Tuesday, October 28, 2008

TheStreet.com: Activist Investor: Liberty Global's Spinning Wrong Way

From TheStreet.com
By Eric Jackson
10/28/08 - 11:17 AM EDT

About 10 days ago, Liberty Media (LINTA Quote - Cramer on LINTA - Stock Picks) Chairman John Malone sold $18 million worth of stock in Liberty Global (LBTYA Quote - Cramer on LBTYA - Stock Picks), a video and broadband service provider catering to Japan, Europe and Chile. Although Liberty Global's stock price is down 55% in the last month, you should follow his lead and get out now ahead of earnings, which will be announced in early November.

Malone's multiple Liberty-related entities (e.g., Liberty Communications, Liberty Global, Discovery Communications (DISCA Quote - Cramer on DISCA - Stock Picks)) have one thing in common: a love for opaque corporate structures with multiple classes of voting shares. In early 2007, before the words "CDS" and "subprime" had entered our collective lexicon, such complexity mattered little compared with high-growth businesses fueled by acquisitions. Liberty Global complied with this preference and its shares peaked at $44 in July 2007. However, there's been a slow descent since then until this month when the stock has fallen off a cliff. They traded yesterday under $13.

Malone's large stock sales this month are not unique for corporate chiefs these days. Sumner Redstone of Viacom (VIA Quote - Cramer on VIA - Stock Picks) and CBS (CBS Quote - Cramer on CBS - Stock Picks) and Aubrey McClendon of Chesapeake (CHK Quote - Cramer on CHK - Stock Picks) both had to unload large amounts of shares in the face of margin calls a few weeks ago. Malone gave no explanation for his sale, although he presumably faced similar pressures, considering that Liberty Global had spent $1.621 billion repurchasing its shares in the first six months of this year at weighted prices between $34.37 and $35.55.

That cash spent on share repurchases at triple the current market price could come back to harm Liberty Global in the coming quarters, as it only had $1.2 billion in cash at the end of June and just under $20 billion in debt.

Liberty Global is essentially a Comcast (CMCSA Quote - Cramer on CMCSA - Stock Picks)for non-U.S. markets. It delivers video and Internet via broadband instead of traditional cable. It derives no revenue from subscribers in the U.S.; its customers are principally in Japan, Western and Eastern Europe, Chile and Australia. In the first half of 2008, when the notion of emerging markets being decoupled from a flagging U.S. economy was in vogue, such a portfolio would be envious. Now, it appears all these countries are in for a longer recession than the U.S.

Aside from country recession risk, Liberty Global is exposed to currency risk. Virtually all the currencies tied to Liberty Global's customers have weakened significantly between June 30 and Sept. 30. In October, the pace has dramatically increased. Hungary's forint is down 30% this month vs. the dollar, the Chilean peso is down 22.5%, and the Aussie dollar is down 31%. These three countries counted for 16.4% of Liberty Global's total revenue last quarter.

Liberty Global does have extensive derivatives to mitigate this currency fluctuation risk. And some of its debt held in these currencies will surely benefit from the strengthening of the dollar in the past few months. However, the explanations given in the most recent 10-Q make don't make clear the extent to which the company is protected. We will probably have to wait for a more complete explanation during the company's next analysts' call. What is clear is that many companies that believed they were protected from currency risk have experienced deep pain in the last few weeks (such as Citic Pacific's $2 billion loss on a wrong bet against the Aussie dollar).

Liberty Global's assets also include stakes it owns in Sumitomo and News Corp. (NWS Quote - Cramer on NWS - Stock Picks). These investments were worth $682 million at the end of June using fair value accounting. Both companies dropped 25% in the third quarter, and more in October.

When you stack up Liberty Global vs. Comcast, Liberty Global's valuation still appears too rich. Liberty Global's trailing price-to-earnings ratio is 98, with a forward P/E of 26. That is starkly higher than Comcast's trailing P/E of 16.8 and forward P/E of 13. Liberty Global also has a much lower operating margin, return on assets, and return on equity compared to Comcast. Additionally, Liberty Global's debt-to-equity ratio stands at 3.84 vs. 0.81 for Comcast.

