An excerpt from the Hidden Worth Shares December 2018 Challenge interview with prime small cap rising worth hedge fund supervisor, Chris McIntyre
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McIntyre Partnerships is a concentrated, 130/30 fund with a objective of serious outperformance over the market cycle. The hedge fundfounded by Chris McIntyrefocuses on occasion pushed, non-cyclical GARP, and distressed investments, with an emphasis on high-quality, predictable enterprise fashions.
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Chris McIntyre has eleven years of funding expertise throughout a number of funds: MAK Capital, Cobalt Capital, MDR Capital, and FNY Securities. Most just lately he was a Managing Director at MAK Capital, a worth targeted fairness and credit score fund, the place Chris McIntyre: managed investments in shopper, telecom, and particular conditions. Chris McIntyr is a CFA charterholder. He’s a College of Virginia graduate with levels in Economics and Authorities.
INTERVIEW ONE: Chris McIntyre, McIntyre Partnerships
To start out, might you give us a quick overview of your background and McIntyre Partnerships?
Chris McIntyre: My background is that I’ve labored in hedge funds/ funding administration since graduating from the College of Virginia in 2007. I’m that child who went off to school considering he’d be a lawyer however ended up buying and selling shares behind class as an alternative. I bit the funding bug in class and have been hooked since. Popping out of faculty, I went to work for First New York, the place I labored on a danger arbitrage desk in the course of the Nice Recession.
Fairly the time to start out! After a couple of years, I needed publicity to long-term investing and pivoted to analyst roles at a number of value-focused hedge funds, together with Cobalt and MAK, the latter of which I spent 4 years at as a managing director earlier than launching McIntyre Partnerships.
Over these years learning and experimenting with totally different funding methods, I all the time religiously tracked my funding efficiency. Ultimately, I settled on a concentrated contrarian worth technique; I concentrate on a small variety of concepts, not more than 5 or eight, and know them in depth. The technique made sense to me, matched my temperament, and most significantly, labored. After a number of years of operating my private account within the technique, I used to be persistently outperforming the market, and I felt satisfied I might proceed to carry out. I left my job and launched McIntyre Partnerships in January 2017. The fund is “one man band” on the analytical aspect – I’ll all the time be the one senior funding skilled.
Additional, the fund focuses on small to medium- sized corporations, and I’m dedicated to maintaining the fund’s belongings small to maximise our complete funding universe. The fund had a robust 2017, returning 46% gross. 2018 has been a tough yr, persistently lagging, however I consider the market has created alternatives on this volatility.
What are you in search of in an funding – what makes you say sure or no?
Chris McIntyre: I make use of a contrarian worth type, which I simplify to 3 common classes: compounders the place the market is underestimating long-term earnings progress, event-driven funding the place a inventory is mispriced and a catalyst will trigger a repricing, and contrarian/distressed investments the place I consider the market is strongly underestimating future earnings. When in search of an funding, I need to discover concepts that fall into at the least certainly one of these classes, ideally all three.
When most buyers hear “fat pitch,” they assume “stocks with a lot of upside,” which is true – my genius technique is to purchase shares that would go up quite a bit. However once I say “fat pitch,” I additionally imply restricted long-term draw back. Much more vital than giant upside, my largest hurdle to funding is a excessive chance of minimal long-term danger.
I look via dozens of shares a yr that match these standards, however what makes me say sure or no is whether or not I consider it’s a “fat pitch.” When most buyers hear “fat pitch,” they assume “stocks with a lot of upside,” which is true – my genius technique is to purchase shares that would go up lots. However once I say “fat pitch,” I additionally imply restricted long-term draw back.
Much more vital than giant upside, my largest hurdle to funding is a excessive chance of minimal long-term danger. “Look down, not up” is a favourite funding quote of mine. From there, I stability my sizing in response to upside potential and catalysts. It sounds cliche, nevertheless it’s the core of what I do.
What makes this technique totally different to different worth funds?
Chris McIntyre: My general funding philosophy just isn’t wildly totally different from most worth buyers. Worth methods have repeatedly been employed efficiently for the previous 80+ years – Buffett, Klarman, Greenblatt, Loeb, and so on. Regardless of its apparent success, most worth funds fail to beat the market.
