Stanphyl Capital April 2016 Letter
Stanphyl Capital letter for the month ended April 30, 2016. Friends and Fellow Investors: For April 2016 the Stanphyl Capital Fund was up approximately 2.1% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 0.4% while the Russell 2000 was up approximately 1.6%. Year to date the fund is up approximately 11.4% net while the S&P 500 is up approximately 1.7% and the Russell 2000 is unchanged. Since inception on June 1, 2011 the fund is up approximately 93.1% net while the S&P 500 is up approximately 70.5% and the Russell 2000 is up approximately 42.8%. (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. In mid-April I increased our short position in the S&P 500 (via the SPY ETF) when it came within 2% of its all-time high, as I believe the broad market is now even more overvalued within the context of sliding profit margins and awful corporate earnings… …which I expect to further decline as the world enters a recession. Meanwhile, the S&P 500’s price-to-sales multiple is nearly back to the bubble level of 2000: Trailing S&P 500 GAAP earnings (including the preliminary Q1 2016 estimate) are approximately just $88 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 1408 vs. its April close of around 2065.
The following is from Stanphyl Capital's latest letter to investors. The hedge fund was profiled in our April issue. Some macro, great returns 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 April - PDF can be found - HERE
Stanphyl Capital - Tesla Motors: Biggest single-company stock bubble
In addition to SPY I increased our short position in what I believe to be the market’s biggest single-company stock bubble, Tesla Motors Inc. (ticker: TSLA; April close: $240.76) which in April reported 14,820 Q1 car sales vs. the 16,000-car guidance, and vs. over 17,000 in the previous quarter. Tesla blamed this guidance miss on Model X parts shortages but failed to explain the nearly 5000-car sequential drop in Model S deliveries, only around 2000 of which can be attributed to a Q4 rush to beat an expiring tax credit in Denmark. Due to that Q1 delivery miss I now expect Tesla’s Q1 free cash flow will set a new “negative record” at somewhere around minus $600 million before adding back any of the refundable Model 3 deposits, a highly specious concept in itself, as discussed below. Of course it won’t surprise me if in its earnings release the company omits the free cash flow figure as it did for the Q4 release (after including it in previous ones) and instead once again substitutes several completely nonsensical self-created metrics of its own. Remember that on the Q4 conference call Tesla said that it would be cash flow positive for 2016 including the borrowings on its credit line. In other words, Tesla is trying to define “borrowed money” as “cash flow”— just par for the course for this highly deceptive company. Meanwhile, as a great demonstration of what an untrustworthy stock-pumper Elon Musk is, note that he was well aware of the significant Q1 delivery miss and yet never mentioned it during the April weekend he spent Tweeting about nonsensically large Model 3 “orders” and revenue projections that he created by assuming 100% sell-through on fully refundable deposits for a car those depositors think they’ll receive in 2018 or ’19 but the bulk of which won’t be delivered until 2020 or ’21 at a significantly higher price than he claims, and by which time there will be 30 or so competing long-range EVs on the market. Perhaps equally significant is that Musk outright lied when he said Tesla is limiting Model 3 reservations to two per person— a friend tested this and was easily able to reserve 20, the bulk of which were done using the same credit card, name, phone number, email address, etc. I thus have no doubt that a significant number of Tesla’s claimed Model 3 reservations are in fact speculative duplicates, and I call upon the company’s underwriters to carefully scrub through the list before selling stock or debt on Tesla’s behalf. As for potential Model 3 profitability, in Q4 2015 Tesla averaged an $18,400 GAAP loss on every Model S it sold despite a starting price of $70,000 and an average price that ran much higher. So how does anyone with a brain in his head think this company can make money selling Model 3s—even if they’re 20% smaller than the S—starting at $35,000? I sure didn’t when I first wrote about this over two years ago and more recent analysis reinforces that conclusion and UBS—the only large sell-side firm not conflicted by Tesla investment banking business— agrees. And here’s perhaps the best article about the Model 3 yet written. As we’re short the stock, I actually do hope the car stickers at $35,000 and gets a trillion “reservations,” as the more Tesla sells the more money it will lose. In reality though, the company