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SethHamot,48,isthefounderandmanagingpartnerofRoark,Rearden,&HamotCapitalManagement.Hisfundhasover$150Millionundermanagement,hasperformedwellthrough2-3recessions,andreturnedanannualized17%toinvestorsnetoffees.

Thefollowingisaninterviewtotryandlearnalittlebitabouthisexperience.Asyoureadthis,dorememberthathehasspent15+yearsbuildingthisinvestmentfundandthisinterviewcannotcapturethat,buthopestobringasmallportiontothepublicsurface.Dr.SergioMagistri,wholedacompanythroughthedot-combubbleandexitedwithalargeacquisitionbyGEalsosharesthisthoughtsonwhathappened.HeledInVisionTechnologies,whichturnedouttobeanamazinginvestmentforSethsfund,andtoday,InVisionsproductscanbefoundinairportshelpingtopreventterrorism.Withhisinput,wecananalyzethisamazinginvestmentfromthesideofSethandSergio,both.

SethHamotreallygreatcompaniesmakeerrors,buttheycanmoveon.Whendidyoulaunchyourinvestmentfundandwhatwereyoudoingleadinguptothat?RRHlaunchedinthemidtolate90sandpriortothat,Iwasworkingwithpartnersbuyingdistressedanddefaulteddebtbackedbyrealestate.Istarteddoingthatin1989and1990.Priortothat,IwasthePresidentofCollegeProPainters,apaintingcontractingcompanywithastudentlaborforce.IgraduatedcollegeandsinceCPPwasownedbyaforeigner,andneededalocalpresidentandleadership,Iwas

broughtonboard.Itwasgoingthroughfinancialdistress,hadnolocalleadership,andsoIwasbroughtintoturnitaround.Wewentfrom$3Million/yearinrevenueto$11MillionwhenIleft.Shortlyafter,arealestaterecessionkickedand,andsoIbeganlookingforturnaroundsituationswithdistresseddebtthatcouldbebought.MypartnersfromthoseventureseventuallyretiredandsoIcontinuedwhatIwasdoingintothepublicmarkets.Wefoundpoorlyperformingassetsthatwereeithertooencumberedwithtoomuchdebtortoolittleleadership,focusingonhardassetslikerealestateandminingassets.Whatisyourfundsunderlyingapproach?Whatwrongdoyourightinthemarkets?

Iwanttofindcompaniesgoingthroughatransition.Eventually,thattransitionwilltranslateintoothersseeingthatthecompanywillbeworthmorethantheyoriginallythought.Itmightbedivestingacashburningdivision,ornewcreditfacility,ormaybethecompanyjustdidamergeroracquisitionallowingthebusinessmodeltobeleveraged,etc.TheobjectiveistoNOTbeanactivistinthesesituations.Therearealotofgreatopportunitiesbecausereallygreatcompaniesmakeerrors,buttheycanmoveon.Weenjoydealingwithsmartbusinessmenona

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dailybasis.Oftentimesthough,managersslowlybecomecontenttohavealargerspanofcontrolandmoreremuneration.Theychangebyrationalizingtheirbusinesstomakethemselvesbetterfocusedandmoreefficientandeffective.Wheredidyougetyourfirst5investorsforyourfundandhowmanyarestill

withyoutoday?Collegeroommates,familiesofcollegeroommates,friends,myownmoney,etc.Whatwerethefirst5yearsofyourfundlike?Howmanyemployeesdidyouhaveandwhatweresomeofthelargerchallenges?Itwasasmallfundandsopickinginvestmentswasthemainchallenge.Itwasjustmyselfinitially.Wetookaverylargepositioninaliquidatinginsurancecompanythatlasted2-3years,butwasveryprofitablebecausethemarketsmisunderstooditentirely.Ittookalittlebitofactivismandattheendofit,Imetsomeone,who

introducedmetohisownlimitedpartners,andthatswhereIbroughtinsomefreshcapital.OneofthejoystherewasthatImetsomegreatpeoplewhowerealsodoingsmallcapvalueinvesting.EventuallyIwasintroducedtoawell-runfundoffundsonthewestcoast.Iwastoldthatwemadesomegreatinvestments,butourdocumentationwasonnapkinsandweusedgridpadsforcalculations.Wegotareallawyer,realdocumentation,puttogetherinformationforinvestors,andthenbegantogrow.Fromtheoriginal$2Millionthatwestartedwith,wehadgrowntosomewherearound$15-20Million,andthentheseguyscamein.Wevebeensuccessfulinourperformancewithinvestors:Overthelastdecade,endedDecember2009,wevereturned17%annualized,netofallfees.

