corsair capital q3 2010

8/8/2019 Corsair Capital Q3 2010

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Corsair Capital Management, LLC350 Madison Avenue, 9th Floor

New York, NY 10017

This letter is not a research report or recommendation to buy or sell the securities mentioned herein. The examples herein are illustrations of ways inwhich Corsair Capital Management, LLC and its affiliates have examined or may examine opportunities. Corsair Capital Management, LLC and itsaffiliates may, at any time, buy or sell any of the securities mentioned in this letter and may change its long or short position at any time withoutproviding any notification of such changes. It should not be assumed that any trading activities pursued in the future will be profitable and may in factresult in losses.

October 13, 2010

Dear Limited Partner:

For the third quarter ended September 30, 2010, Corsair Capital was up an estimated 6.9%* net,after all fees and expenses. Since inception in January 1991, Corsair Capitals compounded netannual return is 15.1%.

Corsair Capital (net) S&P 500 Russell 2000

3Q10 return 6.9% 11.3% 11.3%

YTD return 6.9% 3.9% 9.1%

Annualized since inception (1991) 15.1% 8.7% 10.1%

Total return since inception (1991) 1513% 419% 573%

After declining in August on continued worries about the European Economic Union andsovereign debt risk, the U.S. equity market rebounded strongly with its best September in 71years. Most pundits believe the catalyst for this rally was a speech by Ben Bernanke at theFederal Reserves annual meeting in Jackson Hole, Wyoming, where the rationale for a secondround of quantitative easing (QE2) was first formally suggested. Then, in mid-September, theFederal Reserve released the statement that measures of underlying inflation are currently atlevels somewhat below those the committee judges most consistent, over the longer run, with itsmandate to promote maximum employment and price stability.

In other words, the Fed signaled it was still quite concerned about continued high unemploymentand near term deflation and thus, was again ready to perhaps print hundreds of billions of dollars(QE2) in order to help the situation. Unfortunately, history shows that devaluing onescurrency through money printing and deficit spending is not a recipe for long-term success(otherwise Argentina would now be an economic powerhouse). Since the Bernanke speech, theU.S. dollar has already declined approximately 7% against a basket of our trading partnerscurrencies. And our trading partners are not content to sit by and see us devalue the dollar. Weare in the midst of an international currency war, a general weakening of currency warnedBrazils Finance Minister reminding his fellow International Monetary Fund partners of thebeggar thy neighbor policies (competitive currency devaluations) which exacerbated the GreatDepression of the 1930s.

In the meantime, investors have assumed that the Fed will spend this new money on a largebuying spree of Treasury bonds and other fixed income instruments. This, in turn, has driveninterest rates on both 2-year (0.33%) and 5-year (1.03%) Treasury notes to record low levels andreduced the cost of borrowing for most all borrowers. Nevertheless, many economists wouldargue that lowering interest rates at this point in time is akin to pushing on a string. The realunemployment problem is not due to a lack or cost of capital, but rather that businesses are


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refusing to take risks or hire new workers due to uncertainties over government policies,including higher taxes and regulatory (especially health and environmental) burdens.

Meanwhile savers, who have already taken $1 trillion out of money market accounts sinceJanuary 2009 in search of yield, are again being forced into investing in riskier assets (longer

dated or lower rated bonds and stocks). However, savers are not the only ones affected.Corporations, states and municipalities with pension and healthcare plans now find themselveswith massive future burdens as they are unable to earn enough on their assets as originallyassumed. For example, according to the National Association of State RetirementAdministrators, the top 100 U.S. public pension plans currently use an expected annual return of8% on their assets when calculating their outstanding pension liabilities. Should the actualreturns be 2 or 3% lower (very likely given approximately one-third of their assets are inTreasury bonds), the present value of their obligations would go up by hundreds of billions ofdollars. Of course, the liability associated with our countrys Social Security promises wouldlikewise be hugely underestimated.

As far as the stock market is concerned, however, many stocks are currently trading at 11-12times next years expected after-tax earnings. This equates to approximately 8 9 times pre-taxearnings or (calculated inversely) an earnings yield of 11-12% which is looking more and moreattractive in a 3.8% 30-year Treasury bond world. Investors, who are being forced to take morerisk by the Fed, are starting to believe that stocks are cheaper by comparison. If investorsentiment changes just a little bit, there is no reason why we cannot see stocks at 13-14 timesearnings (an earnings equivalent yield of 7-8%). Of course, investors take on the risk that thesecompanies might not earn what they are expected to. Nevertheless, this sentiment shift andsearch for yield seem to be the driving forces behind the market moving higher right now.

