Investor Insight: Zachary Scheidt, Stearman Capital
Written by: Zack Miller | January 7, 2008
The entire interview with Stearman Capital’s, Zachary Scheidt, is part of our new subscription newsletter, Israel Opportunity Investor. You can find out more about the product and the opportunities we cover at www.israelnewsletter.com
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Can you tell us a bit about your firm?
Zachary D. Scheidt: Stearman Capital is unique in that it focuses on stocks that are new to public markets. While our formal universe includes stocks that have been public less than five years, most of our investments turn out to be companies that have issued stock within the past 12 to 18 months.
We believe that there is an information disconnect for many names in our universe because up to this point there has been little or no media or analyst coverage leading up to the IPO. Once a company comes into the public realm, the first people to write about the names usually have an agenda. Underwriters issue reports after the quiet period is over with the hopes that their positive rating will propel the stock higher. This helps their reputation when soliciting investment banking business from other clients and also creates goodwill with the management of the newly issued stock. Goodwill is important in their business model because a large portion of companies who issue public stock come back to markets to raise additional capital.
I believe that Stearman is able to capture positive returns by digging through the primary information from the company as well as third party research to find the nuggets of truth that point to the eventual direction of these often misunderstood stocks.
One more advantage that we have is our relationships with multiple underwriters. When a company is pricing an IPO, we take calls from most of the major brokerages selling the deal and are able to pick up on the demand for a particular issue. If a contact calls in and says, “This deal is going to be red hot and I can get you as many shares as you want!”, we know that there is excess supply and the underwriters are pushing to get the deal sold. So, while you have to read between the lines at times, the relationships with these important firms gives us an edge that is difficult to quantify and nearly impossible to duplicate.
How does a firm located in Atlanta, GA start investing in small Israeli companies?
ZS: Well, believe it or not, the process is very simple. As Israel’s economy continues to evolve and new enterprises demand capital for expansion, companies often come to US markets to raise that capital. With technology making the world smaller every day, our research process is able to grapple through the same information that hits the desk on the 87th floor of a Park Avenue office (with considerably less overhead, I might add) and we are able to make a well-informed decision based on publicly available information.
To me there is not much difference in picking a stock based in NYC, San Francisco, London, Buenos Aires, or Tel Aviv. While currency issues come into play, local culture and customs are of course important, but the bottom line is whether I can make money trading the stock or not. The price of the stock will fall in line with supply and demand and that will be based on the public expectation of the future prosperity of the business. So if I can get an edge on what that public perception will be, I can trade a stock successfully, no matter where the company is located.
Can you tell us about 2 of your Israeli holdings?
ZS: 012 Smile Communications (Nasdaq: SMLC) is the most recent Israeli name I have added. The stock has only been public a few months and has gotten very little attention from the media or from analysts. The company is a leader in its field, rolling out new telecommunications technology at an impressive clip. From what I understand, the regulatory environment has worked out very favorably for SMLC, as they have been granted exclusive rights to roll out a WiMAX network as well as Voice over Broadband technology. While competition will certainly be allowed to enter the market in the future, SMLC gets a head start by being able to test the technology and build up a good base of initial customers.
How does the regulatory environment affect 012 Smile?
ZS: Bezeq is the incumbent state-owned telephone operator that holds the majority of local wired lines. The trade commission has stated that Bezeq will not be able to enter the Voice over Broadband market until it sheds 15% of its local lines. This means that companies such as SMLC can pick these up at a discount and begin to eat into Bezeq’s market share with the government’s blessing. Pricing power is attractive because Bezeq will not likely cut rates as it is content to sit on the market share it has while collecting attractive revenues.
On December 1st, number portability, the ability for consumers to switch carriers and keep their own number went into effect. Does this help 012?
ZS: Number portability should work in SMLC’s favor as only recently, customers have been able to switch wireless carriers and take their phone numbers with them. The broad array of services offered by SMLC allows them to bundle different service offerings and present them to potential customers in a very attractive package. The future looks bright for the company and I am excited to see how the stock behaves as the word starts to be disseminated.
What else do you like?
ZS: Another favorite of mine is Ceragon Networks (Nasdaq: CRNT), which is involved in the wireless networking area as well. The difference is that Ceragon offers its services on a global level to large cellular companies. The gear that the company offers provides customers with a solution in a very specialized niche of the network setup called the backhaul portion of the network.
Now I’m not a technology genius but from what I understand, the backhaul is essentially the back portion of the network that typically connects cellular towers to the main switch to the wired phone system. With increasing data from 3G services placing a heavy burden on the existing infrastructure, many cellular operators are resorting to digging and running additional fiber to connect to the main switch. Ceragon’s technology bypasses this antiquated method and wirelessly transmits the backhaul data directly to the switch.
The technology has the potential to benefit both rural and high population networks and could experience huge demand over the coming years. The fear, however, is that the company will be unsuccessful in defending its intellectual property and could have to compete with copycat technologies from the likes of NEC. Legal battles are likely to take time and capital but even still, profitability is expected to be sustainable.
The company recently came back to market with a stock offering which appears to have depressed the stock a bit. Still, the returns over the past few years since coming public have been tremendous.
Are there any other companies that you like?
ZS: The final name I’ll share with you is Cellcom Israel Ltd (NYSE: CEL).
So you like telecom?
ZS: It appears that I am only interested in telecom companies, which is not true. For some reason, the most interesting names coming out of Israel these days appear to be in the sector.
At any rate, Cellcom is one of the two major players in the cellular market and has been growing market share. Management has the unique quality of being new (therefore fresh eyes, stimulating ideas, energetic optimism), while at the same time being backed by one of the largest and most diversified Israeli holding company (IDB Group). The backing by IDB (the largest shareholder) ensures quality and experienced oversight of this new, well-structured management team.
With Israel’s high rate of cellular penetration, where will new growth come from?
ZS: Cellcom has an attractive capital structure with a debt level that is manageable and attractive interest rates. Revenue is growing at a moderate but very steady clip and the company is capitalizing on the ability to offer new data services to customers. These value-added services offer higher margins and should also drive customer loyalty. That loyalty is paramount going into this new year with the number portability regulations in place.
Cost control is an important issue for the company as they approach the maturation stage. Since management has placed this metric as one of their four strategy pillars, I expect expenses to be in-line with historical norms allowing the company to profit from the steadily expanding revenue stream.
There are plenty of other names coming down the pipeline in 2008 and I have no doubt that there will be several attractive Israeli companies to choose from. I look forward to picking through the details to find the gems.
Thank you.
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