Seth Klarman's hedge fund, Baupost Group, has achieved annualized returns of 19% since its inception in 1983. His performance is legendary. Interestingly, only about 7% of the fund's $22 billion in assets is invested in equities with the lion's share going into bonds. Unfortunately, only the equities are disclosed, hence the focus on its stock holdings. It's unusual to find such a successful investor hanging on to long-time losers but a previous article examined Domtar (NYSE:UFS), held since the first quarter of 2007 and today's will look at Multimedia Games (Nasdaq:MGAM), held since the third quarter of 2006. Klarman must be a patient man because by my estimation, Baupost Group is currently sitting on an $11.8 million loss from its $24.6 million investment.

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Diminishing Returns
Multimedia's annual revenues peaked in 2004, generating $153.7 million an operating profit of $50.4 million. It's been downhill ever since. Baupost Group first bought shares between July 2006 and September 2006. This was Multimedia's final quarter of fiscal 2006. In 2006, it generated revenues of $145.1 million and an operating profit of $7.5 million. In the span of two years, its operating margin fell from 32.8% to just 5.2%. Its stock dropped from $15.50 down to $9.08, a loss of 41.4% compared to a gain of 19.9% for the S&P 500. In the past five years, it's lost $24.1 million on $678.5 million in sales. What could possibly be keeping Klarman in the game when it appears there's no light at the end of the tunnel?(Both indexes include the same stocks, but their weightings give them very different properties, read S&P 500 ETFs: Market Weight Vs. Equal Weight.)

Short-term CEO
When former Harrah's executive Anthony Sanfilippo took the job as CEO in June, 2008, he said this about the company: "This is a terrific opportunity to lead an organization that promotes a professionally fulfilling environment for our employees, to develop outstanding products and services for the market, and to have financial outcomes that our shareholders will value."

Less than two years later, Sanfilippo jumped ship, moving to Pinnacle Entertainment (NYSE:PNK), an operator of casinos in Nevada, Indiana, Louisiana and Missouri. Considering Pinnacle's taken $525 million in impairment charges over the last two years, Sanfilippo must have wanted back into the casino game in a big way. It makes me think he only took the job at Multimedia to keep his foot in the door for a future gig, which makes me wonder why the board hired a casino operator when it clearly needed a turnaround artist. In response to this relatively quick departure, its board implemented a retention bonus for key executives including interim CEO Patrick Ramsey that would see six of them receive $2.6 million in additional cash simply for sticking around until the end of December. (Impairment charge is a term for writing off worthless goodwill, but you need to know what it means and what its potential impact is on EPS, check out Impairment Charges: The Good, The Bad and The Ugly.)

Competitors Faring Better
The casino business has seen a slow recovery in the first half of 2010 and that should help gaming-equipment manufacturers in the months ahead. The past three years have been tougher on Multimedia than many of its competitors. While Multimedia's experienced seven consecutive losing quarters, both WMS Industries (NYSE:WMS) and Bally Technologies (NYSE:BYI) have been flawless, going 11-for-11 in quarterly profit reports while International Gaming Technology (NYSE:IGT) and Shufflemaster (Nasdaq:SHFL) have gone 9-for-10 and 7-for-10 respectively. Clearly some have a better grasp of operations than others. I'm having a hard time finding something to point to that Klarman and company would find appealing enough to hang in. Perhaps it's the unlocked value Mutimedia referenced in its press release way back in 2008 when it hired Anthony Sanfilippo.

The Bottom Line
In its second quarter earnings report, Multimedia admitted it was considering different strategic options including selling the company outright. Given its stock is trading at just over one times book value compared with three times book for its competitors, I'm guessing Seth Klarman believes it's worth much more than $4 a share to anyone interested in purchasing the company. If you're a risk-taker, this could be the perfect bet.

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