Alta Fox Opportunities Fund commentary for the third quarter ended September 30, 2024.
Limited Partners,
In Q3 2024, the Alta Fox Opportunities Fund ("the Fund") produced a gross return of 5.65% and a net return of 4.16%. The Fund's average beta-adjusted net exposure during the quarter was 62.85%.
Since inception in April 2018, the Fund has produced a gross return of 808.14°A and a net return of 482.12% compared to the Russell 2000's return of 59.25% and the S&P 500's return of 143.73%.
Read more hedge fund letters here
As always, Alta Fox strives to ignore short-term price fluctuations and instead focuses on the intrinsic value growth in our portfolio holdings, which should converge with portfolio performance over time. We encourage limited partners to do the same both in times of outperformance and underperformance. We firmly believe that our strategy of buying high-quality and underfollowed businesses at attractive valuations will deliver appealing absolute and relative returns over time. Our approach remains disciplined with strict risk controls, minimal gross leverage, and, in our view, a robust research process.
Q3 2024 in Review and Market Observations
A "risk on" appetite prevailed in Q3 2024, driving strong gains across most indices and historically low levels of volatility. While, in our opinion, our portfolio companies posted solid results, our relatively lower net exposure was a headwind in this environment, consistent with our 2024 year-to-date performance. The Alta Fox research process demands a minimum medium-term IRR (typically 20% minimum) and does not incorporate multiple expansion into our base cases. As a result, we are often waiting for specific price levels on a targeted basket of watchlist candidates as we need strong organic earnings growth to meet our hurdle rate. In Q3 2024's environment, we often found ourselves watching watchlist securities appreciate as multiples expanded, a frustrating experience. However, we believe it is this valuation and underwriting discipline that has contributed to strong downside capture since the Fund's inception, and it is a core tenet of our investing approach.
At the time of this writing, our portfolio's gross exposure is near its historical high and significantly higher than at the end of Q3. This reflects the research team's identification of numerous high conviction opportunities. Many of these opportunities are in "self-catalyst" names, where we can directly influence the outcome from a governance or strategy perspective. A key tenet of our philosophy is that a business can be "cheaper" at a higher stock price than it is at a lower price if the facts have changed about the normalized earnings of the business. We have multiple examples of businesses in our portfolio that we believe are cheaper on a forward multiple of normalized earnings and free cash flow than they were when the stock was 20% lower. Typically, this occurs when the business outlook strengthens faster than the stock price. These situations have created some of our highest conviction buying opportunities since the Fund's inception, and we currently have several in the portfolio today. One noteworthy position in the portfolio fits this description perfectly. Expect more details on this position and our plan to help drive value creation later in Q4.
AppLovin Corporation (“APP”): Example of Our Disciplined Valuation Approach
Alta Fox has followed Applovin Corp (NASDAQ:APP) since its IPO in 2021, watching its initial high valuation (>30x EBITDA) through the mobile gaming downturn in 2022, failed Ironsource bid), and its consistent share gains from Unity/Ironsource. After years of diligence and consistent admiration for APP's adtech revenues, we gained conviction in Applovin's data-driven competitive advantage and initiated a position this summer.
We purchased shares at -11x NTM EBITDA, an attractive price relative to APP's growth and quality compared to similar adtech peers. The entry price also appeared inexpensive relative to APP's own historical valuation, which averaged -20x EBITDA. We felt confident in underwriting mid-teens revenue growth and modest operating leverage over the medium-term. Without any multiple expansion, we expected to earn a low-20%s IRR in the stock - an attractive return for owning such a dominant, secular growth business.
As the year progressed, the market increasingly rewarded APP for its quality & growth, nearly doubling its forward EBITDA multiple from our cost basis. With the valuation nearing —20x EBITDA, we no longer saw a sufficient margin of safety and exited our position at roughly 2x our cost basis.
