Institutional investors have powerful tools at their disposal to screen through reams of data.  Part of the institutional investment process entails screening through thousands of securities looking for a needle in a haystack — stocks that fit certain investment criteria.  From thousands of stocks, analysts can filter through a couple of hundred that fit these so called screens.  With a couple of hundred stocks in hand, analysts set out to do the hard work analyzing these companies, comparing them to one another, speaking to management and whatever else hedge fund and mutual fund analysts do when looking at prospective investments.

If I’m a value investor, I’m probably going to use some metrics that focus on Return on Capital (RoC) or Return on Equity (RoE) and Earnings Yield (E/P).  Growth investors might like to compare the price/earnings ratio (P/E) to the actual growth prospects of the stock in question.  There are literally thousands of things to look at.  So, where to start?

As we discussed in the “Piggybacking the Pros“, the Internet is a wonderful place to get information on stocks.  From monitoring actual moves that uberinvestors make to seeing what your peers think of certain firms, the information is out there.  You just need to be able to find it.  Investment Screening 2.0 is all about using screening criteria from super investors like Warren Buffett to find the next big stock.  Think of it as tapping the world’s greatest minds to see what they think of a given investment.

John Reese, a well-regarded entrepreneur with degrees from the two best schools in Cambridge, MA, has created a premium service that is the product of many years of research into the strategies of super successful investment managers.  Having devoured numerous investment books and interviews with the world’s best investors, Reese embarked on an ambitious project to computerize this information.  His firm, Validea, has created an algorithm capable of analyzing thousands of stocks according to differing investment strategies ranging from Fidelity’s Peter Lynch to Berkshire Hathaway’s Warren Buffett and applies screens to the overall market to find stocks that would fit these uberinvestors’ criteria.

John Reese joins New Rules of Investing for an exclusive interview.

John, can you tell us a bit about yourself?
John Reese, Founder, Validea: I have a degree in electronics and computers from MIT and a Harvard MBA.  Professionally, I worked for TI (Texas Instruments) in software and in strategic planning for GTE and Verizon.  I then founded my own company in computer networking and sold the company to GE Capital.  Post sale, I was looking to invest my own funds and wanted to do it in a very methodical way.  I began reading probably 50 different periodicals including investment magazines, news, and investment newsletters.  I was faced with numerous opinions.  Who should I listen to?  Who has the best track record?

In 1996, I began tracking recommendations from all the media sources I was monitoring (TV, magazines), much like Mark Hulbert does to find leaders in the investment newsletter space. I found that I was still not getting an answer as to who had the best track record or strategy.

Things became clearer when I read One Up on Wall Street, by Fidelity’s Peter Lynch, an investor with a proven track record, who shared in a step-by-step manner his strategy of stock picking.  I realized that this could be computerized and I actually programmed the Lynch guru, an AI model that could receive the data for a particular stock and analyze it according to pre-programmed Lynch criteria to see if it would past muster.

I then tie the guru models into a Reuters database (using more than 300 different models, per stock per day), only looking at US stocks and ADRs.

How much of John Reese is in the formula?
JR: I try extremely hard to mimic the guru’s strategy as closely as I can through real-life examples he’s written or spoken about.  Sometimes, it requires interpretation.  For example, in particular cases where the professional investor is not clear enough with his methodology.  The Guru has to have clearly described his investment process with quantitative aspects to it.  Peter Lynch, Benjamin Graham from Intelligent Investor, Dreman, Zweig, Motley Fool for Small Caps (written in book), O’Shaughnessy (45 years of what worked on Wall Street), John Neff (Windsor), and more recently, Joel Greenblatt, have all done this.

What does the Validea output look like?
JR: At a high level, Validea either summarizes a Guru score for a particular stock or we can drill down into an individual strategy, which criteria are employed by the particular guru and how certain investments meet or don’t meet this criteria.

In 2003, we came up with methodology that displayed a top 10 stocks/top 20 stocks portfolio generated by each guru out of a database of 6000 stocks.  The system makes a recommendation every 4 weeks and the results are available every day.

We distribute this information via a subscription newsletter called, Hot List, which uses a consensus strategy of gurus, which basically lets each guru strategy vote on each stock and weights each vote according to the risk-adjusted rating on each stock, our website, various reselling packages we have with various brokerage firms, and packaged onto Yahoo Finance.

How do investors encounter your research?  Where do they find you?
JR: It happens in three ways.  People frequently find out about Validea because the media likes to write about us given our unique approach.  We’ve run a contest via Microsoft’s Strategy Lab.  Lastly, people get to us from a wide variety of sources, including a lot of Google searches for gurus.  For example, investors read about Peter Lynch and all of a sudden, they now have a step-by-step way to follow his strategy or others like his.  There are a lot of people who have read these classic investment books.

How are you seeing investors interface with your products?
JR: It used to be that prior to 2003, the detailed guru pages (ie., the Ken Fisher model or the Ben Graham model) were regularly the most popular pages of the site.  Once we began offering the models, those became the most popular.  We began to hear from readers — some were tracking us for a long period of time, others were running their own portfolios, and some percentage of these actually wanted us to take over management of their portfolios.  We became an RIA (Registered Investment Advisor) in 2005 and took on an SMA (Separately Managed Account).  So, we’ve got two businesses now: one is stock market research business and the other is traditional asset management business.

