I

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February 5, 2016
Dear Investori:
Our portfolio was roughly flat in December of 2015 versus the S&P 500s decline of -1.58%,
bringing our full year (unaudited) return to 3.69%. This compares to the S&P 500s total return
of 1.38%. The table and charts below include other performance figures:
Incandescent

S&P 500

Difference

3.69%
75.46%
20.61%

1.38%
52.54%
15.11%

2.31%
22.92%
5.50%

2015 Year
Since Inception (36 Months)
CAGR

Returns Since Inception

Incandescent

S&P 500 Total Return

80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%

Last 12 Monthly Returns

Incandescent

S&P 500 Total Return

10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
(2.00%)
(4.00%)
(6.00%)
(8.00%)
J

40 Fulton St, 20th Floor New York, NY 10038 646-912-8886 www.incandescentcapital.com

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Although Incandescent Capital was officially founded in 2013, I have personally managed
money for friends and family since 2009. Gross returns (unaudited) from my personal reference
account (where I keep 95% of my net worth) since then are thusly:

2009
2010
2011
2012
2013
2014
2015
CAGR

Incandescent
50.75%
18.78%
2.28%
16.38%
60.68%
5.31%
3.69%
20.73%

S&P
26.46%
15.06%
2.05%
16.00%
32.31%
13.69%
1.38%
14.79%

Difference
24.29%
3.72%
0.23%
0.38%
28.37%
(8.38%)
2.31%
5.94%

HFRX1
13.40%
5.19%
(8.88%)
3.51%
6.72%
(0.58%)
(3.64%)
2.02%

Difference
37.35%
13.59%
11.16%
12.87%
53.96%
5.89%
7.33%
18.71%

And here is how $100,000 would have compounded versus those two benchmarks if it was
invested at the end of 2008:
$373,950

$400,000
$350,000

$300,000

$262,673

$250,000
$200,000
$150,000

$115,027

$100,000
2008

2009

2010

Incandescent

2011

2012
S&P

2013

2014

2015

HFRX

All figures above are gross of fees (that is, before any fees are deducted). Since each investor in
Incandescent Capital has the option to negotiate different fee arrangements, net returns will
vary. For 2015, if you elected our standard 20% performance fee (no hurdle, no management fee)
arrangement, your net return would be around 2.95% compared to your gross return of 3.69%.
Also, depending on when your account was on-boarded, your results may differ from the main
reference account reported above. It takes a bit of time to sync each account to the same
exposure as I buy/sell according to the ebb and flow of the market. As always, your patience is
asked for as I build your new portfolio up, but rest assured: what you own, I own. I am
committed to eating my own cooking2.

This is the HFRX Global Hedge Fund Index, a widely used index to praise or pan hedge funds in the press.

The main reference account statement is available upon request from any investor.

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The View From 30,000 Feet

Here are how our positions look as a percentage of total portfolio and its geographic split:

Position Size by %

Geographic Split

9.2%

12.1%

20.1%

13.6%
87.9%

11.5%

7.4%

11.0%

Cash

Canada

USA

And heres a snapshot of where our investments fall into various types and sectors:
Sectors

Investment "Type"
Other
8%

Special
Situations
10%

Compounders
45%

Mispriced
45%

Tech
27%

Consumer
Cyclicals
18%
Energy
15%

Financials
32%

As a reminder: Compounders are businesses I believe have long, predictable runways for
growth that weve invested in at fair, if not arguably bargain prices. Mispriced are businesses
undergoing transformation or have fallen out of favor with the market and are thus in my
opinion widely misunderstood and misvalued. Special Situations are businesses with hidden
assets and/or have potential catalysts that will unlock value in the near future, e.g. spin-offs,
buyouts, arbitrage, and the sort.
Despite being relatively concentrated in our top five names, I am comfortable with the degree of
our diversification. More significantly, it is the moat of safety created by investing at a discount
to intrinsic value that fuels my confidence. Our weighted average price-to-earnings ratio (with

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earnings defined as adjusted run-rate free cash flows) across the entire portfolio is less than 9.
The ROEs of our compounders range from the low teens into the twenties. We own businesses
that have fortress balance sheets net cash positions for our commercial & industrial businesses
and conservative leverage ratios for our financials. It is enormously satisfying to follow them
every day and continuously learn how their exemplary management teams build value for us one
block at a time.
***

