element global value - letter 2012

7/29/2019 Element Global Value - Letter 2012

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Element Global Value

2012 Letter

Another year is behind us, and what a year it was! Not to make money this year required

some hard work, as all major asset classes were up significantly, although it didnt trully

feel like it until the year was over and performance was forever carved in stone.

This letter is divided into three main parts. First a performance review, depicting which

positions gained and lost more money, followed by a brief explanation of how I go about

finding new investments, my research process and the investment rules for this portfolio,

and finally, a review of some of the portfolios positions.

Performance Review

In a year where all major equity markets were up double digits, the portfolio ended the

year with a gain of +13.73%, virtually erasing all of the losses of 2011 and beating its

benchmark, the MSCI World Local Index, by a thin margin of 0.66%.

The positions that contributed more to global performance were The Gap (+2.7%),Amadeus IT Holdings (+1.8%), BMW (+1.6%) and Apple (+1.5%). During the year I

significantly decreased the position in shares of The Gap, as the market finally rewarded

managements outstanding job, taking the stock to levels not seen in the past decade. I

also took the opportunity to buy more shares of Apple towards the end of the year, as the

share price decoupled from fundamentals. More on that later.

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec YTD

2011 -1,11% 1,61% -2,05% 3,30% -1,25% -1,72% -1,37% -7,23% -7,20% 8,70% -2,83% -1,18% -12,57%

2012 7,06% 5,19% 1,62% -0,86% -6,98% 2,62% 0,62% 2,67% 1,35% -1,50% 0,97% 0,87% 13,73%

Portfolio Performance

82

85

88

91

94

97

100

103

106

109

Jan-11 Mar-11 May-11 Jul-11 Oct-11 Dec-11 Feb-12 May-12 Jul-12 Sep-12 Dec-12

MSCI World Local

Portfolio


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The largest performance detractors were Energold Drilling (-0.79%), La Seda de Barcelona

(-0.54%), Telefnica (-0.47%) and Veris Gold Corp (-0.42%). Veris Gold Corp was added to

the portfolio in September, and I reinforced the position in October and December, as

shares slided after the initial purchase. The price slump ofTelefnicas shares was caused

by the contagion of the European periphery debt crisis to Spain, which significantly

increased this highly geared companys cost of debt, forcing it to sell some non-strategic

assets. Even so, part of the loss on Telefnica was offset by a successful short PUT position

that I closed in December.

10 new positions were added to the portfolio during the year. These positions now make-

up for a little over 19% of assets. One position was exited (Premier Exhibitions) and

another significantly reduced (The Gap). This low turnover goes to show the long-termperspective that is taken when adding a new position, and is something expect to

continue going forward.

Also noteworthy, the position in Renault earned a return of 57.7% in 2012. This compares

with a return of -54.8% for Peugeot shareholders, which we thankfully are not!

Since its inception in January of 2011, the portfolio has lagged its benchmark by -2.4%,

this despite a small outperformance this year. I am not happy with the overall

performance, either relative to the benchmark or (especially) in absolute terms. I could

give you several reasons why the performance is not better, the center of which would belimited time, but in reality the explanation is simple: the stocks I picked did not go up as

much as the overall equity markets. Doesnt take a genius to get to that one!

Despite the, so far, uninspiring performance, I remain committed to this project. I honestly

think that, on a long-term time-frame, I am capable of outperforming the equity market in

general and, more importantly, of generating low double digit returns on an annual basis.

I sincerely hope you find this annual letter, as well as the monthly factsheets, interesting

and remain available to discuss anything related to the portfolio.

How I Find Investments

The vast majority of the stocks in the portfolio were ideas I picked-up from someone else,

and there is nothing wrong with that. In the investment world, almost everyone shares

their ideas, be it in the newspaper, TV, presentations, blogs or in a friendly conversation.

There is nothing wrong with getting ideas from other investors. In this field there are no

copyrights, in fact, studying ideas from other investors is an efficient way to get a quickglimpse at the story behind each company, so you can decide the idea is promising and

follow-up with extensive research of your own.

