered by these financial statements” or something like that.  Ultimately I had no idea what I was doing at the time and if we had succeeded it would have been one of the most impossible victories ever as the management controlled 35%+ of the company and we needed 50% of the total shares to act by written consent.

Sometimes you learn fastest by starting with the hardest possible situation and working backwards.  Valentino Rossi, the greatest MotoGP racer says that he skids out in the first turn every time when on a new bike to learn faster where his limits are.  In the case of Tongxin, the damage had already been done and the stock was down so it was a reactive move on my part that wouldn’t have had any real downside at that point.  But I learned an enormous amount that I have built on for the much better results with HearUSA and hopefully soon InfuSystem and Pinnacle Airlines.

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