ThenameofyourfundhasaveryuniquenameithasnamesofcharactersfromthebooksofAynRand.Canyoutelluswhyyoudidthis?Ingeneral,wetakeacontrarianview.Doingitallthetimeisnotcontrarianandsothisallowsustotakeinvestmentsfromauniquevantagepoint.Whatdoyoulookforinaninvestment?Aperfectinvestmentwouldbeinabusinessthatwasoncewellcoveredbyinvestors,analysts,raisedalotofmoney,etc.andthenthecompanyandindustrywentthroughatransformationandthestocktradesverycheaply.Evenafterthat,

theunderlyingbusinessitselfmakessenseandwithsometoughdecisions,itcanregainitsvalueanditwillrightitself.AsimplisticexampleisaREITthatforsomereasonnolongerpaysitsdividend,drivingthestockpriceverylow.Itsahardassetbusinessthatwontjustdisappear.Ifyoucanforeseethedividendcomingback,itwillgetboughtagainforitsyieldeventually.

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Soifsomeonecallsinandsays,IvegotthisREITIwantyoutolookat,Illrespondbyasking,Isitpayingadividend?Iftheanswerisyes,thenIdontcare,butiftheanswerisno,thenletstalk!Howdoyoufindyourinvestments?Aretheybroughttoyouordoyouscreen

forthem?Wedontuseasmanyscreensasourcompetitorswelookforsituationsoftransition.Wemonitoralotofannouncementsforspinoffs,acquisitions,divestitures,distributionsandone-timedividends,etc.Agood1/3rdofourinvestmentscomefrompeoplewhocallabouthowtheyvelostalotofmoneyandtheydontunderstandwhytheequityisperformingsopoorly.Theywantinformation,butinanothersense,theyrequestioningwhetheranactivistcouldhelpout.Moreoftenthannot,presentmanagementandtheboardofdirectorswilldealwiththeissues.

Wedontwanttobeactivists,generally,buttotheextentthatwerewrongthattheCEOisntgood,wehavetodoit.Ifitsactivism,itsbecausetheboardorCEOisnotreasonable.Whenweareactivists,wealwayssaytoCEOsandboardmembersthatweseethis(somethingspecific)asaproblemandthatanyreasonablebusinessmanwouldseethisasaproblem.Reasonableowners,yourshareholders,seethisasaproblem.Whydontyougetinfrontofthisandsolveit?Itsonlywhentheyrefusetoaddresstheissueandcompletelyignorerationalshareholdersthatwebecomeactivists.Itsnotacaseofthemnotbeinggrantedan

opportunitytofixit.Furthermore,whentheysticktotheiractionsoftentofeathertheirownactions,theyrefusetoacceptthatwearetheshareholdersandownersofthebusiness.Instead,theytrytopublicizethatwearealesserclassofshareholder,ahedgefund.Oneextremeexampleisaboardthatsaidtheyhadaprograminplacetofindnew,moredocile,shareholders.Insteadofrealizingvaluebyspendingtimetofollowsuggestions,theywerespendingtimeonfindingmoneyandnewbosses.

Howlongdoyoutypicallyholdaninvestmentfor?Ouraverageinvestmentperiodiswelloverayear,probablyclosertoacoupleofyears.ImthechairmanatTEAM,chairmanatORNG,bothofwhichwehaveownedforover4years.Someofourotherbigpositionsareinthe3rdyearofourownership.Werenottradersandourinvestorsseeitbythetaxbillwerenotpayingshort-termtaxesnearlyasmuchasothers.