My main sources of ideas come from reading several publications focused on value-

investing (Graham and Doddsville, Value Investor Insight, Sum Zero, ), reading hedge

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fund letters, browsing through dozens of blogs & websites (valueinvestorsclub.com,

Seeking Alpha, ), reviewing several stock pitches (Value Investing Conference, stock-

pitching contests, ) and scourging though the 13D fillings and top holdings of investors I

admire. I go through dozens of potential investments each month and reject the vast

majority.

An example of stocks I picked up like this are:

PAX Global Technology: from the 2011 annual report of Fidelity China Special Situations

PepsiCo: from a lunch with Donald Yacktman, of Yacktman Funds

Amadeus IT Holdings: a top holding a fund I follow closely (Oddo Avenir Europe)

Renault: a 2005 David Einhorn enterview for Value Investor Insight (which I read in 2011)

Lowes: from a Bill Ackman (Pershing Square) stock pitch at a Value Investing Conference

AvangardCo, Alternative Asset Opportunities and Energold from investment blogs

Societe dEdition de Canal+: from a SumZero article

But, sometimes the ideas come from much simpler places:

Apple: I have been using its products for a long time, the only thing I regret is not

researching what was under my nose earlier

Ted Baker: a small article I read on the FT sparked my interest. Then Afonso went on aresearch field trip and got a close shave at one of Ted s grooming rooms in London

The Gap: walked by their stores and decided to research the company further

BlackRock: I have been using iShares ETFs for a long time, decided to see what the

parent company was up to, and it turned out to be very attractively priced

Starbucks and Amazon, which I go to / use regularly, are examples of two stocks I

researched but decided to pass due to their rich valuations (Amazon was actually a

contender for a short position)

One thing I dont do, is actively look for ideas in equity research published by investmentbanks. In my modest opinion, the analysts never really express their true thoughts, and

always set price targets that are somewhat close to the current price. Also the vast

majority of research is focused on the next 12 months, while Im more interested in the

next 12 years. One example of this is Apple, where, after the recent drop in price, the

majority of analysts redid their price target calculations, and suddenly reached price

targets that were more in-line with the current stock price. Analysts typically move like a

herd and avoid straying too far from the pack, in what is called prudence bias (the

tendency for most analysts to generate estimates that are in line with what everything

else is doing). This way, if they are wrong, they can point out that everyone else waswrong as well, an easier way to live your life and keep your job! Who can blame them!?

I just hate reading equity research where the analysts spend half of the report stating that

they are 4% above the consensus on the EPS numbers or revenues came in 5% below

our estimates, frankly I have better things to do with my time.


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This does not mean that I do not find equity research useful. The way I operate is: I do the

research myself, go through the company annual and quarterly reports, presentations, and

other relevant materials and, only afterwards, do I read research reports to check if I

missed something important. Of course, there is always the chance that analysts missed it

too, but I am better-off checking than not.

A Face-Lift

When I started this project I thought the name Element Global Opportunities Equity

Portfolio was a good choice. It clearly stated my intentions: equity market opportunities

in a global scale. Turns out that for others this is not so clear, and frankly I have grown

tired of the big name. So, I decided to do a small face-lift, and change the name to

Element Global Value Portfolio. Besides being more pleasant to write, it shows that the

strategy is skewed towards value investing, something that should be clear from the start.

Portfolio Investment Rules:

In order to force myself to be disciplined, I imposed a set of rules on the portfolio. Theserules are intended to define what I can and cannot do, set limits towards what type of

instruments are available and define where I can invest:

Gross long exposure must be within the 70%-130% range

Long stocks, with a maximum gross exposure of 130% of assets

oMaximum individual position is set at 10%

Short stocks, with a maximum gross exposure of 30%

oMaximum individual position is set at 2.5%

Warrants & Options, with a maximum exposure (notional) of 20% Currency is hedged to Euros on a best effort basis

No geographic/sector restrictions

No restrictions on investable asset classes (as long as it is traded in a stock-exchange)

I am very conservative in what concerns asset allocation, avoid using leverage and do not

engage in short-term trading. Shorts, warrants & options are not actively seeked, only

wanting to have the possibility of using these instruments if presented with the right

opportunities. If you have been following me from the start, you will know that I only used

this ability once, shorting a put option on Telefnica to guarantee a dividend (positionnow closed).

