My interview with Paul Sonkin | Street Capitalist: Event

Driven Value Investments

My interview with Paul Sonkin

Paul Sonkin, manager of the Hummingbird Value Fund, is an awesome investor

and a great guy. I’m extremely grateful that Sonkin was willing to contribute his
time to this interview (the first interview here at Street Capitalist). I wanted to
interview Sonkin in particular because his fund employs a strategy accessible to
all of us small investors. Some of the companies are absolutely tiny on a market
cap basis and he goes after arbitrage situations that most investors will never
hear of. This style of investing embraces the advantages of a small investor and
allows you to exploit greater inefficiencies in the market, as many of these
neglected companies are too small for the big Wall Street firms to cover or invest
in. I hope you enjoy the interview and let me know if you think I should do more
of these.

Tariq Ali: Could you give us your brief career history?

Paul Sonkin: I bought my first stock with my bar mitzvah money. I went to
college and when I graduated it was when Drexel had just went belly up and I
was looking for sell side research positions, couldn’t really find any because all
the assistant positions got taken up by those ex-Drexel people so I worked at the
Securities and Exchange Commission which was a lot of fun spending a year and
a half there spending a year and half at Goldman Sachs. My career was going in
one direction and my interests were going in another so I went back to business
school and I graduated in 1995. I worked for Chuck Royce for 3 years and then
worked for First Manhattan which is Sandy Gottesman’s firm for a year and then
I started Hummingbird about 10 years ago. That’s sort of a nutshell.
Tariq Ali: You often hunt in the nano-cap space, how do you find out about
these companies? Is it like Buffett said, that you need to just “Start with
the A’s” or do you use things like screens or local news periodicals?

Paul Sonkin: You know I’d say that most of my ideas come off of the new lows
list. I take that that’s sort of the best hunting ground. And then the other thing
that I do is I have these lists of companies i’ve owned before or am interested in.
And then I get the news headlines for them on a daily basis and then I do a lot of
keyword searches for like spinoffs, liquidations, merger arbitrage, stuff like that.
And then I go to conferences I source my ideas pretty much from everywhere.
The only place where I don’t source my ideas from is Wall Street. Not a lot of
Wall Street research at all.

Tariq Ali: Yeah, that 52 weeks low list really exploded a few months ago.

Paul Sonkin: Yeah. And I guess that in times like that there’s so much to look at
you can almost close your eyes and buy anything.

Tariq Ali: A lot of the companies you invest in are pretty small. Do you
ever interact with the management of companies you invest in? How
receptive are they to your ideas? Many of these companies have small
shareholder bases, do you ever have to work with them to help promote
changes in these companies?

Paul Sonkin: I guess. Yes and no. Sometimes they are very receptive sometimes
they’re not receptive. I would say that we always talk to management over the
phone and we’ll sort of have them walk us through the story and we’ll discuss
their capital allocation decisions and just you know, go through various things
like that.

Tariq Ali: And one thing I noticed is that some of the companies in this
size range may have an incredibly small shareholder base. Do you ever
work with these shareholder bases?
Paul Sonkin: Yeah, it’s very common.
Tariq Ali: And the other thing I noticed with some of them is they don’t
register with the SEC, is this ever a problem for you? Do you ever have
issues trusting their financial statements?
Paul Sonkin: No, I’d say that usually the financial statements are pretty good
with the ones that don’t file. Sometimes they just file once a year. But it’s sort of
like how the old pink sheets used to be.

Tariq Ali: You teach students value investing at Columbia Business School.
When analyzing securities in the micro-cap/nano-cap space, are the
methods different than researching mid-caps / large caps?

Paul Sonkin: Well yeah. You know it’s always easier to analyze something that’s
simpler than something thats more complicated. So think of it as if you were
dissecting a human body as opposed to an amoeba. You know when you have a
company where there are just fewer moving parts it’s just easier to do the
analysis. So that’s why we’ll keep track of 100 different companies and it’s pretty
easy to do that because there’s just less to analyze.

Tariq Ali: I saw in another interview, you mentioned how the portfolio
works at Hummingbird where you almost allocate 50% of the portfolio to
arbitrage situations. Could you talk a little bit about position sizing — does
your firm put limits, do you have a hard formula for that kind of thing?

Paul Sonkin: You know I’d say that we used to have much more stringent limits
but what we’ve found is that lately there aren’t that many interesting arbitrage
deals. So we have allocated a lot more money to the general portfolio. So its
become a little bit overweighted in that respect.