I hate to say it and danger the ire of the buying and selling gods, however the important thing “bet” an investor within the fund makes is on me – that I possess the analytical expertise, judgment, and temperament to efficiently implement tried and examined worth methods.
Nevertheless, if do possess these expertise (and that’s an enormous if…), the fund is differentiated in that I’m dedicated to taking concentrated bets, being the one senior funding skilled, and holding AUM small.
I’m prepared to spend money on a lot larger focus than the overwhelming majority of funds – we had a 30% place at launch, as an example. Whereas that provides single identify danger, it’s so much simpler to seek out 5 good concepts in a yr than fifty. As I run a “one man band,” I’m capable of convey focus and rigorous analysis to the handful of important selections I make a yr. Lastly, by retaining the fund small, the fund has a large potential funding universe. I feel it’s so much simpler for one individual to seek out 5 good concepts within the ~25,000 shares with larger than $100 million market caps than for 20 individuals to seek out 50 to 100 good concepts within the ~1,400 public shares with higher than $10 billion market caps.
You have to be snug operating a concentrated portfolio. Are you able to speak a bit about why you selected this strategy?
Chris McIntyre: Considered one of my favourite Warren Buffett quotes is “No one ever got rich off their eighth best idea.”
One other I’m keen on is Andrew Carnegie, “Put all your eggs in one basket and then watch that basket.” Easy monetary math exhibits that a five- inventory portfolio achieves 82% of the diversification advantage of a 500 inventory portfolio. Whereas most buyers perceive that math, they continue to be scared of creating a mistake when operating so concentrated. The trick for me is that I do the work myself, solely spend money on corporations I consider I perceive completely and am obsessive about danger. I additionally spend vital time on every funding – I’ll sometimes put at the least a number of weeks of analysis into anybody funding. Frankly, I sleep a lot better with 70%+ of my internet value in 5 issues I do know in depth than 30 names I barely know.
Might you give us a case research of an organization that exhibits off your technique?
Chris McIntyre: The perfect instance is the fund’s funding in Chemours (CC), not solely due to its robust efficiency however as a result of it’s the largest guess the fund has taken and touches all three of our classes: a high-quality enterprise spun out in a time of misery. I invested in 2015, and when the fund launched, we had an ~30% place.
Chemours got here throughout my desk as a part of my normal spin off analysis course of. In June 2015, DuPont spun out Chemours, which consists of DuPont’s (DWDP) legacy TiO2 (a chemical that makes paint opaque), fluorochemical (assume Freon and Teflon), and a few smaller commodity chemical belongings.
For quite a lot of causes, Chemours was spun in a frankly irresponsible method. The TiO2 enterprise was getting into a nasty recession, the dividend was unsustainable, the debt load was too excessive, and Chemours had indemnified DuPont in a big class- motion lawsuit. Administration ought to have postponed the spin or restructured Chemours, however an activist was pressuring the corporate, so Chemours was pushed into an unprepared market. Additional compounding issues, the complete commodity fairness/ credit score market imploded in August 2015 resulting from China fears, and Chemours’s pure competitor group – of different publicly traded TiO2 producers – fell 50%.
It was an ideal storm – a sophisticated story, spun incorrectly, right into a market that tanked.
One among my favourite funding varieties could be very difficult tales that may be boiled right down to easy ideas. Regardless of the inventory volatility and fears of insolvency (shares went from $20 at spin to $three in January 2016), Chemours was an exceptionally high-quality enterprise with predictable, albeit cyclical, earnings. Chemours’s key differentiators are that their TiO2 enterprise is likely one of the most dominant companies I’ve analyzed and the TiO2 market is comparatively predictable. For over sixty years, Chemours has been the low-cost TiO2 producer by a considerable margin. The enterprise has a a number of hundred greenback per ton value benefit, which equates to roughly double the margin of rivals via the cycle. Additional, whereas TiO2 costs are risky, TiO2 volumes are comparatively secure – international inventories are at most a number of months of provide and finish market volumes develop and contract in keeping with GDP. In consequence, when pricing tanks and the marginal producers’ margins fall to money prices, Chemours nonetheless generates vital EBITDA.