Note that I put no restrictions on investable asset classes. What this means is the

possibility of investing in other asset classes, as long as the instrument is publicly listed

shares. Examples are the positions in Chatham Lodging Trust (Hotel REIT) and Alternative

Asset Opportunities (a close-ended fund that invests in US Traded Life Interests).


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Review of Selected Positions

On the following pages I review the top 10 positions, as well as some of the smaller ones,where performance was poor. The number in parenthesis that follows the company name

is the return of an equity investment in that company during 2012. If the position was

added during 2012, the performance is since the first purchase price.

IBM (2012: +5.96%)

IBM has been a holding since the portfolios inception, and I have personally been a

shareholder before that. I increased the position significantly between August and

October of 2012, which made IBM the largest holding.

With its massive buyback program, the company has reduced share count by since

2004. As I perceive IBMs shares a bargain, I am happy to see the company allocating cash

this way.

My take on IBM is simple. The company said it will earn $20 per share by 2015 and I

believe this is a realistic target, and they will achieve it. To get to its target the company

wants to grow its revenue, increase operating leverage and continue with its aggressiveshare repurchases program.

Assigning a conservative multiple of 15 returns a price target of $300 by 2015. When you

add the 1.8% dividend yield, the IRR from the current price is close to 18%.

Apple (2012: +32.6%)

Apple shares first made their way into the portfolio in June of 2011 at $314, and I haveadded to the position several times since then, especially after the drop in share price

from $700 to $532 towards the second half of the year (so far, in 2013 shares have

continued to fall).

Nowadays dozens of articles pound the company on a daily basis, and investors (or dare I

say speculators) who loved the company at $700 now hate it at $500.

Here is my (simplified) take:

Apple has a cash position of about $117bn, which will grow by about $67bn in 2013,

reaching close to $184bn. As part of the cash is offshore, I apply a 25% discount, whichtranslates to $138bn or $147/share

The company earned roughly $48 per share in the past 12 months. Lets assume it will

earn just $50 during 2013, an increase of only 4%


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Company Valuation

Cash position: $14712 x EPS 2013= $600

Share Price = $747

To put the 12x multiple in perspective, earnings for the S&P500 have not grown in the

past year, but analysts estimate they will grow by 10% in 2013, which is a bit rosy in my

opinion. This index is trading at 15 times earnings. I am assuming a below average

multiple for Apple, this despite it has grown earnings by 80% and 60% in 2011 and 2012,

respectively. I am aware that the company will not continue posting these outsized growthrates, but the current 7.7 (x-cash) multiple is just too low. If shares trade at a multiple of

18x, which I think is very reasonable, you get a price above the $1000 mark.

Apple is shifting from a high growth phase to a more mature one. With this shift, growth

driven investors are leaving the scene and value driven investors have not yet arrived.

Hence, the stock price will likely remain in limbo for a while.

Apple has grown into one of the biggest positions in the portfolio and, despite feeling the

urge to do so, I will not be adding to this position: I can never discard the possibility that

my analysis is wrong, and the current weight already makes this a high conviction position.

Fidelity China Special Situations (2012: +16.2%)

I am a big believer in China, and am especially keen in the emergence of its domestic

consumer. This being said, I am not a fan of Chinese state-controlled mega-caps, like China

Mobile, Agriculture Bank of China and the likes, as I feel their managements focus is not

exactly centered on maximizing shareholder value. I much prefer smaller companies,

geared towards the Chinese consumer, and where the state doesnt interfere (much).

The problem with this sector is that extensive due diligence is crucial, as several reports of

fraud have surfaced in recent years. Because my resources are limited, and I prefer having

a broad exposure to the Chinese consumer, I chose to make the majority of my allocation

to China via the Fidelity China Special Situations Fund, managed by Mr. Anthony Bolton.

