Stanphyl Capital April 2016 Letter
The following is from Stanphyl Capital's latest letter to investors. The hedge fund was profiled in our April issue. Some macro, great returns (up 16.6% YTD through June and mostly due to small cap bets) and discussion of positions.
If you would like to talk to the portfolio manager about any positions feel free to contact below.
Mark Spiegel
300 E. 77th St. 18B New York, NY 10075
(917) 579-1884
[email protected] Capital letter to investors for the May - PDF can be found - HERE
Stanphyl Capital letter to investors for the month ended June 30, 2016. Friends and Fellow Investors: For June 2016 the Stanphyl Capital fund was up approximately 1.4% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 0.3% while the Russell 2000 was up approximately 0.1%. Year to date the fund is up approximately 16.6% net while the S&P 500 is up approximately 3.8% and the Russell 2000 is up approximately 2.2%. Since inception on June 1, 2011 the fund is up approximately 102.1% net while the S&P 500 is up approximately 74.0% and the Russell 2000 is up approximately 45.9%. (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.
Stanphyl Capital - Short Positions
We continue to maintain our large short position in the S&P 500 (via the SPY ETF) as I believe the broad market remains hugely overvalued within the context of declining corporate earnings and revenue… …which I expect to further decline as the U.S. and the world enter recessions. Intermodal rail traffic—one of my favorite real-time economic indicators—has been in steady decline lately, stretching back to well before last week’s Brexit decision. Meanwhile, the S&P 500’s price-to-sales ratio (courtesy of multpl.com) remains the highest in recent history… …while trailing S&P 500 GAAP earnings through Q2 2016 (including the Q2 estimate, which is probably far too high) are just $90.02 and a 16x multiple on that (generous if earnings stay flat or worsen as I expect them to, and yet some “generosity” is probably warranted considering how low interest rates are) would put the S&P 500 all the way down at 1440 vs. its June close of around 2097. Nevertheless, I’m well aware of the money-printing tendencies of the no-common-sense academics who rule our Federal Reserve and thus—fearing either more QE or so-called “helicopter money”—may look to cover the position somewhat higher. Regardless, it will all end very badly. In addition to our SPY short we remain short what I believe is the market’s biggest single-company stock bubble, Tesla Motors Inc. (ticker: TSLA; June close: $212.41), which really jumped the shark in June when it announced (pending shareholder approval) a “bailout buyout” of Elon Musk’s other cash-burning, bankruptcy-bound company, Solar City (ticker: SCTY). Rather than laying out here the absurdity of this proposed transaction, I urge you to read through the fantastic articles about it on Seeking Alpha (not the ones written by the financial illiterates who own the stock, but the work of those who have actually done the math), or for a quicker take you can check the WSJ’s excellent “Heard on the Street” column. Even if the hype-hunting, intellectually lazy, Musk Kool-Aid drinking mutual funds that are long TSLA veto the deal, the credibility gap created by the self-serving obviousness of Musk’s proposal may finally pull those guys off the golf course (or at least delay their tee times) long enough to dump the stock.
Stanphyl Capital - Long Positions
And now for the longs… We continue to own medical equipment maker MGC Diagnostics (ticker: MGCD; basis: $6.00; June close: $6.52) 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 Medisoft 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.
I added in June to our position in Echelon Corp. (Ticker: ELON; basis: $5.75; June close: $4.76), an “industrial internet of things” networking company now primarily focusing its growth on “smart” commercial & municipal LED lighting, as its fab-less chip business has long been in gradual decline. As expected, in May the company reported a lousy Q1, and Q2 (also as expected) will be even worse as Enel— its largest customer—goes away. However, Echelon’s commercial and municipal “smart lighting” business has grown quickly with just a part-time sales staff and the plan for 2016 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 late 2017 at which point—assuming $18 million of remaining net cash (vs. $23.7 million today) and 4.4 million shares outstanding, an enterprise value of 1x revenue on this 55% gross margin company would put the stock at over $13/share; meanwhile it currently has approximately a zero enterprise value. Additionally, Echelon has roughly $240 million in NOLs which are 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 an incredible 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; June close: $4.48), which in May reported a terrific 2016 Q1 with revenue up 13% year-over-year including 45% growth in the high gross margin (62.5%) software business. The company also raised the high end of its 2016 revenue guidance to $215 million while conservatively maintaining non-GAAP EPS guidance at .25/share as it continues to invest for growth; I think 2017 EPS could be around .40/share, although both figures exclude around .10/share in stock comp, so adjust accordingly. RadiSys recently underwent an extensive cost-cutting restructuring while simultaneously focusing on its high-margin cloud and wireless carrier software business which is a play on a massive shift into software defined networking, voice over LTE and small-cell wireless stations. In June the company announced that Verizon will be the first customer for its new FlowEngine product, the kind of “order validation” that often results in multiple orders from other carriers around the world.
