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Author: formorears Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 46837  
Subject: Mr. Lynch plays some cards Date: 5/26/2004 11:20 PM
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The gray suit gets my attention, not the white hair. After all, the average age of Bridge League members is sixty-six, so there's plenty of white hair in the room. The rest of the players are dressed casually, however, so the suit immediately catches my eye.

Some players are already sitting at the card tables chatting, others are munching on bundt cake and M&Ms in the kitchen, and still others are milling about in anticipation of the start of tonight's tournament. Although this is the club championship, it doesn't look much different than any other night at the bridge club, except of course for the suit.

He is sitting South. In duplicate bridge, the North-South pairs remain at the same table for the whole session while the East-West pairs rotate to the next table after every round. Because I'm also sitting South, it means I won't get to meet him tonight.

Too bad. I had imagined starting a conversation with him about Varsity Group -- a company we both own. Of course he made his purchase a few months earlier…and (ahem) owns a few more shares than I do.

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Peter Lynch bought 1,070,000 shares of Varsity Group (OTC BB, VSTY.OB) – a 6.5% stake – toward the end of January, 2001. At the time, Varsity was selling for roughly $0.30 per share. The closing price for Varsity on May 26, 2004 was $6.09, so assuming Mr. Lynch still holds these shares – which he did as of December 31st -- and assuming he paid somewhere near the $0.30/share price, he has a twenty-bagger. His original investment of roughly $300,000 has grown twenty times to somewhere over $6 million.

[ Mr. Lynch originated the expression “four bagger”, “ten bagger”, etc. It comes from his love of baseball, a ten-bagger meaning two home runs and a double, or ten total bases. - from a PBS Frontline interview]

It's not hard to see why Mr. Lynch was attracted to Varsity in early 2001. For starters, the company was backed by some influential investors…

* The Carlyle Group owned 13%. One of the world's largest private equity firms, with more than $18 billion under management, The Carlyle Group's was chaired by former Secretary of Defense Frank Carlucci. [ now chaired by Louis V. Gerstner Jr. ] Key advisors to The Carlyle Group were former Secretary of State James A. Baker and former British Prime Minister John Major.

* The Mayfield Fund owned 14%, with another 14% controlled by Allen Morgan, a Mayfield partner. Mayfield has over $2 billion in capital under management, with historical investments in companies such as Compaq, Genentech, Legato, and Tandem. [ On its Web site, Mayfield lists a current investment in The Motley Fool. ]

Despite its impressive ownership, Varsity was virtually ignored by the market in early 2001. The company had lost plenty of money since its inception in 1997, and its stock had recently been delisted from Nasdaq. Varsity was seen as just another failed 'dot.com' as the country headed deeper into the bear. Nevertheless, with an untapped niche market, a new business model that had just turned the company cash flow positive, no debt, and $1.09 per share in cash, Varsity certainly was appealing at $0.30/share.

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Varsity is just one of the high risk stocks that make up Mr. Lynch's personal portfolio. There are at least a dozen others. He has to disclose ownership in these companies because he owns greater than a 5% interest in them. The stocks are owned by Lynch himself, family trusts, and his charitable Lynch Foundation.

These visible investments most likely represent a small portion of his holdings. He declines to discuss the specifics of his portfolio other than what he is required to disclose. But he does say that they are a meaningful part of his overall investing strategy.

Peter Lynch holdings based on SEC filings:

Abraxas Petroleum
Barbecues Galore
Calloway's Nursery
eRoomSystems
Hartville Group
IntegraMed
Interep National Radio
Miller Industries
PHC
Rag Shops
SafeScript Pharmacies
Segmentz
Tenera
Varsity Group
WorldQuest Networks

"A pretty hairy list", says Mr. Lynch. "These are not high-quality, easy to buy for your mother-in-law stocks…I deal in stocks that I think are high risk and high reward. A lot of times things go wrong and the company buys the farm. It's not for everyone and it's not a normal method of investing. But these are not lottery tickets. I've done thorough research on every one of these. But it doesn't mean I'm right.” - all material in this section is from an Aug 29, 2002 Steven Syre article in The Boston Globe

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You don't have to look far to find one of his stocks that bought the farm.

