Turnarounds Seldom Turn, but When They Do

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1 Turnarounds Seldom Turn, but When They Do Most people forget but one of the largest companies in the world today was once a turnaround situation. It may seem like forever ago, but in the late-1990 s Apple Inc. was a struggling computer company that was on the verge of bankruptcy. In 1997, Steve Jobs came back to save the company but it took a lot of time (nearly seven years) before the stock finally took off in earnest. It also took a dose of financial reality and humility as during the depths of Apple s crisis in 1998, Jobs had to reach out to his nemesis Bill Gates at Microsoft to secure a $150 million investment to stabilize the company s finances. The resulting success of Apple required the right leader with the right vision who pushed and prodded greatness out of his team. The rest, as they say, is history. Turnaround (noun: turn a round): an abrupt or unexpected change, especially one that results in a more favorable situation While the world obsesses about central bank policy and the movement of the broad financial markets, our day-to-day, bottom-up research effort focuses on finding value in our investable markets. As discussed at length recently, both the stock and bond markets are not very cheap these days. Yet our search for value continues unabated. With a lack of obvious value based upon traditional valuation metrics P/E, P/S, P/B 1, etc. our search has more frequently led us to companies that are undergoing some type of internal change. This change can be in the form of a new management team, a new strategy, or both. Turnarounds, from our view, can present an opportunity to add value. Turnarounds can also present a fair amount of risk. As Warren Buffett likes to say, Turnarounds seldom turn. And while this opinion is certainly noted and respected, we do believe that an increase in profitability (and security prices) is certainly achievable if the right company finds the right management team to execute the correct strategy. Identifying turnarounds takes a commitment to subjective analysis i.e., knowledge of the background, experience and skills of a management team; a review of the competitive position and realities of the company in its current state; or, an understanding of the likelihood a change in strategy will lead to success. While our research process is anchored by profitability ratios 1 Price-to-Earnings multiple (P/E) is a valuation ratio that compares a company s stock price per share to its earnings per share. Price-to-Sales multiple (P/S) is a valuation ratio that compares a company s stock price per share to its sales per share. Price-to-Book multiple (P/B) is a valuation ratio that compares a company s stock price per share to its book value per share. Page 1 of 5

2 and returns on capital, incorporating subjective variables is necessary and can be both challenging and rewarding. Subjective analysis is much more difficult to grasp than objective analysis. How a strategy will potentially impact margins is much tougher to gauge than calculating an actual change in profitability margins. But we feel skillful, subjective analysis is key to seeing opportunities and taking advantage of mispriced securities. Many sell-side analysts remain justifiably skeptical until strategic change tangibly impacts operating results and earnings. But usually by the time this change is recognized and appreciated by the market, the underlying security has already realized significant gains. Over the past two years, the Berwyn Income Fund has realized some of its best gains from individual turnaround situations. Many well-known (and not so well-known) companies have disappointed investors over the years and this disappointment led to negative views for their publicly traded stocks and bonds. This decline in value is what first allowed us to be introduced to these investments. But our willingness to identify and appreciate positive change and shifts in strategy gave us the confidence to take action and invest in these companies. Here are a few short summaries of current investments in the Berwyn Income Fund that we deem to be Turnarounds: Nintendo (NTDOY) Finally willing to look outside itself; Can Mario and Donkey Kong break down the walls? (1.4%) 2 Nintendo historically operated in an insular fashion driving all of its content through its internally developed gaming console systems. But through a careful reading of the company s annual reports and message to shareholders over a number of years, we noticed a tangible and dramatic shift in strategy in early 2016: With the belief in our mission to put smiles on people's faces around the world through products and services, we have followed our basic strategy of expanding the gaming population by offering products that can be enjoyed by everyone regardless of age, gender or gaming experience. We now want to take this mission a step further by increasing the number of people who have access to Nintendo s intellectual property (Nintendo IP). We are actively offering Nintendo IP in a variety of different ways so that not only current players of our video games but all consumers - including those who used to play but currently do not and even those who have never played our video games before - will also come in contact with Nintendo IP. After researching and passing on Nintendo over the past few years, this statement was exactly the type of strategy change we were looking for. Nintendo is a company with a multigenerational wealth of content that we believe should be able to leverage this intellectual property to generate higher profits in the future. 2 The numbers in parentheses following each company mentioned reflect the percentage of the fund s net assets comprised of such securities as of 8/31/2016. Page 2 of 5

