Corporate Activity as a Driver of Equity Value Creation

February 27, 2024 in Equities, Letters

This article is authored by MOI Global instructor Amit Wadhwaney, portfolio manager and co-founding partner at Moerus Capital Management, based in New York.

Amit is an instructor at Best Ideas 2024.

With the notable exception of 2022, it could be argued that the better part of the past decade has generally been a challenging period (at least in a relative sense) for those who follow value-oriented, price-conscious investment strategies that invest based upon corporate fundamentals, such as the one we employ at Moerus. The latest reminder of this was in 2023, a year in which the highly concentrated, top-heavy nature of benchmark performance was again dominated by mega-cap growth stocks that already had been trading at what, in our view, were quite gaudy valuations (e.g., “the Magnificent Seven”). Further, the recent euphoria surrounding Artificial Intelligence has resulted in soaring stock prices of a number of Technology stocks that are deemed – credibly, in some cases, but perhaps not so much in others – to have meaningful potential exposure to this rapidly developing technology. Combined with a “bad news is good news” narrative – in which developments such as the U.S. regional banking crisis or heightened concerns of a recession were, oftentimes, deemed “good news” by the market at large for expensive Tech stocks because they lowered interest rate expectations – this made for a general market backdrop that saw mega-cap Tech and “story stocks” return with a vengeance after a very painful 2022 for most of them.

For value-oriented investment strategies that, like all others, are often judged by many in the investing world, rightly or wrongly, relative to short-term benchmark index performance, this market environment presented its share of challenges. However, it also highlighted the importance, in our view, of constructing an investment portfolio that is not dependent solely on the market coming around to agree with your point of view or deciding to favor your particular investment style in order to succeed. Instead, we believe that investors benefit from having access to multiple potential paths to value realization across portfolios. But how can this be achieved? We believe that one way to do this is through striving to build a portfolio of holdings that are rich with potential for individual corporate events and developments, which could positively impact returns in a way that, importantly, is not overly dependent upon (and thus potentially less correlated with) the overarching market sentiment of the day or top-down economic developments around the world that investors tend to fixate on.

In our experience, most investors tend to estimate the majority (oftentimes all) of a business’ value based on it just being a “going concern.” While we do believe that it is of paramount importance for a business to remain a going concern – as in it will not be forced out of business in the near future – we also believe that value realization shouldn’t be exclusively reliant on the path of recurring earnings and eventual recognition in the market. Value could be created and realized in other ways as well, including via corporate activity.

Although we doubt anyone would disagree with that statement, we believe this potential source of returns is often overlooked or underestimated by investors – likely because both the timing and magnitude of such events are often unpredictable, and therefore do not lend themselves well to financial modeling like going concern earnings do. As a result, we believe there is a bias among investors and analysts in favor of the income statement, the near term, and going concern metrics such as earnings. We believe this often offers us attractive long-term investment opportunities in the form of businesses that may not seem attractive to those who are largely focused on next quarter or next year’s earnings, but which possess the potential to create significant value from their assets through corporate activity.

We believe that our investment approach at Moerus, which entails striving to own a collection of undervalued, asset-rich companies, provides the added benefit of the potential for value-accretive corporate events – carried out by the company itself or by external actors (e.g., a bidder). In short, we believe this approach offers potential upside in a couple of different ways: either through the market eventually coming around to recognize and adequately reflect the value that we believe is present in our holdings; or, failing that, through corporate events that could crystallize such value when markets don’t.

Examples of such corporate activity include M&A, significant returns of capital to shareholders (e.g., share repurchases), spin-offs, sales of assets or a complete division, as well as others. We will touch briefly upon a few of these potential sources of value creation below.

Spin-offs

One way in which companies can sometimes create value for shareholders is by spinning off one or more of their businesses into independent, separately traded entities. Doing so could be value-accretive in cases in which the pre-existing company is being valued in the market for less than what the sum of its individual components would be worth if they were listed separately. In addition to the possibility of being valued by the market at higher multiples separately than they had been valued together, spin-offs could also potentially allow for management teams to better give the respective businesses that they are charged to manage (post-separation) their undivided attention and strategic focus.

Asset Sales

Another way that companies can create value for shareholders is through the sale of an asset or business unit. Provided that it takes place at a good price, such asset sales can sometimes unlock value that was not being fully recognized within the whole company (as implied by its stock price), while strengthening the financial position of the remaining company and generating capital that could be either redeployed into remaining businesses or returned to shareholders (e.g., through share repurchases or dividends).