Looking Forward
Although our returns in 2015 were slightly higher than the S&Ps, it is, given the volatility that
has engulfed the market, nothing to crow about. It was a year for patience and for sowing new
seeds. We are in the early innings of many of our investments, several of which have the
potential to multiply in value over the next five plus years. It will be critical to keep our eye on
the ball, especially since global stock markets are being routed in the start of 2016.
2015 was also a difficult year for those adhering to a value-oriented strategy. Multiple billion
dollar funds led by Buffett-inspired luminaries with decades of successful track records endured
their worst losses since 2008. Notably, in October, during the biggest rally of the year, several
bore astonishing drawdowns instead. But I have no interest in naming names and engaging in
schadenfreude. Investing. Is. Hard. Anyone who wants to earn long-term above average returns
will suffer setbacks, sometimes dramatic ones. Berkshire Hathaway itself has declined -50%
from peak to trough on three different occasions. In 2015, it, too, fell to a tune of -12%.
I bring this up because there will almost certainly be a month/quarter/year we go through
something similar. And its important to ask yourself: would I be willing to stay the course? If
there are doubts, please reach out to me so we can discuss in depth. Its beyond important our
expectations remain aligned. Because it is during the periods of great suffering that we should be
adding to, not pulling out, of our investments.
In my estimation, the two most important ingredients to success involve:
1.) Like-minded, long-term oriented partners
2.) Irrevocable liquidity, ideally cold hard cash
If we have those two ingredients and invest in common stock, unlevered, at a good valuation,
and, furthermore, if the underlying corporations also have those above two ingredients, its
highly improbable to lose money over time.
The reason is you can simply wait out any storm. Prices today in a growing number of securities
have become unmoored with their fundamentals. This is not something to lament, but
something to celebrate if you have cash and you do not have anyone, e.g. brokers, lenders, or
investors, knocking down your door forcing you to sell. It is an underrated advantage, only made
obvious blindingly obvious during periods of tumult. What is coined cash drag during
periods of unrelenting melt-ups become cash is king on the flip side.

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As the market thrashes and fear takes over financial airwaves, we get to watch calmly and wait
for bargains to emerge. Then we buy. Our interim results will assuredly look bad, but like
investing in anything, there is always a cash outflow in the beginning. Whats relevant is what
will your results look like in the future. During market panics your motivation should evolve
from limiting losses to maximizing gains. Be not afraid of mark-to-market losses, but of missing
the opportunity to make large amounts of money down the line.
Yes. I am essentially saying: Be greedy when others are fearful.
***
It seems a ritual now for me to begin a letter with the goal of recounting a past period only to be
forced to address an urgent matter in the present. Can you believe I wrote the above page just
prior to year-end 2015? Then the calendar flipped and January was, to put it bluntly, the worst
start to the year since the depth of the financial crisis in 2009. The first week of 2016 was the
worst start to any year since the inception of the S&P 500 index. At one point in January, it drew
down 11%, a comical level of panic that ought to discredit the Efficient Market Hypothesis for
good. We were not spared in the carnage.
But unless you anticipate needing cash in the near-term, this is, without a doubt, a positive. Ever
since the beginning of 2014 I have been sounding an alarm in these letters on the broad
overvaluation of the market and bemoaning a lack of obvious opportunities the buy low kind
that power sustained outperformance over a multiple years. The first cracking of the market in
Q3 last year and now, in January, with the earnest return of volatility, is the sound of our
starting gun going off. Its time to put our money where our mouth is.
To my fellow investors of Incandescent Capital: prepare to get greedy in this expanding
environment of fear. Capital contributions (of the long-term variant!) are now encouraged. We
will move forward with prudence and patience and a margin of safetyalwaysbut my outlook
is we are entering a period where we will, finally, have more prospects. How long will this last?
Are we entering a recession? Will 2016 be a repeat of 2008s terrible year? I have no idea, nor
does it concern me to any large degree.
What I do know is if this is a top, this wont be The Top. On the other side of the valley is another
mountain. That is what we must be ready for. Not to avoid the fall, but to fully participate in the
rise after. Consider and admire the following: Berkshire Hathaway fell a sickening -48.7% from
1973 to 1975 as Buffett scooped up stocks left and right, even issuing 8% debt to fund his buying
spree while telling Forbes now is the time to invest and get rich. Berkshire then rocketed up
+5,922% from 1975 to 1985, racking up a 30% CAGR from beginning to end despite the pain
from the first three years. It is the same dynamic that, as Buffett fond of saying, saw the Dow
Jones Industrial Average go from 66 to 11,497 in the 20th century despite two World Wars and
worst depression of our modern era, and countless panics and recessions throughout.
Now lets talk stocks.
***

