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A Fallen Angel Pick in Global Small Caps

Katie Rushkewicz Reichart, CFA

Katie Rushkewicz: I am Katie Rushkewicz with Morningstar. I am here with Robert Gardiner of Wasatch Global Opportunities, a world stock fund that launched in November 2008. Thanks for being here Robert.

Robert T. Gardiner: Thank you, Katie.

Rushkewicz: You've had a long career at Wasatch and previously managed the micro-cap fund. Micro-caps play a pretty big role in this portfolio, too. Are there significant challenges to investing in micro-caps overseas versus domestically?

Gardiner: Just the challenges that you'd see are just the ones you'd expect. You've got a different language, you've got a different culture, you've got different accounting, you've got probably more currency issues, and in the emerging markets, you might have some corporate governance issues. And actually, probably the hardest thing of all is the travel schedule that you've got to follow to go see these companies. It's a little harder to get to Australia. I was in Australia a month ago, and it's a long flight, and so that takes its toll. So those would be the challenges.

Katie Rushkewicz: You've been in micro-cap investing for nearly 30 years. How has that changed during your career?

Robert Gardiner: We're doing – I am doing almost exactly the same thing I was doing 30 years ago, only, hopefully, I am better at it, but pretty much, we're following kind of the same process we always have. And the only change I might say is, domestically, in the U.S., Sarbanes Oxley has maybe hurt the micro-cap space because of the all the regulations, there haven't been as many IPOs coming. Now, the positive on the international side is the IPO markets have never been better kind of over the last decade.

And so, we still invest domestically and are still excited about the micro-cap space, but with fewer IPOs, because of the cost for micro-cap companies, they've deferred becoming public or chosen not to come public or waiting until they are bigger, that has maybe dampened the micro-cap space domestically, and that's probably the most profound change. It's kind of an interesting time, though, there might be some pent-up demand; we are seeing a little healthier IPO environment now.

We are not big IPO players. We typically buy six to nine months later, kind of after Wall Street's moved on to the next hot IPO. So that's a pretty big change in the last decade, that it's been a little tougher domestically, but the exciting part about this global product is, I can kind of go where I need to, and the IPO area internationally has been very exciting with a lot of companies coming public, so that just gives me a big universe to choose from.

Rushkewicz: Your strategy centers a lot around high-quality growth companies, but I understand you also invest in what you call fallen angels or companies with temporary setbacks. Can you give me an example?

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Gardiner: So, an example of a fallen angel – these are companies that we view as strong companies, but they hit a bump in the road. And as you know, when companies hit a bump in the road their stocks go down and typically they can be overly punished at times. An example that I like, right now, is a company called Melexis. It's a semiconductor company based in Belgium. They sell semiconductors into the auto industry. And of course, it has been a pretty tough environment for auto manufacturers and suppliers to the auto industry for the last few years.

And so, their business has been down after 15-plus years of having 20% operating margins. The company actually had a loss in a quarter over the last – they had a couple of losses in the last year, as the auto market fell apart, and there was a massive inventory correction among auto suppliers. And this actually tripped one of their bank covenants.

Melexis is a very strong company financially, but they've always had a strong dividend-paying policy, and so they paid a lot of their cash out over time, so they didn't have a big cash balance, and so the stock got heavily punished, with the fear of the bank issue and with the semiconductor industry down. We thought they'd be just fine, made a big bet, and the stock has come back as inventories have needed to be replenished, as the Asian auto side of the story is very, very strong in China, and so forth, and as some of the stimuluses helped the European companies.

We're a little worried about Europe on the auto side, but the exciting thing about selling into the auto semiconductor industry is that there is a greater dollar content for semiconductor and for electronics going into vehicles for all sorts of things, entertainment, GPS, especially for safety, and just the car, these automobiles are running with more electronics and Melexis is a play on that. They are a very strong competitor there, been a really well-managed company with a strong track record.

And so, fallen angels are companies, really solid companies that maybe hit an issue in the short run, see their stock prices get tanked, and then we kind of come in and buy them. And we still like it. They had a $0.19 quarter last quarter, so they are at about a $0.80 run rate and the stock is around $8, and so it's 10 times earnings, which is pretty cheap. And it's a company with a great long-term track record. And we think – for as far as the eye can see, semiconductor content is going to go up in vehicles ... you've got Europe, that's weak, but you've got Asia that's strong, and so there is some positives and negatives, but that's an example. Did you want an example on the other side or…

Rushkewicz: Sure, high quality.

Gardiner: Yeah, okay, yeah. One name that I'd highlight there is the company called Wirecard. They are based in Germany, in Munich. In the '80s and '90s, I've had a lot of success owning the transaction processing companies. We had some big holdings in the credit card processing area. We really love the business model, because it's a click business, it's a recurring revenue model, very stable business model. Back then, credit cards weren't in supermarkets, they weren't in retailers and that wave hit, and we did very well in them.

Wirecard is a little bit different. What they are, is, they are an Internet retailer transaction processor, and so, they process the transactions for Internet retailing companies, both companies that have bricks and mortar with an Internet site and pure Internet retailers. And they actually offer a large number of services for them, and one might be fraud detection, as an example, but they are basically a click model. And so, it's very stable, very steady.

And then we love the whole play to more retail happening online. And so, for example, this last year in a really tough retailing environment over the last 18 months, they've continued to grow 15%, not as fast as in some of the prior years, but the growth rates have held up. The stock is very reasonably priced. It's about mid to high teens multiple here.

One interesting thing is a comparable company called CyberSource in the U.S., was just bought out by Visa for like a 40% premium and a very high multiple. And so, here we've got Wirecard is actually the European leader in this space, and they are getting into Asia as well. And so that's a name that we like.