We have seen highly levered companies with high P/E ratios -- such as Las Vegas Sands (LVS Quote - Cramer on LVS - Stock Picks) and MGM (MGM Quote - Cramer on MGM - Stock Picks) -- punished in the last few weeks, even though they had both experienced significant sell-offs over the last eight months. (Las Vegas Sands' debt-to-equity ratio is only slightly larger than Liberty Global's.) Liberty Global needs to win back the trust of shareholders by simplifying its corporate structure and fully explaining the extent of its currency exposure in next month's analyst call. Until then, investors should follow John Malone's lead and stay away from Liberty Global.

At the time of publication, Jackson's portfolio was short Liberty Global, CBS and News Corp.
Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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Wednesday, October 22, 2008

TheStreet.com: Activist Investor: Ballmer Needs to Live Up to the Hype

From TheStreet.com

10/22/08 - 10:00 AM EDT

By Eric Jackson

Following Tuesday's disappointing Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks) earnings, we'll see many press articles Wednesday congratulating Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks) CEO Steve Ballmer for walking away from the $31-a-share deal to acquire Yahoo! a few months back. Jerry Yang and his board will be pilloried again for their arrogant decision to dismiss the buyout offer.

Yet, shareholders might soon plant a bull's-eye on Ballmer's back.

Microsoft's stock sits around $24, as it did in 1998. Like the S&P 500's returns over the past 10 years, you could also refer to that period as Microsoft's lost decade.

Microsoft has more revenue, more businesses and more employees today than in 1998. But with this, it has become more bureaucratic. It's paid out dividends and bought back stock with its considerable cash hoard. And shareholders see its grip on the PC loosening as the world moves to Web services, and Microsoft is a distant competitor to Google (GOOG Quote - Cramer on GOOG - Stock Picks) in that sphere.

Although some Microsoft shareholders I spoke to this summer were pleased that the company abandoned its foray to purchase Yahoo! at a significant premium, Ballmer's reputation among his shareholders was damaged from that episode.

More than ever, Microsoft shareholders are wondering where Ballmer is leading the company. Will Microsoft be a large cash-cow conglomerate that pays a nice dividend and grows much more slowly?

Will it make a splashy and expensive acquisition of Yahoo!, Research In Motion (RIMM Quote - Cramer on RIMM - Stock Picks), or SAP (SAP Quote - Cramer on SAP - Stock Picks) to try to keep up a faster rate of growth? Or will it be stuck in the middle of those two very different strategies, trying to do both?

It's up to Ballmer to articulate first to his board and then to shareholders (and potential shareholders) what his plans are. Eight years into his tenure, he hasn't done this.

A classic stereotype about CEOs is that those who come from a sales, engineering, or finance background tend to be more short-term focused and analytical. Those from marketing or a variety of functional background experiences tend to be more strategic and long-range thinkers.
It's not either/or, of course, as the best CEOs have a combination of short-term decision-making and street smarts, balanced with a long-range vision.

Ballmer is often described (even in his official corporate bio) as ebullient, hard-charging, passionate and dynamic. These are all fine characteristics, but clearly he's not spent enough time with shareholders selling the overall plan for Microsoft.

If you're a value institutional investor and buy into Microsoft now because of its low price-to-earnings ratio and dividend yield, you face the possibility that Ballmer might change the rules of the game next week with another "transformational" acquisition. This "undefined strategy risk" is a weight on the stock price.

Ballmer can easily correct this problem, and Microsoft has such wealth, talent and market leadership that it cannot be counted out. Despite Ballmer's enormous personal wealth, it's likely he views the next 10 years of his career as the most important. This is his time to step out of Bill Gates' shadow and truly leave his mark on Microsoft.

I believe the "growth model" of Microsoft is a more compelling vision than the "utility model." To execute that vision, he will probably need to shed some businesses to increase its focus.

We'll see whether Ballmer can make this elephant dance.

At the time of publication, Jackson's fund owned no Microsoft or Yahoo! Jackson still personally holds a small long position in Yahoo! in his personal account.

Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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Wednesday, October 15, 2008

Directorship: Election Disconnection

From Directorship
October 01, 2008

Yahoo’s flawed shareholder vote casts a shadow on the proxy-voting process.
by Django Gold

In the year since the furor surrounding Yahoo’s 2007 shareholder meeting and then-CEO Terry Semel’s subsequent resignation, the beleaguered Internet giant’s affairs have continued to slide. Facing a botched—some critics would say sabotaged—deal with Microsoft and the increased ire of investors who had endured a steady decline in stock value, the Yahoo board looked like it was heading for another trip to the woodshed. Shareholders and the media were calling for reorganization among upper management, and though Carl Icahn had secured his three board seats and was for the moment placated, there were many other shareholders who were out for blood.

Despite the energy of Yahoo’s critics in the weeks leading up to the August 1 annual meeting, the event itself seemed remarkably sedate. In fact, when the proxy votes were posted that afternoon, no director earned less than 78 percent approval—by no means a show of rousing support, but nowhere near the revolution that some had expected. Members of the media consequently dubbed the meeting a virtual non-event; the board had successfully weathered the storm and shareholders seemed more content than anyone had expected. “It’s almost as if the past six months never happened,” noted BusinessWeek in its coverage of the annual meeting.

Many dissident shareholders weren’t pleased with the meeting’s benign results. Others, among them Eric Jackson, founder of Ironfire Capital, an activist investment firm that owns about 3.2 million Yahoo shares, didn’t believe them. In a blog post on his website, Jackson questioned the validity of the election.

While allegations of wrongdoing in director elections are extremely rare, Jackson is not the first to cry foul. The proxy voting process is complex, obscure, and, as underscored by Jackson’s complaint, woefully imperfect.

Through the complications of custodial ownership (85 percent of shares are controlled by custodians—banks and brokerage firms) and the sheer scale of an election in which hundreds of millions—and sometimes billions—of votes are cast and counted, the proxy-voting process can be a web of confusion. A widely circulated essay on proxy voting titled “The Hanging Chads of Corporate Voting” describes the process as “noisy, imprecise, and disturbingly opaque.” Edward Rock, one of the paper’s co-authors, claims that “most of the people who run companies and administer the rules that govern them do not understand how proxy voting works.”

For example, Jackson knew that something was wrong with the Yahoo results, but he didn’t know how to prove it. Instead, he noted an inconsistency in the number of votes cast. He found that the publicly posted results from Yahoo’s 2007 proxy indicated a total of 1.2 billion votes, with the 2006 vote count closer to 1.3 billion. The 2008 vote count? Just under 1.05 billion—200 million fewer than the average of the last two years.

“It was bizarre,” says Jackson. “Given the increased scrutiny and media attention, there’s no reason for such a drastic drop [in shareholders casting votes].” Jackson posted the findings on his blog and shareholders took notice.

Gordon Crawford, portfolio manager for Capital Research Global Investors, which owns a 6.2 percent stake in Yahoo, immediately requested a recount from Yahoo and Broadridge Financial Solutions (formerly ADP), the proxy-services manager that administered the vote. Broadridge performed the recount with disarming speed: On August 5, Yahoo issued a press release claiming a “truncation error” that resulted in some directors getting fewer “withheld” votes than had actually been cast. The modified count added 200 million votes to three directors’ “withheld” column—CEO Jerry Yang and chairman Roy Bostock among them—and 100 million to two others. The changed votes weren’t enough to dislodge any directors (Bostock’s 39.6 percent disapproval was highest), and the overall vote count—1,046,098,584—remained the same. Yahoo maintains that the mishap was an honest mistake. Critics aren’t so sure. The problem is that without much transparency in the system, shareholders like Jackson are forced to take Yahoo’s and Broadridge’s word for it.

Nuts and Bolts

When a proxy vote occurs, the “issuing company” must perform a number of duties besides producing the proxy card and its accompanying literature, including identifying the shareholders. As most of the shares are held by custodians, the issuer must identify these custodians and determine the number of shares held by each. This is accomplished by soliciting the Depository Trust & Clearing Co. (DTCC), the holder and “bookkeeper” of the vast majority of all securities held in the United States. The task is complicated by the fact that custodians frequently lend the shares out to other institutions.