Do you have any competitors?
JR: I hold a patent on our computational engine for simultaneous analysis by multiple guru investment strategies.  All the industry will say that this is the model they like.  However, most companies promulgate just one model — I took the broader approach of including many successful strategies.

What about future guru additions to your engine?
JR: We’re very slow to add gurus.  We’ll test new gurus internally for a number of years.

What your take on expert investment communities like the Fool’s CAPS or Covestor?
JR: I’ve found that there is no predictability between the top 20% of performers in one period, the hot hands, to what happens in the next period.  I think investors need long track records of 10+ years — there is going to be very little of a success factor when people follow anything less.

What about market neutral strategies, meaning investors who short stocks as well as buy them long?
JR:I haven’t found one guru who’s written about shorting with an established track record.  I also don’t address endowment managers like Yale’s Swensen because his strategy employs things outside of equities, like Real Estate and Private Equity, which are all areas I don’t cover.

After following multiple strategies over the years, do you have any interesting takeaways?
JR: I’d like to share a couple of interesting things we’ve learned.

First, there are several approaches successful over the long term. To my surprise, though, there are many successful models that exist simultaneously.  But, you have to be disciplined to stay the course of a particular strategy over the long run, even when severely hurt by the market in the short term.  Many investors don’t stay the course. For these strategies to beat the market, investors have to stick with them.  David Dreman and Ken Fisher all say that you have to ride it out.  No matter what, we’ve found that you have to resist modifying the strategy.

Secondly, every single guru has had a down year or two in a row compared to their benchmarks.  Nevertheless, these gurus beat most indices and other investment professionals over the long term.  If you read Greenblatt, he makes it very clear that investors will encounter 1 or 2 years which appear not to be working.  Given the fact that the systems always seem to snap back, I also wondered myself what success investors would have in investing in gurus after a smashing year.  What if you invested after a year of losses?  I found that in most cases, guru strategies returned either in in that year or caught up next year caught up (made up for losses).

How is your general performance [ed. this question was posed in September 2008]?
JR: At this moment, our 2 top strategies with highest annualized returns 5+ years are Benjamin Graham and Ken Fisher’s SuperStock (p/s) up over 21%. while the S&P is up just over 3%.  It’s a huge difference.  In fact, all strategies have outperformed the S&P 500.

How about tumultuous years like this one?
JR: Graham and Fisher continue to be best performers.  That said, I found no price predictability in short periods (3 months).  If you had looked at these at different points of time, you would have found down years throughout the period.

One of the things I want to emphasize is that Validea’s guru models implement a lot of AI that is not present in Screening 1.0 products.  I’ll give you an example: one of William O’Neil’s rules is that earnings must increase year over year unless there is a dip one year and earnings recover to new highs.  That kind of intelligence is part of the O’Neill guru model.  Another example: determining an earnings growth rate is not simple.  Let’s assume we drill down on a 3 years earnings growth rate.  What if you begin with 0?  Our system adjusts to be able to assess the stock and make it useable the same way as human analysts deal with data.  There is a major shortcoming in Screening 1.0 — databases are not clean, don’t have all data points, and plus, the databases can’t adjust for certain criteria which makes it hard to stay on scale.

Thanks for participating, John.

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It seems in regard to newer channels of communication, Reg FD has led to a diminishing in frequency of communications.  In spite of leveling the investment playing field, is this a long-term good for investors?
Maureen Wolff-Reid, President: Reg FD has largely succeeded in leveling the playing field while maintaining the frequency of communications between companies and the investment community.  This is a long-term good as investors have a higher degree of confidence that they can make educated investment decisions with access to the same information as any other investor.

What’s the communication plan for companies in the future with new technologies like webcasting, XBRL, blogs, Facebook and Twitter?
MWR: Webcasting has been a ubiquitous tool for companies to reach out to investor audiences for many years, and XBRL soon will be a requirement for all public companies.  It remains to be seen how prevalent some of the new technologies will be, although blogs are being used increasingly by both investors and public companies.  The next generation of investor communications is still in its early stages.  In the future, online resources such as Facebook, MySpace and Twitter may offer opportunities for groups of investors to exchange ideas.

Are execution issues with wire services perpetuating a form of selective dissemination for paid subscribers to these services?  Will companies follow Sun’ Microsystems’ lead and go direct to EDGAR in the future and bypass the wires?

MWR: Wire services currently constitute full disclosure of material news.  News releases distributed over a wire service are publicly available on the services’ websites and are sent to online resources such as Yahoo! Finance.  Bypassing the wire services as Sun has done may offer companies significant cost savings; but there is a trade-off in the loss of potential visibility and opportunity to fully explain the news.  In the future, posting to the company’s website might constitute full disclosure under the SEC’s guidelines and then companies may decide to simply post press releases on their corporate web sites in lieu of wire service distribution.