In August, 2003 Mr. Lynch purchased a 7.2% stake in RTIN Holdings Inc. [ now SafeScript Pharmacies Inc. (OTC Pink Sheets, SAFSQ.PK) ]. On March 19, 2004, Safescript's board of directors filed a petition for bankruptcy protection under Chapter 11 of the US Bankruptcy Code.

But we are getting ahead. This story starts with a baseball player.

Stanley Lawrence Swanson signed with the Cincinnati Reds as an amateur free agent in 1963 at the age of nineteen. He played in the minor leagues for the next eight years before he was traded to the Montreal Expos organization in 1971. He made his major league debut for the Expos on June 23, 1971, and played in forty-nine games that year. An outfielder, he batted .245 with fourteen home runs. He earned his place in the record books by becoming one of Nolan Ryan's 5,714 strikeout victims.

Stan Swanson left baseball in 1972 to go into the restaurant business. After a few years, he moved to Montana to try real estate. In 1986 he started Canaan Enterprises, a real estate franchising business. In 1989 Mr. Swanson sold Canaan Enterprises, moved to Texas, and with the money from the sale of Canaan, opened "Bosko's 3 N 1 D-Lite" restaurant in Marshall, Texas in 1989. Over the next few years, he opened several more restaurants, and the fledgling company was incorporated in Delaware in 1990 as Fresh'n Lite Inc. In 1995 it became a Texas corporation, with four active restaurants (four others were closed or sold).

In 1997, the company went public, keeping the name Fresh'n Lite, with Stan Swanson as CEO and Chairman, his wife Carole Swanson as Secretary, and their son, Curtis Swanson, as CFO. Dallas Cowboy star and Hall of Famer, Bob Lilly ("Mr. Cowboy"), sat on the board of directors, together with a fellow named Ed Dmytryk, a name that would pop up later in this troubled tale.

Over the next six years -- or until the summer of 2003, just about the time Mr. Lynch would have been doing his due diligence -- the Swansons compiled the following enviable record…

* They never filed a 10-K or 10-Q on time.

* They changed auditors five times.

* They changed the name of their company three times.

In 1998, doing business as Restaurant Teams International, the Swansons borrowed $3 million from an investment firm. They used $1.2 million of the proceeds to buy a building from Four Seasons Marine, a company in which they owned a 43% interest. They then filed suit against the investment firm, alleging fraud and violation of federal and state securities laws. The debt had a conversion rate based on 80% of the market price of the Company's common stock, which the Swansons alleged was manipulated downward by illegal short selling in order to obtain a larger number of conversion shares. The defendants counterclaimed alleging default on the debt, breach of contract, securities fraud and common law fraud. This battle dragged on for years.

By the year 2000, the Swansons had closed all but one of their original restaurants, bought another chain of eight restaurants -- called Tanners -- out of bankruptcy, and purchased a professional services training company called RSI. The sale of RSI was later rescinded because the Restaurant Teams International defaulted, resulting in a loss of $1.2 million. Tanners was also sold at a loss in order to pay off debts. During this time, they tried -- unsuccessfully -- to buy a restaurant chain called Fatburgers, and several other chains. This pursuit lasted a couple of years and ended up costing them over $4 million with nothing to show.

In 2001, the company name changed to RTIN Holdings, and the Swansons liquidated all their restaurant assets. They then purchased Medex Systems, a company that developed and licensed hardware and software for electronic transmission of prescriptions, and also purchased Pegasus Pharmacies, a chain of pharmacies that used the Medex technology. The sale of Medex and Pegasus was later rescinded for non-payment. As part of the settlement, the owners of Medex and Pegasus received a stake in RTIN, and RTIN received the right to sell licenses for Medex products and to open Pegasus pharmacies in certain territories in the U.S. They sold these licenses under the name SafeMed Systems and SafeScript Pharmacies.