Because most investors prefer not to let the issuer know their vote, it is necessary to use a third-party administrator to find the beneficial shareholders. The administrator’s duties also include issuing and collecting the vote. The administrator is hired by the custodians, but is paid by the issuing company. The dominant administrator in this process is Broadridge, which administers most of the proxy votes in the United States—“the lion’s share,” according to a company representative. An archived SEC filing on Broadridge’s website claims the company processed 70 percent of all U.S. shareholder votes in 2006.

It is only after the voting rolls have been determined that the vote can take place. The administrator collects proxy-voting materials from the issuing company and transmits them to the beneficial shareholders. This is accomplished by either mailing voting materials (which include an individual ballot along with a proxy statement and the issuing company’s yearly report) to the beneficial owner, or posting them online so electronic votes may be cast.

After voting has closed, the administrator sends the returned votes to a separate transfer agent (also paid by the issuing company), who counts the votes and determines the
results. For votes that could be contested, such as elections at companies with shareholder unrest, a tabulator instead counts the votes. Two major tabulators are IVS and Corporate Election Services (which tabulated the contested Yahoo vote). After the tabulator or transfer agent counts the vote, making sure that the total number of votes cast matches the issuer’s records, the results go back to the administrator, who reports them to the issuer, and then the issuer releases them to the public. “It is a difficult, obscure, and complex system,” says Rock, “and with a system of this complexity, things will invariably go wrong.”

It’s not just complexity that raises the possibility of problems. Another obstacle is the narrow window in which the vote must be conducted. Delaware corporate law mandates that the “record date”—the point in time prior to a shareholder meeting at which the shareholder voting rolls are determined—must be within 10 and 60 days of the meeting. Most companies take the full allotment to allow for potential hiccups, but sometimes 60 days isn’t enough. Each of the steps required to ensure a smooth vote can take days and even weeks, and there are innumerable reports of voting materials never making it to shareholders, or of voting materials arriving well after the vote has concluded.

Another problem that accompanies the record date is the routine practice of securities lending. Voting rights go to the borrower of the share, usually a short seller, who ostensibly has an interest in seeing the share price decline. Therefore, short sellers may be inclined to vote against directors to foster the impression of turmoil at the company.

As in many corporate affairs, the specter of conflict-of-interest also rears its head during the proxy-voting process. In a given shareholder vote where the issuing company’s board is at stake, the conflict can be defined as the issuer versus the shareholders. But the issuer also happens to be in charge of controlling the vote up to a point, after which control cedes to an administrator, who is paid by the issuing company. This fundamental bias present in a proxy election means that the odds are, by default, positioned in the issuer’s favor, especially because abstaining votes (or those that never arrive in the first place) generally count in the existing board’s favor.

But none of these obstacles would matter were it not for the fundamental flaw in the proxy-voting system that Rock views as the chief impediment to legitimate elections: the lack of transparency in the process as a whole. “In any election, you want to establish an end-to-end audit trail so that you can show the vote was fair and accurate,” says Rock, “but the current proxy-voting system is too complex to allow that to happen.” Very few votes are contested, and regulators such as the Securities and Exchange Commission rarely probe into specific proxy contests. Critics charge that there are insufficient checks on the process to ensure that voting moves smoothly and in accordance with proper conduct. It is this lack of transparency that leaves shareholders, company personnel, and regulators in the dark.

In the Yahoo case, this lack of transparency has been a source of frustration for certain shareholders. “No one from Yahoo or Broadridge has provided an answer to where the extra votes went…it doesn’t give you confidence that they went back and analyzed the votes. It’s more like they just wanted a quick fix,” says Jackson.

Chuck Callan, Broadridge’s senior vice president of regulatory affairs, called the error “an isolated incident brought about by a confluence of factors,” and claimed a review of past votes found that no such error had occurred previously.

A Voting Monopoly

With its “lion’s share” control of the U.S. proxy-services market, Broadridge has a kind of monopoly that most companies dream of. Since Broadridge (then called ADP) began offering proxy-voting services in 1989, it has come to define the industry. In its first year, it administered voting for 31 client custodians; today, Broadridge annually processes around 818 billion votes in 14,000 elections.