Before managing money in China, Mr. Bolton led the Fidelity Special Situations fund for 28

years, compounding its investors money at an annual rate of 19.5%, turning a 1000

investment in 1979 into 147000 by 2007. The bear market that resulted from the 08/09

crisis saw Chinese equities plunging by from their peak, creating an opportunity Mr.

Bolton couldnt refuse. So, he started a new (close-ended) fund focused in China in 2010.

The expectations were tremendous, and the funds shares even traded at a 10% premium

during the first year. But the negative returns on Chinese equities, coupled with lackluster

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returns from the fund itself and the increasing number of frauds by Chinese companies

caused the shares to trade at a discount. I took this opportunity to build a position in the

fund, between June and August of 2011, at hefty discounts.

Last year Mr. Bolton managed to outperform a rising equity market, and the discount gap

is now almost nonexistent.

Microsoft (2012: +5.8%)

Since the tech bubble burst in 2000/2001, Microsofts shares have been stuck in a $20-

$30 trading range (only leaving this range in 3 short occasions). Despite the dull price

action, the company never stopped growing. In 2002 Microsoft had revenues of $28bn

and profits of $5.3bn, while in 2012 its profits were $23bn on revenues of $74bn

(adjusting for one-offs). This represents an annual growth in revenues and profits of 10%

and 16%, respectively. Also, since 2004, Microsoft has reduced its share count by 22% and

increased its dividend by 100%.

What happened during these 10 years is that the multiples compressed. The company is

now trading at only 10 times earnings. Add to this a pristine balance sheet and almost

$70bn in cash and you got yourself a bargain. There is only so much the multiple cancompress

PepsiCo (2012: +6.4%)

PepsiCo made its way into the portfolio in November of 2011, at $62.56, and despite the

unimpressive return in 2012, PepsiCo shares have contributed significantly to

performance.

PepsiCo is a mix of a beverage company and a snacks company, having a 50/50 split

between the two, which provides it with very stable and predictable cash flows. Its moat

is its direct store delivery system, scale and dominance in the US snack industry. The firm

has strong brands such as Frito, Lays and Doritos that dominate less powerful brands in

the snack business. Also PepsiCo has leveraged its existing distribution system, built to

distribute the firm's beverage products, to sell the snacks. This vast infrastructure has

provided a strong barrier to entry because it would be too costly do replicate. What I like

most about PepsiCo is: first, earnings are very stable; second, they are increasing at a

good pace; and third, emerging markets pose a great source of untapped growth for both

beverages and snacks. What most people dont know is that PepsiCo actually makes more

money with Frito-Lay than selling carbonated drinks, an area that has been under scrutiny

recently.

For the past two decades PepsiCo increased its dividend at an impressive rate of 11.6%/yr

with shares now yielding 3%. Although the company is not as cheap as it was when first

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purchased, it still represents a good allocation of capital.

BMW (2012: +45.5%)

BMW was added to the portfolio in July of 2011, at 72.6. The timing was horrible, as

shares quickly plunged almost 40% over the following three months Despite the stock

almost being cut in half, BMW was posting record sales on a monthly basis! There was a

huge disconnect between the underlying business and the stock price, and I took this

opportunity to meaningfully increase the position, making it one of the largest positions in

the portfolio, and averaging down the price to 60.6.

It is my belief that one can make reasonable expectations about how a company is going

to perform and, in the long-term, I expect the stock price to match that performance, but

in the short term, you might as well flip a coin!

Despite an uncertain market and dismal auto sales in across Europe, BMW managed to

sell more cars in 2012 than ever before, and most important, they did not sacrifice

margins. Comparing the first 9 months of 2012 to 2011, the company sold the same

number of cars in Europe, and increased sales in North America by 7% and in Asia by 27%

(33% in China). Given the uncertain times we live in, and the fact that the cars BMWproduces are not exactly cheap (BMW also owns Mini and Rolls Royce), this performance

is truly remarkable.

For the first 9 months of 2012 the company posted a profit of 3.9bn, a number that is

expected to exceed 5bn for the whole year, meaning the stock is trading for 10 times

earnings.

