Hazelton Capital Partners commentary for the first quarter ended March 31, 2024.
Dear Partner,
Hazelton Capital Partners, LLC (the “Fund”) increased 10.4% from January 1, 2024 through March 31, 2024. By comparison, the S&P 500 increased 10.5% during the same quarter.
The Quarter in Review – Continuing Where 2023 Left Off
Hazelton Capital Partners ended the 1st quarter with a portfolio of 16 equity positions and a cash level of 18% of assets under management. The top five portfolio holdings, which are equal to roughly 43% of the Fund’s net assets, are: Burford Capital (NYSE:BUR), Micron Technology (NASDAQ:MU), Caesar Entertainment (NASDAQ:CZR), International Money Express (NASDAQ:IMXI), and KKR & Company (NYSE:KKR).
The first quarter of 2024 picked up where 2023 left off, with strong momentum driven by several positive factors including economic resilience, subdued inflation, positive earnings, and the anticipation of future interest rate cuts. The positive persistence of the US economy is puzzling, especially when considering the size and cadence of the Federal Reserve’s interest rate hikes that began in March of 2022. Offsetting those hikes is a strong labor market, declining inflation in the energy sector and other non-durable goods and services, and a consumer willing to spend. However, the euphoria surrounding Artificial Intelligence (AI) is having the biggest impact on the market’s top tech companies which, because of their market capitalization, are pulling the S&P 500 higher. The usual suspects, Amazon (NASDAQ:AMZN), Meta Platforms (NASDAQ:META – Facebook), Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT), and Nvidia (NASDAQ:NVDA) are up at least double digits in the first three months of the year with Nvidia topping 80%.
Hazelton Capital Partners’ 1st quarter portfolio performance was led by Micron Technology (MU), which benefited greatly from the AI hysteria. During the quarter, the Fund took advantage of the appreciation in Micron’s share price, selling a large portion, and reducing the position to the portfolio’s second-largest holding which will be discussed in more detail later in the letter. The two largest drags on the portfolio were Caesar Entertainment (NASDAQ:CZR) and Apple Inc (NASDAQ:AAPL). Both were negative in the quarter, weighed down by pessimistic sentiment. Going forward, one should expect a more moderate portfolio performance as the Fund patiently redeploys its cash and repositions the portfolio.
Apple Inc (AAPL) - Current Holding
Noticeably missing from Hazelton Capital Partners’ top five holding is Apple Inc. In late July of 2023, Hazelton Capital Partners halved its Apple holding, dropping it from the Fund’s secondlargest holding down to its fifth by the end of the 3rd quarter of 2023. By Q1 of 2024, Apple Inc had fallen out of the top five entirely as shares of the iPhone maker declined 11% in the first three months of 2024.
Hazelton Capital Partners has owned Apple Inc. for over ten years, during which the stock appreciated over 1100%. At the time of purchase, Apple had a market capitalization of around $375 billion, generated $110 billion in sales, and traded at 16 times its earnings. When Hazelton Capital Partners reduced its position, Apple’s market capitalization was just under $3 trillion, generating ~$385 billion in sales, and trading at roughly 30 times earnings. This begs the question, “Why not sell the entire holding?”
Hazelton Capital Partners has often written about its dogmatic approach to selling when shares of a company approach their intrinsic value. However, the fund also has come to recognize that there are a handful of extraordinary companies whose intrinsic value will continue to appreciate as the company continues to play a vital role in our daily lives. Hazelton Capital Partners believes Apple to be one of those extraordinary companies. Currently, shares of Apple are overvalued based on its current and short-term expected revenues and earnings. While Apple’s Service segment has demonstrated strong growth and margins, it has not achieved both the size and scope to offset the drag from lagging iPhone sales. With over 2.2 billion active mobile devices, Apple’s mobile products are sure to play a key role in the next big disruptive technology which includes Artificial Intelligence (AI), advanced connectivity (5G and beyond), and extended reality which comprises both virtual reality (VR) and augmented reality (AR).
In May 2023, Morgan Stanley Research released a case study entitled “The Roadmap to Monetizing Cycles: The Mobile Internet as a Case Study,” which mapped out the three distinct waves of mobile’s exponential growth from 2010 through 2017. The first wave revolved around the semiconductor providers that produced the chips that became the backbone of mobile devices. They quickly earned outsized profits which attracted competition, increased supply, compressed margins, and eventually led to product commoditization. The second wave came from infrastructure and mobile devices, which quickly consolidated the smartphone and tablet market into either Android or iOS devices. The third wave came from software and services built on top of the first two waves. These included companies such as Amazon, Facebook (META), and Google. All three expanded their global reach beyond the PC and into the mobile market. Amazon, Meta, Google, and others could not have come to dominate the mobile market without the smartphone, and the smartphone could not have existed without the semiconductor chips that provided computing power.