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Someofyourinvestmentsareinpharmaceuticalsorbiotechsalongwithenergy,mortgageprocessors,etc.,howareyoudoingthis?Weregeneralistsandstartdiggingintoanything.Iftheproblemisproductbased,wedontdigintothat.Werefocusedonthebusiness.Ifthecompanyhassuccessful

products,butisspendingtoomuchonR&D,itsaquestionofcapitalallocation.Weavoidbiotechcompanieswithoutsignificantrevenuesbecausewedonthaveatakeonscience.Atthesametime,wedonthaveanyproblemininvestinginapharmaceuticalspendingalotonbiotech,butalreadyhassuccessfuldrugsinthemarketplace.Ifthereisamismatchbetweencapitalizationandvalueofdrugsthatarealreadyinthemarket,therewillbeamajordiscounttothemarketvalueofthecompany.AbigdiscountpointsoutthatinvestorsdontvaluetheR&Dpipelineeventhoughthedrugsarekickingoffalotofcash.

Howmuchdoyoucareaboutwheretheoverallmarketsareandwheretheyareheaded?Weusedtonotcareatall,andthrough2008,alotofmycompetitorsandIstartedtocareverygreatly.Idontreallypayallthatmuchattentiontoitthough,becauseIminvestinglongertermthanmost,2-4years,andiftheycanturnabusinessaroundin2years,any1daysheadlinestodaywontbetheheadlines2yearsfromnow.Doyoutakelongpositionsonlyorshortpositionsaswell?Isanyofthisasahedgeordoyoulookforcompanieswithsomethingthatisfundamentally

wrongwhentakingashortposition?Wedotakeshortpositions,butwerenotnearlyasgoodatthemasourlongs.Welookforbadbusinessmodels,toomuchleverage,andcompaniesgenerallyrunforthebenefitofseniormanagementandboardmembers.Shortstendtogoagainstusbecausewheneveranyactivitycontinues,theinvestmentcommunityratesithighly.Werenottoogoodatanythingotherthanwhenthedebtcomesduecausingthecompanytoreorganizeorhandoverownershiptothedebtholders.Yourfirmseemstobeokaywithsmallcappositions.Doyoueverworryaboutacompletelackofliquiditythatsmallcapswillseewhenevertheresa

downturn?Yes,weworryaboutliquidity.Wethinkaboutitmoretodaythan2or3yearsagobecauseitisanissueandwithmanystocksthatweusedtogetinvolvedin,wewillnolonggetinvolvedin.Howdoyoumanageanddefinerisk?

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Wedefineriskasleveragecertainlynotbeta.Ouronlyuseofleveragewillbeusedtotradearoundpositions.Thatsaid,liquidityisthefirstcowardandwhenliquiditydriesup,youjusthavetoputupwiththebumpyroad.Theresadesiretoavoidvolatilityatallcosts.Theflipsideisthatyourepayingforitinliquidity.Our17%annualizedreturnpartlycomesduetoanilliquiditypremium.Neithertheauditor

northeIRSmakesusgivebackourexcessreturnduetothatthough!Yourfundhaslivedthrough2or3economicdownturnswhichonewereyoumostpreparedfor?2000Internetcrackup.In2002,whentheS&P500fell22%,wewereupalmost10%.Thesecrisesareverygoodforus,eventually.Theyrenotsogoodshorttermbecausewegothroughhelltoo.Justafteritthough,wetendtodoubleandshowover100%returns.Leadinguptotherecenttroubles,wewereshortonhomebuildersandheldCDSsatonepoint,howevergavethoseuponsuspicionsthatthemarketswererigged.

Doyouevernoticethatitseasiertoberightthanitistoknowwhenyoullbeprovenright?Yes,verymuchso.Ithappensinrealestatequiteabit.Youcanbuyapropertyoneminuteandtheninthenextminute,youcancomeupwithanumberforwhatitsworth.Sometimes,ittakeslonger,andsometimesitsshorter.Thisappliestostockstooyouknowwhatitsworthwhenyoubuyit,youhavetowaitthough.Wewereinvesting3-4yearsagoandarestillwaitingfortheinvestmentstocomplete.Weseehowtheywill,butthemarketshavenotrecognizedityet.