Broadridge cites a variety of internal and external checks to ensure the integrity of its system, including annual reviews with both the SEC and NYSE. It also reports that its voting system—which constantly moves towards electronic recording and away from paper ballots—saved clients almost $500 million in the recent proxy-voting season. Broadridge’s services are “unparalleled in the public market,” Callan says.

But critics like Rock continue to cite transparency as being essential to an accurate and trustworthy voting system. “If the public had access to the vote, we could be confident in Broadridge’s ability to effectively administer the proxy,” he says, “but without that transparency, we can’t trust that this huge and complex process is going through without a hitch.”

A Better Way?

Identifying a problem is easy, but how to revamp a system as complex and far-reaching as proxy voting? An end-to-end audit trail that would allow a given proxy-election’s results to be verified by a third-party would require regulators such as the SEC to increase oversight and develop new methods to probe a given vote.

“Investors would feel better assured that their best interests were being looked out for if there was more oversight by the SEC,” says Patrick McGurn, special counsel at RiskMetrics. “Shareholders need to know that their vote counts, and that means more oversight on more levels. If there were more independent inspectors, voters would have better faith in the system.”

In their paper, Rock and co-author Marcel Kahan propose an outright “redesigning of the architecture” in which the complexities of the custodial ownership system of share-voting are discarded in favor of the “Spanish” model. Spain’s public companies distribute shares to investors through a centralized bookkeeping system in which the company registers its stock sales through a depository known as IBERCLEAR. Through this method, third-party intermediaries such as investment banks and stock brokers are not involved in the voting process; when a proxy vote occurs, the third-party vote administrator just has to contact IBERCLEAR to determine who should receive proxy materials.

The proof of the efficacy of this system is the fact that voter rolls are taken a mere five days before the shareholder meeting, not the 10-to-60-day window offered in the United States. One vote for one share, and one regulatory system to keep the numbers in line. “I’m not sure how easy it would be to implement,” says McGurn, “but the more streamlining, the better.”

We May Never Know

Several months after the Yahoo share-holder meeting, the controversy surrounding the alleged missing votes has for the most part faded from the public eye. Yahoo’s board remains whole—Carl Icahn’s negotiated additions notwithstanding.

Eric Jackson’s disappointment in what he now refers to as the “scandal” also remains. “I’m frustrated with how the voting scandal played out,” he says. “Yahoo’s strategy was ‘put your head down and hope it goes away,’ and that’s exactly what happened. It may have just been a mistake on Broadridge’s part, but Yahoo cooperated with it, and so we’ll probably never know just what happened with the vote.”

For Jackson, frustration with the outcome of the Yahoo vote gave rise to a brief flurry of media attention, but ultimately led to no changes in the makeup of the Yahoo board. However, this brief time in the limelight was perhaps not in vain, as it exposed deficiencies of proxy voting as a whole.

As companies and regulators consider the possibility of improving the proxy-voting process, expect more complaints like Jackson’s. Expect, too, that the conversation will likely emerge in the forefront of regulatory discussion.

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Monday, October 13, 2008

TheStreet.com: Activist Investor: Sell Yahoo!

From TheStreet.com

10/13/08 - 11:30 AM EDT

For nearly two years, I've been engaged in an activist campaign to aimed at improving the performance of Yahoo! (YHOO Quote - Cramer on YHOO - Stock Picks). No more. I sold my fund's stake last month. The risk/reward ratio of continuing to hold the stock had become too high.

When I started my activism with Yahoo!, I was attracted to the Internet company's strong brand, which continues to drive impressive traffic to its many popular properties. It's still the No. 2 search engine in the world and it's also No. 1 for email.

Any new Web company has no hope of emulating those numbers. Microsoft (MSFT Quote - Cramer on MSFT - Stock Picks), with its online services division, has been trying to achieve credible numbers in all those areas for the last 12 years -- with little success to show for its efforts.

I believed that with better oversight from a new board and management, Yahoo! could finally capitalize on its many strengths. We've had no significant changes at either level. The company is still muddling ahead with just as many priorities, just as many staff and just as many boxes on the organizational chart. I came to the conclusion that this company is doomed to failure with the current board and leadership.

Leadership matters. It helps companies to pull away from competitors or to catch up. Unfortunately for shareholders, Yahoo! has lacked a strong CEO for seven years now. Its board has continued to approve excessive pay to executive management and themselves. They will always be remembered for turning down $31 and then $34 a share from Microsoft.