Asset Acquisitions from Distressed and/or Motivated Sellers

On the flip side of things, sometimes value can be created by acquiring assets or businesses. Now, to be clear, we believe a healthy amount of skepticism towards acquisitions, in general, is warranted; we believe that not a small number of the Mergers & Acquisitions seen in the headlines are of dubious strategic and/or financial merit and risk destroying shareholder value rather than creating it. However, there are times when quality assets or businesses that would make an attractive acquisition candidate for strategic and financial reasons become available at bargain prices for one reason or another – perhaps there is a distressed or otherwise motivated seller who needs to raise capital quickly, for example. In such a scenario, an asset-rich company with a strong financial position could seize the moment and acquire assets for less than they are worth from a longer-term perspective. In doing so, the opportunistic buyer may also be able to grow its footprint and operational reach, remove a competitor from the market, extract cost synergies, and/or diversify its business across different business lines or geographies.

Share Repurchases at Discounts to Net Asset Value (NAV)

Sometimes the most value-accretive acquisition a company can make is that of its own shares. The key word there is “sometimes”; as in the case of acquisitions, not all share buyback plans are created equal. If a company is repurchasing shares when its stock is overvalued in the market, or it is increasing its debt levels to fund such buybacks – or both at the same time – share repurchases could very well impair shareholder value longer-term rather than create it. On the other hand, we believe that asset-rich, well-financed companies could potentially grow their NAV per share considerably over time through stock buybacks – provided they are done only when the shares are trading for less than they are worth and done without imprudently leveraging the balance sheet. If those conditions hold, we believe share repurchases can often create value for remaining shareholders, in a way somewhat akin to how you would get wealthier over time if you had the opportunity to purchase dollar bills for 70 cents and do so repeatedly.

Takeovers

If a company’s discounted valuation persists in the market for long enough, it sometimes becomes a target for strategic or financial buyers (provided that no material structural impediments to a change in control exist). Because we generally prefer to invest for the long-run in assets and businesses that could potentially compound value over many years, at times takeovers could be a mixed blessing – particularly if, for example, a buyer swooped in at a time of temporary adversity to buy the business for less than its longer-term worth. Still, in many cases a bidder must offer a substantial premium to the stock price in order to get management and enough existing shareholders to agree to a sale. As such, in our history, takeovers have offered us another potential road to value realization in cases in which the stock market, for one reason or another, has not come around to more appropriately reflecting the value of a business.

Some Closing Thoughts

A caveat worth emphasizing, however, is that the timing of value-realizing corporate events are uncertain and unpredictable. Although we have conviction in the underlying value proposition of our investments, it is quite often unclear to us precisely when that value will be either unlocked via corporate activity or eventually more fully appreciated by the securities markets. Indeed, at any given point in time, while some areas of our portfolio may have already realized some of their value via recent corporate events, other holdings may have yet to be rewarded via value realization in the market, despite taking actions that, in our opinion, are creating shareholder value that is not being recognized yet – though we believe such activities are likely to be eventually recognized over the longer term. Indeed, in our experience, we have often noticed that some of the portfolio’s leading positive contributors to performance in any given year had also been meaningful detractors from performance in prior years; although some of the latent value in those holdings was realized through share price appreciation in that same proximate year, we’d argue that in many cases, much of the value was actually created over the months and years prior, even though the stock market might not have been giving those holdings credit for it at the time. Again, the eventual timing of value realization at the individual company level is uncertain.

It is also worth emphasizing that we do not make investments with an expectation of the specific path that a company may take. We are not investing in situations where we believe that we have identified a “catalyst” as we think that this catalyst would already be reflected in the valuation and thus creates price risk if the catalyst fails to materialize as the market anticipated. Instead, we seek to make investments in securities that we believe are cheap enough that there is a situation of many potential catalysts, none of which are certain and thus none of which are priced in already.

However, these uncertainties notwithstanding, we believe that an investment approach that is focused on finding well-financed, asset-rich businesses whose shares are undervalued – if well-executed – may lend itself well to the creation of a portfolio that possesses ample potential candidates for value creation via corporate events – in addition to value creation from the more traditional going concern route. If one is successful in identifying and assembling a portfolio of well-financed, undervalued investment opportunities, with management teams that are creating shareholder value rather than destroying it over time, we believe that corporate activity could positively contribute to performance over the long-term on a portfolio basis – with, at any given time, some holdings further along in the path towards value realization while others are earlier in their journey, sowing the seeds for future value creation.

