Excellent Anthony Weber Interview
interactive.wsj.com
The Hardest 15%
A small-cap growth manager scores hefty gains while rivals lose big. Your grandmother could have produced triple-digit returns in last year's market. But the 112% gain delivered last year by Tony Weber and his partner, Charles McCurdy, of $600 million Louisville-based Veredus Asset Management is special because these small-cap growth specialists have come through with an encore of sorts in this most tumultuous of years: Their Alleghany Veredus Aggressive Growth mutual fund is up 22% and their hedge funds are up 55% and 76%, after fees. Most of their mutual-fund competition is down by double-digits. So are all the pertinent benchmarks. A carefully honed strategy, developed out of Weber's years at Fred Alger Management and McCurdy's years at Citizens Fidelity, combined with skillful trading set these two apart. To see why they're the kind of jockeys you want to bet on when the horse is tired, read on.
Barron's: You make no bones that this a bear market. When did it start?
Weber: March 10 was the high, but I feel the bear market started the week of April 3. Tuesday April 4 was the closest thing to the crash of '87 that I've seen since. It was wicked. Terayon Communications Systems, a name I spoke about with you last year and one in which we did very, very well, started to form a real broadening top in the spring, trading around $100. On that Tuesday it traded between 99 and 58 and it closed at 96. I called the office at 12:30 from Washington, and our mutual fund was down 14% at 12:30. We rallied back and closed down 2.5%-3%. When you see extreme volatility like that, at low points or high points, the markets are going to go the other way-that's all there is to it, in my experience. We sold our entire position in Terayon over the next two days, with the stock in the mid-90s. Within four to six weeks the stock traded in the low 30s.
Q: The momentum crowd headed for the exits?
A: Keep in mind that my competition focuses on absolute growth rates; they think 40% growth is going to get you out of any situation in any environment. If you look at a chart of the average monthly return of companies with the highest growth rates compared with companies with single-digit growth rates going back to November 1982, you'll see the highest-octane growth companies gave you only six basis points of outperformance above the S&P 500. That's not enough reward for the risk you're taking, and people are finding that out right now. Most of our competition is down 15%-25% year-to-date and down 20% for the past four weeks, where we are up 22% for the year and down 2% in November. What we focus on are quarterly earnings surprises and the sustainability of the quarterly earnings surprise. There are no one-quarter phenomenons, either up or down. Once a company comes in below plan, chances are it's going to continue. Lucent Technologies is a prime example. But if you take companies with two quarters of positive earnings and rank them by which ones are experiencing the greatest revision to the upside, this is where we are going to be fishing from and that's what gives us an edge. Those companies have produced a return of 2.44% a month, or close to 100 basis points over the S&P return, based on historical analysis. In late 1998 and 1999, the technology names, especially optic companies and telecom-equipment makers, were all on the first page of the hit parade as they were experiencing the greatest revisions to the upside. Now it has totally flipped; we are starting to see revisions downward.
Weber "The Russell 2000 is down 8 1/3%, but the Nasdaq is down 32%.
Q: You've said this is the hardest 15% you've ever worked for.
A: It's been unbelievable. Our variable hedge fund was up 5% at Labor Day and now it's up 55%. The dollar-neutral hedge fund is up 76%. In the variable one, we can have any kind of exposure; it could be 100% long or 20% short. In the dollar-neutral fund we try to keep to a tight band of between zero and 10%. Typically, the variable fund has been 55% net long. Right now it's 16% net long. In the second quarter we had a contratrend rally off the bottom that gave us a great opportunity to get out, and we took advantage of that. We underperformed in the second quarter because we were moving out of technology. We haven't had a net short position, though we've been net short technology. In the third quarter Cisco Systems warned it was building inventories 10% above normal, which probably meant 15%20% above normal, and still everybody pretty much ignored it, even though Cisco is the best company at putting expectations out there. In November we started to see that inventory levels of components had gone from six days to 21 days. Inventory turns went from eight to 6.7. People forgot that the semiconductor industry is not a growth industry, but a cyclical growth industry subject to downturns. A lot of people felt PMC-Sierra and Applied Micro Circuits were immune to a downturn because they focused on communications. Well, broadband is not getting built out as everybody thought it would. If you look at SBC Communications, the biggest DSL player in the country, they deployed only 117,000 lines in the third quarter, down from 178,000 in the second. That's a big sequential dropoff.