Artificial intelligence is the next disruptive technology and many investors fear that Apple’s failure to forge a clear AI strategy will prevent it from benefiting in the future. The first wave is well underway with Nvidia producing 80% of the chips needed to power AI’s large language models. Currently, the cost for Nvidia’s latest AI chip, Blackwell, is roughly $35,000 per unit. Strong demand combined with exorbitant AI chip prices are responsible for Nvidia’s 78% gross margin it achieved in its most recent quarterly earnings in Q1 of this year. Just like with the mobile internet, the invisible hand of capitalism will eventually bring balance to the semiconductor market as competition will rise, supply will increase, and unit prices/margins will fall. In the past, Nvidia’s competition would have come from other semiconductor companies. Today, it is very likely that Nvidia’s future competitors will be some of its current customers: Amazon, Meta, Google, & Microsoft, who have both the capital and technical expertise to design their own silicone. These four companies currently represent roughly 40% of Nvidia’s AI chip sales. If history is a guide, future demand for AI semiconductor chips will be insatiable until it’s not.
AI’s second wave is just emerging, but its full impact will not be truly felt for a year or so. Just like with the mobile internet, Apple’s iPhones, iPads, and laptops will play a dominant role as they become the platform to interact with AI applications (apps) running “on-device” vs. in the cloud. This will launch a massive refresh cycle that will include iPhones, iPads, Laptops, and even desktops, taking place over a number of years.
As for the third wave, given the amount of data and capital needed to “feed” AI’s large language models, Amazon, Meta, Google, and Microsoft are well positioned to dominate. However, it is just as likely that other companies, ones just forming or operating below the radar, could disrupt the status quo.
For the first three months of 2024, Apple shares were down nearly 11%. Late in Q1, Hazelton Capital Partners repurchased a small number of Apple shares at a 15% discount to where the Fund sold in 2023. Hazelton Capital Partners is keeping a watchful eye on Apple’s share price and is looking for an opportunity to rebuild its position when the valuation makes sense.
Burford Capital (BUR) - Current Holding
Charlie Munger’s quote, “The big money is not in the buying and selling, but in the waiting,” perfectly encapsulates Hazelton Capital Partners’ investment philosophy, especially regarding Burford Capital. In the first quarter of 2024, Burford Capital became Hazelton Capital Partners’ largest portfolio holding due to a reduction in Micron (MU) shares, not an increase in Burford’s share price or share count.
Like most industries, the legal industry’s productivity has benefitted greatly from technological innovation. However, when it comes to litigation, the cadence of a court proceeding moves at a predetermined, methodical, often unbearably slow, pace. On average, it takes over 3 years for a court case to be resolved. Unfortunately for Burford, which finances litigation cases, a resolution does not automatically result in revenue recognition, as appeals, payment delays, and outright refusal to comply are common. This is where the waiting comes in. Even with uncertainty, legal complexity, and illiquidity inherent within Burford’s litigation finance business model, the return on their investment is very meaningful and well worth the wait.
Since its inception in 2009, Burford Capital has achieved an 82% return on invested capital with a 27% internal rate of return (pre-tax and expenses) on the cases it has funded. This includes 2020 through 2022 when the courts were either shut down or backlogged because of the Covid Pandemic. Over the last five years, Burford’s has deployed roughly $1.8 billion of its balance sheet to fund new litigation cases, a 22% increase from the previous five years. The company’s litigation funding has grown in both size and scope as Burford began raising outside capital to manage and invest in litigation cases alongside its own capital starting in 2017. Over the years, Burford has expanded its investment landscape beyond single litigation cases to include litigation portfolios, complex strategies, pre- and post-settlement finance, and asset recovery. As the company grew, so did the size of its commitments and deployments. Today, Burford Capital’s company-wide litigation investment portfolio is over $7 billion, a 17% increase year-over-year, with Burford’s own investment representing 68% of the total. With courts back to full capacity and the backlog of cases continuing to clear, Burford’s portfolio realization accelerated in 2023, momentum that should continue through 2025 at the very least. Even with all these positive catalysts, Burford Capital’s share price remains captive by the news flow surrounding its YPF case.