Historically,doyouhaveanyinvestmentsthatyourememberasamazing?Maybeaninvestmentwhereyouwerejustsodarnrightthatitwasmemorable?Yes,twoinspecific:1.NursingHomes

Intheearlypartsofthelastdecade,nursinghomeswereprovidingelderlyhousingandelderlycare.Theywereexpandingtheelderlycaretoprovideancillarytypesofprocedures,likeoccupationaltherapy,breaththerapy,etc.

andallthesethingsmadetonsofmoney.Theunderlyingbusinesswasgreat,andthentheyissuedatonofdebt,raisedcapital,etc.Shortlyafter,congresscutbackfunding.Withthat,thetoplinesandmarginswentthroughthefloor,leveragedoneswentbankrupt,andtheindustryinitselfwentthroughatransition.

Themarketspricedthatasifnursinghomeswouldgoaway.Inreality,therewouldonlybemoreelderlypeoplegivenenoughtime.Wewerebuying

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healthcareREITS,preferredshareswith20%yields,dividend-payinginstrumentsfor50%ofpay,etc.Loandbehold,theInternetstockswenttohellandthesenursinghomesweregoingthroughachangetoo.Evenwhiletheywentthroughachange,theyhadtokeeppayingrent,andsotheREITdividendskeptcomingin.Itwaspricedlikeajunkbond,buttheyieldswere

betterandactualratingswerebettertoo!2.InVisionTechnologies(SethHamotspointofview)

INVN,InVisionTechnologies.Duringtheinternetbust,youwouldheartonsofideasthatallbegan,Thiscompanyhassomuchcashonhandandisonlyburningthismuchperquarter.WefoundINVN,whichwasacollectionofventureideasthatwerebeingcommercialized.TheCEOofthiscompany,though,wascommittedtobeingprofitable.Samesortofupside,butwithoutthecashburn,astheInternetinvestments.TheCEObasicallysaidthis:They(ourinvestments)turnpositiveNOW,notlateron.Meanwhile,

Imgettingatonofcallsfrompeopletobuy1of6onlinepetfoodsupplierstocks,theyhaveatonofcashandlittleburntheydontneedmoneyfortwoyears!IheardthatalldaylongandthenwenttobuyInvision.Ipaidlessthanthecashtheyhadandsawsomeupsideonaloggerproductthatwasgoingtomakeloggingmuchmoreefficient.Theywerentburningcasheither,andthatswhatmadeitattractive.

Iwentoverjust1%ofthecompanybySeptember10th,2001.Onthenextmorning,terroristsattackthecountryandsothemarketsdontopenforawhile.Invisionactuallyhadtechnologythatsniffsforbombthreatsinairports.Atthistime,itwasinbetatestingatafewregionalairports.Ihadnt

paidattentiontothispartofINVNatall,butnowitwasalotmoreimportantthanalltheotheractivityatthecompany.Ihadbeenbuyingthestockfor$3pershare,lessthannetcash.Itwasanetnet.Asyouknow,themarketsremainedcloseduntilSeptember17th,whenitopenedaround$7.50.Bythatafternoon,ittradedaround$9.Thisiswhenallthevalueinvestorsgotoutrightaway.Aroundthistime,Isaid,Youknow,ifitsarealbusiness,anditsupto$9today,becauseitwasinstalledasabetatest,thegovernmentwillwanthundredsandthousandsoftheseintherecentfuture,thesewillbehot.Eventually,Igotoutbetween$17-20.Ifyoutravelnowandlookbehindthecheckincounter,thosemachinesthattheyputyourluggagethroughareInvisionmachines.Ihavenoideawhathappenedtothelogcutting

advancementsoranythingelse,IwasfollowingaCEOwhowantedprofitabilityevenwheneveryoneelsehaddifferentideas.

2a.InVisionTechnologiesDr.SergioMagistriwasthePresidenttheCEOofInVisionTechnologies,whichdevelopedtechnologiesforExplosiveDetectionSystems(EDS)andothercivil

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aviationsecurity.Hejoinedin1992,raised$21Min1997,andenteredintoamergeragreementfor$900M,or$50pershare,onDecember6th,2004.