will probably only be willing to sell Model 3s in the $50-$60,000 range (thereby substantially limiting its appeal), larded up with “options” that will be standard on mid-level Hondas by the time the car is available. Of course the idea that the Model 3 can be in mass production by late 2017 (as Tesla claims) is a pipe dream, considering that the company’s February 2016 10-K states: “We have not yet finalized the design, engineering or material and component sourcing plans for Model 3.” So now that you’ve seen the “driveable prototype,” keep in mind that Tesla did the exact same thing with the Model S a full 3.5 years before it was in mass production, and even if we were to credit Tesla with “additional experience” and shave a full year off that figure, it wouldn’t put the Model 3 in meaningful production before late 2018. But hey, while you’re waiting don’t forget to reserve your $49,000 Model S! Oh, and one other thing: if Tesla goes belly up before your Model 3 is delivered, your $1000 deposit will make you just another unsecured creditor; i.e., a generous donor into the pockets of the $3 billion of bondholders who will auction off whatever’s left of the company. Meanwhile in January General Motors formally introduced its new Bolt EV which really will sell for $37,500 (before the $7500 Federal tax credit) and offers true five-passenger seating, a range of over 200 miles and a 0-60 time of under 7 seconds for HALF the price of the cheapest Tesla Model S while matching its 94 cubic feet of interior passenger space (albeit with less storage). Seeing as studies show that 15% of Tesla buyers come from a Prius and many others come from other inexpensive “eco-favorable” cars, I expect the Bolt to grab back a significant number of them—what I call the “stretch buyers” who paid up for a Tesla because they wanted an electric car with 200-miles of range; those people can instead now choose the much less expensive/easier to park Bolt which will be available late this year, probably two years before “the comparably priced Model 3 that won’t really be comparably priced.” And then of course plenty of potential wait-listed Model 3 buyers—realizing they won’t get a car until 2020 or later—are likely to pick up a Bolt instead too, or perhaps the 200-mile Leaf which is rumored to be out by mid-2017. Meanwhile, Tesla’s rollout of its new Model X has been a disaster, with various enthusiast forums and now Consumer Reports reporting myriad problems with its “falcon-wing” doors, seats and general build quality, as well as a very low confirmation rate for the refundable “orders” the company claims to have. In fact, in mid-April Tesla opened up Model X ordering to anyone (not just those with reservations) and promised delivery a month later; as the company can manufacture approximately 750 Model Xs per week, this would seem to indicate that the backlog is tiny. I thus expect overall 2016 Tesla deliveries to be only around 65,000 vs. guidance of 80-90,000 (a huge miss), with only 20,000 or fewer of them being the X. In addition to its design and quality problems, the X’s $6000 to $8000 premium to a comparable Model S sedan is a huge sales-limiting factor, as nearly all of the luxury competition prices its premium SUVs considerably less expensively than its premium sedans. For instance, the most basic “X” with no options and a range of just 237 miles starts at $84,200 with only five seats standard. By comparison, the Porsche Cayenne starts at just $58,000, the Audi Q7 at $55,000, the BMW X5 at $55,000, the new (and award-winning) Volvo XC-90 at just $44,000, the new Jaguar F-Pace at just $40,990 and the new seven seat Mercedes GLS at $67,000, and all these vehicles average more than twice the range of the Tesla with far more flexible refueling capabilities for long trips. The heretofore revered Tesla Model S is now on Consumer Reports “Used Cars to Avoid” list with “much worse than average reliability” and I think that raises a VERY important point: the “Tesla love” and “Tesla loyalty” that one reads about on the forums (“Even if my Tesla is in the shop a lot I’ll never go back to an ICE [Internal Combustion Engine] car!”) is really “EV loyalty”/“EV love”—in other words, many people like the instant torque and quietness of their EV drivetrains, not necessarily the fact that those frequently repaired drivetrains happen to come from Tesla. This means that when the Germans (Audi, Porsche, Mercedes and BMW) roll out their 300-mile luxury EVs in just two to three years, they’ll capture a lot of Tesla owners who love the driving experience but not the reliability experience, especially as fear grows that Tesla’s cash bleed means it may not be around to honor the eight-year drivetrain warranty that those “reliability issues” force it to provide. Meanwhile, Tesla owners are getting to make lots of