REV Group. Inc. (“REVG”) Updated Thoughts
We believe that our original Rev Group Inc (NYSE:REVG) thesis has only strengthened since we initiated the position earlier this year. The quality of REVG's earnings profile has significantly improved, with Fire & Ambulance (high quality, non-cyclical) exceeding expectations, while RV (lower quality & cyclical) underperformed. Our FY25 estimates now underwrite the RV segment at only 15% of EBITDA (down from 58% of EBITDA in FY23).
We expected other shareholders to be similarly pleased with the Q3 results:
- REV surpassed our Fire & Ambulance margin estimate by 100bps in the quarter and re-emphasized imminent margin expansion as their higher-priced backlog is realized over the next 18 months.
- Management upgraded EBITDA guidance again and the earnings mix shift improved significantly, justifying a higher multiple for the consolidated entity.
However, in one of the most bizarre share price reactions we have seen in small caps to date, REVG crashed precipitously after the Q3 results. The stock traded down nearly 30% as the market obsessed over the headline revenue miss (caused by the underperforming RV business) and did not give due consideration to the improving EBITDA guidance and earnings quality. With our view of fair value increasing post-Q3 earnings, we decided to buy the dip aggressively. Intraday, the stock quickly traded down as much as 29% at the lows, then recovered throughout the session to close down 11%.
It is hard to explain why such an anomaly occurred. Perhaps it is the lack of fundamental small-cap managers trafficking in these names, the growth of algo trading, the "noise" in their release given various divestitures and different business segments. Regardless, we see the increasing rate of extreme price volatility in small caps as an opportunity for Alta Fox to capitalize on our diligent research process, with REVG's Q3 earnings trading being a prime example.
We have increased conviction in our REVG thesis today following management's outperformance in Fire & Ambulance YTD. While market consensus3 believes FY25 EBITDA is —$200M and stays there in subsequent years, we believe that REV's normalized EBITDA is $300M+ (-100% higher than FY24 levels and —50% higher than consensus FY26). Moreover, we believe that the balance sheet is significantly under-levered (we estimate 0.5x net debt/EBITDA as of Q4 FY24 adjusting for the ENC divestiture proceeds) and will be put to good use for shareholders. For example, leveraging the balance sheet by repurchasing shares aggressively over the next two years could easily boost our medium-term EPS target from $4+ to $5+, implying that REVG is trading at only —5x our view of "normalized" EPS, far too cheap for one of the highest quality industrial small caps in public markets.
Firm Updates
Alta Fox is wrapping up Junior Analyst recruiting as well as our 2025 Summer Quant recruiting class. Both processes received record applications this year. For research, we expect to hire one full-time Junior Analyst for 2025, as well as summer interns. For 2025 Summer Quant internship recruiting, we expect to add two undergraduate interns and one PhD intern. This team will support quantitative analyst Miles Child and data analyst Stephanie Chen on our ongoing data initiatives. We are very excited to unveil some of these initiatives in an LP webinar in 2025.
The research team will be in Boston on Saturday, November 16th for a national undergraduate stock competition we are hosting at Northeastern University this year. We have sponsored similar events almost every year since inception, a fun way to engage the next generation of stock pickers and a valuable recruiting channel.
Finally, based on recent fundraising success, we expect to close the Fund to new investors again in early 2025.
Conclusion
We are enthusiastic about allocating capital today with a multi-year time horizon. The convergence of attractively priced small-cap assets and a diminishing competitive landscape fuels our excitement.
We are fortunate to have exceptional limited partners committed to long-term partnerships. This has enabled us to make strategic, long-term investments that strengthen the Fund for sustained success. Our primary commitment is to leverage this position by investing thoughtfully in people, processes, and technology.
We are grateful for your trust in Alta Fox. We remain dedicated to continually improving our research and operational processes to build a world-class investment firm.
"The leading rule for the lawyer, as for the man of every calling, is diligence. Leave nothing for tomorrow which can be done today." - Abraham Lincoln
Sincerely,
Connor Haley
Alta Fox Capital Management, LLC