Another factor which might boost the equity markets could be a significant acceleration inmerger and acquisition activity. Over the past two years, many corporations have ruthlessly cutcosts, improved efficiency and lowered inventories and receivables. In short, even in thisrelatively weak economy, they find themselves solidly profitable with significant cash reservesand access to capital. Since they are not growing organically, they may very well start toconsider growing by acquisition. As was clearly demonstrated by the bidding war for 3ParCorporation between Hewlett Packard and Dell, when companies use cash (which for practicalpurposes earns them nothing), corporate management teams can justify paying very high pricesfor target companies.

The Portfolio

Innophos (IPHS) traded up during the quarter as the company reported very strong Q2 resultsand announced an accretive debt restructuring, cutting interest expense in half starting in Q4.IPHS earned Q2 adjusted EPS of $0.94, or an annualized EPS run-rate of $3.74, despite analystexpectations of $0.69 for the quarter. Over the next few quarters, management believes thecombination of effective pass through of higher prices to customers and shifting of capacity tohigher-value products in Mexico will more than compensate for increasing input costs. Based onthe companys stable end markets, high barriers to entry, leading market shares, under-levered


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balance sheet, and ramping cash earnings, we firmly believe that IPHS is a very good businessand that its P/E multiple will expand to reflect these characteristics (see Appendix). The stockended the quarter at $33.10.

Globe Specialty Metals (GSM) positively contributed to the portfolio this quarter, as it

announced FY2010 earnings last month that exceeded analyst estimates. The shareholderfriendly management team and board also initiated GSMs first ever annual dividend, signalingconfidence in the companys underlying business fundamentals. Silicon metal and ferrosiliconprices continue to strengthen amid tight industry supply dynamics and a rebound in demand fromkey markets. As such, industry experts are currently predicting higher near and long term pricesfor silicon and ferrosilicon. Ongoing acquisition activity represents another key catalyst, asdominant strategic players announced acquisitions in the silicon metal sector. We believe theM&A activity reinforces our thesis that the industry boasts high barriers to entry and tightsupply, which will continue to lead to higher silicon metal prices. The stock ended the quarter at$14.04.

MDS Inc. (MDZ) shares rose strongly during the quarter as the company reported severalpositive developments that brought the company closer to completing its restructuring by the endof 2010. Most notably, the NRU nuclear reactor returned to operation, allowing MDZ to re-enterthe Mo-99 supply chain in the medical imaging market. In connection with the re-start of theNRU reactor, the company also signed a contract with its primary medical imaging customerwhich should improve financial results starting in fiscal Q4. In the medical sterilization segment,MDZ announced it has extended an agreement with a Canadian power generator that will securethe companys Co-60 supply through 2020. We expect more positive developments, includingthe conclusion of the MAPLE Project arbitration proceedings. The stock ended the quarter at$10.10.

Expedias (EXPE) stock price more than made up for its second quarter decline, rising nearly50% during the past three months. The company beat earnings expectations due to continuedstrong growth at its TripAdvisor division and robust travel sector trends led by increasedconsumer discretionary spending. The stock ended the quarter at $28.23.

On the negative side of the ledger, Live Nation (LYV) declined as their earnings disappointedinvestors. Interestingly, through 2009 and the beginning of 2010, LYV's concert businessgenerated consistent results and defied much of the economic downturn - a factor which attractedus to the investment. However, as 2010 progressed, LYV's concert business proved to be morecyclical in nature than we and the market had anticipated. While LYVs concert segment hasfaced challenges in recent quarters, LYV reported strong earnings in its sponsorship andticketing segments. We continue to closely monitor the concert industry in order to assess thecompanys ability to meet the business model potential we recognized following its merger withTicketmaster in the beginning of the year. The stock ended the quarter at $9.88.