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My Favorite Security
In my 2014 letter, BlackBerry (BBRY) was highlighted as our New Hope. This is a company
that reached its all-time high back in 2007 and has since collapsed 95% from that inglorious
peak. Basically, exactly our type of tea. In 2015, BBRY became my best idea.
A brief recent history: In 2013, as the ascent of the iPhone and Android-clones flooded the
handset market they previously dominated, the company bet the farm on their new generation
of handsets christened BB10. They changed the name of the company from Research in
Motion to BlackBerry. It was do or die and they died. Billions were spent in unsold
inventory that piled up. Operating losses mounted. Executives were fired. A once iconic
company that revolutionized mobility found itself at the edge of the plank.
Prem Watsa of Fairfax Financial loaded up on BBRY shares and began the turnaround process.
A consortium led by Fairfax invested $1.25 billion of convertible debt into the company to shore
up their cash position. And then, the coup: Mr. Watsa convinced John Chen to come out of
retirement to become BlackBerrys new Chairman and CEO.
Lets pause here to consider why, on a philosophical level, a tech turnaround is actually a very
enticing proposition for a Buffett-schooled value investor.
Firstly, not all tech is created equal. The label is applied on companies ranging from Facebook to
Apple to Microsoft and, of course, to BlackBerry. But Facebook is an advertising company
reliant on a stable stream of eyeballs to its products. Apple is a hardware company reliant on
being able to build devices that people lust after. Microsoft is a software company with a sales
force that dominates the enterprise channel. Each have dramatically different business models.
BlackBerry was a hardware company that is transforming into a software company. To be more
specific, an enterprise software company. In essence, they are transforming from a company
that relied on building hit device after hit device for fickle consumers in an increasingly
competitive space where margins are single-digits to a company that sells products which cost
nothing to reproduce to enterprise customers who are sticky and wary of fads and slow to switch.
Software is generally a superior business to hardware. In Wall Street parlance, it is asset-lite.
Very little tangible capital is required to launch a product that costs nothing to replicate.
Returns on equity are effectively infinite. If you think a little outside the box, its not unlike Sees
Candies or Coca-Cola, which take raw ingredients that costs very little (cocoa, water, sugar) and
formulate a product that sells for many multiples of their costs. And like Sees or Coke,
successful software companies become unadulterated free cash flowing machines.
BlackBerry has always had a software business behind their hardware business. Their software
is what enables IT administrators to commission and manage thousands of corporate
BlackBerry devices. And the great irony is BlackBerry was giving their software away for free in
order to sell more phones. It was like giving away free razorblades to sell the razor. John Chen
came in and immediately set forth righting that wrong.

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While management quality is a key consideration in any investment endeavor, it is, in my
opinion, the single most critical ingredient in a turnaround situation. Mr. Chen has been in the
technology business his entire career, starting from the bottom as a systems engineer manning
the overnight shift in mainframe server rooms. In 1993, he turned around Pyramid Technology
Corporation, which was one payroll from being insolvent when he took control, and sold it to
Siemens two years later. In 1997, he became CEO of Sybase and turned a has-been database
maker with a market cap of under $400 million that was getting its lunch eaten by Oracle into a
mobility pioneer that was eventually acquired by SAP for $5.8 billion in 2010 a 20+%
compounded annual growth rate (CAGR) over 12 years.
Mr. Chens success has made him a wealthy and connected man. He sits on the board of Disney
and Wells Fargo and was Senior Advisor to private equity giant Silver Lake. He did not need the
BlackBerry gig and in fact turned down Prem Watsa several times before finally saying yes. In
the end, he took over BlackBerry for the same reason why Lou Gerstner took over IBM in 1993
for the challenge of saving an icon. Our investment thesis would be moot if we did not have John
Chen as our de facto partner captaining this ship.
It has been a little over two years since the inception of the turnaround and I have watched Mr.
Chen and his management team with admiration as they turned a company that was
hemorrhaging cash and losing its identity into one that is now generating positive cash flows
and, for the first time since their BB10 debacle, growing revenues quarter-over-quarter. Most
importantly, the source of their new revenues is largely from software subscriptions. Revenue
that is recurring, high margin, and rapidly growing. Theyve tapped the fountain of youth.
BBRY stock has yet to reflect their nascent success, but it will. At todays single-digit prices, it is
my favorite idea. There is no risk of them going bankrupt because they have a significant net
cash position and generate positive free cash flows. And while it was defensible to doubt the
execution of the turnaround in the early days, their latest quarter put most concerns to rest,
registering software revenue growth of 43% year-over-year organically and an other-worldly
183% overall.
Their market cap is less than $4 billion. $1.5 billion of that is net cash. The remaining $2.5
billion enterprise value includes a software business with a $600 million revenue run-rate (up
from ~$250 million in 2014) growing double-digits and a treasure trove of 40,000 patents and
relatively un-monetized gems like their QNX operating system that has a chance of becoming
the standard OS in future Internet-of-Things, e.g. smart medical devices, connected cars, assettracking tokens, etc. There is a significant probability that BlackBerrys revenues five years down
the line will be well into the billions.
We own shares with a cost basis in the mid-$8 range while I estimate fair value to be in the midteens. Meanwhile, the volatility of the general stock market has given us repeated opportunities
to add to our positions after good news. On one hand, I suppose itd be nice if it rapidly rallied.
On the other hand, it would be even better in the long run if it stays stagnant while we continue
to opportunistically accumulate shares. After all, John Chens last endeavor yielded a 20+%
CAGR over 12 years. If he comes anywhere near the ballpark of repeating such a feat, itd be a
damn shame were we not fully positioned to reap such a rich reward.