When Yahoo! Vice President Brad Garlinghouse penned the infamous Peanut Butter Manifesto in October 2006, there was reason to hope that some new ideas and energy might actually spring up from within Yahoo! to shake some of the scales from this organization's eyes.

Two years later, that letter's call for changes have gone unanswered and the prescriptions are as relevant now as they were then. I suspect the same will be said again two years from now.

Anyone holding a long position in Yahoo! is doing so for the potential value their assets might fetch in a company sale to Microsoft, not for the potential increased value current management might create from extending the current assets. It is likely that some kind of deal with Microsoft will happen. Microsoft continues to be exactly nowhere in terms of search and Web services traction.

Yahoo!'s proposed deal with Google (GOOG Quote - Cramer on GOOG - Stock Picks) appears to have stalled in regulatory approval. Most importantly, Yahoo! is trading at its early-2003 levels -- 59% below its Feb. 12 close after the Microsoft bid earlier this year.

I judged I couldn't continue to hold Yahoo!'s stock based on a strategy of hoping that Steve Ballmer will come back to the negotiating table. As he's bidding against himself, he has no incentive to come back now versus waiting and watching Yahoo!'s stock continue to drop. And, with the frozen credit markets and large media companies having seen their market capitalizations drop 30%-60% in the last month, make no mistake: Microsoft is still going to be the only bidder for Yahoo! in the foreseeable future.

A scary thought for Yahoo! longs is that, as much as Yahoo! has dropped, it could still have further to go. Yahoo! has stubbornly kept a higher price-to-earnings ratio than Google over the last two years, when it would not appear to be warranted. Today, Yahoo!'s forward P/E for 2009 is still 23, vs. 14 for Google, 15 for InterActive Corp (IAC Quote - Cramer on IAC - Stock Picks), 16 for Apple (AAPL Quote - Cramer on AAPL - Stock Picks), and 11 for Research In Motion (RIMM Quote - Cramer on RIMM - Stock Picks). If Yahoo! were to see its forward P/E contract to be in line with Google's, its share price would drop another 40% to $7.50.

Yahoo! bulls will argue that Yahoo! has $2/share in cash and that its Asian assets are worth another $3/share, so a $7.50 price target is too low. However, Yahoo! had the same amount of cash on its balance sheet in 2002, when its stock price hit its post-bubble nadir of $4.87. The current advertising market downturn likely will be longer and deeper than the one we saw in 2000-02. Those Asian assets have certainly dropped 25%-35% in the last month with the rest of the Internet sector.

Lower forward-looking guidance during next week's analysts' call could prompt more dumping of Yahoo! shares.

Nothing will change at Yahoo! until its board is revamped. Chairman Roy Bostock was unapologetic about his handling of the Microsoft negotiations when he spoke at the August shareholders' meeting. Bostock wasn't embarrassed that 33% of shareholders voted against his reelection in 2006. He should be. Over 40% voted against him in 2007 and next year he will likely break the 50% threshold. Bostock should leave now, along with other longtime directors who were hand-picked by Terry Semel and still serve.

Jerry Yang and Sue Decker also need to be replaced. They have carried on Terry Semel's Yahoo! There is little different about the company today vs. two years ago. An outsider needs to come in and clean house. There is still great talent within the company and great assets.

I wish the current Yahoo! longs well, and I suggest they find inspiration from Gordon Crawford of Capital Research Global Investors (now a 10% owner of Yahoo!). Crawford has been absolutely on the mark in his criticisms of the board (and correctly recognized that there was a major vote-counting error that understated the degree of anger aimed at the board at last August's annual meeting).

If you're a long investor in Yahoo! and think you can free-ride off the activist efforts of Crawford (or Carl Icahn), this movie will end in tears. This board will retain power and this company will drift rudderless. Passive investors who keep doing what they've been doing will keep getting what they've been getting from Yahoo!.

At the time of publication, Jackson's fund owns no Yahoo!. Jackson still holds a small long position in Yahoo! in his personal account.

Eric Jackson is founder and president of Ironfire Capital, LLC, and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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