In September of 2023, Judge Preska, of the Southern District of New York, ruled against the country of Argentina and in favor of Petersen Energia & Eton Park Capital Management. The judgment in these two cases (known collectively as the YPF case) totals over $16 billion with Burford expected to make $6.2bn for funding both cases. Shares of BUR spiked over 25% on the news of the judgment before softening and becoming range bound between $13-$14/share over the next few months. Most legal experts believe it is highly improbable that the plaintiffs will receive the full $16 billion judgment and expect a discounted settlement. How much, how Argentina plans to pay off the settlement, and when remain key hurdles that still need to be resolved. In the meantime, Burford Capital has begun collection proceedings to collect what it can and pressure Argentina to get to the table and resolve the matter. In December of 2023, the newly elected President of Argentina, Javier Milei, acknowledged both the outstanding YPF judgment (which is currently on appeal) and that Argentina needs to pay its debts, leading to a rally in the stock price before settling into its new range between $14.5-$15.5/share
From an outsider’s point of view, the movement in Burford’s share price makes perfect sense as the $6.2bn that Burford could receive is twice its current market capitalization. However, what many investors are missing is that Burford is more than any one litigation case, even one as large as YPF. Over the past five years, Burford Capital has had a steady growth in the amount of capital it has deployed that has yet to be realized. Given its historic return on capital and internal rate of return, Burford’s deployments will continue to expand the company’s profits for years to come. In addition, the Covid-19 Pandemic and the recent increase in interest rates have acted as industry headwinds, reducing competition, and solidifying Burford’s place as the industry leader. Unlike finance companies in other industries, Burford is restricted from divulging substantial information about its investments (litigation cases), leaving its earnings discussion opaque and many investors unsatisfied.
Hazelton Capital Partners is comfortable with Burford taking the top spot in its portfolio. The Fund recognizes that Burford’s long-term growth and profitability are uncorrelated to both business and interest rate cycles. One could argue that rising interest rates will benefit Burford as fewer corporations will want to commit their own capital to litigate a case and fewer litigation finance firms will have the capital base to fund the growing cost of litigation. Those that continue to fund litigation will ask for returns commensurate with the higher cost of capital. Even when removing the substantial benefit of a future YPF payout, Burford’s share price remains meaningfully undervalued, presenting a significant upside opportunity.
Micron Technology (MU) - Current Holding
During the first quarter of 2024, Hazelton Capital Partners reduced its Micron Technology (MU) position by over 70%. Over the past eight years, Micron shares have been a significant contributor to the portfolio’s performance, compounding at roughly 30% per year. Of course, that is the aggregate result and not the actual yearly contribution. On a year-to-year basis, Micron’s stock movement could often resemble more of a rollercoaster ride than a steady ascent. During 2021, shares of Micron rallied 35%. By the end of 2022, they had plunged nearly 50% only to recover 70% through 2023. In the first 3 months of 2024, Micron shares gained 47%. To be fair, Micron shares have been influenced by the same reactive, bi-polar behavior impacting both the semiconductor industry and overall market as a whole.
The foundation of Hazelton Capital Partners’ investment thesis for Micron has remained consistent over the past eight years: Micron’s profits would continue to grow as exponential growth in the creation and integration of data across data centers, gaming platforms, highperformance computing, and mobile devices would require larger and faster storage and memory solutions. What has changed during that time has been the cadence of growth and the impact of Artificial Intelligence (AI).
AI is not new to Hazelton Capital Partners. The Fund has been writing about Artificial Intelligence and Machine Learning for the past five years. To say that Hazelton Capital Partners fully recognized AI’s impact or how it would become the driving force it is today would be an over exaggeration if not intellectually dishonest. The Fund saw AI as a consistent and growing tail wind, not the category five hurricane we are experiencing today. Like the introduction of electricity and the internet, generative AI is a disruptive technology that is permeating all aspects of our daily lives. It is dramatically changing how we work, create, and communicate with the world around us. The changes are both profound and wonderous. Artificial intelligence is the rising tide that is lifting all boats, and Micron is in the harbor.
Hazelton Capital Partners’ investment in Micron has provided a valuable education into the semiconductor industry, a thoughtful management team, a well-run business model, and the uncertainty and constant competition facing chip design and manufacturing. Even though the company’s semiconductor chips are on the cutting edge of technology and a necessary component for the growth of AI, they still remain a commodity product that is susceptible to current and future market cyclicality. As a long-term investor in Micron, Hazelton Capital Partners has learned to leverage the unpredictability of the company’s share price by adding to and pruning around its core holding. By the end of 2023, Micron had become a dominant position in the Fund’s top five holdings and toward the end Q1 2023 was approaching Hazelton Capital Partners’ intrinsic valuation. Even though Micron’s intrinsic value is likely to appreciate over time, the cyclicality of the semiconductor market makes holding the position less attractive. Instead of paring back the position, Hazelton Capital Partners meaningfully reduced its Micron holding and will likely continue to do so.
Investing in Hazelton Capital Partners
Hazelton Capital Partners was created as an investment vehicle, allowing those interested in long-term exposure to the equity market to invest alongside me. With a substantial portion of my own capital in the fund, I manage Hazelton Capital Partners’ assets in the same way I manage my own capital. The best source of introduction to potential investors in the Fund has come from those that have invested or followed Hazelton Capital Partners progress over the years. Introductions are both welcome and appreciated.
If you are interested in making or increasing your contribution to Hazelton Capital Partners or just learning more about The Fund, please feel free to contact me.
Please do not hesitate to call me at (312) 970-9202 or email me bpasikov@hazeltoncapital.com with any questions or concerns.
Warm Regards,
Barry Pasikov
Managing Member
Hazelton Capital Partners