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New GM vs. Old GM: A Battle Of Perceptions

I first initiated our position in General Motors (GM) in 2014 after their ignition-switch
scandal broke. Value Investing 101 go where most people reflexively avoid due to an ick
factor. The genesis of this playbook is the infamous American Express salad oil scandal of the
1960s. Classic overreaction by investors who sell first and ask questions later.
At the time, it was feared GM would have to pay billions in fines and judgments, and worst of all,
suffer a permanent tarnishing of their brand. But it became progressively clear none of the
above were going to happen as time went by. New CEO Mary Barra, to her immense credit,
instead of bobbing and weaving from responsibility like too many of our corporate leaders today,
stood in front of Congress and took it on the chin. Contrary to the moving on rhetoric most
people take when confronted with scandal, she exhorted the company to never forget instead.
GM hired independent administrator Ken Feinberg to pay out any and all legitimate claims
against them. And although it will take time to change the culture of the company to be more
transparent and proactive with future recalls, Ms. Barra has the ball rolling in the right direction.
Meanwhile, the strength of GMs brands were put through a trial by fire and their sales figures,
record breaking on the back of tremendous pent-up demand generated by the 08 recession,
demonstrated their durability in the eye of the American and Chinese consumers. People didnt
care. They loved their Chevys, their Escalades, and, for the Chinese, their Buicks. It may surprise
you that GM makes very good cars now. The Chevrolet Camaro won Motor Trendss 2016 Car of
the Year while their new mid-sized pick-up Chevrolet Colorado won the Truck of the Year for
both 2015 and 2016. The latter is especially important in our current environment of low gas
prices which has rekindled the American love of trucks. Trucks that, of course, have the best
profit margins of all.
The stock, however, has languished, which has allowed us to pick at it continually throughout
the year. Our cost basis is around $33 per share. It continues to trades at a deep discount
were talking 6x earnings and 3x EV/EBITDA, a valuation that portends impending doom, as if
they were a coal miner or offshore driller. Why is that? My theory is as follows.
GM has been accused of being a value-trap. Historically, the argument goes: automotive OEMs
deserve to trade at single digit multiples because when the cycle turns, their pants are always
down and they end up losing gobs of money.
But theres just one table that you need to see to understand this is not your fathers GM
anymore:

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(Source: General Motors Company 2015 Global Business Conference Call)

While its fair to be skeptical of the U.S. breakeven SAAR claim, debt and pension liability are
just balance sheet figures. The fact of the matter is that their bankruptcy and bailout in 2009
scrubbed out a lot of legacy liabilities. New GM halved the number of brands of Old GM, took
debt down by 75%, and trimmed their workforce by over 20%. It simply costs less to run the
business now. And there are new sheriffs in town, focused more on ROIC and profitability than
volume, and more on staying ahead of the curve rather than resisting innovation 3. There is
ample reason to believe GM will be able to manage the cycle much more deftly this time around
and that our investment is safe, especially given how little we paid for its shares.
***
A sidebar on perceptions: There seems to be an aversion in the market for cyclical businesses,
which the automotive business surely is. But it is a curious aversion, because such a reflex seems
to be confusing the end-goals of investing which could not be more basic: end up with more
money than you begin with. Cyclical companies may be a tad trickier to value, but they possess
value nonetheless. Those applying blanket biases such as avoiding cyclical businesses or trying
to time the top regardless of valuation is akin to someone complaining that their dollar bill is not
crisp enough. Value is value, whether you get it in smooth or lumpy payments.
So while New GM is not being given the benefit of the doubt right now, we know if they simply
execute year in and year out, thatll change. Altering perceptions take time. Consider Microsoft:
widely panned by the market to be a dinosaur ten years ago! Google was beginning its neckbreaking ascent and Steve Jobs had turned around Apple. MSFT stock languished and began
paying dividends, a signal that it had made the turn from growth engine to cash cow. Influential
venture capitalist Paul Graham penned an essay titled Microsoft Is Dead4.
Today, MSFT is one of the hottest names in the market. New CEO Satya Nadella is the darling of
both Wall Street and Silicon Valley. What happened?