1. DoesthedescriptionthatSethgaveofthesituationsoundadequate?

Yes,fromacontrarianinvestorpointofviewlookingattheoverallhigh-techspaceneartheendofthedot-combubble.AtInVision(INVN)though,weneverfeltthatwewerepartofthedot-commania.Wehadalong-termstrategythatwasquitesimple:(1)Securityisaneventdrivenmarket(2)Thebestmarketingisthequalityofourproducts(3)Keepdevelopingthebesttechnologyintheindustrywithoutrunningoutofmoneyandmaintainingatleastacashflowbreakevenorbetter

(4)Atsomepointintime,themarketdemandwillcome.Inretrospect,Iwishwewouldhavebeenwrongoratleastthedemand(asaconsequenceofaterroristevent)wouldhavebeenlesser.

2. Whydidyoucareaboutcashflowbreakevenorpositiveatatimewhenmostothersdidnot?AtthevaluationwehadbeforeSeptember11thandduringthedot-comperiod,thecompanywasnotre-financeablealmostatanyvaluation,becausewewerenotfashionable.Wehadrealproducts,revenues,andevensomeprofit.

3. Didyougetahardtimefromanyoneforpursuingcashflow

breakevenandprofitabilitybeforeothers?Quitealotofourinvestors(andourownpeople)werepushingforsomekindofsplashchangeinstrategytoappeasethedot-combelievers,butatthelevelofmanagementandboardofdirectors,wedecidedtokeepexecutingoursecuritystrategy.Wehadaclearunderstandingthatwedidntbelongtothedot-comworld.

4. Sethmentionedaloggingenhancementthatyourfirmwasworkingon,butthatmighthavebeenhiddenbythesuccessoftheExplosiveDetectionSystems.Couldyoutelluswhateventuallyhappened?AfterSeptember11 th,weweremanagementandresourcelimited.Forawhile,wetriedtospinitoffasanindependentandfinancedentitytoavoiddefocusingoursecurityeffort.Oncethisfailed,wedecidedtoabortthedevelopment.Eventoday,whilerecognizingtheneedforthedecision

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atthetime,Ibelievethatthiswasandwillbeaveryinterestingopportunity.

Whendealingwithsmallcaps,doyoueverthinkaboutwhysomeofthemarepubliclytradedtobeginwith?

Allthetime.Ifyouactuallyunderstandtheclassicaltheoryofpublicmarkets,theyexistforraisinginitialcapital.Noonewouldactuallygivecapitalunlesstheresanexitstrategy,andthepublicmarketsallowthatexitstrategytobearealityforsmallholdersofstock.Lookingatyourcurrentpositions,canyouofferanyinsightastosomeofthemoreinterestingones?Aeropostale(ARO)Aeropostaleisthepremierteenretailerinmyestimation.Whenyoucomparethecompanysfundamentalstotheotherlargeplayers,AEOand

ANF,youseethesuperiorityclearly.Yet,AROisrelativelycheaperthanitscompetitors.Letsfirstlookattheabilitytodrivesamestoresales.In2009,arguablytheworstyearforretailinthelastgeneration,AROhadyearoveryeargainseverymonth.Furthermore,ifyouconsiderthegainsintotalsalescomparedtotherecenttrimmingofinventorythatsright,thedeclineininventoryyourealizetheincreasingefficienciesthataredrivinghugecashflowsatARO.[Specifically,letstakethesummationofthelastfourquartersofpercentageyearlyrevenuegainsandsubtractfromthatnumberthesummationofthelastfourquartersofpercentageofyearlyinventorygains,thelatestquarterbeingactuallyareduction

ininventory.AROsresultingnumberis50.83andaccelerating.AEOsis21.88,andgoinginthewrongdirectionandANFsis34.68andalsoheadedinthewrongdirection.]Analystsmissallthisthough.TheyaresowedtotheirbullishcallsonANFandAEOthattheyhaveconjuredupastorythatoncetherecessionends,allthosecustomerswhoaremovingtoalowerpricepointbyshoppingatAROaregoingtoreturntothecompetitorsstores.Hence,AROtradesat5.43xitsLTMEBITDA,whileANFtradesat7.26xandAEOtradedat7.14xuntilitlost35%ofitsvalueinthelastquarter.Caughtupintheirpastviewoftheworld,theyaremissingoneofthegreatretailstoriesaroundtoday,whichcontinuestoimproveitsbusinessquarteroverquarter.