Before buying shares in a company I always write a paragraph explaining why I decided to

do so. This is an excerpt of what I wrote for BMW:

BMW is an excellently run company, that has positioned itself on the high end of each of

the segments where it operates (BMW, Mini, Rolls Royce, Motorcycles). The reason I like

this company is its growth potential: The volumes in developed markets are still 14-15%

from their pre-crisis levels. With time consumers will heel, and volumes will eventually top

the previous pre-crisis levels. Adding to this the majority of BMWs sales growth has been

coming from emerging markets, mainly China (despite still only accounting for 12.5% of

total sales). Consumption in China will continue increasing, and the appetite for luxury

cars will double, triple, and eventually quadruple. This is not a question of if, it is a

question of when. Only 3% of auto-sales in China are luxury cars, comparing with 15-19%of that in Developed markets. As Chinas domestic consumption grows and evolves, BMW

will go along for the ride. This is a way to get exposure to emerging markets with the

safety net of the developed markets. The company is currently trading at 10.8x 2011

earnings which I think is more than reasonable for the quality and opportunities of this

business.


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This rationale still holds and, with the shares trading at 10 times earnings, I dont think Ill

let go of them anytime soon.

Amadeus IT Holdings (2012: +55.0%)

This is the type of company I love: boring, unknown to most and with a good business

model.

Amadeus acts as a connection between travel providers (Airlines, Hotels, Railway

operators, Car Rental, Tour operators, Cruise & Ferries and Insurance Companies) and

travel agencies, providing indirect distribution services. It also provides back office IT

solutions for airlines. The company operates in a transaction-based business model with

90% of recurring revenues.

This mighty middleman has a 38% market share in travel agency bookings, providing its

services to over 130k travel agencies, 700 airlines and 85k hotels worldwide. In 2012 it

was responsible for over 550Mn passengers boarded.

Despite the impressive numbers, Im feeling increasingly uncomfortable with holding such

a large position in Amadeus. With a 38% market share, the company is now the largestGDS player in the market, enjoying 40%, EBITDA margins, a perk which I dont think is

sustainable:

Airlines, which are in perpetual distress, are starting to show their discontent towards

the cut Amadeus takes from their precious revenue (despite this being


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on this industry that I highly recommend reading.

Curiosity note: to see how Amadeus works, go to your email and search for Amadeus,and you will likely find some of the airline tickets you purchased.

Berkshire Hathaway (Apr-2012: +13.5%)

I first bought Berkshire in April of 2012, at around $79 /share. How I didnt add this

position sooner has no logic explanation.

As most of you know, Berkshire has been magnificently managed by Warren Buffett. Sincetaking control of the company more than 40 years ago, Mr. Buffett managed to grow

Berkshires book-value at an annual compounded rate of 19.8%, a truly remarkable and

unparalleled track-record that turned a $1000 investment into a $5720563 fortune.

Berkshires cheapness first came to my attention when Mr. Buffett authorized a share

repurchase program back in September of 2011. This announcement was huge. Here you

have the worlds best capital allocator, who has a very high reputation for being honest,

telling you that his own companys stock, which he knows better than anyone alive, was

trading at very cheap levels (around $72).

The portfolio paid dearly for my unforgivable delay in taking a closer look at Berkshire.

When I was finished studying and evaluating the company, and finally added the shares to

the portfolio, they had already advanced by more than 9% since the announcement.

Back in April I valued Berkshire by adding the value of the publicly traded stakes (Coca-

Cola, IBM, ), the cash & equivalents and assigning a 10x multiple to operating earnings,

which yielded a target price of $118 per class B share, or a 49% upside. Performing the

same calculations today yields a price of $131 (publicly traded stakes increased by 12.8%

and operating earnings by 7.5%), still a 46% upside from the year-end price.

Teva Pharmaceuticals (2012: -5.1%)

Teva Phamaceuticals is a hybrid company, combining both generics, where it is the largest

player, and proprietary pharmaceuticals. The company enjoys massive economies of scale

and has vertically integrated operations that create some of the highest profit margins and

returns on capital in the industry.

I first bought Teva in August of 2011, at $38.40, and the company ended 2012 at $37.34. If

you take into account $1.25 in dividends received, this position has generated close to nil,

which is disappointing.

