Stanphyl Capital commentary for the month ended August 31, 2016. Friends and Fellow Investors: For August 2016 the fund was up approximately 6.8% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 0.1% while the Russell 2000 was up approximately 1.8%. Year to date the fund is up approximately 20.2% net while the S&P 500 is up approximately 10.2% and the Russell 2000 is up approximately 8.3%. Since inception on June 1, 2011 the fund is up approximately 108.4% net while the S&P 500 is up approximately 80.7% and the Russell 2000 is up approximately 57.4%. (The S&P and Russell performances are based on their “Total Returns” indices which include reinvested dividends.) As always, investors will receive the fund’s exact performance figures from its outside administrator within a week or two.
We continue to maintain large short positions in both the S&P 500 (via the SPY ETF) and the Vanguard Total International Bond ETF (ticker: BNDX), the latter comprised of dollar-hedged non-US sovereign debt with ridiculously low yields; i.e., what I believe to be the “root cause” of the stock market bubble. As of this writing, BNDX has an average duration of 8.2 years and an “SEC yield” of less than 0.5%, representing what may be the greatest asset bubble in history considering that Europe and Japan (which comprise most of its holdings) are printing massive amounts of money (over $180 billion a month!) yet are long-term insolvent due to their retiree liabilities. What will force the central bank bond buying to stop and thus pop the bubble? For Europe I suspect it will be pressure from banks, insurance companies, savers & pension funds, none of which can continue to stomach negative rates, as well as the very real threat of additional “Brexits” for the same reasons the UK left (immigration and resentment of centralized bureaucracy). Japan I think can never stop printing (its ratio of debt to GDP is too huge and growing too quickly) but will eventually crash the yen into oblivion (we’ve been short yen since 2012 and added a lot recently) and with that its bonds will crash too. When will the bond bubble break? I don’t know, but the borrow cost for BNDX is less than 2% a year (plus the yield) and as I see around 5% potential downside to this position (plus the cost of carry) vs. at least 30% upside, I think it’s a terrific place to sit and wait for the inevitable denouement.
As noted above, we also continue to be short SPY, as I believe the stock market remains hugely overvalued, as despite negative revenue growth…
…
…sliding global trade …awful intermodal rail freight data that isn’t being offset by increased trucking and corporate debt defaults that have reached their highest level since 2009, the S&P 500’s price-to-sales ratio (courtesy of multpl.com) continues to set new highs…
…while its GAAP trailing PE ratio = 24.9. The only thing that tempers my bearishness is that Q2 GAAP earnings came in slightly better both sequentially and year-over-year: Q2 2016: $23.35 (w/96% reporting) Q1 2016: $21.72 Q4 2015: $18.70 Q3 2015: $23.22 Q2 2015: $22.80 It’s thus plausible that S&P earnings may have at least stabilized-- possibly fueled by share reductions thanks to buybacks enabled by the aforementioned bond bubble (but maybe not for long)-- and with bond yields in the bubble they’re in, I’m not certain that the multiple placed on those earnings can’t become more generous to the point of even greater absurdity. Thus as noted in last month’s letter, in July I somewhat reduced the size of our SPY short concurrent with implementing the “root cause” bond short via BNDX.
Stanphyl Capital - Long Positions
And now for the longs…
Just a quick note - we sincerely apologize for the delay in the August issue - just contact us to get credit for extra month whether you are monthly, quarterly or yearly - the August will be out in a few days and the October issue should be on time. In the August issue we are profiling Barry Paskiov of Hazelton Capital and going in-depth on two small caps with little coverage. The two stocks are tickers CUI and CPS - neither are discussed even in recent shareholder letters to his investors but Barry was kind enough to explain the thesis to our subscribers. You can find Barry's Q2 here (we only attached as PDFs to make this email (somewhat) concise))
Now to updates on some funds we profiled.
The following is from Stanphyl Capital (the fund is killing it up 20.2% net), S&C Messina, and foundry Capital latest letter to investors. Stanphyl was profiled in our April issue, S&C Messina in June and Foundry in our inaugural edition.
If you would like to talk to the portfolio manager about any positions feel free to contact below and as always we are happy to intro if you want.
Mark Spiegel
(917) 579-1884
[email protected]
Troy E. Marchand
317-402-1563
[email protected]
Noh-Joon Chou
[email protected]
415-275-0291
Stanphyl Capital letter to investors for August - PDF can be found - HERE (text below followed by Foundry) and S&C we just are attaching as PDF to preserve space.
