The Good, the Bad, and the Ugly
Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over on my old trading desk at RBC Capital Markets, we used to play a little stock picking game based off the Sergio Leone title starring Clint Eastwood. The goal of course was to choose 3 stocks, one good, one bad and one ugly and evaluate the action in each over the coming months. The idea was simply that the good should keep getting better, the bad should continue to decline, and the ugly... well the ugly would often turn out to be the wild card, in many cases outperforming the other 2 stocks.
Why was this? I mean the ugly was in theory a name you wouldn't want to touch with a ten-foot pole. And yet often it outperformed many of the good names selected. In fact, the right ugly stock might be the best stock pick of the year. For months this concept baffled me but then I started to realize that the point of the entire game was finding a name that was so unloved, so reviled, so hated by the so-called experts that any sliver of optimism might begin to catapult the stock price. As the contrarian investor says, "buy when there is blood on the streets" this was the guiding principle behind betting on the ugly duckling and watching it turn into the beautiful swan.
Finding the one ugly name became everything. Anyone could see that an Apple (NASDAQ: AAPL) up a whopping 74% over the last year may very well continue its path skyward. Or conversely that a Cisco (NASDAQ: CSCO) down 22% over the last year, may continue to lose market share despite its once grand-tech-bellwether status. But finding that one ugly name, much like "finding a fortune of gold buried in a remote cemetery" as the trailer to the movie suggests, required great cunning and foresight.
My greatest ugly stock was Sirius Radio (NASDAQ: SIRI), in February of 2009. Let's not forget that at that time there was blood all over the street and people calling for the end of the world. Mark Haines was on CNBC every morning talking about the once great capitalist society known as the United States. No joke, as if it had sunk into the ocean, like Atlantis. Things were that bad. But still a month off that V shaped bottom, when things looked like there was no end in sight, I was culling for the ugliest of the ugly, looking for my date to our next desk meeting.
It wasn't hard to find these names back then but picking an ugly isn't as easy as it seems. The thing about an ugly is that behind its exterior it has some real merits waiting to be seen. An ugly isn't just some debt-laden company or some penny stock that is going to go under, it is a name that is down on its luck, but has a real good fighting chance to rebound.
Sirius Radio at the time was trading around 5 cents and was one week away from defaulting on a substantial loan that had come due. In fact, Sirius was looking at $600 million in loans due that year and needed backing to help refinance. Every article, blog, story I read about them seemed to suggest that they were not going to be around in another year. That bankruptcy was the only option. But SIRI interested me as a story.
They had won a substantial battle to merge with their competition XM Radio and so were (and still are) the only game in town. Also Sirius Radio's CEO and front man Mel Karmazan was just the kind of guy you wanted running the show. COO and President of CBS, Karmazan was a legend in radio, he was business savvy and he had personally backed shares of Sirius Radio with that of his own fortune. He was as invested in the dogfight as were his shareholders. What’s more, Sirius had deals with many automakers that were putting satellite radio into the new cars that were being manufactured. In fact, over the previous 3 months, my Mother and my Uncle had both been introduced to Sirius through the new cars they were driving and both raved about it. It boasted no commercials, a monthly subscription charged right to their bill, and it was clean and easy and just so much better than public radio. There was a Frank Sinatra station and an Elvis station and they had new celebrities every day joining up.
To me it seemed like a good story but a stock that was down on its luck. It seemed as if the stock could just make it through the next week it may just survive. But their survival was dependent on them finding a partner and according to all the experts nobody in their right mind was going to help this company. I felt differently, based on the story and the risk/reward, I thought the potential upside versus the downside risk was great.
My presentation at the desk meeting that week was met with little enthusiasm. Within a few weeks, SIRI with a partner in tow in the name of Liberty Media Corporation was beginning to look solid. Within a few months my call to buy SIRI at 5 cents had become a thing of legend. Still to this day when I speak with my old RBC desk-mates not a conversation goes by where one of them doesn't ask me, "seen SIRI lately?" One of them told me “every time I see that ticker roll across the screen, it kills me... I woulda been rich if I had just listened to you." With the stock closing today at $2.18 it does look to be a pretty solid call. But the point of this is less to pat myself on the back and more to teach you how to spot an ugly. What did I see that others could not? And what is the next potential ugly I am looking at?
The fable of SIRI is here to elicit a point. An ugly is a hated stock. There is no question about that. But just because a stock is unloved does not mean it necessarily deserves to be priced where it is. Often with these types of stocks, certain pieces of information that are out there are misinterpreted or the picture is not fully clear. Everyone writing stories about SIRI at the time could not fathom that someone might see value in the company, might see the market share or unique placement it held, and might be willing to help the company refinance. Certain pieces of information that were taken for granted were indeed incorrect.
An Ugly to Keep an Eye On:
With Mankind Corporation (NASDAQ: MNKD) back on the move in recent weeks, I have begun to watch the stock for some large potential gains into year-end. I believe that Mankind may be one UGLY to keep an eye on. A few words about Mankind, and some of the misconceptions that exist.
Mankind has been pulverized over the last year and a half. Since January 2011, the stock is down from a high of $9.83, closing Friday 06-29-12 at $2.29. This is significantly off it’s 52-week low of $1.57. Although a stocks previous price has no bearings on its return, it is important to keep in mind that this was the perceived value of the stock as it moved toward its most recent FDA rejection. This was the day the company announced the need for further testing on their oral insulin drug.
Many articles and blogs have been written citing a rejection from the FDA on their product. This is not exactly the case. MNKD is being forced to conduct further Phase-III testing on the mouthpiece of the oral insulin product Afrezza, which was added last minute. The company stressed that the new applicator was more comfortable and more effective but now must conduct the tests to prove it.
This testing looks to wrap up around early 2013. But the FDA did not reject MNKD because of what was in the canister so much as the canister itself, which was altered last minute. This distinction is just the type of overlooked piece of information that analysts ignore and tells a different story then the one you may have heard.
Secondly, MNKD’s Chairman and Chief Executive, Alfred E. Mann has put almost 1 billion dollars of his own money into the company. He said on a recent conference call when he was directly asked, that he “was not sure if he was going to put more of his own money in the company or not.” All articles and blogs I have read seem to suggest that he would not be putting any more money into the company. This is a second misconception. One has to believe that after investing a billion dollars of his own capital into his company, he is not going to let it fall into despair.
Thirdly, MNKD cut over 40% of their workforce, news that was for some reason met with continued selling. From a business perspective, cutting overhead is a positive for the company as it tries to remain afloat while it completes the Phase-III trial to the specifications of the FDA.
MNKD’s balance sheet is a disaster. There is no denying that. Uglies are still ugly for a reason. The question of course is will the company be able to wait out the storm for approval? And will Afrezza eventually be approved by the FDA? MNKD does also have a melanoma drug in phase-II trials with some early positive results. The drug is years from being approved even in a best-case scenario, but the company does have other potential drugs in its pipeline.
All and all, I find much of the MNKD news as misinterpretations of the facts. There is no denying that there are many hurdles to overcome for MNKD’s stock price. This of course, is the case with any ugly. The stock seems to have many investors betting against it with a whopping 19% of the float now being held short! Like most UGLIES it is at this moment-- when all hope seems lost-- that one positive piece of news could catapult the stock.
apavone has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple and MannKind. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.