SeekingAlpha is providing free access to earnings transcripts.  Is this something that individual investors will benefit from or are these reports somewhat arcane for most investors?
MWR: Quarterly conference call and investor conference transcripts have become a valuable resource for both individual and institutional investors.  SeekingAlpha’s approach to publishing transcripts at no cost to the public is a great asset for individual investors, who previously had limited access.  Very few people have the time to listen to a complete webcast or comb through the SEC filings of all the companies in their portfolio.  Additionally, with more companies holding their conference calls closer to the 10K and 10Q filing deadlines, there are many calls being held at the same time.  By making the transcripts available and easily searchable by keyword, SeekingAlpha is saving investors time and money, while helping them to make more educated investment decisions.

Thanks.

Maureen T. Wolff-Reid
President & Partner

Based in Boston, Sharon Merrill Associates has been executing award-winning programs and staying in daily contact with Wall Street and the media since 1985. Today, the firm is a nationally recognized investor relations and corporate communications strategic advisory firm serving public and private companies in a broad range of industries. In addition to providing Sharon Merrill Associates with leadership and long-term vision in her role as president, Maureen supports clients with strategic counsel, directs the agency’s operations and is active in business development.  During her more than 20 years with the agency, Maureen has conceptualized, planned and implemented investor relations and corporate communications programs for a diverse array of companies across a broad spectrum of industries.  A nationally recognized leader in the fields of investor relations and corporate communications, Maureen is a past chairman of the National Investor Relations Institute (NIRI) and is currently serving on the editorial advisory board of NIRI’s IR Update publication.  She was a member of the board of directors of the organization for four years.  She also is a past president and honorary director of NIRI’s Boston Chapter.

She is a frequent speaker on IR issues and has authored numerous articles for business publications.  A noted expert on IR topics, Maureen’s comments have appeared in Bloomberg Magazine, CFO Magazine, CBNC, Compliance Week, FinancialWeek, Financial Times, Investor’s Business Daily, IR Update and Management Review.  Maureen’s work at Sharon Merrill Associates has earned her awards from the Public Relations Society of America and Publicity Club of Boston.  In 2005 she was named as one of the “Top 10 PR Specialists” in Boston by the readers of Women’s Business magazine.  She holds a bachelor’s degree in communications from Montclair State University.

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Tell Us A Bit About TAMID Israel Investment Group.

Eitan Ingall, President: This whole idea started because Sasha Gribov and I are both the Presidents of Pro-Israel groups on campus at University of Michigan. Sasha is head of the Hillel group, American Movement for Israel and I am currently heading up a pro Israel political advocacy group called the Israel Initiative for Dialogue Education and Advocacy. We have both noticed a serious void in hasbara (Israel advocacy) on our campus in that there is a serious lack of sustained and substantive interaction with Israel. Sure, anyone can go hear a lecture or seminar for two hours, but what about interacting with Israel in a way that runs a bit deeper?

We also noticed that for all the hummus and pita we were providing the students and for all the guest speakers coming to campus to talk about Israel, no one was talking to the business students. No one was talking about Israel’s economy and speaking directly to the future Jewish business leaders of the world.

So, those two things—the combination of the lack of substantive and sustained interaction, coupled with a serious lack of interaction with Jewish business school students—were what drove us to establish this fund.

What we also understood, however, was that in order to attract business minded Jewish students to Israel, we had to reach them in their space. What are they interested in? What makes them tick? And how do we align these interests with the greater collective of Israel and the Jewish people?

What are their interests? investing and finance. So we came up with quite a simple way to align these interests with Israel—we created a student-led investment group that manages a portfolio of Israeli companies. It’s actually quite simple. These students are all joining investment clubs anyway. They want something they can slap on a resume and something that will give them real life experience with the investment landscape.

So, we said, how about we have them do all this while investing in Israel? Its quite a simple solution.

And so we created the TAMID Israel Investment Group.

The structure of the group is also very simple and is designed to target the specific interests of each student. The Executive Board is made up the fifteen most talented Jewish business minded students at the U of Michigan. We shouldn’t say only Jewish, we do in fact have a non-Jew on the board as well.

How does the board work?

EI: The board is broken down into 4 teams: investing, marketing and PR, IT and fundraising. The investing team has students who are incredibly well-versed in investing—some of them have already begun to manage money professionally. The marketing team is currently led by a girl who recently had a job with Walt Disney’s Marketing department. A member of the fundraising team was the president of his regional USY chapter and has raised tens of thousands of dollars.

The IT team has a few kids double majoring in Computer Science and business—they’re designing a highly advanced and interactive website for the group.

As you can see, we’ve made it a priority that each student is working in an area that interests him or her. This isn’t the usual, mundane form of Israel advocacy. What we’re trying to say with TAMID is, “This is Israel and all that it has to offer you. This is Israel’s economic environment.” Plain and simple. In a way that students can relate to and enjoy. TAMID brings a perspective on Israel that these students can fit in with their professional aspirations.

The board also has the opportunity to interact with four support bodies.

The Advisory Board is made up of top Israeli executives and fund managers who have commitment to interacting with students once every financial quarter. This gives students an opportunity to interact with Israelis who have built the economic culture of the country and will leave a lasting impression on the students.

The Resource board are American and Israeli lawyers and accountants who are working to establish and maintain the infrastructure of the organization

We are working with three U of Michigan business school professors who are overseeing the general operations of the group and are assisting with the educational curriculum.