Some examples of GMs leadership in car tech: Sold more 4G LTE enabled vehicles than the entire industry
combined, semi-autonomous driving capability in new Cadillacs, a $500mm investment in Lyft, acquiring the
assets of Sidecar to accelerate their car sharing initiatives, etc. Not everything will succeed, but this is evidence
they are not sitting still. Mary Barra and her team are, in her words, disrupting themselves.

http://www.paulgraham.com/microsoft.html

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Mr. Nadella deserves credit for being a likeable, charismatic leader, but the turn in MSFT
started long ago. The groundwork was laid early on, by circling their wagons around the
enterprise market, a far more stable customer base. Quarter after quarter, year after year, they
delivered gobs of cash flows. Did they innovate? Thats debatable. But at worst, they kept up as
the fast fashion of the tech world. And their entrenched dominance in enterprise IT did not
require them to cater to the fickleness of the consumer.
The market took a long time to recognize this, but now they have. Leave it to Apple and Google
and Facebook and Amazon to R&D next generation whiz-bang products. Microsoft can simply
mimic them and slide it down their enterprise channel chute. The result is earnings stability on
the level of a consumer staple, and they are finally getting a multiple that reflects such a
consistent business.

Regional Banks
Our biggest winners last year belonged to a couple of regional banks, one based in Pennsylvania
and another based in Jacksonville, Florida.
1.) Our position in Customers Bancorp (CUBI) of Wyomissing, PA was initiated back in Q4
of 2013 with a cost basis around ~$17 per share. Customers is the second act of CEO Jay Sidhu,
former boss of Sovereign Bancorp who grew it from a tiny thrift into a $89 billion asset
powerhouse. His exit, however, was ignominious, as he lost a battle versus a disgruntled activist
in 2006. A non-compete clause kept Mr. Sidhu on the sidelines until 2009, when he led a
recapitalization of New Century Bank, took over as CEO, tacked on a couple of acquisitions, and
rechristened the resultant entity as Customers Bancorp.
A management trait Ive come to appreciate is the proverbial chip on the shoulder. Jay Sidhu
was pushed out of Sovereign, a bank he spent the majority of his career building. If anyone has
an incentive to reclaim a legacy, its him. He set up shop in the same city where he built his
previous empire and rallied his old Sovereign executive team back together. By 2013, four years
after taking control of the erstwhile New Century Bank, Customers Bancorp had grown assets
from $350 million to $4 billion.
Customers is primarily a business bank that eschews the land-and-expand-branches method of
growth and instead focuses on recruiting banking teams who travel to client sites to conduct
business and have deep roots with the local community. The benefits of this concierge model
are multiple. CUBI has much lower fixed costs and much higher productivity per employee than
the typical bank. Lower fixed costs give them the leeway to generate good ROEs without
reaching for higher-yielding risky loans.
Our cost basis of ~$17 was initiated around tangible book value. CUBI generates 10-12% ROEs,
which means we are effectively compounding our investment at that rate. Banking is not a sexy
business, but as a former professor of mine once said, if you want excitement in your life, try
sky-diving. The stock did little in 2014 but rose by 40% in 2015, buoyed by boring, predictable
earnings growth quarter after quarter. Assets have marched up over $8 billion.

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CUBI has become a yardstick of sorts. If I can find something to invest in that can beat a
predictable 10-12% return year after year, Ill trim our gains and reinvest in that. (Indeed, recent
market volatility has yielded a few such opportunities.) As for the rest, Im content to sit on it for
years to come.
2.) Atlantic Coast Financial (ACFC) is a significantly smaller position than CUBI but its
45% return during 2015 was meaningful to our bottom line all the same. Its story shares a
protagonist with Customers Bancorp. Jay Sidhu was brought onto the board of Atlantic Coast in
2010 to find a bank bogged down by bad loans from the financial crisis. Mr. Sidhu tussled with
the board over strategy, and in particular, he waged a proxy battle in 2013 to block a sale to
Bond Street. In that battle, unlike the one seven years ago at Sovereign, he was victorious.
Instead of a sale, Atlantic Coast recapitalized via a public offering later that year and began the
hard work of rebuilding their business. I followed them throughout 2014 and watched them
block and tackle their way methodically out of trouble. By the end of Q1 2015, their regulators
blessed Atlantic Coast by removing the troubled-condition designation they slapped on them
in 2012 and replaced it with the well-capitalized seal of approval. The turnaround was
substantially complete and the stock had not moved for over a year.
I bought in soon thereafter for around $4 per share. Its not as big a position as CUBI, partially
because it is a microcap stock that trades 10,000 shares on a good day, but mostly because they
dont yet have the scale to generate good ROEs. I took half off the table when it rose to $6, and
will trim opportunistically, but I believe there is a decent chance ACFC is bought out in the next
couple of years. Florida banking is experiencing an M&A boom, and we know ACFC was in play
in the past. With a much cleaner balance sheet and regulators off their backs, Atlantic Coast
could be a valuable acquisition for a larger regional bank looking to scale.