The main reason for this lackluster performance is Copaxone, the Worlds best-selling drug

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for the treatment of Multiple Sclerosis (or MS). This is Tevas best-selling drug, accounting

for 20% of revenues and as much as 40% of profits, and its patent will expire in 2015. This

means competition and lower margins.

I am aware that the patent expiration will take a toll on earnings, but investors can't see

the forest for the trees. In 2012, Teva generated $4.5bn in operating earnings or roughly

$5.15 per share, implying a current P/E multiple close to 7.25. Assuming that Tevas other

businesses continue performing the same, and taking out Copaxone completely, would

reduce operating earnings by ~$1.8bn, implying a multiple of 12, which is by no means

expensive. A more realistic estimation would assume that profits from Copaxone would

start decreasing once the patent expires, and would level at some point, say 50% of their

current level. In this instance, and again assuming everything else remains the same, themultiple on Tevas share price is just 9! (as an aside, sales of Copaxone were up 14% 2012)

For me, what is happening to Teva is a clear overreaction from the market in general,

which I dont expect to evaporate any time soon. When I added Teva to the portfolio I was

aware of the Copaxone issue, but never thought the stock would get hung for so long on a

known and, in a way, measurable issue!

The big picture is that as healthcare continuously improves, people will continue to live

longer lives, which means more money spent on drugs. Also, with governments

increasingly counting their pennies and looking for ways to cut expenses, generics offer aneasy way to cut healthcare costs. Teva is in a good place to benefit from these two huge

trends. Again, investors are not seeing the forest for the trees.

But it wouldnt be fair to only go over the top 10 positions, because I would be favoring

the companies whose share price evolution was favorable, since their weight in the

portfolio increased along with their price. I would thus be padding myself on the back by

putting more weight on reviewing what went right in 2012, and not sharing with the

reader what went wrong. So, below is a review of what didnt go according to plan:

Mining Companies: Monument Mining, Energold Drilling, and Veris Gold Corp

(previously called Yukon Nevada Gold Corp).

Mining related stocks, and especially the segment of junior miners, have (so far) been a

place where dreams go to die. Whenever there are good news, the stock price barely ticks

up, and bad news are met with panic selling by investors who are throwing in the towel

after months or years of pain and disgust. I recognize I am more patient that most

investors, but I admit this sector is testing my limits.

Monument and Energold were first bought in 2011 at C$ 0.56 and C$ 4.26 respectively,

and have since lost roughly 1/3 of their value. Veris was added in September of 2012, at

$C 2.92 (split adjusted), but quickly made up for lost time, with shares falling by more

than 40%.


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Know what you own, and know why you own it, Peter Lynch

When it comes to these 3 holdings, Mr Lynchs phrase has been my only consolation.

When I first purchased Monument, it was operating only one mine in Malaysia, but the

company had tremendous potential as it owned adjacent properties that eclipsed the size

of the operating one. Since then, the company doubled the plant capacity at its operating

mine, paving the way for gold production to double, and bought a 70% interest in a new

property. This new property holds significant reserves which, at current prices, equate to

total future revenues (over the life of the project) of roughly $13bn. Right now,

Monument has a market cap of $90 million, holds $40 million in the bank and generates

another $40 million of cash flow per year. The stock is trading at 1x earnings (x-cash), butthe market refuses to recognize more value for the company, since it will have to raise

cash to develop the new project, which will dilute existing shareholders by half. When this

happens, Monument will be trading at two times earnings, a bargain by any standard.

Veris Gold Corp or, as I like to call it, the widow maker, is a turnaround story that has

come a long way since flirting with bankruptcy in 2009.

I had been following the company for a while, and decided to invest only when most

uncertainty was behind (company reached steady-state production and became

profitable), but significant upside still remained. They are on their way to make $150Mn

this year, while the market capitalization is around $180Mn. The reason for the awful

share price action since the shares were added to the portfolio was the announcement

that capital needed to be raised to bring an additional mine into production.