We will also be working with Israeli students at Israeli universities to align our generation of business minded students. Students will have the opportunity to interact through various forms of media and will work together on various projects.

Please explain a bit about how it all works.

EI: There are three phases to the fund: Education, Investing, and Fund Management

During the educational phase students are engaged in a curriculum that teaches them about general investing and Israel-specific investing through a series of seminars, lectures, guest speakers and interactive activities. It is during this phase that students will have their first interactions with Israel’s economic landscape in an effort to prepare for investing.

Next, the students make the initial investment, and thus begin investing the portfolio.

We are in the process of raising $1,000,000 [ed. Fundraising activities are taking place through TAMID's channels.  IsraelNewsletter.com is not party to these activities]. Professional Israeli account managers will manage half of this in order to reduce risk. These account managers, however, have committed to maintaining a high level of interaction with the students in order to teach them about the Israeli economic environment.

The other half of the portfolio will be managed by the Executive Board, led by the investing team. They are working to create a conservative growth investment strategy that will allow the students to interact with Israel’s economy. The students will use what they learned from the educational phase of the program coupled with their interactions with the professional account managers, to successfully manage this half of the fund.

For the duration of the program, students are actively managing a portfolio of Israeli companies. They are making day to day investment decisions while interacting with Israeli company executives to be constantly learning about Israeli markets. The Executive Board thus becomes fully engaged with Israel’s economic environment.

So if the principal of the fund comes from tax-deductible donations, not investments, what do you plan to do with the returns?

EI: The fund is a perpetual fund, hence the name TAMID. It stays on the college campus and the money stays in the Israeli market. Therefore, a large portion of the returns are re-invested in order to grow the fund.

The remainder of the ROI will be used to establish the TAMID Business Scholarship Fund, where we will be providing financial compensation for business minded students to work in Israel. We have begun working with Israeli companies to set up infrastructure to house 1-2 business students for an internship. Our dream is that instead of working one summer for an investment bank in Manhattan, students will come work in prestigious financial internships in Israel, which they can use to further their own professional aspirations.

How did you elect students to the board?

EI: We sent out an initial press release in February of 2008. After receiving an overwhelming number of inquiries, we set up formal interviews with the most qualified students over the course of the following two weeks. We then selected 15 of the brightest, most experienced students for TAMID’s Executive Board. It is a prestigious group of students. These are the students going on to top jobs in the American financial sector and working their way to becoming business leaders and top executives.

How is this an answer to divestment?

EI: The initial idea for the group actually came out of a response to divestment. As two leaders of campus pro-Israel organizations we knew resolutions calling for the divestment of Israel are brought before the regents of the University of Michigan. To counteract these resolutions in the past, students have launched pro-Israel flyering campaigns and invited high-profile speakers to campus to speak about Israel. However, we felt none of this was enough and we felt we could come up with something more creative and more effective that would have a profound impact on our generation of Jewish college students.

So, at 4am in the study lounge, we looked at each other and said: if they want to divest from Israel, we are going to invest in Israel. Not only are we going to invest in Israel financially, but are also going to invest human capital in the future of the State of Israel.

Do you see this as something that could work beyond the University of Michigan?

EI: Absolutely. We have purposely created an extremely scalable model—TAMID Michigan is just the pilot site. Within the next year there will be a TAMID UPenn, TAMID Harvard, and TAMID Northwestern. Within the next five years, there will be a TAMID National Organization which will be setting up sites at top universities across the U.S., each site managing its own $1 Million portfolio of Israeli companies. We are talking about millions of dollars being invested in the Israeli economy and hundreds of students having sustained, substantive interaction with Israel in a way that has never been done before.

What’s the end game?

EI: TAMID will lead a paradigm shift by creating a new status quo where business students across the nation are active stakeholders in the economic growth of Israel. This organization will be a bridge between the passions, interests and aspirations of American business students and the Israeli economy which, until now, had been inaccessible to these students. As such, TAMID will realign the mismatch of personal and collective by engaging the personal and professional goals of American Jewish business students. TAMID has made Israel’s economic landscape accessible to the full time student by utilizing the tangible incentives of professional opportunities, experience and success.

We are building a massive network of business minded Jewish students and exposing them to Israel in an unprecedented way. Our vision is create a sustainable, highly interactive ecosystem of businessmen working in symbiotically with Israel’s economic landscape. We are thus opening direct access to a pipeline of the next generation of Jewish philanthropists and cultivating the next generation of investors in Israel.

Why invest in Israel/what makes Israel interesting as an investment destination?

EI: Israel has a flourishing economic landscape. Whether it is in high-tech, life sciences or consumer goods, Israel is pioneering a business culture of entrepreneurship and innovation. Our goal is to get people to recognize Israel beyond just a distant place to support through donations and activism.

How do motivated college students in Ann Arbor research small cap technology firms in the Middle East?

EI: Thanks to research vehicles, companies and organizations on the ground in Israel that we have partnered with, the research will be easy and engaging for the students.  Additionally, the University of Michigan has a state of the art virtual investment lab with advanced research programs, which the executive board will be using during the educational phase and to assist in fund management.