I added in August to our position in Data I/O Corporation (ticker: DAIO; basis: $2.53; August close: $3.49). In July DAIO reported fantastic Q2 results and announced a major partnership with Bosch to utilize its machines to program chips for the looming onslaught of “connected” and self-driving cars. The Q2 numbers (which don’t include any Bosch revenue) had revenue up 17% year-over-year and EPS at .06/share vs. .01/share in the previous year. Run-rate revenue is now $23 million/year and the Bosch deal should add around $2.5 million to that in both 2017 and 2018, with lesser amounts before and after. If we assume 30% incremental operating margin from the Bosch deal and add the result to the current run-rate EPS, we get .33/share in 2017 EPS. However, those earnings are untaxed as the company has around $20 million in NOLs while around $5 million of its almost $9 million in cash is held overseas. So we’d need to use $5 million of the NOLs to count the cash at face value, leaving $15 million in NOLs to offset future profits. I’d thus tax-adjust my .33/share 2017 estimate to .23/share x 15 = $3.45/share + $1.10/share in cash + ($15 million in remaining NOLs x a 30% tax rate) = $4.5 million cash value of the NOLs = .56/share. So by early 2017 I think DAIO could be worth $3.45 + $1.10 + .56 = $5.11/share. Also, due to the cost of being an independent public company on such a small revenue base DAIO is a natural strategic acquisition candidate, as the elimination of $1.5 million in “independent public company costs” would be hugely accretive to EBITDA.
I added in August to our position in Lantronix, Inc. (ticker: LTRX; basis: $1.44; August close: $1.41) following a solid earnings report indicating that the turnaround under its new management team has begun, with FY 2016 Q4 revenue up 5% sequentially and 2.9% year over year, while GAAP net loss shrank substantially from both periods and the company reached cash flow break-even (and non-GAAP profitability). Back in June Lantronix took in a $2 million expansion capital investment from a successful microcap tech investor who also took a board seat, and as several of this investor’s previous companies wound up being acquired (as did the CEO’s last company), I think it’s reasonable to assume that’s the path for this one too. Meanwhile the company has a new management team consisting of an accomplished CEO with a turnaround plan that seems to make sense, as well as a solid new Chief Technology Officer and VP of Sales. With $42 million of annual run-rate revenue, $6 million in net cash and $88 million of federal NOLs and $27 million of state NOLs, an enterprise value of just 1x revenue for this 47% gross margin company plus a conservative $5 million for the NOLs would value Lantronix at over $3/share.
We continue to own medical equipment maker MGC Diagnostics (ticker: MGCD; basis: $6.00; August close: $6.60) which in June reported a solid FY2016 Q2, with revenue up 8% year over year and .10 in EPS vs. .02 the previous year. Particularly impressive was the improvement at the company’s European Med6isoft division, with both revenue and gross margin up significantly and near break-even operating performance (although I expect that to regress a bit during the summer quarter, when Europe works even less than it does the rest of the year). Meanwhile, thanks to its 54% gross margin and potential for large SG&A eliminations, I think MGCD should be sell-able to a strategic buyer at a significant premium to the current price; for example, an enterprise value of 1.5x estimated 2016 revenue would be roughly $14/share.
We continue to own Echelon Corp. (Ticker: ELON; basis: $5.75; August close: $5.65), an “industrial internet of things” networking company with a near-zero enterprise value. Echelon is now focusing its growth on “smart” commercial & municipal LED lighting, as its fab-less chip business has long been in gradual decline. As expected, in August the company reported a lousy Q2 as Enel—its largest customer—has gone away, but its commercial and municipal “smart lighting” business has grown quickly with just a part-time sales staff and the plan is to upsize that staff considerably. If the company accomplishes that (and it appears to be off to a good start by hiring a well-qualified new VP of Sales), I think there’s a chance it can hit a break-even annualized revenue run-rate of $40 million by Q1 2018 at which point—assuming $20 million of remaining net cash (vs. $24.2 million today) and 4.43 million shares outstanding, an enterprise value of 1x revenue on this 58% gross margin company would put the stock at over $13/share. Additionally, Echelon has $254 million in federal NOLs and $127 million in state NOLs, worth tens of millions of dollars if it can utilize them. So if it can pull this off (and theoretically, the market for the networking of commercial and municipal LED lighting should be huge between the U.S. and Europe), this stock can be a home run for us. Although this position is clearly somewhat speculative, the company’s flush balance sheet gives it a long runway to succeed.