3 Carlsberg (CABGY) A beer company run by the milk man? (1.0%) After experiencing four years of stagnant earnings, Carlsberg hired former milk company executive Cees t Hart. He also happened to be the first non-dane leader since the company was founded in t Hart is a well seasoned executive whose career includes a 25 year stint at global consumer company Unilever. We feel his focus on cost containment and operating efficiency should lead to more stable results especially with the Russian beer market stabilizing more recently. Royal Philips (PHG) Turning away from the light (1.2%) Philips is well known for a few things, but none more so than its lighting products. The company however, is dramatically shifting its focus from this low margin business to the higher margins of the healthcare and consumer products businesses. This shift, if successful, could lead to both higher sales and profits in the years ahead. Landauer (LDR) Bringing radiation monitoring to a new digital world (1.1%) Landauer manufactures dosimeters which monitor and record radiation exposure. The company s market share in this niche market was substantial but a slow grower in the early 2000s. So, as is far too common, the company s former management team incurred debt to make acquisitions in other supposedly faster growing areas. As it happens time and again, the new acquisitions were not nearly as profitable or successful as their core business. The management team was re-vamped in 2015 and is re-focusing the company on their core dosimeter business, working to digitizing their main product offering. Additionally, new regulations may help to expand Landauer s market reach in the future. Cryolife (CRY) New CEO brings this small cap company back to life (1.0%) We found Cryolife as a sleepy small-cap company with a decent cryopreservation business and a good balance sheet. But the company s founder was in his late 70s and a change in leadership was needed. Enter Pat Mackin, an executive with more than 20 years of experience at much larger companies in the healthcare and medical device industry. One of Mackin s first actions was to leverage the company s solid balance sheet to make an acquisition that has the potential to be transformational. Now viewed as a growth stock, it appears Cryolife s future may be resurrected. Page 3 of 5

4 Superior Industries (SUP) Wheels of change (0.6%) Superior Industries was a maker of aluminum wheels that was mired in a decade-long slump. But the company had a great balance sheet and a business that was profitable despite being terribly managed. The company s founder passed the reigns of the company to his son in 2007 (bad decision). But it was not until a new chairperson led a search for a new CEO that things got interesting. Don Stebbins, a 20-year auto industry executive, was hired in 2014 (good decision). Stebbins direction was exactly what the company needed to allow Superior to take advantage of burgeoning sales for new autos (and wheels). Summary Turnaround situations can take a few different forms. From our standpoint, the most powerful and potentially profitable investment opportunities occur when a good business has been mismanaged in some way. Then new (high quality) management leadership or a (logical) shift in strategy can affect the kind of change that can lead to investment success. As Buffett says, Turnarounds seldom turn and this can be very true. We have found that one of the most common threats to a turnaround is execution risk. The best manager with the best intentions can (and will) fail if the underlying business is not fundamentally strong enough to allow for the time that is required to execute the prescribed strategic changes. We believe a research effort that is keen on identifying a good business that is mismanaged in some way can be alerted by the types of change (management or strategy) that can lead to success both for the company and investors. As managers of the Berwyn Income Fund, we will continue to attempt to identify these opportunities to add value to your portfolios. Of course, every turnaround may not be Apple Inc., but the potential fruits of this research effort can be sweet, nonetheless. We just have to try to make sure we don t bite into any worms along the way. Past performance does not guarantee future results. Investing in any mutual fund involves risk, including the risk that you may lose all or part of the money you invest. The Berwyn Income Fund invests in both fixed-income and equity securities. The Fund s investments in fixed-income securities are subject to such risks as: interest rate risk; call risk; default risk; high-yield (junk bond) risk; and unrated bond risk. The Fund also invests in equity securities which carry the potential for unpredictable drops in value and periods of lackluster performance. For additional information on these risks and other related risks (non-principal), please review the full prospectus. An investor should consider the investment objectives, risks, and charges and expenses of the Fund carefully before investing. The Fund s prospectus contains this and other information Page 4 of 5

5 about the Fund and should be read before investing. The Fund s prospectus may be obtained by downloading it from the Fund s web site ( or by calling Holdings are subject to change at any time. The Berwyn Funds are distributed by IMST Distributors, LLC. Nothing in this letter should be construed, and is not intended to be construed, as advice on buying or selling any individual security. Page 5 of 5