Different Strokes

It isn’t easy to be a nonconformist in the staid, buttoned-up world of finance.

So, after some 20 years managing investment portfolios at large firms, Mark Watson struck out on his own. In 2006, he founded the small, employee-owned boutique firm, Keel Asset Management L.L.C., in his native Chicago, to pursue his own brand of against-the-grain investing. His institutional clients include First Affirmative Financial Network, Manhattan and Bronx Surface Transit Operating Authority, and The Community Renewal Society.

Watson, who is also Keel’s chief investment officer, uses a blend of fundamental and quantitative tools to create investment portfolios. “The stocks we choose have two characteristics,” Watson explains. “Our choices tend to possess theses that run counter to consensus views. And secondly, we use a ‘relative value’ approach. So, the stocks are cheap when compared to peers in their respective industries.” Black Enterprise sat down with Watson to tap into his unconventional stock-picking wisdom.

Where do you see the economy heading over the next six months?
I actually think that in one shape or form we will get more liquidity introduced into the market. And whether that happens through another round of stimulus, a change in regulatory policy, private equity being provided, there will be

some incentives to move forward. I do think ultimately that will give confidence to businesses to invest in labor capacity.  But, it will be slow. The world thought we were in a “V-shaped” recovery. I see it as a “U”–but with a long base.

That makes bargain hunting all the more important for investors. What’s a stock that you consider to have good relative value these days?
Zimmer Holdings Inc. (ZMH). Zimmer makes prosthetic devices and is one of the largest players in hip and knee replacements. About 58% of its sales are in the Americas, and roughly a quarter are in Europe. The balance is in the Asia-Pacific region. So, this is a global play in the aging population. This company didn’t go down much in terms of revenues during the recession. And they will grow during the recovery. There is a market penetration play here as well. While Zimmer has more than 20% of both knees and hips of a global market, they have 13% in shoulders and elbows, and 6% in dental, 5% in the area of other broken bone pieces, and 3% of the spine market. So, there’s room for them to grow current product market share. Also, it’s an

inexpensive stock relative to peers. We expect revenues to grow in 2010 because of their potential increasing global footprint. We see earnings growth opportunity beyond the consensus expectation. For the stock, we see a 20% upside, with a 12-month target of about $66.

OK, what’s next?
I have a controversial one: Eastman Kodak (EK). The negatives of Eastman is a perception that their business, the traditional silver hyaline business, is going away and that there is no growth overall in earnings long term because the core business is declining. Their growth end of the business, digital applications, is not sustainably growing. We actually believe that there is a dollar of earnings power embedded in the current model of Kodak. This is the first year that Kodak’s digital business–which includes cameras, printers, and digital video cameras–will generate a profit in total. It was previously generating losses. I think most people are familiar with their printers with reduced ink costs. Now, they’re rolling similar technology out to the commercial market. So we believe that the digital business, which would include these printers, ultimately can generate 5% margins, which is not a stretch. The market is overly focused on the declining business while you have emerging digital

business that should be increasing in profitability over time. The risk of failure is low in that they, essentially, have no long-term debt. They have more than $2 billion of cash in the balance sheet. So, the question is: Can they continue the growth rate of the digital business and reinvest free cash flow and excess cash? We have confidence in the current CEO, Antonio Perez, who used to be the corporate vice president and a member of HP’s [computer-maker Hewlett-Packard] executive council and who has executed a cost-reduction program and re-engineered this firm over the last three years. For Kodak, one-year price target is $8.

So, that’s a risky pick.

Can you give us something a little more conservative?
Syneron Medical Ltd. (ELOS). We actually bought a stock called Candela (CLZR), which, about a year ago, was purchased by Syneron Medical. Both companies are in the medical devices business, making lasers that either remove hair or cellulite. They are in the medical aesthetic industry. They sell primarily to dermatologists. So, our interest really was with Candela, but Syneron actually improved the financial strength of Candela, and is in the same market, and broadens the product breadth. Candela is the only laser manufacturer that has

global distribution. The biggest part of the business is hair removal. And, they have been best-in-class in terms of research and development. Our view is that the financial strength of Candela has significantly improved now that it’s embedded into Syneron Medical. But, now we can enjoy the benefits of their product launches as they go forward. The company is attempting to develop a laser product that removes or reduces cellulite. They are also working on a consumer application for the “at home” consumer market, which would be much larger than the market they are playing in now. Syneron is a small little company. It’s less than $350 million market cap. This could be a $14 stock in 12 months.

Is there a consistent theme in these three picks?
All three of these plays are situational. We are making bets against consensus. You need an economy to recover. But with all three companies, they also need specific events, whether it is balance sheet improvement, re-engineering the firm, like Kodak, or penetrating markets where they aren’t there yet, or, in this situation, a product launch in a whole new arena. So, those could serve as catalysts even though the overall stock market may not be that attractive.