For March 2016 the Stanphyl Capital Fund was up approximately 9.3% net of all fees and expenses. By way of comparison, the S&P 500 was up approximately 6.8% while the Russell 2000 was up approximately 8.0%. Year to date the fund is up approximately 9.0% net while the S&P 500 is up approximately 1.3% and the Russell 2000 is down approximately 1.5%. Since inception on June 1, 2011 the fund is up approximately 89.0% net while the S&P 500 is up approximately 69.9% and the Russell 2000 is up approximately 40.6%. (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
While our short positions (SPY and TSLA) worked against us this month, our longs--
Stanphyl Capital Q1 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 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 month ended March 31, 2016 - PDF can be found - HERE
Friends and Fellow Investors:
particularly the two largest, RSYS and BWEN-- collectively did quite well, thereby outweighing the negative short performance. However, as I’m still quite bearish on the broad market (and because shorting is fun, when it occasionally works), let’s start with the shorts…
I increased our already-large S&P 500 short (via the SPY ETF) significantly in mid-March (while simultaneously closing out a much smaller IWM short) as I believe the S&P 500 remains extremely overvalued within the context of declining earnings…
…and declining revenue…
…which I expect to further decline as the world enters a recession. Trailing S&P 500 GAAP earnings were just $86.40 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 1382 vs. its March close of around 2060. Meanwhile (and almost unbelievably), the S&P 500’s price-to-EBITDA multiple is back to the bubble level of 2000:
Stanphyl Capital - Long Positions
And now for the longs…
We continue to own RadiSys Corporation (ticker: RSYS; basis: $2.59; March close: $3.95) which 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 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 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 now 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.
I added in March to our position in wind tower manufacturer Broadwind Energy (ticker: BWEN; basis: $2.04; March close: $3.01) after the interim CEO presenting at the Roth Capital conference said she expects capacity will soon be completely sold out for 2016. In February Broadwind reported a disappointing 2015 but the conference call provided a much more positive outlook and with Congress having renewed the Production Tax Credit late in 2015 with a gradual phase-out into the early 2020s (including project completion times), beginning in Q2 and going forward I think Broadwind can average around $13 million in EBITDA for a very long time, assuming $20 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 $10 million in net cash plus a $20 million valuation on over $200 million in NOLs would value the stock at over $7/share. Broadwind still needs to appoint a CEO to replace the one who was fired, however it now appears that the CFO temporarily serving in that position will get the job, and with the wind now at its back (no pun intended) I think it can begin announcing some very significant orders and the stock should move accordingly. Additionally, the late-March approval of a major new wind energy transmission line could be a nice catalyst for the stock as well as additional insurance that business will remain strong following the eventual PTC expiration.
I added in March to our position in MGC Diagnostics (ticker: MGCD; basis: $6.09; March close: $6.13) when the stock sold off after reporting 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 only around 5x EBITDA!
We continue to own MRV Communications Inc. (ticker: MRVC; basis; $11.66; March close: $9.06) although I slightly reduced the position in March after the company 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 0.4x 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 newly announced $10 million buyback program should keep a floor under things.
We continue to own Echelon Corp. (Ticker: ELON; basis: $6.06; March close: $5.495), 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 I think 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 0.11x that anticipated late-2017 revenue run-rate; meanwhile it currently has a negative 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; at least the flush balance sheet gives it many years to try.
We continue to own Lantronix, Inc. (ticker: LTRX; basis: $1.52; March close: $0.95) which in February reported a quarter down somewhat on revenue but with minimal cash burn and, most importantly, a brand new management team consisting of a new and accomplished CEO with a turnaround plan that seems to make sense (I met with him in February), a new Chief Technology Officer and a new VP of Sales. With $38 million of annual run-rate revenue and $3.1 million in projected net cash as of March 31 (four years of normalized burn even assuming no improvement) and 15.23 million shares outstanding, this is currently a 48% gross margin company selling for only around 0.3x revenue with approximately $90 million of federal NOLs and $30 million of state NOLs. So an acquisition price of just 1x revenue plus the net cash plus a few million bucks for the NOLs (heavily discounted for the change-in-control limitations) would value Lantronix at over $3/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; March close: $2.62), a maker of custom flash programming machines used in a variety of industries-- which in February reported a decent 2015 Q4, with year-over-year revenue down a bit due to currency translation but EPS and EBITDA flat. Assuming approximately $10 million in net cash (adjusted for an unusually high reduction in Q4 A/R) and .12/share in EPS, $1.4 million in EBITDA, $20 million in revenue and 7.95 million shares, this is currently a 52% gross margin company selling for an enterprise value of only around 0.5x revenue, 7.7x EBITDA and 11x earnings net of its cash. (DAIO also has approximately $20 million in NOLs, although a chunk of those would be used to repatriate the $6 million of cash held overseas.) Equally important is that due to the cost of being independent this is a natural acquisition candidate, and the elimination of $1.5 million in “independent public company costs” would roughly double the company’s EBITDA.
We remain short the Japanese yen via the Proshares UltraShort Yen ETF (ticker: YCS) as Japan continues to print nearly 30% of its monetary base per year. David Stockman wrote a great piece in March about what a fiscal and monetary disaster Japan has become and I urge you to read it. Meanwhile, 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:
This month I sold our position in the US 12-month Natural Gas ETF (UNL). I’m hesitant to have a position there heading into summer (the end of heating season), but plan to revisit this at some point in the future.
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