Q: Is it lack of demand or lack of ability to supply demand?
A: It is a lack of ability to deploy it. Customers have to call up and order it, and that's a source of some delays. Another part of the problem is that the central switching offices are so jampacked it's physically hard to find the right connections-it takes three or four weeks. Also, the phone companies never had to compete against anybody. They don't know how to compete in a timely fashion. As a result, there are 1.2 million DSL lines installed versus 3.5 million cable modems. I've had a cable modem in my house for seven months now. There was some downtime that lasted two or three days when the network had to be rebuilt. But DSL runs at half the speed and, in most cases, is more expensive, so I think cable has the advantage here. That said, AT&T came out recently and told Antec to look for orders to be down and that stock went to 7 from 43.
Q: Scientific-Atlanta got hurt by that news as well.
A: We are short Scientific-Atlanta right now, based on what AT&T said. In an environment like this, you can play those kind of synonymous shorts. The same is going on in the cellular-handset market. Early last year, expectations were for 900 million handsets this year. The number has dropped to 600 million. More realistic expectations are for 520-550 million, but that means the number will probably be 480 million. The way I look at the handset business is a lot like the way I see the PC business. The phone I have now, a Motorola phone, has great functionality and a lot of great features. I haven't thought about changing this one and I've had three phones in the past two years. It's like the PC business. It reaches a point where it doesn't pay to upgrade. The product cycles in technology are so short now. Time-to-market is everything. At the beginning of the fourth quarter, the Big Five-Cisco, Microsoft, Intel, Sun Microsystems and Oracle-had more market cap than the entire Russell 2000. What's great about this year is the Russell 2000 is down 8 1/2 % but the Nasdaq is down 32%. It's a total flip-flop of what happened from 1996 through 1998. Small-cap is back in favor and outperforming. Small-caps will lead us out of this market, much as they did in 1975. I won't go so far as to say this is 1973-74 all over again, but we are very close. We are very, very close.
Q: What leads you to draw that parallel?
A: Sentiment. After this bear market we've experienced, it's amazing you still get bullish sentiment. It's off the charts at an all-time high. Everybody thinks it's their God-given right to have a great fourth quarter going into the Christmas season, and that's a problem.
Q: What would change sentiment?
A: Don Hays, a strategist whose firm is Hays Advisory Group, has a great chart comparing the Nasdaq of the past two years with the Nikkei of 1989-90. It's scary, it's so close. He is calling for a 1800-2000 Nasdaq at yearend. I don't necessarily agree with that, but I can see 2250, which would be the base point of where we broke out from in 1998. If we do that, that would sufficiently scare enough people to the point that we have a contratrend bear-market rally of 30%-40% off the bottom. It would be short-term rally, centered in the names that have been beaten up the most. Technology and whatnot. What is crucial here is the Fed meeting December 19. If the Fed takes a neutrality stance, and since we finally have a President-elect, we are set up for a very strong contratrend rally because people will expect an easing in the February-March timeframe.
Q: Do you?
A: No.
Q: Why not?
A: Everything is geared off expectations, and 2001 expectations are still too high.
Q: Even though people are looking for single-digit earnings out of the S&P?
A: Technology expectations are still too high. People don't want to face the fact that we're in a downturn. If we don't get an interest-rate cut in the first quarter and we get more preannouncements for first quarter numbers, which we are certainly getting in the fourth quarter, people will start ratcheting down estimates, and we are going to start the cycle all over again. The rally I spoke of off the bottom will be a contratrend bear-market rally and it will be vicious. Nasdaq could go to 3400-3500. All bear-market rallies are vicious, just as bull-market corrections are vicious. We've had five 5% one-day rallies in the past six weeks. A few weeks ago, we were up 9% in the Nasdaq and we gave it all right back. Right now what we're seeing is little demand in the mutual-fund sector. Everybody is waiting for dividends to be paid out. Most of those will be paid out by the second or third week in December. The problem gets worse because there are funds like the Putnam OTC Emerging Growth fund that have had a rough year-Emerging Growth was down 20% in October and the dividend payout at that point was going to be 15% of net asset value. Now that fund is down 50%. People are selling funds like that, trying to avoid paying taxes. It's become vicious. The same stocks, the same funds are going down, day in and day out, and I don't see any relief until the middle of December.
