Starting with Z.

Each year I try to go through the Russell 2000 to look for investment opportunities.  I don’t like screens (for reasons described here), so I slowly plod my way through the list each year.  However, last year I noticed that although I made it through the end, the last few letters of the alphabet may have been getting the short end of the stick with a lot of holidays bunched up at the end of the year.  I thought I would reverse the process this year to make sure no companies were discriminated against due to their end-of-the-alphabet names….

“Invert, always invert.”  This saying from Munger has always resonated with me, and when looking for companies to invest in, I typically find a lot of things I don’t like.  If I ever fail to find these things, I might be on to something.  In that same spirit, I am going to write once a week  (or at least try to write) about companies that come up as I make my way through the Russell 2000–and for the majority of the time, I predict writing about things I don’t like.

These thoughts will be brief.  I don’t like complex models or write-ups and if I am saying no, all the more reason to move on….

Starting with Z….

Zogenix, Inc. is a pharmaceutical company commercializing and developing products for the treatment of central nervous system disorders and pain. The Company’s product Sumavel DosePro offers needle-free subcutaneous administration of sumatriptan for the treatment of migraine and cluster headache in a pre-filled, single-use delivery system. Its lead product candidate, Zohydro (hydrocodone bitartrate, formerly ZX002) is a 12-hour extended-release formulation of hydrocodone without acetaminophen for the treatment of chronic pain requiring opioid therapy.

I am going to need opioid therapy if I have to read any further.  However, I am looking for lessons here, so I opened up the most recent 10k on this company.  $200m in operating cash flow losses over the past three years and $185m in capital raising through stock sales.

Reasons not to invest in a company:

1. Business I can’t understand (for this reason alone I usually stop reading at “is a pharmaceutical company…”)

2. Business is unable to generate positive operating cash flow.

3. Due to company’s inability to generate operating cash flow, it is forced to continually dilute existing shareholders through stock sales.

This might be the triple crown of anti-investing.

I wonder why people invest in pharmaceutical companies, but then once in a while a company like Intercept Pharmaceuticals will come along and sky rocket 569% in a matter of days upon good results or approval of a drug (see article here).  These companies are basically lottery tickets and not my cup of tea.

ZaZa Energy Corporation: independent exploration and production company focused on the exploration and development of unconventional onshore oil and gas resources in the United States of America.

I think Mark Twain said it best, “A gold mine is a hole in the ground with a liar on top.” I apply the same principle to oil exploration companies.

Zillow/Yelp: I am lumping these two together in the category of “Companies that will either revolutionize their respective industries in 5-10 years or cease to exist.” I am happy to watch as a bystander here.

YRCW: This is a trucking company that you have most likely seen on any major US highway. Over the years, they have had various brands, Yellow, Roadway, USF Holland, and now YRC Freight (these various names are the result of mergers and brand combinations).

This company provides plenty of learning opportunities, especially for an old school value investor. Trucking companies show up on a lot of investment screens because their balance sheets tend to have a lot of assets and show real tangible book value (the assets being the trucks) in excess of their market value. For example, the balance sheet may show net assets of $500m, but the entire company is only worth $300m. At first blush, that seems like a screaming deal.

However, trucking companies are illustrative of companies that invest heavily in assets that are unable, due typically to competitive pricing pressures, to earn returns on these assets. Next time you are on the highway, look around, there are easily 15 different national carriers and a lot more local John Doe Trucking companies. The barriers to entry involve only leasing a truck and adequate insurance coverage. These low barriers to entry have consistently led to extensive pricing wars between the trucking companies.

Another aspect of YRC Freight is the make-up of its workforce at 76% union.  I am probably going to regret the following comment when I run for Governor of California or Mayor of Chicago, but I am inclined to stay away from companies with a large percentage of union workforce.  Collective bargaining agreements almost universally extract benefit promises at some later date that are estimated to be X, but typically turn out to be 2X, by which point all people involved in making the original agreement have long since moved on.

YRC Freight is no exception to this general rule.  The company currently carries a pension liability (unfunded pension) in the amount of $550m.  Pension accounting being overly susceptible to manipulation (err, I mean estimation), a general rule of thumb is to double this amount.  An additional wrinkle in typical union workforces is multi-employer benefit plans.  In these plans, various peer employers contribute to these plans, but as some inevitably fail, the ones left over are forced to contribute more to make up the shortfall of their bankrupt peers.  In other words, if you are a well-run company and put your competition out of business, you will end up bearing some portion of their underfunded pension liabilities.

I am oversimplifying this discussion of pension liabilities, however, in an industry subject to fierce price-competition, an additional layer of complex and daunting pension liabilities is not a recipe for one-foot hurdles.  I’ll pass.

 

 

Postscript: I couldn’t pass up the opportunity to cut and paste another business towards the end of the alphabet.  I don’t like screens since I would miss out on all the humor of these business descriptions.

XOMA Corporation (XOMA) is engaged in the discovery and development of antibody-based therapeutics. The Company’s lead drug candidate is gevokizumab (formerly XOMA 052), a humanized monoclonal allosteric modulating antibody designed to inhibit the pro-inflammatory cytokine interleukin-1 beta (IL-1 beta). 

 

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