In March RadiSys announced a major data center contract with Verizon that could be the first of many for its new DCEngine (which has low gross margins but 8-10% operating margins), meaning that its hardware division—which had been in gradual decline—is now growing again, and that new hardware product is a “gateway” for its higher margin software sales. An enterprise value of just 1x $215 million revenue for this now high-growth tech company (inclusive of around $7 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) equals a per share price of around $6.80.
I added in June to our position in Lantronix, Inc. (ticker: LTRX; basis: $1.45; June close: $0.97) which this month took in a $2 million expansion capital investment (priced with no discount) from a successful microcap tech investor who also took a board seat. 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, in April Lantronix reported a surprisingly decent quarter with solid sequential revenue growth and roughly break-even normalized cash flow.
The company has a brand 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 $40 million of annual run-rate revenue and $3.3 million in net cash and 15.3 million shares outstanding, this is a 48% gross margin company selling for less than 0.3x revenue before putting any value on approximately $90 million of federal NOLs and $30 million of state NOLs. So a valuation of just 1x revenue plus the net cash plus a conservative $10 million for the NOLs would value Lantronix at roughly $3.50/share.
We continue to own Data I/O Corporation (ticker: DAIO; basis: $2.43; June close: $2.35), a maker of custom flash programming machines used in a variety of industries, which in April reported a somewhat “transitional” 2016 Q1, with revenue down vs. the previous quarter and only break-even EBITDA but backlog up substantially, primarily due to the massive increase in sophisticated electronics (most notably, infotainment and autonomous driving systems) being built into the latest cars. With $9.7 million ($1.22/share) in net cash, .09/share in TTM EPS, $1.2 million in TTM EBITDA, $21 million in TTM revenue and 7.95 million shares, this is a 52% gross margin company selling for an enterprise value of approximately 0.4x revenue/7.5x EBITDA/13x earnings net of its cash. (It also has approximately $20 million in NOLs, although a chunk of those would be used to repatriate the $5 million of cash held overseas.)
Most importantly, 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 more than double the company’s EBITDA. We continue to own wind tower manufacturer Broadwind Energy (ticker: BWEN; basis: $2.04; June close: $4.22) although I reduced the position in June when the stock spiked into the $5.30s (near the midpoint of my estimated valuation range) upon the announcement of a huge contract that helps ensure backlog through 2019. With Congress having renewed the Production Tax Credit late in 2015 with a gradual phase-out into the early 2020s (including project completion times), going forward I think Broadwind can average around $10 million in annual EBITDA at least through 2022, assuming $17 million from the wind division and then subtracting $7 million for corporate overhead and stock-comp and assuming break-even for the gearing division; a 6x multiple on that EBITDA plus the existing $12 million in net cash plus a $20 million valuation on over $200 million in NOLs would value the stock at over $6/share. More conservatively, one could take $10 million in EBITDA less $4 million in normalized capex and put just a 10x multiple on the resulting $6 million (even though the NOLs make it tax-free); that plus the net cash would make Broadwind worth around $4.80/share.
Additionally, the recent approval of a major new wind energy transmission line could ensure that business will remain strong even after the eventual PTC expiration.
I added in June to our short position in the Japanese yen via the Proshares UltraShort Yen ETF (ticker: YCS) when the yen spiked in a “Brexit panic” (or what I like to call “a kneejerk flight to stupidity”) because Brexit or no Brexit, Japan continues to print over 25% of its monetary base per year. In April Wolf Richter wrote a great piece about this absurdity and in March David Stockman did; I urge you to read both. Meanwhile, there’s nothing more important to me than getting Stanphyl back above its high-water mark (we’re currently approximately 3% below it) and I believe we have a portfolio that can get us there and beyond. Thanks and regards, Mark Spiegel