Disclaimer: IsraelNewsletter is not affiliated with the TAMID Israel Investment Group and this interview should not be construed as an offer or a solicitation for TAMID.

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Can you tell us a bit about yourself?

Gili Beiman, Founder and CEO: I was the founder of the largest groups site in Israel, Tapuz, which we sold a few years back.  lived in the States for 3 years.  Like any good American, I opened an etrade account and 2 things stood out as problems in the whole data acquiring process, meaning trusted data and content that I could invest on:

1. too much information: There is a ton of information out there.   But if you don’t have a ranking system on all the content, I can’t really tell what to think – if I see a guy who’s writing a great blog on Apple, I have no idea whether he’s been right or wrong in his analysis.   There was no rational order or hierarchy in this information.
2. generic information: I find it interesting to know that the biggest source of financial content is via subscription newsletters, which is a $6.5 billion industry.  What an anomaly to think that all this content is generic, meaning newsletters are making recommendations to people they don’t know.  Your picks may be great but they can also be really risky — certainly not suitable for a retired school teacher.

So, where does MarketGuru come in?

GB: MarketGuru solves this issue.  Most Americans hold blue chip stocks in their investment portfolios and they know that risk and reward go hand in hand.  My target for MarketGuru is a dentist living in Wyoming – he can’t use social investment sites.  While more content has been generated, he still doesn’t know how to act on what he reads.

MarketGuru is a community of investors picking stocks and managing portfolios online.  In our beta launch, we allow users to subscribe to receive portfolio updates of other users, called ‘gurus’.  Ranking amongst the community is determined first by the number of followers subscribing to a particular portfolio and then by performance.  We call ourselves the world’s first financial community where members are ranked by peers, not just by performance.

It’s a very competitive system.  Not only do you need to have good returns, you have to continually defend your strategy by convincing the community of its merits.

Are gurus judged only on a diversified portfolio?

GB:If more than 35% of a user’s holdings are in conglomerates and the users has at least 3 holdings in the sector, you can be considered a conglomerates guru.  Sector ranking helps other people find you.

I feel that you can’t change investor philosophy.  Technologists have a high percentage of technology holdings in their portfolios.  We’re not looking to change that.  People like to bring in their own philosophies into investing.  I’m looking to cater to this philosophy.  MarketGuru is the human algorithm which gives a holistic approach to investing.  You become a guru when I like the way you think.  When I like the way you write.

So, is there a monetary incentive built into the community yet?

GB: Up until now, it’s been free.  Once I’ve chosen a guru or gurus, you can follow my historical performance and even drill down on my trading history.  What users really want to know, though, is what you’re going to do.  Your next move.  That will be a premium service.  Let’s say for $30 you can hire up to 3 gurus at a time.  You’ll get instant alerts when the guru trades.  50% of that fee would go to MarketGuru and the rest split out.  This whole platform, for it to work, is about partnerships.  It’s a partnership between MarketGuru and our gurus.

When you can create a financial relationship that can be measured with real numbers, that’s the value proposition.  SeekingAlpha takes you part of the way.  I can read your thoughts but I don’t ever get to meet you.  I’m looking to give the layman 3 best friends who have his best interests at heart.

Again, the algorithm is human. The dentist from Wyoming already has a portfolio. He’s going to look for people who own things similar to what he owns.  If I own MSFT and AAPL, I’m not interested in people who own small caps.

Can you explain how MarketGuru can address sector exposure?

GB: Via MarketGuru, you can go out to the community and find pharma, energy, and tech gurus who are tops in their sectors.  I want 3 gurus to help me research those sectors.  If you are going to play blackjack, you need to know the math.  These are people who can help with the math.

A user who does well with his portfolio but doesn’t convince the crowd ends up being a follower.  ‘Karma’ is something we do but don’t get paid for and something we’ll also be adding to the community.  It doesn’t make you a guru but it’s the intangible quality that says we like the effort and thought you’re putting into your portfolio,    We will give you some points when people like your writing but we need to separate this ‘karma’ out from guru ranking.

Who are your targets for the community?

GB: We’re targeting broggers, a new cross between broker and blogger.  You need good results and good writing.

I think there are three circles of investors:

1. Family brokers: people who handle their own portfolios already.  For these users, the value proposition is that you’ll do better with MarketGuru than without.  The size of these portfolios are on average $200k to $300k.  There are approximately  20 million families in the U.S. who fit this profile.
2. Managed portfolio: These are people who have an advisor managing their assets.  They turn to MarketGuru to test what their broker is doing against others.
3. Novice investors: This is definitely the biggest and largest crowd but I don’t think MarketGuru addresses these people yet.

Again, our community is extremely competitive.  You need to continually convince me that you are a guru and continue to provide ‘follower care’, a new form of customer service that gurus need to provide to continue working with their followers.  That said, In the U.S., if you don’t have a $2m portfolio, no one calls you.

So, we see MarketGuru providing a vital source of idea generation.  We help find and connect you with a guru who you trust.  We now we have year to date stats (YTD) and soon we’ll have year over year.

What are you doing to differentiate from other sites?

GB: Next step is to build more quality into our community.  We’ll be launching a widget that bloggers can put on their sites as a stamp of approval.  We’re developing tools for bloggers to post directly to MarketGuru.  But our first priority is to bring in a higher level of professionalism to the community.