Over the next year and a half, the main business of RTIN was selling license agreements for SafeMed and SafeScript. However, with debts and lawsuits mounting, Stan Swanson resigned in July, 2003, and his son Curtis took over as Chairman and CEO. It was at this time that Barron Partners, a small investment firm out of NYC that specialized in OTC stocks, introduced Mr. Lynch to RTIN. Barron had purchased an 8.2% interest in July, 2003.

In August, 2003, Mr. Lynch purchased 1,200,000 shares of RTIN at $1.25 each in a private placement. He also received warrants to purchase additional shares for $1.50 each, exercisable over the next three years. In addition, he bought some shares on the open market (selling at that time around $1.70) for a total holding of 1,785,000 shares -- a 7.2% stake. After news broke of the Lynch purchase, RTIN shares climbed 24% to $2.10.

On August 29, 2003, in a statement to Dow Jones, Curtis Swanson exclaimed "Obviously, we were happy and humbled that he would take an interest in our company and we are excited to see how this will develop in the future". He said Mr. Lynch's advice was "to hold true to our business model and stay focused and do what we're doing because that's been successful". Prophetic words.

In December 2003, Mr. Lynch exercised his warrants at $1.50 per share. As of 12/31/03 he owned 7.95% of the company, or 2,047,000 shares. In the same month, RTIN changed its name to SafeScript Pharmacies. On January 27, 2004, after an endorsement by an investment bank, SafeScript's stock rose to a new high of $5.45. The picture looked rosy.

Then the bottom fell out.

On February 3, 2004, the company disclosed it was under investigation by the SEC. On February 5th, SafeScript's auditor's quit, alleging they were lied to by management about finances for the year's 2001 and 2002. These were the years that SafeScript was actively selling licenses for territories in the U.S. In company filings it appears that several of these licenses were sold for notes receivable. (The previous auditors were fired in 2002 because they had expressed doubts about RTIN as a going concern).

On February 5th, CEO Curtis Swanson and CFO Steve Cavender resigned. Curtis was replaced by an old friend from earlier days, Ed Dmytryk, one of the original board members and good friend of Curtis (and part owner with Curtis of a pizza restaurant at Six Flags in Texas).

Under Mr. Dmytryk's leadership the company announced it would conduct its own internal investigation, would hire a law firm to defend SafeScript in the SEC action, and hire another firm to help provide financial advisory services. In the next few weeks the company backed away from these initiatives, and fired both firms.

On March 19, 2004, SafeScript filed for bankruptcy. The company listed assets of up to $1 million and liabilities of up to $10 million, with about $3.6 million owed to its 20 largest creditors. The SEC probe, and numerous other legal battles also are pending. The company disclosed it does not have director or officer insurance, so it may not have the resources to defend itself in court. Effective March 15, 2004, SafeScript was deleted from the OTC BB, and listed on the pink sheets. Its stock sells for $0.08 as of May 26th.

It's possible that Mr. Lynch was able to sell his shares during a large volume sell off (3,549,464 shares) when the stock closed at 0.93 on March 8th. If not, his original investment of about $2.5-3.0 million is worth about $165,000 today.

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A bridge hand consists of thirteen cards randomly dealt from a deck of fifty-two. The number of possible distinct bridge hands is a little over 635 billion. A bridge player cannot know how to play every one of them. Instead, you must learn how to value a hand using some rules of thumb and judgment based on experience. As you progress through the bidding and play of the hand, you must also learn to constantly reevaluate your hand in light of new information you receive from your partner's bids, and your opponents' bids and play. It's not unlike investing.

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One investment Mr. Lynch constantly reevaluated was Worldquest Networks (NasdaqNM, WQNI), a company that sells virtual prepaid calling cards on its Website and transmits long distance calls at discounted rates via the Internet and traditional networks.