Tariq Ali: About the arbitrage part of the portfolio, with my own portfolio
I’ve participated in a few small, odd-lot tender kinds of things. Does your
firm deviate from small micro-caps/nanocaps for arbitrage or do you stick
in the same space?

Paul Sonkin: We do a lot of small odd-lots and other forms of arbitrage. We

really don’t deviate because the competition there are the big arb funds and they
have a mandate to put a lot of capital to work so the spreads and risk/reward
scenarios aren’t appealing. With these larger deals you can do these odd-lots,
like if they’re tender but they’re going to do it on a pro-forma basis if you own
less than 99 shares usually you can tender into that. So it’s possible to do odd-
lots with larger tender offers but it’s not an area of our focus.

Tariq Ali: In another interview, you mentioned Seth Klarman as an

investment hero. Reading Margin of Safety, he talks a lot about looking at
investments with potential catalysts. Is this a case for you to, do you look
out for certain catalysts or is it more of buying low and eventually the
market will figure it out?

Paul Sonkin: You always want to look for a catalyst but sometimes there is no
catalyst. So with Steinway (NYSE:LVB) there’s no real catalyst there. Earnings
will recover and that will be the catalyst but the catalyst isn’t obvious and when
it is obvious it’s too late.

Tariq Ali: Do you think you could walk us through a failed past
investment?
Paul Sonkin: I guess like other value investors, we’ve paid homage to
newspaper stocks. We had one called American Community Newspapers
(OTC:ACNIQ) which we thought they had a little bit of a different business
model because while they were dependent upon advertising they weren’t really
dependent on subscription revenue. What happened was that business just
completely imploded. So I think that all value investors have paid homage to old
media companies and that was one failed investment that we had.

Occasionally we’re going to get caught in other situations where you get
involved and the problems are more than you thought. So a company like that
was Meade Instruments (NASDAQ:MEAD) where we were an activist and got a
board seat. By the time we got inside we realized that the business was in much
worse shape than we would have thought. We would have done fine except the
economy was the kind of nail in the coffin.

Tariq Ali: Could you talk a little bit then about shareholder activism. Is it a
strategy you actively utilize at Hummingbird or is it more of a strategy of
last resort?
Paul Sonkin: We don’t go into any situations with the intention of being
activists. There are some people who do that and it’s just not a focus for us. I
guess there are cases where we felt as though they weren’t being fair for
shareholders and we stuck up for our rights but I don’t see us going on boards in
the future.

Tariq Ali: Since you told us about a failed/disappointing past investment,

could you walk us through one you’ve been pleased with?
Paul Sonkin: There are some we have now that we think will do quite well going
forward. Rand Logistics (NASDAQ:RAND) is a large position for us. The
interesting thing about Rand is they’re embarking on doing an acquistion of a
company that’s in bankruptcy. So we expect that acquisition, if they complete it,
will be an accretive acquistion even though they’re going to have to issue quite a
few shares. But just looking at the business on a standalone basis you figure that
they’re projected to do $16M of EBITDA this year. They’ll have $6M of CapEx,
$4M of interest, and $1M of preferred dividends, which leaves you with about
$5M dollars. If you take that and divide that by 12.7 million shares you get about
$.40 per share of FCF for March 2010. For March of 2011 we think they’ll do
$0.75 of FCF and for March of 2012 we think they’ll do about $1.00 of FCF and
the stock is currently trading below $3.00 so we think that’s extremely attractive.

Another company we have a significant investment in is Southpeak Interactive

(OTC:SOPK). I think the video gaming companies have had a lot of pressure
because some believe that people may just download video games off the
internet for free but they can’t get the same kind of experience on a game played
online as they can on a CD that they buy. That company is trading at $0.60 and
they have about 51 million shares outstanding so figures about a $31M market
value with about $5M of interest bearing debt. So you’re talking about $36M, this
is a company that could easily do north of $100M in sales at 8% operating
margins. So we think that that is a pretty attractive situation. It’s in a very sexy
niche and they just brought on the ex-CEO of Take Two Paul Eibeler Interactive
as a board member which gives added credibility to the company. Terry Phillips
is a very good manager who is very well known in the industry. They’re executing
very well and we feel like we’ll make a multiple on our investment going forward.

Tariq Ali: Could you talk a little about Fortress International

(NASDAQ:FIGI) with your take on the situation there?