Thanks, Gili.

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Tell us a little about yourself and your fund.
Abba Horwitz, Portfolio Manager: We started started Old School Partners in March of 1999.  Since then, we’ve compounded a net return to investors of around 19%.  We’re running the fund for the most part from Israel.  With a junior partner, I’m managing roughly $60 million.

What’s your philosophy?
AH: We focus primarily on the small to midcap world.  We apply a value approach.  Basically, we’re looking for two things.  We’re looking for value where there is a clear catalyst to unlock this value or cheap growth with value undiscovered, on the cusp of coming out.  Unfortunately, I’m not a big commodity buff and have not been riding this current wave.

Can you give us a couple of examples of some successes you’ve had?
AH: I’ll give you an example from last bear market of 2002.  We invested in a firm, CNXS, that manufactured a product called Breathe Right nasal strips.  The firm had $1.50 per share in cash, was going to earn $0.40 and was trading at $4.50.  The following year, the stock was up 3x or 4x as the company expanded margins and grew its business.  We saw insider buying and management change, two other things we look for.  Eventually, Glaxo bought the company for $37.

A holding on our books now is New Motion (NWMO).  This company has $1.50 per share in cash and no debt.  They provide mobile content and own properties on the internet that target 25m users per month.  This division is doing very well.  They make money via advertising but more importantly, New Motion sells content over the mobile and delivers advertising alongside it.  With over 1 million users it’s charging for content, mobile advertising is off charts as well.  The CEO is someone I know very well.  They merged with TRFX, a company with great assets but not run efficiently.  They now have $15 million in cash flow and trading at 3.5-4x this year’s cash flow.  They’re growing the top line at 30-35%.  We’re basically witnessing the shareholder base transitioning from the old TRFX investors to a new set of shareholders.

Do you invest in Israeli companies?
AH: I used to invest in Israeli stocks a lot.  Israeli companies have disappointed so much though that it’s hard to get quarter-to-quarter confidence in their numbers.  I find it difficult to find ideas that I can invest in over a long period of time in the Israel universe.  The ones that I do put money into are mostly trades, not investments.  Look at BluePhoenix Solutions (BPHX).  They were confident to do their $1 in earnings this year and then they couldn’t, and it halved itself twice.  Some Israeli firms, given their high tech businesses, don’t have very good visibility and therefore not the track record I’m looking for.

We do own RRSat Global Communications (RRST), a company that global broadcasters use to outsource their satellite transmissions.  It’s actually a bit of a different animal.  It has $2 per share in cash.  Backing out the cash, this firm has a high level of visibility.  We know their backlog.  The likelihood of them missing has to be less because it’s hard to cancel this type of business.  They have been hurt because of the strength of the Israeli shekel, which has hurt their margins.  I don’t see a visibility issue and at this level, we think the risk/reward is pretty good.  They are also in high growth market.  They could be doing this for a few years and growing 20-25% per year.

Are there other Israeli companies on your radar?
AH: We’re looking at RadVision (RVSN), the Israeli developer of video conferencing technologies.   It’s trading at about cash.  I estimate that their SIP business is worth at least a buck or two.  Maybe their enterprise business is worth nothing, but it’s probably doesn’t have negative value.  It’s possible that maybe no one cares about this market.  It’s very intriguing if you are a pure value investor.

We’re also looking at cosmetic laser company, Syneron (ELOS).  They don’t have good visibility and sell a product that is used for high-cost cosmetic procedures.  In 2009, the introduction of a new, home product could be huge for them.  They continue to hit their numbers even in a tough environment and that says something about them and the products if they can continue to do this.  Compared to its peers, Syneron outshined everyone last quarter.  With some newer products that have recurring revenue attached to them, this could be a very interesting and different approach to their business.

Lastly, we have car-security firm Ituran (ITRN) on our screens. Their whole business essentially is in Israel, Brazil and Argentina.  With this geographic spread, we’re just uncomfortable.

What would it take to get you more interested in Israel?
AH: With a couple exceptions, I’d like to see greater management depth.  One problem is that Israeli entrepreneurs don’t take their firms to the next level.  This occurs because many managers don’t have sufficient management experience.  What should happen is that these founders need to bring in another layer of talent.  The minute that one product stops selling, these entrepreneurs don’t know what to do.  They spend more on R&D.  If you really knew what was going on inside these companies, you would never invest in them.  Typically, there are only one, two, or three people internally who know what’s going on and that’s it.

I’d love to invest in more Israeli companies.  Take ClickSoftware (CKSW).  It’s a software company with a good product.  Management kept promising performance but continues to bring projections down and down.  As a portfolio manager, I can’t afford to lose money on these stocks.  Even though I have competitive advantage in investing in Israeli companies because I’m based here, I can’t take the risk on these firms.

We’re also looking at Comverse (CMVT.pk).  It needs to get re-listed on the Nasdaq from the Pink Sheets.  It’s interesting if you do the arithmetic: their businesses are doing really well.  They have a huge cash position and could be trading in the mid-twenties.  Comverse is expected to get re-listed in August and expectations are so low.