Mr. Lynch purchased a 5.7% stake -- 364,000 shares -- in Worldquest in the fall of 2001 when the stock was selling for around $1.90/share. In the following year he increased his stake to roughly 10%, or 646,700 shares when Worldquest was selling in the range of $1.60/share. By early March 2004, Mr. Lynch had accumulated 796,700 shares -- a 12.5% stake.

In the next fifteen days Mr. Lynch sold off all but 67,500 shares, at prices ranging from $4.00-$6.00/share. Most of the shares were sold on the day that Worldquest announced an agreement to merge with Ntera Holdings, a privately-held provider of voice over Internet protocol (VoIP) services. The stock is currently selling for about $3.30/share.

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His partner at the club championship is a well-known bridge teacher in the area. Perhaps his coach. This wouldn't be surprising. After all, his wife plays in many tournaments with her teacher -- Dennis Dawson, one of New England's top players -- as her partner. Warren Buffet pairs up with mentor Sharon Osberg, a two-time world champion. Bill Gates is coached by Ms. Osberg and also Fred Gitelman, a bridge gold medallist and developer of educational bridge software.

Sometimes they all get together. Bill Gates and Warren Buffet teamed up at the Summer Nationals in Long Beach, California in July, 2003. A week after that, Mr. Buffet entertained Mr. Lynch and his wife in Omaha, and they played a friendly match. Mr. Lynch and his wife then moved on to play in the Nebraska regional tournament where their team won three events. - material from Alan Truscott, New York Times, Aug 21, 2003

It would have been fun to sit in on the Lynch/Buffet game. According to a January 23, 2004 article by Harvey Schachter in the Toronto Globe and Mail, Mr. Buffet is very competitive: "Two-time world bridge champion Sharon Osberg, who plays with billionaires Bill Gates and Warren Buffet, says that while Mr. Gates is a scientific player and Mr. Buffet an intuitive player, both hate losing. In one game, where she and Mr. Buffet were trailing his sister and brother-in-law, his sister said she wanted to frame the score sheet -- so Mr. Buffet ate it."

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If you've been keeping score, Mr. Lynch has had great success with his investment in Varsity Group, flopped so far with SafeScript, and executed exquisite timing with Worldquest.

How have the other hands played out?

Tenera (OTC Pink Sheets, TNRA.PK) -- Tenera provides Web-based learning and training products. Mr. Lynch purchased 782,000 shares -- a 7.8% stake -- in 1997. As of 12/31/03, he held a 3.9% stake, or 389,000 shares. On November 20, 2003, Tenera shareholders approved a resolution to dissolve and liquidate the company. Shares currently sell for $0.05.

IntegraMed (NasdaqNM, INMD) -- This company offers products and services to patients and providers in the fertility industry. Mr. Lynch purchased a 12% stake in 1997, and last reported a 4.8% stake on December 31, 2001. The stock price has ranged between $4.00-$8.00 during that period.

Calloway's Nursery (OTC Pink Sheets, CLWY.PK) -- This Texas-based retail nursery company is going private. Mr. Lynch initially purchased an 11% stake in 1995, and held a 109% stake as of 12/31/02. He did not file a registration statement in 2003, so the shares may have been sold.

Barbeques Galore (NasdaqNM, BBQZ) -- Mr. Lynch initially purchased 201,350 shares of this barbecue specialty retailer with stores in Australia and the United States in the summer of 2002. His stake has grown to 337,000 shares -- 8% -- as of 12/31/03. His purchase prices were in the $3.00-$3.50 range, and the stock now sells for around $8.00 per share.

Eroom Systems (OTC BB, ERMS.OB) -- Sells refreshment centers, safes, and thermostats -- all connected by a network -- to the lodging industry. This company had been heavily financed by Alan Ashton, co-founder of WordPerfect Corporation. Mr. Lynch invested in 7.9% of the company in March, 2002, and held an 8.5% stake as of 12/31/03. The company has done poorly, and there is some doubt it will continue as a going concern. Shares currently sell for about $0.30.