Paul Sonkin: I think it’s a very very well run company. I think that they had
some challenges with some of their customers getting financing but I think that
long term it’s going to be a great investment because it’s a play on server farms
and on these data processing facilities. Even though near term they may not put
up great numbers. I think that long term they’re capable of some meaningful
earnings growth and generating a lot of free cash flow. I was sitting with the CEO
of the company about a month ago and if you just look at the companies that
they’ve done initial build outs for I think they can get about $400M of revenue
just by building out the facilities that they’ve already started to work on. Because
when you put up a facility if they put up a 150,000 facility, they may only build
out 20,000 feet but as more tenants come in they get that add on work.

Tariq Ali: As a teacher, do you have any advice for students of value
investing right now?

Paul Sonkin: I think that it’s a great time for young people to be getting into the
business. If you look, a lot of the firms were created after the aftermath of the
20’s and there were a lot of firms created after the 70’s. I think that there are a
lot of firms that will be created out of the aftermath of 2008. So I think that it’s a
good time to be getting into the business. Usually, the advice that I give my
students is to keep your eyes open and your mouth shut. One of the pearls of
wisdom that I give them is if your boss asks you for a red umbrella, don’t bring
him a blue one and explain how it’s going to keep him dry. Just give your boss
what he wants. I think that there are a lot of people who start working that get
off on the wrong foot.

Tariq Ali: Do you have any book recommendations?

Paul Sonkin: There are several books that I really like. I like Hidden Champions
by Hermann Simon. David Dreman wrote a book back in the 70’s called
Psychology and the Stock Market. Another one I really like is Style Investing by
Richard Bernstein. And all of the classics.

Tariq Ali: Thank you so much Paul for taking the time to do our interview.
We wish you the best of luck!

I really enjoyed having the opportunity to interview Sonkin. During the

interview, I learned quite a bit about his process and I hope you did too. Here are
some thoughts:

For his search strategy, It looks like following the 52 Week Lows is your best bet.
In addition though, Sonkin mentions that he employs keyword searches to find
things like liquidations and other special situations. There’s a few ways to do
this. One, you can set up alerts with the SEC database to send you a message
whenever a particular company has filed a document you’re looking out for.
Different SEC filings correspond to different corporate events, there are filings
for spinoffs, material events, tender offers, and so on. Or, you could rig up your
own Yahoo! News Alert so that whenever a story comes with a particular trigger
word, such as liquidation, you’d get notified so you can quickly act. Other things
are more simple. For example, Sonkin mentioned that he keeps a list of
companies that they watch. These are things you just have to do on your own, it
becomes easier after you’ve analyzed more and more companies. Right now I’m
throwing a number of companies in the too expensive pile, but I look at how they
perform over time. Eventually maybe something will happen to cause a company
to fall below its intrinsic value and because you’ve already done work on it, you’ll
be able to act quickly.

I hope you noticed that when I said small companies, I meant it. Fortress
International only has a market cap $13.67M, Southpeak Interactive trades at
a $24.78M, Rand Logistics at $37.13M, and Steinway at about $102M. My guess
is that most of these companies will have little by way of analyst coverage or
attention on Wall Street or CNBC. The advantage is simple: less coverage means
there’s less eyes on them and produces greater opportunities for you, the small
investor. The market in these area is generally less efficient and the businesses
are actually rather simple. I think that companies of this size are better for newer
investors because like Sonkin says, they’re much easier to analyze. Steinway is
going to have less moving parts than a company like Kraft and it means you can
hone in on your analysis better.

I also thought it was interesting that Sonkin sees some of these companies as
ones with great long term prospects to grow as business. I know that other
investors only venture into companies of this size range in order to find net-nets
or special situations, but it seems like Sokin is taking a much comprehensive
approach. To find these kinds of companies you’re probably going to have to
broaden your search a bit in order to find them, since they may not come up on
an ordinary screen. Sonkin’s Fortress International investment is probably the
best example of this.

I haven’t read any of the books that Sonkin mentioned but Hidden Champions
looks to be very interesting. The book is a study on small companies (that most
people may never have heard of) that are market leaders in their respective
areas. Such a book could probably prove helpful for analyzing some of these tiny
companies from a qualitative perspective.

Hopefully you enjoyed my first interview here at Street Capitalist, I plan on

doing more of these in the near future but with readership participation. I think
that they’re great learning tools for students of investing because you’re able to
pick the brains of people with more experience in the field. I already know that
I’ve learned a lot from this interview with Paul Sonkin.