Energold Drilling is a drilling contractor, and a different story. What caused the share price

to head south was not the fear of dilution, but the companys actual business. When I

analyzed this company I failed to realize just how fast the earnings could go from good to

bad.

Energold services major mining and junior mining companies. While the majority of

clients are majors, the juniors pay the highest rates for the rigs because they have less

bargaining power and they usually drill in more frontier markets. Because currently the

juniors find it practically impossible to raise money for exploration, they dont have any

money to drill for gold, silver or any other commodity. Consequently, this slowdown is

reflected in Energolds financials.

I still think Energold is a great investment and that its results will improve substantially

and reach new records, taking the share price along with them, but the road will not be a

straight one!

My expectation is that the huge potential of these 3 companies will be recognized in the

medium-long term. Every storm eventually runs out of rain


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OPAP (2012: +1.1%)

I first bought shares of OPAP at $7.91 in July of 2011, just in time for the shares to drop,finishing that year at $4.28. In 2012 the price dropped, but a chunky dividend put the

return for the year at +1.1%.

OPAP has the monopoly for lottery and sports betting in Greece. What attracted me about

OPAP were its steady cash-flow generation abilities, almost no competition, highly

variable cost structure, solid balance sheet and very depressed valuation (PE of 5) due to

the ongoing crisis in its home country. Furthermore the state was (still is) in the process

of selling its 34% stake in the company, and OPAP was in the process of introducing the

Video Lottery Terminal (VLT) business, which would be a significant source of growth.

During the last year the company faced a new gaming tax and its monopoly status was put

into question by the European court, which weakened its moat.

Despite all this, profits are only down 9% from a year ago, the companys shares are now

trading at less than 4 times earnings and entitle the holder to a 10% yield. Despite the

compelling valuation, I must admit I misjudged just how bad things would be in Greece

and how thirsty the government would be for cash (resulting in the new gaming tax), and

should not have rushed to buy the shares. Even so, in my opinion, the new VLT business

will bring substantial growth to OPAP in a not so distant future, which should be a catalystfor both earnings and multiple expansion.

CNinsure (2012: -5.3%)

CNinsure is an independent insurance intermediary operating in China that is in the

portfolio since inception. I first bought shares at $18.99, and later added to the position at

$16 and $14. The shares ended 2012 at $6.55, down -65.5% from where I first bought

them.

There are two reasons that justify the current share price:

After the Chinese lumber company Sino Forest was rightfully accused of fraudulently

inflating its assets and earnings by Muddy Waters Research, several other Chinese

companies were also accused (with a special focus on reverse-merger, a method for a

company to go public without undergoing the typical IPO and SEC scrutiny). Despite

having undergone a normal IPO process, CNinsure was also accused of fraud, with the

lawsuit alleging that it had materially overstated net income by understating the costs

associated with the companys scorecard system, and failing to account for incentivesprovided to the companys agents as costs.

Despite revenues increasing at a good pace, earnings are down more than 60% since

2010, a result of intensified competition and increasing commission expenses.


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There are several indications that lead me to conclude that the fraud allegations were

unfounded: first, the companys auditor, Deloitte, did not resign (as is the case whenever

there is fraud involved); second, the company has implemented a share buyback program;

and third, a very well-known investor, Prem Watsa from Fairfax, bought shares in the

company recently.

Despite the slimmed down results, I continue to hold CNinsure in the portfolio because it

Is incredibly cheap. The company has no debt, trades below the cash it holds in the bank,

and is developing its e-commerce platform which should significantly improve earnings in

the coming years.

After such a bad experience with Cninsure, it took me almost two years before buyingshares in another Chinese company. I finally pulled the trigger in August of 2012, investing

in PAX Global Technologies. So far, the experience has been more pleasing, with the

shares already up 46%.

Before starting to write this annual letter, I read all the monthly factsheets sent over the

past two years and reached one conclusion: I completely lost the power to efficientlysummarize my ideas. The graph below illustrates this trend, by showing the word count in

each report:

Last week I went to the cinema to see the film about Abraham Lincolns life (which I highly

recommend). In the film President Lincoln says somehting that I found to be particularly

suited for this part of the letter.