Lastly, as many of you know, Corsair has enjoyed a long history of investing in postreorganization equities. Most recently, LyondellBasel (Lyondell) has proven to be a classicpost reorganization investment, having emerged essentially as a new company with a highly
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improved balance sheet, new upper and middle level management and very conservativeprojections set forth in its Plan of Reorganization. Lyondells stock rose sharply during thequarter, driven by blowout Q2 earnings. In fact, the companys Q2 EBITDAR alone almost metits entire fiscal year 2010 projection published in its disclosure statement. Though Lyondellrecently emerged from bankruptcy, the company has already generated enough cash that it can

now be considered underlevered. We look forward to Lyondells imminent NYSE stock listingunder ticker LYB, which should serve as a catalyst for sell-side firms to discover Lyondellsattractive valuation relative to its peers in the chemical industry and will enable institutionalinvestors and mutual funds to invest in the company. Finally, we are very impressed withLyondells new executive management team who seems focused on one goal: creatingshareholder value by delivering operational and financial excellence. The stock ended the quarterat $23.90.

Organizational Matters

After nearly seven years of working at Corsair Capital Management, we bid farewell to Alec

Henry, who joined Eagle Capital Management. We wish Alec all the best in his new position.

Additionally, we are pleased to welcome Daniel Friedman who joined us during the summerfrom Goldman Sachs investment banking division.

Thank you for your continued support and confidence. The attached Appendix is a write-up of acore investment. Please feel free to call us with any questions you may have at (212)389-8240.

Sincerely,

Jay Petschek Steven Major

* The funds returns are based on a typical investor in Corsair Capital since inception. For Corsair Capital 100 or Corsair

Capital Investors returns, please refer to your capital statement.


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Appendix Innophos (IPHS $33)

IPHS is a leading specialty phosphates company in North America serving stable, diversified endmarkets. Applications for its products include flavor enhancers in the food and beverage industryand inactive drug additives in the pharmaceutical industry. Our thesis rests on the view that 2008

and 2009 earnings misrepresent the business stability, and reported GAAP earnings understatethe true earnings power of the company.

Because IPHS uses raw materials like phosphate rock and sulfur that overlap with the broaderfertilizer industry, fertilizer supply/demand dynamics can create volatility in IPHS results. IPHShistorically priced supply contracts on a one year lag to market prices; as phosphate rock pricesspiked in 2008 from $50/ton to as high as $450/ton, IPHS benefitted significantly by raising itsprices to customers while not incurring higher input costs. However, this dynamic reversed in2009 when IPHS raw material costs reflected the higher 2008 phosphate rock prices, whilelower 2009 rock prices forced IPHS to lower its fees. IPHS earnings in 2009 halved year overyear, and based on this volatility, the market now considers IPHS a very cyclical company.

IPHS has since tailored its business to properly align changes in raw material costs with productpricing. Three key changes are worth highlighting: 1) supply contracts for rock will re-pricequarterly instead of annually, limiting lag time; 2) capacity in Mexico will be reallocated fromphosphorous-based detergents, which face demand headwinds stemming from environmentalconcerns, to stable food, beverage, and pharmaceutical specialty salts/acids; 3) phosphate rocksourcing will expand from one supplier to multiple suppliers. We believe that these changes willresult in future earnings stability at the company. Our view is that IPHS has a great businessstemming from its diversified end markets, specialized products and high barriers to entry (theseinclude the cost of constructing a greenfield plant, locating phosphate rock supply anddemonstrating flavor/cleaning agent efficacy).

Bain & Co. recognized the companys stable end markets and cash generation and bought outIPHS in 2004. Excess depreciation from the write-up of fixed assets in the buyout has causedreported GAAP earnings to understate cash earnings. IPHS reports around $50m of annualdepreciation, outpacing maintenance capital expenditures of only $20m-$25m. This factor leadsus to believe that the current reported earnings do not accurately reflect the true earnings powerof the business. IPHS earned Q2 EPS of $0.79 removing the excess depreciation yieldsadjusted EPS of $0.94. We expect sell-side analysts to appreciate IPHSs true value in the nearterm as depreciation begins to decline and approach maintenance capital expenditures.

Because there is little seasonality in the companys markets, we can use Q2 performance tomeasure run-rate earnings; Q2 adjusted EPS of $0.94 equates to an annual run-rate of ~$3.75.We feel confident that IPHS can earn $4.00 of adjusted EPS in 2011. Our target price of $50reflects a 12x-14x multiple we view the business warrants. We also believe IPHS is once again apotential LBO target as it is under-levered and generates stable cash flow.
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corsair capital q3 2010

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