new friends at their local service centers (for which there are reportedly one-month waiting times for an appointment), as guess who’s at the very bottom of TrueDelta’s car reliability list, ranked 54th: The big picture issues for Tesla are twofold (note: these links are updated monthly): 1) The market is under the mistaken impression that it has significant & sustainable proprietary technology when it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in cars (in fact LG now offers a complete turnkey electric drivetrain to any manufacturer who wants one) and many of these EVs will be sold at or below cost (subsidized by the profits from their makers’ conventional cars), thereby creating intense pricing/margin pressure on Tesla; it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in car batteries (where even its sole supplier Panasonic is going into direct competition with it via a factory unrelated to Tesla’s still 85% unfunded Gigafactory); it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in storage batteries (where its supplier Panasonic is going into direct competition with it both at utility scale and in the home) and the Tesla PowerWall has no business model anyway as partially proven in March when Tesla discontinued 50% of its hype-driven home product line; it doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t, doesn’t and doesn’t in autonomous driving while even the new $20,000 Honda Civic offers nearly autonomous driving; and it doesn’t and doesn’t in charging (Tesla has spent only around $200 million on its much-touted Supercharger network, a rounding error for the inevitable upcoming charging consortiums of big auto makers), and 2) The company’s management tells deception after deception after deception after deception after deception after deception after deception after deception. So in summary, this cash-burning Musk vanity project is worth vastly less than its current approximately $37 billion fully diluted enterprise value and—thanks to its debt—may eventually be worth “zero.”
Stanphyl Capital - Long Positions
And now for the longs… We continue to own RadiSys Corporation (ticker: RSYS; basis: $2.59; April close: $4.46), which I pared back a bit in the $4.50s but remains by far the fund’s largest long position. 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. Although overall gross margin is only a bit over 30%, the margin for the software business (currently around 35% of overall revenue and expected to grow double-digits in 2016) is north of 60%. In March the company 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 high operating margins), meaning that its hardware division—which had been in gradual decline—is now growing again. Additionally, that new product is a “gateway” for its higher margin software sales. RadiSys is guiding to 2016 non-GAAP EPS at a midpoint of around .25/share (which I now think it will easily beat) and 2017 could be around .40/share, although that excludes around .10/share of stock comp so adjust accordingly. Additionally, the company has around .25/share in net cash (corrected for a single-project temporary drawdown) and minimal tax liability “forever,” with $167 million in federal NOLs, $79 million in state NOLs and a $16 million tax credit. We bought RadiSys at an enterprise value of less than 0.5x estimated 2016 revenue before putting any value on those massive NOLs, and I think it’s worth at least 1.25 estimated 2016 revenue of $195 million plus .25/share in net cash plus (conservatively) $20 million for the NOLs = around $7.35/share. We continue to own wind tower manufacturer Broadwind Energy (ticker: BWEN; basis: $2.04; April close: $3.38); although I sold some in the $3.30s after its huge run-up, it remains the fund’s second-largest long position. In April Broadwind reported a significantly improved Q1, indicating that the company is back on track after a terrible 2015. 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 for a very long time, 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 a 10x multiple on the resulting $6 million (because the NOLs make it tax-free); that plus the net cash would make Broadwind worth around $4.80/share. Either way, with the wind now at its back (no pun intended) I think the company can begin announcing some very significant orders and the stock should take another leg up. Additionally, the March approval of a major new wind energy transmission line could be a nice catalyst as well as additional insurance that business will remain strong following the eventual PTC expiration. I added in April to our position in MGC Diagnostics (ticker: MGCD; basis: $6.00; April close: $5.41) which in March reported a decent FY2016 Q1 (its seasonally slowest), with revenue up 3.4% year over year and break-even EPS vs. a .13/share loss last year. The company continues to