Q: When should we expect a sustainable rally?
A: We've got to cleanse the excesses and the bullishness and that could mean another 30%-40% to go.
Q: But then it might be quite awhile before people get interested in stocks again.
A: Right. That's why I'm fearful this is similar to 1973-74. Nasdaq in five years went from 1000 to 5100. If you drew a trendline from the 1994 low to 1998 low and extend it out, it is 1800. Don Hays may be right in his conclusions.
Q: That said, a few weeks ago, you thought technology names had begun to look interesting again.
A: We did take some trading positions. But the volatility has been absurd. So we turned to our screens and the names that started to bubble up were in health care.
Q: How much health care is in your portfolio?
A: In the second quarter we had 37% technology, 12% telecom, 16% health care and 13% energy. At the end of the third quarter, technology stood at 7%, telecom 5%, health care 29% and energy 23%. Now health care is 40%, energy is 17% and telecom and technology are 7%. I feel everything's flipped and health care is recession-resistant. If you owned health care from 1989 to 1991, you never knew there was a recession. A decade ago, all the health-care boats rose. And the demographic argument for health care is more compelling today than it was in 1991.
Q: What are some favorites in that area?
A: We still own quite a few of the HMOs, but that's an area I would look to cut back. Oxford Health Plans is our largest holding. We got involved with that earlier in the year, and it has done exactly what we thought it would do. In November, the stock was up 20% while the Nasdaq was down 23%. But they've wrung out most of the margin expansion they can get and now they have to start growing the top line, and that may be more difficult. Still, we think the stock can trade to 45 -- 50 based on a $2.50-a-share number in '01 and $3 in '02. One area we've been buying more recently is in the hospital area. Rural hospitals. We don't want to be involved with the urban hospitals.
Table -- Weber's Picks
Q: What's the advantage of the rurals?
A: The rural hospitals have several things on their side. Keep in mind that 25% of the population in this country live in rural areas. Also, a lot of rural areas are growing much faster than urban centers, especially in the Southwest. Most of these companies are the sole provider for the market they serve. Managed care has no real presence in rural areas. And under the Balanced Budget Reform Act 2, Medicare reimbursements that had been reduced will be reinstated to rural hospitals.
Community Health Systems of Nashville is our largest holding in this area. It has great management in Wayne Smith and Larry Cash, ex-Humana guys. They've got 51 hospitals in 20 states and they're the sole provider in 84% of their markets. One of the great things about Community Health is that they are broadly diversified geographically in terms of states. So if somebody changes the Medicaid rules on them, they are not going to get hurt. The average population in Community Health's system is 80,000 per market. There are 400 hospitals they've targeted for acquisition. Up to this point, their acquisitions have been almost exclusively nonprofit hospitals, which typically have high-single digit margins versus 24% for a mature Community Health hospital. Over a three or four-year period, they have shown they can take 7%-8% margins and expand them to 20%-24%. And they can get a lot of organic growth through the acquisitions, mostly from cutting labor costs. We expect the company's growth rate to be 30%-35%, and earnings should come in at 53 cents next year and 93 cents in 2002.
Q: What's another example of a rural hospital you like?
A: We own LifePoint Hospitals as well. LifePoint was a small rural division spun out of HCA. It runs 20 hospitals in eight states and 21 markets. That adds a certain risk to the stock because they've got a lot of hospitals in Tennessee and Kentuckybecause of their connections to HCA. But the story is very similar in terms of the roll-up strategy and margin expansion. The company is growing at 25%, and earnings are coming in at 72 cents in '01 and 82 cents in '02.
Q: What about biotech?
A: Cell Therapeutics is a name we've owned and traded around quite a bit.
Q: For how long?