A Quick Tour Of A Few Others

The Compounders:

Atlas Financial (AFH) is a niche insurer of taxi, limousine, and paratransit

commercial vehicles. The company was spun out of Kingsway Financial, a hodgepodge
collection of insurance entities on the verge of imploding in 2010. Led by CEO Scott
Wollney, theyve meticulously expanded their business since, growing from $20 million
in premiums written to nearly $200 million today. I am an ardent admirer of Mr.
Wollney, who, in my opinion, hosted one of the best annual meetings Ive ever attended
last year, featuring highly educational panels on how their niche business works and why
it can sustain a 15-20% ROE over entire cycles. Our cost basis in the name is ~$16 just
shy of 2x book when I initiated it which is a bit pricier than what Im used to paying for
a financial. But factor in their growth and profitability, its no more than 9-10x earnings
a fair price for a defensible business led by a long-term oriented leader who has the
majority of his net worth in the stock.

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Billy, the Canadian alternative energy power producer I talked about in the 2014
investor letter5, remains a staple in our fund as it has been for over three years now.
Nothing has changed with the core thesis. Wind keeps blowing and water keeps running
and their cash keeps flowing, driving their stock up another methodical 12.5% in 2015.

In The Incubator, i.e. small positions we recently initiated and are slowly building:

Longtime readers of my letters will remember my admiration for DISH Network

(DISH) CEO Charlie Ergen, one of the savviest strategists and great wealth creators in
the history of U.S. telecommunications. Weve invested in his spinoff EchoStar (SATS) in
the past, but now were getting a shot at his main baby, DISH, which has sold off due to
the uncertainties surrounding their hoard of wireless spectrum. Mr. Ergens foresight
several years ago led him to the conclusion that the availability of wireless spectrum in
the U.S. was finite but the thirst for broadband-speed mobile internet was not. So he
used DISHs cash flows to buy up swaths of spectrum in a variety of creative ways over
the past few years. Today they own as much spectrum overall as T-Mobile. Its like
owning virgin beachfront property in an area that is all but certain to be densely
populated soon. The prices weve paid for shares thus far is a fair value for their satellite
TV business with all that spectrum included for free. While Mr. Market may not be
patient enough to see how Mr. Ergen monetizes DISHs spectrum, we certainly are.

Calpine (CPN) is an independent power producer that owns a fleet of best-in-class

natural gas power plants and a not-insignificant amount of geothermal assets in the
California Geysers. The thesis behind this investment is simple. Natural gas is Americas
primary power source now that king coal has been usurped by concerns of climate
change. Calpine owns arguably some of the most efficient natural gas fleets in the
industry. Throw in the Geysers and a management team that prioritizes free cash flows
and stock buybacks at 6x FCF and we have a hidden compounding machine in an area of
the market thats been left for dead.

CIT Group (CIT) is a 100+ year old middle-market lender that has undergone a multiyear transformation ever since emerging from Chapter 11 bankruptcy during the
financial crisis. CEO John Thain 6 has led them since 2010 and has substantially
completed the turnaround with his pice de rsistance acquisition of OneWest bank.
Going forward, all CIT has to do is focus on basic commercial banking drive down costs,
grow deposits, maintain their middle-market lending niche, and the stock should have
no issues trading up to at least tangible book value.

Which, unfortunately, I will continue to demure from revealing for now due to political reasons. Call me if you
want to know.

Yes, the John Thain, who installed a golden commode in his office at Merrill Lynch at the height of the financial
crisis. Poor taste and a tone-deaf, yes, but in his defense he did reimburse the company in full.

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A few years ago, I would never have thought of being able to buy shares of Whole
Foods Market (WFM) at an un-obscene valuation. But here we are, thanks to the
manic-depressive Mr. Market, offering us WFM for 13 times cash flows ex-store
expansion costs. 13x may be a bit more than I usually pay for a stock, but for those
unfamiliar with Whole Foods, it is the premiere organic supermarket in the U.S.
(number two isnt even close, reputation wise). Quality is worth paying up for as
evidenced by its history of trading two, even three times that multiple. Real estate prices
are higher in places close to their stores! I believe this is a window of opportunity to buy
into a platinum brand with a history of success and plenty of expansionary runway left.
The market fears Whole Foodss best days are behind them and will be forced into a price
war as other supermarkets beef up their organic offerings. But anyone whos ever
shopped there knows theres a huge difference between buying products with an organic
sticker slapped on at your local generic supermarket versus the all-in experience of
quality and service and overall happiness of browsing a Whole Foods.

