Lakewood Capital Hopes To Continue 96% Track Record With New Nevada Short

Lakewood Capital, long known for its aggressive short exposure, delivered the rare feat of profiting on both long and short during the fourth quarter. The fund was up 6.2% overall as the stock market, particularly small cap issues, sprinted higher. In this environment Lakewood Capital thinks it may have found another fraud in the desert, according to a January 17th letter to investors reviewed by ValueWalk.

2016 Hedge Fund Letters

Lakewood Capital load up on financials after Brexit, recently reduces exposure after run-up

Long stock exposure was up 10% in the fourth quarter while short positions also generated positive 1%. Hedged long equity positions, a smaller portfolio component, were down -12%.

On the year, the fund was up 11.2% and the Long / Short picture was slightly different. Long stock exposure almost doubled the yearly fund total return, but short positions detracted from performance. Long equity positions generated a +21% return, hedged long equity positions were down -5% and short exposure lost -6%, a more traditional win / loss ratio. Fixed income positions were positive by 14%.

One of the key performance drivers of performance on both the year and in the fourth quarter was the fund’s counter-trend bet on the financial sector. In the immediate wake of the Brexit vote, Anthony Bozza and his management team upped financial sector exposure to 27%, the highest exposure the fund had ever devoted to a single sector.

“As financial stock valuations improved in the back half of 2016, our positioning yielded significant gains,” he pointed out. With the financial sector jumping significantly higher than the S&P 500 average since the election, the Lakewood Capital has subsequently reduced financial sector exposure to 14%.

Lakewood Capital Q3 Letter: Short ViaSat, 2U, Inc.

Lakewood Capital’s Bozza doesn’t understand why ICE is priced so much below CMEGroup

Another significant long the company established in 2015, Intercontinental Exchange (ICE), saw increased allocation in the fourth quarter. Bozza doesn’t understand why ICE, trading at 16X 2018 earnings, is the low valuation in the listed derivatives industry laggard. Bozza tripped over a key difference between the derivatives and stock market exchange operations at the end of the statement:

ICE earns just over half of its operating profit from its trading and clearing business. In this segment, ICE operates 11 global exchanges and six central clearing houses in every major geographic region. ICE’s primary business in this segment is the trading and clearing of futures contracts in products such as Brent crude, U.S. natural gas, sugar and European short-term interest rates. This business tends to be winner-take-all in each product as scale creates the best liquidity and the tightest bid/ask spreads for key products. Furthermore, ICE controls the clearinghouse for these products so clients benefit from putting up less collateral by trading with the company. Volumes in this segment can be unpredictable but there is secular growth in the futures business due to innovation, regulation and the shift of over-the-counter products coming onto the exchanges. ICE also has an equity and equity option business resulting from its acquisition of NYSE. While equity trading is much more competitive and lower margin than the futures business, net equity and option revenue is only 8% of revenue and an even smaller portion of operating profit. In addition, we believe ICE earns the majority of revenue from opening and closing auctions which are protected from competition.

Lakewood Capital is also back into VEREIT, a position it sold after a summer stock run-up and then bought on a recent drawdown recently:

Under the prior management team, the company pursued a leverage-fueled acquisition strategy and subsequently endured an accounting restatement that forced the departure of key executives and the suspension of dividend payments. Following the arrival of respected industry veteran Glenn Rufrano as CEO in 2015, the new management team outlined its business strategy to sell non-core properties and reduce balance sheet leverage. Over the past two years, a total of $2.5 billion of assets have been divested at attractive valuations which resulted in a less-leveraged core portfolio of assets. Management further improved the balance sheet during the middle of last year through well-timed issuances of both equity and long-term debt.

Lakewood Capital likes slapping around Nevada-incorporated firms, particularly in medical fields

Lakewood is also known for its short exposure. In particular, Bozza has a fondness for short-selling Nevada-incorporated companies. “The median return of ( 47 Nevada-incorporated) stocks is shorted by (Lakewood Capital) negative 96% in the subsequent three years… just saying,” he quips.

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