2013 Q4 Client Letter

January 6, 2014

Dear Twinleaf Account Holder:

Managed account portfolios finished a very good 2013 with some autumn underperformance that left us disappointed at year end despite solid outperformance for the year as a whole. Perhaps it’s inappropriate to dwell on the negative but like a pitcher who loses a shutout in the ninth inning, a potentially great year slipped away as two stocks contributed about 600 basis points of overall performance erosion. As detailed below, one of the culprits was a regrettable investment decision and the other remains our best investment idea that hasn’t yet performed. 

Nonetheless, accounts that were with us for the entirety of 2013 returned +50.3% net of fees, considerably better than the total return of the two most relevant stock market indexes, the S&P 500 (+30.4%) and the Russell 2000 (+37.9%). In Q4, Twinleaf accounts were +3.0% net versus +9.4% for the S&P 500 and +7.0% for the Russell 2000. 

Notable investment winners in 2013 that are sizable core positions in Twinleaf client portfolios are Marchex (MCHX +103% in 2013), Envivio (ENVI +87%) and Crown Media (CRWN +83%). Despite the large gains, we continue to see value and catalysts for further appreciation at each company. 

Marchex began 2013 as an overlooked mobile advertising company with a $4 stock price, an undeveloped core business and a non-core web domain unit being prepared to be spun off to shareholders. By year-end, Marchex had an $8.65 stock price (and nearly $10 as I write this), a more established core mobile ad business growing at a double-digit pace, a patent portfolio newly discovered by investors and a slimmed-down web domain business remaining in-housebut no longer a meaningful drag on revenue growth. Marchex is the leader in a segment of mobile advertising that generates and analyzes calls (not “clicks”) for clients, ideal for marketers of more complex products like insurance, banking, home security and hospitality. We are bullish on the company’s prospects as mobile advertising gains market share and calls become a more valuable customer conversion tool. It’s also quite possible that the company is sold to a “click” advertising company in the next 18-24 months at a price well above current levels. 

Envivio is a provider of software that facilitates delivery of video content to tablets and smartphones. We believe that Envivio, with a solid customer roster of pay TV operators and mobile carriers, is well positioned to capitalize on the explosive growth in video consumption (and targeted advertising) on the second screen. Envivio has endured a rocky existence as a public company; since its IPO in 2012, shares are down 60%. Envivio was early to market and only now are its customers exhibiting strong demand for its products. We believe that as Envivio reaches profitability this year (we forecast it to be in the spring quarter), its stock price could double again in 2014. 

As for Crown Media, we have opined extensively on this company: on web sites for portfolio managers, in blog posts on the Twinleaf site and even to the media. To summarize, we believe that Crown is likely to be sold in 2014 at no less than $4 per share and possibly as much as $5 if the controlling shareholder maximizes value in an auction. 

More recent additions to Twinleaf-managed accounts include ChyronHego (CHYR), Kona Grill (KONA), nTelos (NTLS), CafePress (PRSS) and TiVo (TIVO). TiVo, while a profitable holding, has been disappointing; despite a reinvention of its business that has reached solid profitability, $1+ billion of patent litigation proceeds on the balance sheet and competent and incentivized management, the stock remains chronically undervalued. We think this could be the year that the company is sold to a strategic buyer. 

Returning to our 2013 underperformers, we were impacted by poor operational performance and balance sheet mismanagement at The Dolan Company (DM) that called into question the value of its most prominent asset, an e-discovery software subsidiary. We had been modeling a valuation for the e-discovery unit of $200 million and we were expecting management to shed assets to yield a $4 DM share price. While that outcome is still possible, we’re not waiting around for value realization; we sold shares at a painful loss for some Twinleaf clients. Reminder to self: avoid overextended balance sheets when weak financial and operational executives are managing your investment.

The most frustrating investment in Twinleaf client portfolios, our highest conviction position, is MagicJack (CALL), a pioneering provider of VoIP service aimed at cost-conscious and expatriate consumers. Until recently, perhaps a ridiculously low valuation was warranted for this company since its former CEO, while a brilliant entrepreneur, was no manager and had few fans on Wall Street. But professional management has been installed, the brand is being polished with a new web site and ad campaign, retail partnerships strengthened and product features added. Management has indicated monetization of the MagicJack app and guidance is for double digit growth in 2014. Yet the stock trades at the lowest EV/EBITDA multiple on our screen, below 3x. The stock has been an epic battleground with short sellers winning of late but we believe our thesis will play out sooner rather than later. We look for solid execution to attract investors and trigger short covering. We believe the stock to be worth $20 today and perhaps $30+ in 12-18 months. 

Our passion for uncovering compelling investment ideas is as strong as ever and we enthusiastically engage in it every day. With stock prices higher, it’s more challenging but undervalued small-cap stocks with catalysts for appreciation are still out there awaiting discovery. It’s our job to find them for you. 

As always, we welcome your comments and client referrals and value your trust in us. 

Spencer Grimes