Mistakes, And The Case For Permanence

Our costliest mistake of 2015 was Emergent Capital (EMG) (ne Imperial Financial). They
are in the rather grim business of buying and selling life settlements. For anyone who wants to
liquidate their life insurance, instead of receiving a pittance by surrendering it back to your
insurance company, you can call up someone like Emergent and sell it to them. Theyll calculate
the odds of your survival and make you a bid that is substantially higher than its surrender value.
Should you accept, they take over your policy and pay your premiums. They profit when you die
and they collect on your insurance.
From an abstract perspective, it appears to benefit both parties. You get a bigger lump sum
payment and Emergent gets a fair return on that investment. But in practice, it succumbs to the
greed and imperfections of human nature. Life settlement funds goaded people into taking out
life insurance for the sole purpose of reselling it. Big insurance companies, of course, fought this
as it took a cut out of their profits. All in all, the characters involved in this business bear a waft
of something slightly rotten.
Why did we invest, then? Because EMG (which changed its name from Imperial Financial in the
hopes of shedding their past identity that got them in hot water with the DOJ) was super cheap.
It was a classic Ben Graham cigar butt7. Theoretically, via common stock, we were able to create
a claim on their future life settlement cash flows for half of what they were valued at, time
discounted and all. $0.50 cents for $1 dollar right out of the Security Analysis textbook.
Cigar butt investing, however, often lives up to its analogy taking those final few free puffs
from a soggy, left-over cigar is generally unpleasant and it behooves the puffer to discard it
promptly. Our experience w/ EMG unfortunately applies. We entered the stock at around $5.80

The analogy: Find a recently discarded cigar butt on the sidewalk. There are one or two puffs left. Not very
appealing, but its free!

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per share in Q1 of 2014 and watched it briefly top $7 a year later. Exiting there would have
netted us a respectable 20% IRR. But I held on, believing there to be much more upside. Book
value was $10 per share, and book value heavily discounted the cash flows of life settlements,
implying a high-teens IRR even at fair value.
It is perhaps around then that management had delusions of grandeur. Instead of simply
stripping away excess operating costs and letting their valuable life settlements slowly run off
and accrue to shareholders, CEO Antony Mitchell and Chairman Phil Goldstein decided to
invest in more. Which would be a defensible idea were it not for the inconvenient fact that they
had no capital. Which forced them to raise expensive money from hedge funds and establish
esoteric financing vehicles with famed billionaire banker shark Andy Beal to ensure they can not
only buy life settlements but also pay their ongoing premiums.
When youre going to hedge funds and people like Beal8 for money, youre almost certainly the
sucker at the table. Operating expenses elevated as management retained their high salaries and
bonuses. Preferred shareholders got double-digit dividend payments. Beals vehicles got first
crack at the cash from maturing policies. Common shareholders like ourselves? Crammed way
down to the bottom, like a dog begging for scraps at dinner.
The lesson is this: when you invest in a company, whether its through the stock market or
through an advisor or through a limited partnership, you have to trust the people youre handing
your money over to. You are partnering with them. I chose to partner with Mr. Mitchell and Mr.
Goldstein, and that was my mistake. Mr. Mitchells track record managing public companies was
spotty at best and I knew it9. Bottom line: their incentives did not align purely enough with the
common shareholder of EMG and I cant blame them. They naturally do whats best for
themselves. I should have done what was best for us and sold earlier at $7, but instead, sucked
my thumb until it fell to $4.20.
***
EMG, in some respects, fell into the cracks of my evolution as an investor. The longer Im in this
business, the longer I want to hold onto my securities. I touched on this sense of permanence
in last years letter, an expression used by Professor Lawrence Cunningham to describe Buffetts
philosophy in building Berkshire Hathaway. There are practical reasons for this. Good ideas in
general are hard to find. Good ideas in a buoyant market are even tougher, and buoyant this
market was for the past six years. Furthermore, the amount of excellent managers with which to
partner with is slim, and the opportunity is slimmer still that the organizations they lead sell at a
discount. I wanted to hold EMG longer, but it was not the right buy-and-hold type of security.
An investment program contingent on having to constantly cycle through ideas increases the
odds of mistakes happening. Its just statistics. And psychologically, an investor with excess cash

Fascinating fellow who, when markets are overvalued, simply closes up shop and goes racing cars or challenging
poker pros to million dollar face-offs or noodle around in number theory. All true stories. Read em here:
http://www.amazon.com/The-Professor-Banker-Suicide-King/dp/0446694975

Antony Mitchell was concurrently CEO of Ram Power, a speculative geothermal venture that went bust.