be dragged down by modest losses at its European Medisoft acquisition but management seems hell-bent on fixing it and I think it will eventually get there. Meanwhile, thanks to its 53% 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. Meanwhile, assuming $4.5 million of 2016 EBITDA, this is a med-tech company selling at an enterprise value of only around 4.4x EBITDA! We continue to own Lantronix, Inc. (ticker: LTRX; basis: $1.52; April close: $1.13) which in April 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 (I met with him in February), and 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 only around 0.35x 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. Although this is by far the worst-performing stock the fund has ever bought, I think it’s worth holding for the reasons noted above and apparently several of the company’s board members agree with me as they recently bought stock in the open market. We continue to own Data I/O Corporation (ticker: DAIO; basis: $2.43; April close: $2.42), 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 0.5x revenue/8x 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 MRV Communications Inc. (ticker: MRVC; basis; $11.66; April close: $9.86), which in March reported a terrible 2015 Q4, with revenue down 10% year over year and 20% sequentially, albeit— thanks to intense fiscal discipline—with the year-over-year operating loss cut to $1.7 million from $3.6 million. Although management hinted that Q1 of 2016 may be equally ugly, it also indicated that the company should return to at least break-even beginning in Q2 as a couple of large customers resume their normal ordering patterns. So with no debt and an anticipated $34 million (nearly $5/share) in cash at the end of Q1 (including a February payment received from the sale of a division and an estimated $2 million of Q1 cash burn), this is an approximately $80 million revenue company with a 53% gross margin and $377 million of NOL carry-forwards (combined federal, state & foreign) which is now selling at less than 0.5x revenue on an EV basis even if we attribute zero value to those massive NOLs. Unfortunately, break-even revenue is around $88 million but on the other hand activist tech investor Raging Capital Management recently upped its stake to over 30% and with MRV’s board chairman being a Raging Capital partner, management is clearly incentivized to fix and sell the company; in fact, when presenting at January’s Needham investment conference the CEO said outright that MRVC is too small to remain independent. So even if things improve only mildly from Q4 I don’t think we can lose much—if anything-- from here, while if things improve somewhat the stock could be worth $20, assuming a sale of the operating business at 1x revenue and then adding in the value of the cash and NOLs. Meanwhile, a recently announced $10 million buyback program should keep a floor under things. We continue to own Echelon Corp. (Ticker: ELON; basis: $6.06; April close: $5.55), 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. Although in February the company presented a somewhat disappointing year-end report, guiding to an uptick in burn for the first half of 2016 as Enel—its single largest customer—goes away after Q1, its lighting business has grown extremely quickly with just a part-time sales staff and the plan for 2016 is to upsize that staff considerably. If the company pulls that off (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 break-even by late 2017 at which point—assuming a $40 million revenue run-rate, $20 million of remaining net cash (vs. $26 million today) and 4.4 million shares outstanding, this is a 57% gross margin company selling at an enterprise value of just a bit over 0.1x that anticipated late-2017 revenue run-rate; 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, I’m willing to give it a shot because the company’s flush balance sheet gives it a long runway to succeed. We remain short the Japanese yen via the Proshares UltraShort Yen ETF (ticker: YCS) despite the BOJ’s late-April decision (following which I added to the position) not to increase its already massive rate of money-printing because despite that decision Japan continues to print nearly 30% 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 the BOJ now owns over 50% of the entire Japanese ETF market and in case you’ve ever wondered what the balance sheet of a completely out of control, no-common-sense central bank looks like, well, it looks something like this:
Finally, as usual the fund has a long list of companies I‘d like us to own, but-- as always-- only at the right price. And meanwhile, nothing is more important to me than getting Stanphyl back above its high-water mark and I think we have a portfolio that can get us there and further. Thanks and regards, Mark Spiegel