Usually the market awards low-cost producers with much less inventory volatility and better trough multiples, however as Chemours was a current, opaque spin, these qualities of the enterprise have been misplaced available on the market – the proverbial child with the bathwater.
Getting into 2017 and the launch of McIntyre Partnerships, shares of Chemours had rallied significantly, but I felt the fairness remained considerably undervalued. Chemours was buying and selling $22 and I estimated mid-cycle earnings over $four. Additional, I felt there have been robust catalysts – continued TiO2 worth will increase and the decision of the PFOA lawsuit. A excessive chance, excessive reward funding with robust catalysts deserves a big place. On TiO2 costs, the market turned in Q1 2016 and producers put via a number of worth hikes, but the marginal producers nonetheless have been working at breakeven ranges. As TiO2 costs held robust in usually seasonally weak This fall 2016, I assumed costs would rally once more in 2017 and that sell-side forecasts have been underestimating this impression. On the PFOA lawsuit, Chemours had indemnified DuPont in a big lawsuit. Whereas phrases like “indemnity” and “multi-district litigation” seem scary, most authorized liabilities are identical to some other danger – they could have a wider vary of outcomes, requiring a wider margin of security, however they’re not often solely unknowable occasions. I felt the market was drastically overestimating the danger. When the events settled in February 2017, Chemours shares traded over $30 earlier than rallying to $50 over the summer time.
What kind of firm would match into your contrarian/distressed portfolio?
Chris McIntyre: Once I name a inventory contrarian/distressed, I imply a liquid inventory with a excessive yield on my estimated earnings. (Bonds and illiquid securities are a unique matter.) That nearly all the time implies the notion of working or monetary misery, and that I’m going towards the grain.
A current instance is our funding in Garrett Movement Inc. (GTX).
Chris McIntyre: I discovered our Garrett Movement funding in a spot the place one might hope for a discount: a sophisticated, current spin of a small-cap from a mega-cap the place the related peer group fell 30% to 50% within the two months previous the spin. I consider Garrett on two ranges: a guess on auto suppliers broadly and a guess on Garrett particularly.
Knowledge Supply: Morningstar
Auto shares are one of many worst performing sectors year-to-date, with the auto provider subgroup falling ~35% and buying and selling at ~7x to 8x 2019 EPS. International auto purchases have begun to sluggish, lead by a low-double-digit decline in China, and reminiscences of the 2008 recession linger. Additional, the evolution of battery electrical automobiles (BEVs) requires a change within the auto provide chain, including a level of secular danger. Nevertheless, I consider sure auto shares greater than mirror these cyclical and secular dangers. Whereas particular person nations can exhibit substantial cyclicality, international auto demand is extra strong, with a peak-to-trough decline of ~10% to 15% within the Nice Recession. BEVs are a long-term concern, however a really long-term concern versus present valuations. BEV penetration is presently minimal, and the mixed inner combustion (ICE) and hybrids market are unlikely to say no till the late 2020s. The subgroup’s teenagers FCF yield greater than displays the prospect of a considerable decline past 2030.
Garrett is a number one producer within the moat- wealthy turbocharger (TB) market, with a worldwide end-market, industry-leading margins, and a strong medium-term progress story from hybrid penetration. Garrett was just lately spun from the a lot bigger Honeywell. As Garrett represented beneath one % of Honeywell’s fairness worth, I consider most Honeywell shareholders bought their shares with little analysis or regard for worth. Garrett shares now commerce at ~3x to 4x my estimated 2019 FCF/share, the bottom a number of within the auto-supplier area. I consider buyers are ignoring the group due cyclical fears and Garrett’s asbestos legal responsibility, which makes Garrett display as extremely levered. Auto suppliers are inherently cyclical, however the agency has a worldwide end-market, an 80% variable value construction, and the TB market is forecast to develop ~500-600bps above the market fee, which lowers the working danger in a recession. Garrett screens as having ~$three.2 billion in debt/ liabilities versus ~$650 million in 2018 EBITDA, however ~$1.four billion of the debt/liabilities is the asbestos legal responsibility, which is structured as a junior obligation with a $175 million annual cap that may be deferred within the occasion of default. The enterprise solely has ~$50 million in annual curiosity expense and ~$25 million in upkeep capital wants, implying substantial protection versus “true” fastened prices even in a big recession.