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will tend to hunt for ideas rather than waiting for the obvious ones, i.e. to a man with a hammer,
the world looks like a nail. Its no coincidence that I invested in EMG soon after I began selling
Yellow Media, our biggest winner in 2013. Instead, it now seems more rational to take the time
to identify the really good ones, the ones that will compound internally, wait for them to be
mispriced, and then stick with them through thick and thin.
In addition, consider the deleterious effect of taxes. There is obviously a vast difference between
being taxed at the 15-20% long-term rate versus the upper-bracket 35-40% short-term rate. A
fund that is annually handicapped by 20% in extra taxes is certain to underperform in the long
run an underperformance that often goes unnoticed due how most funds report results on a
pre-tax basis. Its partially why its not all that dreadful when one makes the mistake of being
early when investing in a turnaround situation that might take multiple years for fruits to bear
because being early helps gets the clock going on calculating long-term capital gains. 91% of our
realized gains in 2015 were of the long term variety. Thats an A- Im hoping to turn into a solid
A in the years to come.
Of course, finding a business that we can hold permanently as it compounds is even more
desirable. The longer we delay in selling, the less taxes we have to pay, equivalent to an interestfree loan from the U.S. government. A loan we can furthermore choose when we want to repay
at our leisure. Again, this is not trivial. Even a 15% long-term capital gains tax slippage is
significant when compounded over multiple years.
Here now is a thought exercise. Both BBRY and GM have been in our portfolios for well over a
year. Both have had plenty of ups and downs; both have given me opportunities to sell for
double-digit gains but then given it all back. Some may argue theyre deserving of a place in the
mistake section, referencing the old adage that being early = being wrong. But Ill leave it to
you to make that decision.
My position is that as long as the thesis of each investment remains solid, I will pay little heed to
fluctuations in their daily quotations, even if, say, rumors of a buyout move the stock
dramatically up and down intraday. To trade on rumors is to let Mr. Market be your master
when it should be your servant. Most importantly, I believe both companies are in the midst of a
transformation driven by top notch, ethical management teams that have long-term visions
while demonstrating respect for shareholder value. And I believe we got in near the ground floor.
To be clear, facts may change and I may ultimately be wrong and no one will be more pained
than I. But in my judgment, that isnt the case today and mark-to-market volatility and editorial
chatter on the internet does not constitute as facts related to the fundamentals of the business. If
you feel differently, i.e. gains in shares should be preserved whenever possible whether theyre
ephemeral or not, i.e. market fluctuations should be feared and respected, i.e. sell first and ask
questions later because we might be entering a recession then please give me a call. I respect
your opinions, which means I respect that I may not be the right person to execute your
investment mandates. Life is too short to not sleep well at night.
***

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Some Final Thoughts

The great man is he who in the midst of the crowd keeps with perfect sweetness the
independence of solitude.
-Ralph Waldo Emerson
As of this writing, the general stock markets around the world are off to the worst start of the
year in recent memory. In times like this, unless you maintain sizeable shorts or are mostly in
AAA fixed income, few will avoid the carnage. But always keep in mind that investing is a
marathon, not a continuous series of sprints. Monthly, quarterly, and even annual results as
measured by stock prices provide limited signal quality. Focus instead on the underlying
fundamentals, the future earnings power, the asset values, the intangible brands and cultures
that permeate all great businesses.
Its simple to grasp but not easy to execute. Computers and the internet now allow us to
calculate our net worth on a second-by-second basis, firing up the follies of greed and emotion
like never before. Awareness is key, and hubris is the enemy. Never mistake the (mis)fortunes of
short-term volatility as an indicator of skill or accuracy. It is only when, years later and our
analysis has had time to permeate into the real economy to be cross-referenced, can we look
back and say: good work or try again.
Even in the so-called smart money circles of the buy side, there is a growing culture of
publishing research that purports to be long-sighted, but is largely a foil for marketing purposes.
If the long or short recommendation works out quickly, close the idea and declare victory. If it
doesnt, preach patience and reiterate long-term thinking. Its a win-win proposition, and it has
spawned a legion of asset managers and allocators and platforms catering to such a practice that
in my estimation reveal little of the character and fortitude present in all great investors.
Of course, not all who publish their research deserve such cynicism. Many are truly valuable and
well-written, especially those born from years of experience that educate the lay reader. The
trouble is the howling hoard of imitators that follow, diluting the signal-to-noise ratio with base
intentions of raising fast-money capital with which to charge high fees on. Those folks are asset
managers first, investors second 10 more concerned with generating fees than generating
returns. Incandescent Capital will always strive to be the inverse.
Remember, literally 95% of my net worth is invested alongside yours, so constructing a portfolio
that allows me to sleep well while feeling excited about its prospects is my day-in-and-day-out
obsessive concern. That is one constant you can always count on. Investing is not just a job for
me, it is my raison d'tre and a wellspring of purpose and joy. I tap dance to work and feel
humbled and grateful to all my investors who enable me to do what I love every day.

10

You can spot them at cocktail parties comparing Assets Under Management (AUMs) like comparing their
manhood.

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As always, I welcome any questions and/or feedback. I wish you and yours a prosperous and
joyous new year.

Sincerely,

Eric Wu

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