Furthermore, we believe such opportunities for event-driven value realization may be less correlated with, nor heavily reliant upon, top-down macroeconomic factors or the whims of market sentiment and whatever might be the flavor of the day in the market’s eyes – a feature that could be helpful during times in which the market is frowning upon your style of investing for one reason or another.

Three NCAV Bargains in Japan: Kikukawa Enterprise, Charle, Sanko

February 6, 2024 in Audio, Best Ideas 2024, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Juan Matienzo of Mercor Investment Group presented his investment theses on Kikukawa Enterprise (Japan: 6346), Charle Co. (Japan: 9885), and Sanko Co. (Japan: 6964) at Best Ideas 2024.

Thesis summaries:

Kikukawa Enterprise makes wood-sawing machines. It has a long history of profitability and trades at a very attractive discount to asset value.

Charle Co is a Japanese seller of women’s underwear that trades at a discount to its cash net of all liabilities.

Sanko Co is a Japanese maker of precision components. It trades at a large discount to asset value, is profitable, and has significant insider ownership.

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About the instructor:

Juan F. Matienzo is the Managing Partner of Mercor Investment Group, where he is responsible for the portfolio. Juan follows deep value principles, and prefers companies that trade for less than liquidating value. He is also an amateur painter. He has a BBA and a Master of Clinical Psychology from UDLAP, and an MBA from the Harvard Business School.

Talen: Power Producer With Strong FCF and Crown-Jewel Nuclear Asset

February 5, 2024 in Audio, Best Ideas 2024, Best Ideas 2024 Featured, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Alex Gates of Clayton Partners presented his investment thesis on Talen Energy (US: TLNE) at Best Ideas 2024.

Thesis summary:

Talen Energy is one of the largest independent power producers in the US, with a strong free-cash-flow profile and a crown jewel asset.

TLNE will benefit from strong growth tailwinds in AI computing and the energy transition, which are driving the need for zero-carbon electricity. Power generation is now a growth story, and the company’s assets will be in strong demand for years to come.

Talen emerged from bankruptcy last year with a new management team and upgraded balance sheet.

Alex expects TLNE to appreciate in the near term as they monetize non-core assets, return capital, and gain investor awareness. It is a pattern Alex has seen play out in Clayton’s other successful post re-org investments, such as Denbury (DEN) and California Resources (CRC). In fact, the previous CEO of CRC is now running Talen and executing on a very similar playbook.

Talen’s largest asset is the Susquehanna nuclear power plant, which is one of the most efficient and profitable plants in the US. Nuclear plants in the US have become highly valuable due to new federal incentives, which created a government-guaranteed floor price for their electricity generation. Susquehanna is a crown jewel asset for Talen and could be worth upwards of $5 billion alone.

Talen’s normalized FCF yield is around 10% and could be 20+% in strong pricing environments similar to early 2023. Near-term catalysts include uplisting to the Nasdaq, the potential sale of their ERCOT assets, and a possible JV announcement for their data center business. Ultimately, Alex sees fair value close to $80 per share, based on the current FCF yield, and could be upwards of $100 per share if the entire company is sold, which Alex views as the most likely outcome in the long term.

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About the instructor:

Alex Gates is a Partner, Co-Portfolio Manager of CPDS and Chief Compliance Officer at Clayton Partners LLC. Founded in 2003, Clayton Partners is an opportunistic value investment firm.

Clayton manages a private investment partnership and individual separate accounts. The firm takes a private equity approach to investing in the public markets and looks to align itself with shareholder friendly management teams that focus on long-term value creation.

Alex leads the firm’s effort to find compelling public and private investment opportunities in sustainable businesses that have a positive impact on climate change. The current focus is on investments in renewable energy, utilities, bio-fuels, and recycling.

Alex holds a Masters Degree in Business Economics from the University of California at Santa Barbara. Prior to his graduate education, he completed a dual major BS in Economics and Statistics from Cal Poly State University. At both institutions, Alex concentrated in finance and economic modeling. He earned the Chartered Financial Analyst designation in 2015.

Dino Polska: Owner-Operated Compounder With Long Runway

February 5, 2024 in Audio, Best Ideas 2024, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Christopher Karlin of Aquitania Capital Management presented his investment thesis on Dino Polska (Poland: DNP) at Best Ideas 2024.

Thesis summary:

Dino Polska is an operator of medium-sized grocery markets in rural and small towns in Poland where 73% of Poles reside.