What’s your view on the strength of the Israeli shekel?
AH: I’m not a currency person.  Israel is a small country and eventually, it can’t have export businesses survive in such a strong currency environment.  If the American dollar were to strengthen, it would weaken the shekel.  Upgrades in Israel’s economic status and higher growth have all helped shekel versus the dollar.  What I don’t understand is why, with all the political instability in Israel, in its Knesset - I don’t understand why that hasn’t affected the shekel.  If you remember the Clinton impeachment hearings, the market went down every single day.  Yet in Israel, it has no impact.

Thanks.

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Who are Infinity’s Chinese partners?

AS: We have a list of very strong partners from both the government and private sectors in China. We’ve received a large commitment from the Chinese government for the fund. Political support of the fund comes from senior levels in both the Israeli government and Chinese government leading up to the Chinese Premier.

I assume that Israeli companies are traditionally nervous about sharing trade secrets. Is this the case?

AS: A key issue to establishing Chinese-Israeli partnerships requires overcoming this fear of Chinese firms co-opting Israeli tech. We successfully mitigate this problem by building multi-layered partnerships with key incentives beginning at the shareholder level all the way up to management level.

What’s Infinity’s advantage as an investor in Israeli firms?

AS: Infinity Equity had the first foreign fund to be incorportated in a GP/LP format in China. Doing business in China since 2004 has helped build a layer of trust for our network. We have strong support from the Chinese government. China is committed to Infinity because “innovation” is one of key things of the Chinese Government’s 5 year plan. The government has committed to moving from a low cost supply of labor to more value-added services as an economy. Innovation is mandated as part of this plan. The government views Israel and this fund as part of this movement to innovate.

What kind of criteria do you use when sizing up an investment?

AS: Typically, we invest in Israeli companies that have proven themselves in gaining marketshare through leading technologies and product development. Similarly, we invest in Chinese companies with strong market presence. We give Chinese companies, in some cases, equity in the Israeli company to incentivize the partnership and align working terms. There has to be mutual interest for these partnerships to work. We’ve had time to home our model over the past few years.

Can you give us an example of a recent investment?

AS: We invested in an Israeli company, Shellcase, which created a technology for packaging of chips used in cameras in cellular handsets. They had a.fab in Jerusalem with good tech and big losses. Many earlier shareholders gave up. We split the company in 2 parts. R&D stayed in Jerusalem and manufacturing shifted to China. The Israeli part of the company was sold to Tessera (TSRA) and the Chinese company is doing well and is very profitable and will probably float next year. Doing the manufacturing in the Far East has enabled them to do very well. By the way, the strong support from the Chinese government in the form of 0% interest loans made this successful investment and venture successful.

Which sectors are you looking at in Israel to make investments?

AS: In particular, we like the IT sector and see a lot of technology strength in Israel and demand for such technology in China. We also think Israel is quite strong in Medical Devices and related technologies. We’re seeing more activity and potential in Internet related technologies, spanning both consumer and B2B. Lastly, Mobile technologies coming out of Israel are very hot and in absolute numbers, China is the fastest growing market in the world.

Given your model, do you begin by targeting an Israeli firm and then look for a Chinese partner or vice-versa?

AS: More often than not, we start with a Chinese partner with a specific need for technology and we go shopping for the best in Israel. But, it really works in both directions. We get a lot of Israeli companies frequently approaching us looking for Chinese partnerships.

So, Israeli firms see Infinity as a distribution partner who takes equity in return for services?

AS: Infinity provides value in two ways. Most companies know that China should be their next play. These companies also realize that they can’t go to China alone. Many have frequently tried and failed to penetrate into China. They need a partner who can talk to Israelis and knows how to do business in China. We also focus on late stage entities and because this part of the market is not very populated, we can put up a lot of money when public markets are not very receptive to tech companies.

Are you seeing any fallout in portfolio companies that have their cash invested in subprime assets?

AS: Some companies lost money. This is not a huge deal. Other trends like the slowdown of the American market, weakening of the dollar has hit foreign companies twice, at both the operations and expenses level. We also see companies hit by the public market window closing and debt players less willing to put money into late stage technology companies.

Which sectors do you see in the near future as capturing larger share for Infinity?

AS: We are seeing more companies with little technology risk (it’s behind them) and less market risk (they’re selling well). As successful entrepreneurs start their second and third firms, we expect to see more of this as well.

Thanks.

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Please tell us about Xenia?
Anat Segal, CEO: Xenia is an investment firm founded in mid-2003 by a group of entrepreneurs with the vision of being an incubation powerhouse, engaged in the initiation and building of successful high-tech companies in the areas of IT and medical devices. I would say that there are two main similarities we share with traditional Venture Capital (VC) firms.  We invest in startups in return for equity, and the terms of our deals are similar.

What are the differences?
AS: One of the differences is that our investments are in really, really early stage companies. What are   typically referred to as seed and pre-seed stage deals. We establish the company alongside the entrepreneur. Our money is typically the first money in the firm. Sometimes there is friend-and-family round.  We are first and foremost an investment firm. We base ourselves on the unique structure of the Israeli incubator model.