We continue to own RadiSys Corporation (ticker: RSYS; basis: $2.59; August close: $4.91), which in July reported a terrific 2016 Q2 with revenue up 30% year-over-year and an announcement that it expects to meet the $215 million high end of its 2016 revenue guidance. Non-GAAP EPS is still expected to come in at around .25/share (excluding around .10/share in stock comp, so adjust accordingly) with earnings accelerating substantially beginning in the second half of 2017, as RadiSys first adds some “cash flow financed” operating expense to grow its high-margin cloud and wireless carrier software business, a play on the shift into software defined networking , voice over LTE and small-cell wireless stations. In June the company announced Verizon as the first customer for its new FlowEngine product and back in March it announced a Verizon contract for its new DCEngine (which has low gross margins but 8-10% operating margins), and on the Q2 call the CEO said they’re now close to closing deals with a half-dozen other carriers for this product, meaning that the hardware division—which had been in gradual decline—is now growing again and is a “gateway” for higher margin software sales. An enterprise value of just 1x $215 million revenue for this now high-growth tech company (inclusive of around $6 million in net cash and a conservative $30 million valuation on $168 million in federal NOLs, $80 million in state NOLs and $16 million in tax credits) would equal a per share price of around $6.75.
In August I sold the last of our Broadwind Energy-- our second great run in that stock since the fund opened in 2011. I added in August to our short position in the Japanese yen via the Proshares UltraShort Yen ETF (ticker: YCS) as Japan continues to print 25% of its monetary base per year and now insanely is using even more of that money to directly buy Japanese ETFs. In April Wolf Richter wrote a great piece about Japanese monetary and fiscal absurdity and in March David Stockman did; I urge you to read both. The bottom line on our yen short is that if a country is truly determined to wreck its own currency I’m happy to bet on it succeeding.
The fund is now almost exactly back to its all-time high water mark (approximately just 0.014% below it); thanks for sticking with Stanphyl and I’ll do my best for all of us going forward! Thanks and regards, Mark Spiegel
Foundry Value Master Fund latest stat sheet PDF format here->LINK
Foundry Value Master Fund commentary for the month ended July 31, 2016.
Investment Objective
The goal of the Foundry Value Master Fund, LTD. (“FVMF” or the “Fund”) is to generate portfolio alpha over market cycles, while minimizing market risk. We focus on companies trading at a deep discount to intrinsic value with a catalyst on the horizon, where we believe we truly have a “margin of safety”. We invest where valuations are irrational and catalysts misunderstood to achieve superior performance over time. The Fund will only hold our “best ideas”, resulting from deep, fundamental analysis and engagement with a wide network of industry contacts. While we intend to hold positions for a 1-3 year time horizon, we occasionally will invest to exploit shorter term opportunities. In certain situations, the Fund will utilize public activism strategies in to unlock value for all shareholders.
Foundry Value Master Fund - Investment Strategy
The Fund employs a deep value strategy while applying private deal analysis with public market liquidity. The Fund seeks to invest in a concentrated portfolio of companies with:
- secular tailwinds
- competitive advantages
- operating leverage
- low financial leverage
- management teams and boards that are “principals” not “agents”
Why Foundry Value Fund
Our smaller fund size enables a nimble investment strategy to extract value in areas larger funds and institutions do not find investable. We believe the public market offers significant inefficiencies in specific areas:
- Micro- and small-cap companies
- Companies in Liquidation
- Companies that should not be public
- Companies operating sub-optimally
- Companies ripe for activist strategies
- Companies that are under the radar and/or underappreciated
Investment Team
Portfolio Managers – Extensive Public & Private Experience
- Troy Marchand (Kirr Marbach, Stifel Nicolaus)
- Tyler Sadek, CFA (Teays River, Stifel Nicolaus, ABN AMRO)
Senior Advisor – Pioneer in Activist Investment Strategies
- Damien Park (Hedge Fund Solutions)
Fund Terms
Minimum Initial Investment: $100,000 Management Fee: 2% Performance Fee: 20% (subject to a high watermark) Liquidity: 3 year lock up IRR Target: 20% gross / 15% net