Dino’s strategy is designed around developing owned stores in a standardized format with a modest 400 sqm footprint selling fresh groceries, meat, and staples at competitive prices. The efficiency of their store model allows the stores to be supported by a population of just 2,500 people within a 2km radius. Dino has opened 2,340 stores since 1999 at a fast rate of 20+% per year and has not closed any stores. Chris estimates that the theoretical ceiling on stores is around 11,000, almost 5x the current footprint.

Dino is controlled 51% by its founding Chairman, and actions to date indicate the behavior of a highly aligned owner-operator.

Dino’s business model is driven by fully reinvesting all free cash flow into the development of new stores. Chris estimates that Dino achieves a ROCE of 40% at the store level and the firm generates ROIC of 20%.

Dino is reasonably priced, with a normalized FCF yield 50–100bps above 10-year treasuries after backing out growth capital expenditures. The investment opportunity lies not in a repricing, but in the continued execution of a successful business model by a competent and well-aligned management. It is entirely reasonable to project that Dino could compound intrinsic value by 15-20% per annum over the next decade.

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About the instructor:

Christopher Karlin has been in the investment business since 1991. Prior to founding Aquitania Capital Management in 2012, Christopher held positions as a Research Analyst and Portfolio Manager at First Pacific Advisors, Kestrel Investment Management and Fairview Capital Investment Management. Christopher interned with Farallon Capital Management while pursuing his MBA. He began his career with Wells Fargo Nikko Investment Advisors which later became a part of Blackrock. Christopher received his BBA from the University of Wisconsin in 1990 his MBA from Yale University in 1998 and has held the CFA designation since 1994.

Liverpool: Dynamic Player in Mexican Retail, With Major Logistics Asset

February 5, 2024 in Audio, Best Ideas 2024, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Francisco Carrillo of Mexico Value Partners presented his investment thesis on El Puerto de Liverpool (Mexico: LIVEPOLC) at Best Ideas 2024.

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About the instructor:

Francisco Carrillo began his investment career some 25 years ago as an analyst at GBM Grupo Bursátil Mexicano. His tenure at GBM lasted close to ten years and he held various responsibilities during that time. After GBM, Carrillo co-founded Sabino Capital, a Mexico-based investment partnership. In 2012 he co-founded Mexico Value Partners, a Mexico-based investment partnership where he currently serves as Chief Investment Officer.

Conx: Charlie Ergen SPAC in Talks to Acquire DISH-Owned Boost Wireless

February 1, 2024 in Audio, Best Ideas 2024, Best Ideas 2024 Featured, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Nitin Sacheti of Papyrus Capital presented his investment thesis on Conx Corp. (US: CONX, CONXW) at Best Ideas 2024.

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Nitin Sacheti runs Papyrus Capital GP LLC where is he the Portfolio Manager. He is also the author of Downside Protection: Process and Tenets for Short Selling in All Market Environments.

Prior to founding Papyrus Capital GP LLC, Nitin was a Senior Analyst/Principal at Charter Bridge Capital where he managed the firm’s investments in the technology, media and telecom sectors as well as select consumer investments.

Before Charter Bridge, Mr. Sacheti was a Senior Analyst at Cobalt Capital, managing the firm’s technology, media and telecom investments and a Senior Analyst at Tiger Europe Management. Mr. Sacheti began his investment career in 2006 at Ampere Capital Management, a consumer, media, telecom and technology focused investment firm, initially as a Junior Analyst, later becoming Assistant Portfolio Manager.

He graduated from the University of Chicago with a BA in Economics, was a visiting undergraduate student in Economics at Harvard University and attended the Loomis Chaffee School.

Hargreaves: Misunderstood Sum-of-the-Parts Bargain With Catalysts

February 1, 2024 in Audio, Best Ideas 2024, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Simon Caufield of SIM Limited presented his investment thesis on Hargreaves Services (UK: HSP) at Best Ideas 2024.

Thesis summary:

Hargreaves Services is a UK small-cap on the AIM exchange. It consists of three divisions: industrial services, land development, and commodities trading.

Price to book is 0.7, EV/EBIT ratio 4, PE ratio 5 and forward dividend yield ~9%. But it’s even cheaper than it looks as the services business are high quality — capital light with inflation-linked pricing — and the land assets are materially undervalued on the balance sheet.

Simon estimates intrinsic value at £10, compared to the recent price of £4.

Management is well-aligned, with the CEO owning 8% and chairman 2% of the stock. An activist investor owns 28% and has a board seat.