A: Eight or nine months. We recently sold some in the low to mid-60s and the stock is now at 37. A lot of biotech names have been caught in this multiple contraction and it is a difficult area. You really want to focus on those companies with large pipelines and large potential markets. The cancer market is the most promising it's been in years, and Cell Therapeutics has got one drug approved -- Trisenox -- that's used to treat acute promyelocytic leukemia. Only about 3,000 people a year are affected by APL, but Trisenox has potentially wider uses. It might prove useful in treating multiple myeloma, renal, cervical and prostate cancer, among other cancers. They also just got the go-ahead in this country for clinical trials on a drug that's even more exciting, PG-TXL, which could be used to treat lung, ovarian, breast and colon cancer and which is already undergoing clinical trials in the U.K. It's a chemotherapy drug that targets just the cancer cells and leaves the healthy cells alone, making it less toxic and more effective. You can administer this drug in 10-20 minutes as opposed to the three hours or more it takes if only Taxol is used. It could be a phenomenal drug. This drug could hit the market sometime in late '02.
Q: Is Cell Therapeutics profitable?
A: No. They won't be profitable until '03.
Q: So, given your approach to stockpicking, how do you justify the investment?
A: In biotech, you have to determine if they're reaching milestones faster than expected and if the data are equal to or better than what they've been indicating. This stock is one of my favorite cancer plays.
Q: When did you start getting into biotech?
A: Just this year. We missed the genomics move. But I still think the genomics stocks are way ahead of themselves. There are a lot of ethical questions surrounding it. I'm sure genomics will be enormous, but I'm not smart enough to know which names or what the timing will be. I would rather focus on companies with products at market or close to market. We want to focus on names that are tapping very large markets like Cell and its PG-TXL. There's a whole host of other names we are looking at right now to target. But if the rout in the Nasdaq continues, it will get to the biotech area, because they are selling at very high multiples.
Q: What about your energy holdings?
A: I'm nervous about that sector right now. I'm disappointed at how the stocks have acted relative to the high prices. We own the drillers; Patterson Energy is our favorite, but we've tended to take a shotgun approach with these names and so we also own Marine Drilling and Smith International. But the way the stocks are behaving leads us to think that this is 1973-74 all over again because they're not reacting to higher prices, and that tends to be a forecast for recession. Our decision to move out of these stocks is ongoing. We are very concerned. If we move out of these names, it may provide a source of funding to move into technology and play the contratrend rally we think will happen this month. But that rally depends on whether we get a neutrality stance out of the Fed.
Q: And how long would such a rally last?
A: Probably six to 12 weeks.
Q: Any other areas you're looking at?
A: Utilities are an area we are working on. We don't have any exposure yet and we missed the move so far. That area has been big this year. In any industry that's deregulated, there is going to be a lot of opportunity. And again, those areas that lead you through a bear market will lead you on the way out.
Q: What about some shorts?
A: We're short Tellabs. That's more of a longer-term play. It's one of the cheaper names in the telecom-equipment area, even though the market cap is about $22 billion. The problem is, they don't have anything to get them into the optical switching area. They laid their cards on the table 18 months ago when they attempted to buy Ciena. It was a great move at the time, but unfortunately Ciena was going through some short-term problems and the deal fell through because of Ciena's stock price. Now we think they have some competitive questions. Most of their equipment is old legacy systems versus new optical stuff.
Q: Any others?
A: A name that is overvalued here is Stilwell Financial, which for all intents and purposes is Janus. The earnings estimates are too high. This is a difficult year and they are suffering from redemptions. They had a bunch of funds up big last year -- 80%, 90%, 100% -- and a lot of those gains were deferred into this year and now the same funds are down 15%, 20%, 25%. It's difficult to overcome that. I don't see an earnings recovery from Stilwell until '02.
One other name I think is in big trouble is Amazon.com. Amazon has built inventories up for their Christmas season, and remember the correlation between the stock market and retail sales. They are going to make it or break it this year. Their debt load is huge. Why they did a convertible bond offering instead of equity, I have no clue. Debt is a four-letter word and when you get into a down cycle, debt will come back and kill you. They are not going to be able to raise capital. It will be difficult, but they might come through it. But everything has to fall in place.
Q: Tony, thanks.
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Alot of what Weber says is familar. The short on SFA is interesting as I thought the cable box was their strongest seller. 5M high speed lines show that faster access is not even close to becoming a reality. I remember seeing 40M homes online so penetration would be 8% now.
Jack |