Our business model is to transform an idea into a business and provide these companies with all the services, mentoring, systems, etc. that they need. We provide all the layers that our companies need: the physical layer (office space, whatever they need to operate), basic services layer (financial, legal, bookkeeping/accounting), and the people layer (most important in transforming ideas into viable business).  There are definitely advantages of scale in this model.

If you look at our website (www.xenia.co.il ) you will find that within our core team and board, most of them are successful entrepreneurs themselves. Thus, we can provide real experience and know-how to our portfolio companies. We have invested in 18 portfolio companies of which 9 have graduated from the incubator structure — of these, 8 have raised additional funds and the 9th is in deal mode.

Another unique difference is that we are a publicly-traded company on the Tel-Aviv Stock Exchange (TASE). We just recently completed a rights offering where most of our shareholders participated. The fact that we are publicly traded provides a model where we can raise additional funds and follow-on offerings.

Given the fact that you’re publicly traded, how do investors profit?
AS: Investors benefit from an increase in the value of our portfolio with upside for exits. For foreign investors, the fact that we are publicly traded means that they can access local Israeli hi-tech early stage companies via a public market investment.

You mentioned the Israeli incubator model. Can you explain how it works?
AS: From a financial model, 15 years ago, the State of Israel created an incubator model, which was ultimately privatized about 4 years ago. The franchise provided the ability for us to get monies in the form of loans from the Chief Scientist. Our obligation is to operate the incubator but the main benefit is that these funds are granted as loans with all the equity of the upside. Non-recourse loans mean that our upside is leveraged.

Which spaces are you looking to invest in?
AS: We are focused on traditional IT (ie. Internet, software, communications) as well as medical devices and related industries. I must stress that we are not focused on biotech, but instead look for the intersection between devices and drugs, like drug delivery platforms.

What about Cleantech which is so hot right now?
AS: We certainly have a lot of deal flow in the Cleantech space, but we don’t have special expertise in this space.  Given that our investments are really opportunistic, we are looking at everything.  There are other specific funds focused on Cleantech.

Can you tell us about some of your portfolio companies?
AS: We have a company called NeatStitch. Their medical device has FDA approval for internal suturing for laparoscopic procedures. They have developed a patented automated suturing technology primarily targeting the Port & Vessel Closure markets. The device is of small dimensions, easy to use and fast to deploy.  NeatStitch has leading surgeons on its advisory board. Our holdings are worth more than 20x what we invested after only 4 years.

Another company we are invested in is BioProtect. They produce biodegradable balloons for tissue separation. It’s really a platform technology used for a couple of things: radiation treatment for prostate treatments and treatment of rotator cuffs (bringing immediate relief). The company has additional applications as well. With their balloons, radiation can be doubled and tripled without damaging adjacent tissue, as the balloon separates the healthy tissue from the unhealthy. Clinical trials have started in Israel, with US trials expected to begin shortly.  They have submitted an application to the FDA, and expect approval by end of 2008.

Another example of a company we are incubating in Link-it. They are developing a visual search engine. Their technology can search using photos, enables identification of objects/faces, and is able to generate exact matches even among large databases. They are starting pilots with various ecommerce sites and raising funds in the U.S.

How is your portfolio valued as you are publicly traded?
AS: Especially since the market is depressed, the market may not accurately value our holdings. Our rights offering gives investors a way to participate when prices are depressed. Net Asset Value (NAV) is typically calculated on the last stage of financing while other investments are calculated at cost, tangible assets.

Since your model is different than traditional VC’s, where do you profit?
AS: The goal is for our stock holdings to appreciate. I am shareholder myself and we gain from exits and dividend distributions. Our goal is to grow a large investment portfolio.

Very interesting. Thanks.

Zack Miller
IsraelNewsletter.com

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Can you tell us a bit about AudioCodes?

Nachum Falek, CFO: AudioCodes (Nasdaq: AUDC) is a telecommunications firm focused entirely on Voice-over Internet Protocol, or VoIP.  We create hardware and systems to connect and secure networks.  We are leaders in feature richness and voice quality and have been in VoIP for 15 years, an extremely long time for this nascent market.  We are a pureplayer in VoIP unlike some of our competitors who still maintain legacy businesses.

Can you tell us about your technology?
NF: We have three families of products: our Media Gateway, which is located on the edge of the network and converts between old and new networks.  Our Session Border Controllers also sit on the edge and connects one IP network to another.  The majority of the network is still PSTN and when connecting between two IP networks, you still need an SBC. Lastly, we have our Media Server which sits in the middle of the network and provides all the functionality of VoIP like conferencing, announcements to the network and prepaid billing integration.

How has your business evolved?
NF: We began by selling DSP chips and matured our business into selling blades by integrating our own chips on boards.  We’re still in the business of selling blades to OEMs as part of our Technology Group and this accounts for around 30% of our revenues. 

About three years ago, we made the change from pure OEM to going local and building out our service provider business.  We now have AudioCodes people in over 20 different locations around the world.  Our Network Group markets an entire VoIP solution, including our Media Gateways and SBCs to OEMs and Service Providers.  This business now accounts for about 70% and is the growth engine for AudioCodes.  Having a local presence is really important in terms of winning service provider business and contributes to our ability to grow our customer re