Interep National Radio Sales (OTC BB, IREP.OB) -- Interep helps its clients with advertising strategies and the purchase of advertising time on national radio outlets. In the summer of 2001, Mr. Lynch bought 498,00 shares, and now holds 564,000. The price of the stock has ranged between $1.50-2.50 for the last two years.

Abraxas Petroleum (Amex, ABP) -- Acquires and produces crude oil and natural gas. Mr. Lynch began accumulating shares in the summer of 2002 at prices ranging from $0.50 to $0.75, and now holds 3,335,440 shares -- a 9.3% stake -- at roughly $1.90 per share.

Miller Industries (NYSE, MLR) -- The only NYSE-listed firm in this group, Miller provides vehicle towing and recovery equipment. As of 12/31/03, Mr. Lynch owned an 8% stake -- 769,900 shares -- selling at $8.63 per share. He began purchasing Miller shares in the summer of 2002 at prices ranging from about $3.00-$4.00 per share.

PHC (OTC BB, PIHC.OB) -- PHC provides psychiatric services to patients with alcohol or drug dependency disorders, and to clients in the gaming and transportation industries. Mr. Lynch initially purchased a 5.5% stake at around $0.75 share, and now holds a 4.9% stake, or 668,681 shares, at $1.04 per share.

Rag Shops (NasdaqSC, RAGS) -- Operates a specialty retail chain of craft, fabric, and picture framing shops in the United States. Mr. Lynch's first purchase was in the summer of 2002 at prices in the $4.00 range. He currently owns 221,500 shares. Current price is around $3.28 per share.

Hartville Group (OTC BB, HTVL.OB) -- Pet insurer. Next time you go to the grocery store, look for their ads at the checkout counter. This is a recent purchase for Mr. Lynch. He owned 684,000 shares as of 12/31/03. Current price is $4.99 and rising.

Segmentz (Amex, SZI) -- Another very recent purchase. Mr. Lynch bought an 8.5% stake in January of this year. The company provides transportation and logistics services. Current price is $1.90 per share.

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Peter and Carolyn Lynch are recognized for their commitment to education. Since 1991, Mr. Lynch has been chairman of the Inner City Scholarship fund in Boston which raises millions of dollars each year to help send needy students to school. In 2001, he and his wife pledged $10 million dollars to the Archdiocese of Boston for the education of children. - Michael Paulson, The Boston Globe, Nov 20, 2001

In 1999, Mr. Lynch and his wife donated over $10 million to Boston College's School of Education. "People ask why I don't give to the school of management", Lynch said in and interview. "We look at this as 'Where can you get a lot for your money?'" He and his wife felt that the funds would be better served when focused on training teachers. They are particularly interested in improving urban and secondary schools. - Kate Zernike, The Boston Globe, Feb 17, 1999

Peter Lynch is a board member of The Special Olympics. He has an intellectually disabled brother. "There's a misconception that this is an every four year thing; Special Olympics is every day", he says. - Albert R. Hunt, Wall Street Journal, Jun 19, 2003

Much of the money Mr. Lynch earns from the investments mentioned in this post, as well as royalties from his books, go to the Lynch Foundation. The foundation provides money for programs in education, health care, and medical research. - Chris Echegaray, Worcester Telegram & Gazette, May 25, 2003

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There is a style of investing that says mimic the "masters". Find out what they are investing in and follow along. That's what I did with Peter Lynch in 2001. However, after considerable research, I was shocked to find out that most of what he was buying I considered pure junk. So I modified my expectations and picked the one stock in his group that I thought had merit. I haven't been disappointed.

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The tournament is over. We are all leaving. I didn't get to meet him, but I look over my shoulder and silently say "Thanks for the tip, Mr. Lynch".

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I hope this post was useful to you. I am sure there are errors. Corrections would be most welcome.

Disclosure: I own shares of Varsity Group, but do not own shares of any other company mentioned in this post.
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