0

200

400

600

800

1.000

1.200

1.400

1.600

1.800


15/17


I could write shorter sermons, but when I get started I am too lazy to stop

Abraham Lincoln

I hope the reader finds the reports interesting, and appreciates the added detail, as my

objective is surely not to bore him.

2013 has kicked off to a good start, with major equity markets all in the green. So far the

portfolio is in the green, but laging its benchmark. The largest drag on performance has

been Apple, which continued its path South.

I feel the portfolio has a selection of very good companies, that will deliver good

performances over the coming years. I expect their stock price to follow the same path as

the underlying business, but not in a straight line of course.

Best Regards,

Filipe Alves da Silva

E L E M E N T


16/17

Allocation by CountryAllocation by Sector

Currency Exposure


For more information please contact Filipe Alves da Silva directly

or send an email to [email protected]

Contacts

Weight

i Sha re s MSCI Worl d ETF He dge d 9,6%

IBM 8,9%

Apple Inc 7,4%

Fide l i ty China Specia l Si tuations 6,3%

Microsoft Corporation 5,7%

PepsiCo 5,1%

BMW 4,5%

Amadeus IT Holdings 4,2%

Berkshire Hathaway 4,2%

Teva Pharmaceutical s 3,4%

59,4%

Name

Total

11,1%

31,1%

1,2%

1,5%

17,4%

12,0%

5,0%

3,7%

5,2%

0,3%

2,3%

6,9%

0% 5% 10% 15% 20% 25% 30% 35%

Financials

Information Technology

Industrials

Energy

Consumer Discretionary

Consumer Staples

Health Care

Materials

communication Services

Utilities

Real Estate

Cash

52,7%

0,8%

1,2%

4,8%

4,2%

0,4%

4,8%

0,4%

6,6%

0,1%

0,1%

0,1%

7,8%

1,6%

7,5%

6,9%

0% 10% 20% 30% 40% 50% 60%

United States

Japan

United KingdomCanada

France

Australia

Germany

Switzerland

Spain

Sweden

Italy

Netherlands

China

Brazil

Others

Cash

102,7%

-19,7%

6,9%1,6% 4,2% 0,5% 2,2% 1,1%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

EUR USD CNY BRL CAD GBP UAH HKD

Max. Long Exposure: 130%

Min. Long Exposure: 70%

Use of Derivatives: May use options or warrants

(Max notional exposure of 20%)

Ability to Short: Max individual position 2.5%

Max gross short exposure 30%

Currency Hedging: Hedged on a best effort basis

Investment Guidelines

Past performance is not indicative of future performance.

Reference in this document to specific securities should not be

construed as a recommendation to buy or sell these securities.

You should conduct the due diligence yourself.

Disclaimer

E L E M E N T

Largest Positions
mailto:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]:[email protected]


17/17

Complete List of Holdings


Weight

iShares MSCI World ETF Hedged 9,6%

IBM 8,9%

Apple Inc 7,4%

Fideli ty China Special Situations 6,3%

Microsoft Corporation 5,7%

PepsiCo 5,1%

BMW 4,5%

Amadeus IT Holdings 4,2%

Berkshire Hathaway 4,2%

Teva Pharmaceuticals 3,4%

Archer Daniels Midlands 3,2%

Lowe's 3,0%

BlackRock 2,9%

Chatham Lodging Trust 2,3%

Telefnica 2,2%

Avangard 2,2%

Societe d'Edition de Canal+ 2,0%

Corning Inc 1,9%

Renault 1,7%

MRV Engenharia 1,6%

Alternative Asset Opportunities 1,4%

IMAX Corporation 1,1%

Jakks Pacific 1,1%

Monument Mining 1,1%

Energold Drilling 1,0%

PAX Global Technology 1,0%

OPAP 0,9%

Cninsure 0,6%

Veris Gold Corp 0,6%

Calfrac Well Services 0,5%

GAP Inc 0,3%

Ted Baker 0,3%

Addvantage Technologies 0,2%

La Seda de Barcelona 0,1%

Cash 7,4%Total 100,0%

Name

element global value - letter 2012

Documents