Arquitos Capital Management 3Q15 Letter: WMI Holdings NOL Play

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Arquitos Capital Management’s letter to partners for the third quarter ended September 30, 2015.

Having great clients is the real key to investment success. It is probably more important than any other factor in enabling a manager to take a long-term time frame when the world is putting so much pressure on short-term results.

Seth Klarman


Dear Partner:

Arquitos Capital Partners returned -14.7% net of fees and expenses in the third quarter of 2015, bringing the year to date return to -12.5%. Our annualized return since the April 10, 2012 launch is 24.8%.

Arquitos Capital Partners

At the end of the second quarter we had a respectable 2.5% return for the year. Our performance during the third quarter eliminated those gains and has produced a measurable decline. Despite the disappointing results of the share prices of many of our holdings in the quarter, I’m satisfied with their operational results. This has been a buying opportunity.

ALJ Regional Holdings (ALJJ) acquired a new subsidiary during the quarter, doubling the size of the company. The stock price only recently has begun to reflect this very positive development. However, shares are cheaper now than earlier in the year relative to the value of the company. Shares currently trade for less than seven times earnings and less than four times EBITDA. They are worth considerably more. Once investors see the results of the new acquisition reflected in ALJJ’s financial statements, the stock will begin to more accurately reflect that value. ALJJ is a company we’ve owned for three years, and shares are more than 500% higher than when we first bought them. The last three years have been very, very good, but the best is yet to come.

Arquitos Capital Management: RELY stock drop

I wrote about Real Industry (RELY) in the last letter, and the stock promptly dropped 22% during the quarter. Aluminum prices have plummeted this year, which have hit the price of its stock. However, the weakness in the price of aluminum has benefited RELY as much as it has hurt. A large portion of the company’s revenue comes from its tolling operations, where they earn a spread on the price. Increased volume resulting from lower prices benefits this part of the business. There is a structural factor as well, as the automobile and other industries move towards using lighter aluminum in place of heavier steel. The company explains this well in their most recent investor presentation, which you can find on their website. The company also made an unsuccessful bid for a new acquisition during the quarter. It’s likely they will find another deal in the future, which will help them monetize their large net operating loss tax assets.

Sitestar (SYTE) shares dropped 46% in the quarter despite marked progress at the company. SYTE is a good example of how the share price of a very small company can become severely disjointed from its value. SYTE’s primary assets are its real estate holdings, where the value does not change over a short time period. I joined the board earlier this year along with a few other shareholders, and we are working with management to enhance shareholder value at the company.

Our poor performance in the quarter can also be attributed to the following:

  • Bank of America (BAC) warrants dropped 21%, though shares of the common stock are now approaching highs last seen in June.
  • SWK Holdings (SWKH) shares dropped 11% during the quarter after the company bungled a reverse split. While this mistake was disappointing, the thesis for the company holds.
  • Intrawest (SNOW) shares were down 26% on no news.
  • Special Diversified (SDOI) shares dropped 12%. The company now trades for 10% less than its net cash.

WMI Holdings (WMIH) is a company that did not drop in value during the quarter. WMIH is the former Washington Mutual, now post-bankruptcy. Today it is essentially a shell company with a very large net operating loss tax asset. KKR made a significant investment in WMIH last year, took over the board, and has been working to make an acquisition. A few weeks ago WMIH announced that they had identified a potential acquisition, which is the news investors have been patiently waiting for over the past several years. However, WMIH was not able to reach an agreement and the acquisition opportunity WMIH referred to finalized a deal with another company. While losing out on the deal is disappointing, it reinforces the idea that WMIH is looking for a large acquisition. I expect them to identify another opportunity in the future in the same industry of the failed bid.ce fluctuations will happen in the short term. This is something we can’t control, but there is tremendous value in our current portfolio and the market will eventually put an appropriate price on these companies.

Thank you again for being an investor in the partnership. Please don’t hesitate to contact me if you have any questions. I look forward to continuing to compound funds on your behalf.

Best regards,

Steven L. Kiel

Arquitos Capital Management

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The post above is drafted by the collaboration of the Hedge Fund Alpha Team.

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