Foundry Value Fund 4Q15 Letter To PartnersVW Staff
Foundry Value Fund letter to partners for the fourth quarter ended December 31, 2015.
“It seems clear to me: the market does not have above average insight, but it often is above average in emotionality. Thus we shouldn’t follow its dictates.” – Howard Marks
For the month of December, the Foundry Value Fund declined by 4.72%, bringing the inception return to date to -11.14%. For the quarter, the Fund lagged the Russell Microcap Index and the Russell 2000 Index, while posting a positive 2.56% return.
Our returns are driven by the idiosyncratic nature of our agendas and not the market. We are in the process of executing a Private Investment in a Public Entity (“PIPE”), which provides us a control position in a nano-cap publicly traded company, where we believe we can add value on day one. We will be raising additional capital around this idea, which will make up a significant percentage of the entire portfolio. We are buying cash at a discount, with several live opportunities to use the cash on the balance sheet to buy an existing profitable private business in order to use the Net Operating Losses (NOL’s) as a tax shield. The potential of this company offers tremendous upside opportunity and optionality, and taken together with our existing portfolio; we expect 2016 performance to more than make up for the drawdown in 2015. If we aren’t able to execute on the above opportunity, we will find another similar scenario, where we can execute on this playbook.
As private equity investors in public equities, our investment holding periods are measured in years, and as a result, our investment tends to be subject to market volatility. Volatility offers us the advantage to add and trim positions at attractive prices. Again, we do not view volatility as risk.
Howard Marks of Oaktree Capital Management, a leading global alternative investment management firm, sums up the current market best in his recent memo:
“Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what's going on and what to do about it. This is one of the biggest mistakes you can make. As Ben Graham pointed out, the day-to-day market isn't a fundamental analyst; it's a barometer of investor sentiment. . . . You just can't take it too seriously. Market participants have limited insight into what's really happening in terms of fundamentals, and any intelligence that could be behind their buys and sells is obscured by their emotional swings. It would be wrong to interpret the recent worldwide drop as meaning the market “knows” tough times lay ahead. . . . It's important to understand for this purpose that there really isn't such a thing as “the market.” There's just a bunch of people who participate in a market. The market isn't more than the sum of the participants, and it doesn't “know” any more than their collective knowledge.”
While the Foundry Value Fund had a several wins. TSYS was sold achieving a 41% gain for the fund. Half of our OME position was sold achieving a 38% gain for the fund. And BDBD was sold achieving a small gain for the fund. However, these successes were not sufficient to offset the unrealized price declines in the top 2 positions, INAP, and VISI.
We are pleased to report that on Monday, November 23, TeleCommunications Systems (Ticker: TSYS) announced it will be acquired by Comtech Telecommunications (Ticker: CMTL) in an all-cash deal for $5.00 per share.
As of November 23, we owned a roughly 11% position in the Foundry Value Fund at an average cost of $3.54. The investment yielded a 41% return and a 151% IRR for the fund.
We have been in deep discussions with the activist involved in TSYS since August. There were several ways to unlock value at TSYS: 1) initiate a process to explore a range of strategic and financial alternatives to enhance shareholder value; 2) sell the 9-1-1 business, in which case we valued that segment at roughly $4-5 (while only accounting for 1/3rd of their total company revenues); 3) sell the entire company; 4) remove the CEO.
The $5.00 purchase price represents a 28.6% premium to the average closing price for the 90 days prior to the announcement and a 13.9% premium to the previous day closing price.
Another portfolio position that was acquired in the quarter was Boulder Brands, Inc (Ticker: BDBD). On November 24, BDBD announced it would be acquired by Pinnacle Foods, Inc (Ticker: PF) in an all cash deal for $11.00 per share. This was a small position for the Foundry Value Fund. We used a bullish call option spread to express our view on a potential take-out. The price was within our expected range and we achieved a small gain as a result.
Our goal with all of our investments is to invest with confidence in upcoming changes that are in the best interest of all shareholders. This is a good example of that, and we look forward to sharing more success stories with you throughout 2016.
We purchased six new securities in the quarter, most of which came in December. We had fresh capital to put to work but did so sparingly. There are times to be cautious and protect capital, and times to be aggressive, we feel the current situation is the former, protect. Don’t construe this to mean we won’t feel major down drafts in the market, we simply mean we are investing slowly and holding some cash on the sidelines. We are not paying up for large cap stocks, just to feel “safe” and “defensive.” We will maintain our discipline and process, which is owning undervalued securities in the micro- and small-cap space.
Foundry Value Fund – New positions in 4Q:
Associated Capital Group (AC) is a recent spin-off from Gabelli (GBL), which is trading below cash. They have a 500,000 share buyback in place, which should provide somewhat of a floor under this illiquid stock.