Nabi(NABI)thisisawonderfulstory.Nabihasavaccinethathelpswithsmokingsensations.GlaxoSmithCline(GSK)actuallyputup$45Milliontopartnerwiththemonthisdrug.Noonespends$45Monadrugthatisntcredible.Thatwillprobablymoveforwardbytheendof2011.WhenIenteredmyposition,IwasntpayingmorethancashandtheNPVofroyalties,probablylowerandupper3s.GSKvalidatedthevaccineandtheramificationsofitsapprovalaremind-boggling.Youtake4-5shotsover6-8monthsandyoucangetoversmoking.Ournationspendsalotofmoneyon

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smokingandsotherewillbealotofpushbehindthisdrug,youcouldmakebudgetsbalanceiflesspeoplesmoked.Evenifyoudoubtit,theGSKguyshavebeenlookingatitformonthsandwhentheyredonewiththenextphaseofdevelopment,GSKwillpayNABIanother$30Millionfortheworktheyredoing,andthenthenumbersgetreallycrazyforroyaltypayments.WhenIwasbuying,Igotinatpriceswhere

mostofthestorywasforfreebecauseofwherethestockpricewastrading.BreitBurnEnergyPartners(BBEP)Thiscompanyfoundtheywereoverleveragedatonepointlastyearandsotheycutthedividenddistribution,causingthestocktogodownto$6.Dividendmoneywenttocutdowndebtandnowitsat$15.Wewentfrom$6to$15.Baupostisthereandtheinterestingthingisthattheygotinvolvedwithaproxycontestwiththelargestshareholder.Quicksilver,thelargestshareholder,wentontheboardandremoved2guysthechairmanandCEO,thetwofolkswhosenameisinthecompanynameitself.Theybecamemanagementemployees.

Quicksilver(KWK)isoverleveragedandowned21millionsharesofthiscompanyatonepoint,orabout40%ofthecompany.Theyhadaproxycontestandthose2wereremoved.Youhavetotakeastepbackandwonderwhatsgoingon.Ifthereisnothinggoingon,whywouldtheybothertoremovepeoplefromtheboardwhowillobjectandnotbehappyaboutthesituation?TheresapossibilitythatmanagersweretakenofftheboardofdirectorssothatpotentialM&Aactivitycouldbekeptsegregatedfromtheoperations,whichoffersapotentialexitstrategyforQuicksilver.Inthemeantime,Igota10%dividendand37.5centsperquarterpershare,nottoobadatall,andmostlytax-free.Howdoyoutryandstructureyourportfolio?Yourtopholdingis15%ofyour

investedportfolioandthetop5makeup44%ofyourportfolio,eventhoughyouhad29positionsatthelast13Ffiling.Wetendtobuyasmuchas6-7%oftheportfolioandwillbepruningasitcrossesthe10-15%threshold.Wereusuallyalwayspruning.Howdoyoudealwithpricesatwhichyouareokayholdingastock,butnotbuying?Opportunitycostwouldsaythatifyouarentwillingtobuyitatthecurrentprice,youshouldntbeholdingit,becausebynotselling,youreeffectivelybuyingatthecurrentprice.

Oneofthepainsisyoubuystocksoutoffavor.Oftentimes,theybecomeinfavor!Justbecausetheyverisenpastfairvalue,andyousawthatinInVision,wherethefundamentalshadmarkedlychanged,youhavetobepatientandseeitrunsitscourse.Bythesametoken,ifIwasbuyingforthelogcuttingmachinesoftware,andifitwasdonewiththebetatestswithoutmuchbusinessactivity,Iwouldhavefoundanotherinvestmenttomoveonto.Frommypointofview,Icanbepatient.