Management intends to sell the commodities division and selected assets within the Land division over the next two years, returning £6 per share via a stock buyback (provided the share price remains below intrinsic value). That will leave the Services division and a slimmed-down Land division worth £4.

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About the instructor:

Simon Caufield is Managing Director at SIM Limited, a UK-based investment firm. Simon founded the firm in 2007 after selling his stake in Nomis Solutions, a B2B enterprise software company he founded in 2002. His circle of competence is deep value, cyclicals and deceptively cheap compounders amongst the industrial and consumer discretionary sectors.

Previously, Simon was a management consultant for more than a decade, including at Mercer Management Consulting. Simon has an MA in Engineering from Cambridge University and an MBA from London Business School.

DSGR: High-ROIC Specialty Distributor With Consolidation Opportunity

February 1, 2024 in Audio, Best Ideas 2024, Best Ideas 2024 Featured, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Charles Hoeveler of Norwood Capital Partners presented his investment thesis on Distribution Solutions Group (US: DSGR) at Best Ideas 2024.

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Norwood Capital Partners, LP is a concentrated, fundamental value-based long/short investment fund. Norwood relies on primary research to build a portfolio of dominant businesses trading at a discount to intrinsic value. Norwood is managed by Charles Hoeveler, with 20 years of experience in institutional asset management.

LSB: Transformed, Competitively Advantaged Ammonia Producer

January 19, 2024 in Audio, Best Ideas 2024, Best Ideas 2024 Featured, Diary, Discover Great Ideas Podcast, Equities, Featured, Ideas, Member Podcasts

Bob Robotti of Robotti & Company Advisors discussed his investment thesis on LSB Industries (US: LXU) at Best Ideas 2024.

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This session is also available as an episode of Discover Great Ideas, a member podcast of MOI Global. (Learn how to access member podcasts.)

About the instructor:

Bob Robotti is the Founder, President and CIO of Robotti & Company Advisors, a registered investment advisor based in New York City.

Guided by the classic tenets of value investing, VALUATION MATTERS. Robotti & Company Advisors uses a proprietary research approach to identify companies which trade for substantial discounts to their future free cash flows, yet are misunderstood, neglected, or just out-of-favor, so discounted by markets. Once identified, Robotti’s investment team focuses on deep primary industry and company research to select investment holdings through the lens of a long-term business owner.

In this capacity, Bob is currently on the boards of AMREP Corporation (NYSE:AXR), Pulse Seismic Data Inc. (TSX: PSD) for which he also serves as Chairman, and Tidewater, Inc. (NYSE:TDW). Bob previously was on the board BMC Building Materials Holding Corporation, now amalgamated into Builders FirstSource, the premier and differentiated distributor of building structural products to homebuilders.

Prior to founding Robotti & Company in 1983, he was the CFO of Gabelli & Company. Bob holds a BS in Accounting from Bucknell University and an MBA from Pace University.

CAB Payments: Bombed-Out Price Creates Asymmetrical Opportunity

January 19, 2024 in Audio, Best Ideas 2024, Best Ideas 2024 Featured, Diary, Discover Great Ideas Podcast, Equities, Ideas, Member Podcasts

Patrick Brennan of Brennan Asset Management presented his investment thesis on CAB Payments (UK: CABP) at Best Ideas 2024.

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About the instructor:

Patrick Brennan is the founder and portfolio manager of Brennan Asset Management, LLC (BAM), a Registered Investment Advisory firm based in Napa, CA, which utilizes a concentrated value investing strategy. Patrick has given presentations at multiple value investing conferences, including presentations to The New York Society of Security Analysts (NYSSA), The Nebraska Society of Securities Analysts and presentations on various names at the VALUEx Vail Conferences. Patrick co-authored an article on tracking stocks with Lawrence Cunningham for The Financial History Magazine and Patrick was featured in a write-up in The Private Investment Brief. Prior to founding Brennan Asset Management, Patrick managed portfolios and led research efforts at two value investing firms in California: Hutchinson Capital Management and RBO & Co.

Previously, Patrick worked at Mark Boyar & Company, where he led the firm’s research team and helped manage $800 million of assets across individual portfolios, institutional accounts and a mutual fund. Patrick also worked for six years in investment banking and equity research with Deutsche Bank, CIBC World Markets and William Blair & Company. Patrick graduated summa cum laude from the University of Notre Dame with a degree in economics and was inducted into Phi Beta Kappa. Patrick received the Chartered Financial Analyst (CFA) designation in 2002 and is a member of the CFA Institute (formerly AIMR). Patrick is originally from Omaha, Nebraska.

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