CST Brands (CST) was a spin-off from Valero Energy in 2013. CST Brands was the gas station/convenience store segment of Valero Energy. Several activists are involved, who were also activists in Pantry (PTRY) before the company was sold for many times their money. They know the industry well; and Couche-Tard out of Canada is a willing and able buyer with major industry consolidation taking place. The activists believe the CEO needs to be replaced with someone with industry experience, along with adding, at least one new board member with operational experience in the industry. While a sale of the company is a strong option, they have some low hanging fruit that should generate shareholder value.
Kansas City Life Insurance (KCLI) is selling at 50% of tangible book value with no debt. Recently the Company delisted shares from a major exchange after doing a reverse stock split to get shareholders under 250, at a price per share of $52.50 (stock currently trading around $37). KCLI is a somewhat defensive position, but we viewed the massive sell-off from $50 to $36 as well over done, and it seemed retail investors who did not follow the rules missed the tender opportunity and sold at the market, which meant they were not price sensitive. The situation is ideal for those willing to be a liquidity provider to irrational sellers. While we don’t expect this to be a home-run type stock, it seems we are buying a well-run business at an extremely depressed price, clipping a 3% dividend to wait for a more rational valuation. In an uncertain, volatile market, this seemed like a good place to hide out.
QLT Inc (QLTI) is selling for less than net cash on the balance sheet. They have a proven management team, which has had two potential deals fall through over the last year. The deals fell through because a more price insensitive buyer offered huge premiums to acquire the business management had already struck a deal with. These past potential deals indicate management would have created a great deal of shareholder value by just completing the deals, and while it is unfortunate they were not able to complete either one, it also lets us know they are disciplined and will not overpay in a bidding war. Management announced they are investing $45 million in a newly formed Canadian pharmaceutical company (Alarez), which will be the combination of Pozen (POZN) and Tribute Pharmaceutical (TBUFF). Along with the combination, a couple major healthcare private equity investors have also injected roughly $350 million into the entity.
Tribute Pharmaceuticals Canada, Inc (TBUFF) is a small Canadian pharmaceutical company, combining with Pozen (POZN) to form a newly created public pharmaceutical company called (Alarez). Each one share of TBUFF will convert into .1455 shares of Alarez, upon closing.
Foundry Value Fund – Increased Positions in 4Q:
MRV Communications (MRVC) continued its downward slide. If you recall, we purchased at $11.55 and the stock rocketed higher to $19 within a month, which didn’t allow the Foundry Value Fund to buy a full position. We never trimmed the position believing it was still worth significantly more. Since then, the stock has round tripped all the way back to our cost basis and even slighlty lower. We spent little time wishing we would have trimmed some of our profit, as we still believe huge potential is ahead for the stock, and thus the reason we added to our position in the quarter. MRVC is 30% owned by Activist investor, Raging Capital. MRVC recently sold off the non-core business segment, which now creates a pure-play optical networking company that should be sold to a much larger buyer at a price 100% above the current stock price. An even better scenario would be if MRVC sells the assets of the business and keeps the shell company with over $140 million in cash. The cash along with nearly $300 million in Net Operating Losses (NOL’s), would it make it an ideal investment vehicle to use the cash and buy a profitable business to reap the benefits of the NOL’s. NOL’s are considered worthless without a profitable business. Selling the entire entity would expire all the NOL’s through a change in control.
WidePoint Corp. (WYY) missed estimates for the quarter and the stock continued to its downward slide from $2 plus to $0.50 a share. We picked up some more shares as it has continued to fall. We still believe the stock, based on current contracts in hand, is worth considerably more than the current stock price. WYY is heavily owned by retail investors, which cause the stock to be more volatile. The management team members are willing sellers of the business, but want to prove their Certificate on Demand (CoD) business segment out before selling, as they see huge value with the largest mobile phone companies as customers.
Foundry Value Fund – Trimmed Positions in 4Q:
Extendicare (EXETF) was trimmed significantly in October. The position was large, and the stock price had appreciated substantially on the back of an activist taking a position. However, we were unconvinced in the activist’s plan and did not think they would add much value. While we still think EXETF is cheap on many valuation measures, there is not a clear path to unlocking value. We appreciate the trust you have placed in us with overseeing your investment and will continue to manage your capital with diligence. We remain, as always, extremely grateful for the opportunity to manage a portion of your wealth. It is a responsibility that we take very seriously, and we will always endeavor to be a worthy steward of your capital. If you know of others who could benefit from Foundry’s services, we would be grateful for an introduction. As always, please do not hesitate to reach out with questions or comments concerning portfolio holdings, or value investing ideas in general. We always enjoy corresponding with clients.
“the foundation of political economy and, in general, of every social science, is evidently psychology.” – Vilfredo Pareto
Foundry Capital Group