2012 Q4 Client Letter

January 7, 2013


Dear Twinleaf Account Holder:


Managed account portfolios turned in solid performances in Q4, rising by 4.7% net and pushing returns into positive territory since our February 2012 launch. Net of fees, Twinleaf managed accounts were up 1.3% since inception, a bit below relevant benchmark indexes but with Q4 momentum that has continued into 2013.


As account holders are aware, a core Twinleaf investment theme is the prospect of M&A activity positively impacting our portfolio companies.  In other words, if a company is not at least a plausible candidate to be acquired in the near-to-medium term, it fails to meet one of our key criteria for portfolio inclusion.  Overall M&A activity in the US in 2012 was weak:  according to FactSet, merger activity by dollar volume was down by 19% in the $1 billion-plus segment in 2012 versus 2011 and down by 22% in the $500 million to $1 billion segment.  And nor was 2011 a strong year for M&A, as activity was well below the peak year of 2007.  Despite record low borrowing costs, macroeconomic weakness and political uncertainty in the US suppressed corporate and private equity deals.  


Indeed, Twinleaf accounts participated in only a single M&A announcement in 2012 (the deal has not closed).  But the good news is that FactSet says that the average sub-$1 billion deal is getting done at about 9.5x EBITDA and at an average stock price premium of just under 50%.  Given that our emphasis on value has enabled us to accumulate companies in client portfolios at about 5x EBITDA on a blended basis, there should be considerable upside to our names if and when M&A activity resumes.  In the meantime, our portfolio companies are continuing to grow earnings and build value and could see multiple expansion even if the M&A drought continues in 2013, which seems unlikely.  


Q4 performance in Twinleaf accounts was led by SeaChange (SEAC) and TiVo (TIVO), both providers of advanced television software and solutions, up 22% and 20%, respectively.  The investment thesis for both companies remains intact in a space that is not yet fully understood and appreciated by investors.  


SEAC is midway through a transformation from an unfocused, low margin hardware/software company to a highly focused, tightly managed software-only vendor with three core product lines for pay TV and online video customers.  With industry-leading product niches and an activist investor holding board representation and a 9% stake, we believe that the company is a very good candidate to be consolidated in 2013, perhaps in a sale to Adobe or Ericsson.   In the meantime, we look for SEAC’s operating momentum to accelerate and, with $100+ million of balance sheet cash, the company to continue returning cash to shareholders.  


Similarly, TiVo in 2012 transformed itself from an IP holding company with a DVR appliance at retail to a full-service advanced television software provider to global cable operators.  While TiVo continued its litigation prowess, bringing proceeds from IP-driven legal settlements to $1+ billion, the company quietly emerged as a trusted partner to the cable industry, helping it navigate (and integrate) the complexities of multi-screen video delivery.  With multiple customer announcements in Q4, the transition to positive operating cash flow and the prospect of a final legal settlement in 2013 (defendants include Google/Motorola, Cisco and Time Warner Cable) as well as the corresponding decline in litigation-related expenses, investors have finally taken notice of TiVo’s unique position.  While a sale of the company is a possibility, operating momentum and a cash-rich balance sheet should support the stock price in 2013 even without an M&A event.


Twinleaf accounts also have an overweight position in Jamba (JMBA), a company evolving from a chain of owned and operated smoothie shops to a business model that emphasizes franchise outlets, menu expansion beyond smoothies, international growth, consumer products at grocery and a self-serve kiosk concept rolling out to schools -- all under a corporate banner of “good for you” nutritious quick-serve fare.  Even with a 15% pop in the stock price during the first week of 2013 attributable to the launch of a children’s smoothie/meal bundle, JMBA remains very reasonably valued at just 7.5x estimated 2013 EBITDA.  Recent M&A activity in the space (Starbucks/Teavana, Bensicker/Peets, Bensicker/Caribou) was done at well into double digit multiples and we believe that Jamba’s fundamental profile is more attractive than each of those M&A targets.  


Finally, we’ll highlight Crown Media (CRWN), operator of two pay TV networks, Hallmark Channel and Hallmark Movie Channel.  We’ve written about CRWN in the recent past (including a letter to its board of directors posted on the Twinleaf web site) and we believe that 2013 is the year that the controlling shareholder, Hallmark Cards, finally finds a home for the CRWN assets where they belong:  within a media conglomerate that can drive advertising sales and distribution fees to the next level and bring operating efficiencies.  CRWN currently has an enterprise value of just under $1.2 billion.  We believe that a sale of the company could bring $1.6 billion and if media reports last week are accurate that pay TV network Current was sold to Al-Jazeera for $500 million, CRWN may be worth $1.8 billion or even $2 billion, which represent significant premiums to the current share price.  


We have a passion for uncovering investment ideas and we enthusiastically engage in it every day.  We look forward to a successful 2013 and thank you for your support.



Regards,


Spencer Grimes

Principal