I consider Garrett can earn >$four in EPS in 2020 and, because the inventory de-levers and the story is best understood, can commerce at a 10x or higher valuation.
In accordance with your newest letters to buyers, your portfolio appears to be closely concentrated proper now in media shares, notably CBS. What do you want about this sector, and the way does it match into your technique?
Chris McIntyre: I like “legacy” cable TV media as a result of it’s disliked (thus low cost), traditionally the businesses have been high-quality companies, and I’ve a differentiated view on particular names. The area is usually hated as a result of “TV is changing” so “who knows what will happen.” I agree that TV is altering, however I feel the market is overestimating the earnings influence, notably on particular investments.
Technique-wise, I notably like that cable TV media are a contrarian guess in what would in any other case be high-quality compounders.
I consider CBS (CBS) is especially properly located to handle the change in TV. CBS owns the CBS Community and Showtime. The essential element to know when evaluating CBS to different legacy TV companies is that the CBS Community is under- monetized within the present ecosystem. Traditionally, CBS and different broadcasters have been distributed without spending a dime over-the-air (OTA) and monetized completely via promoting dollars. Nevertheless, shoppers now demand streaming-video-on-demand (SVOD) content material, which CBS doesn’t present for free OTA. In contrast to conventional cable networks, this shift creates a completely new subscription income stream for the enterprise. CBS has quickly grown its subscription charges (“retransmission fees” in media parlance) over the previous few years, but CBS is simply ~$three/month in value to the buyer regardless of representing 10% to 15% of complete viewership. Additionally, CBS has an lively studio enterprise, which may produce exhibits for different networks, and Showtime is comparatively insulated from the linear-to-SVOD shift and rising. CBS at present trades ~9x ahead earnings, which I consider can develop earnings at a teenagers or higher price over the subsequent few years. In a recession, CBS ought to solely see modest EPS impression as a result of their >60% recurring income mannequin.
Past secular fears, buyers additionally worry a merger between CBS and Viacom Inc.(VIA), as Viacom’s conventional cable TV enterprise is extra in danger from the shift to SVOD. Whereas I agree Viacom is a decrease high quality enterprise, a merger has strategic deserves from scale, vital synergies, and I consider Viacom shares are exceptionally low cost in their very own proper. Professional-forma, I feel a merger would increase earnings 10% to 30% in 2020 with a big “hidden asset” in Paramount, which presently generates little revenue however could possibly be value $5 billion in a sale or ~15% of my estimated pro-forma market cap.
Over the course of 2018, cable TV shares have usually outperformed, as sub declines have slowed and advert dollars have been extra strong than feared. I’ve modestly trimmed our media investments as they’ve outperformed, however the fund retains a big guess.
What would make you promote a core concept?
Chris McIntyre: The timeless funding query – it’s all the time extra artwork than science. Skipping previous the straightforward half when the thought has labored out, I attempt arduous to stay trustworthy and down to earth with myself. Once I make an funding, I all the time maintain a written report of what my funding logic is and the place I might be flawed. I by no means thoughts if the worth goes towards me or if an concept is caught as lifeless cash, however I’m very, very delicate to when a part of the thesis has been confirmed incorrect.
There’s additionally the “retail shorts” basket in your portfolio. Wouldn’t it be potential to offer us some extra perception on this?
Chris McIntyre: Shorting just isn’t a spotlight of the fund, however I do selectively brief secular losers. As an investor, I merely should concentrate on which industries/sectors are in secular decline. If I don’t, I’ll inevitably find yourself lengthy one, as my contrarian technique includes taking a look at numerous low cost shares which are low cost for a superb purpose. Nevertheless, as an alternative of concentrated bets as I do within the lengthy portfolio, I diversify as a guess is towards the industry slightly than a particularly dangerous administration staff or product.
As for retail, my thesis isn’t distinctive: the web is altering shopper habits and bodily retailers face vital obstacles. US e-commerce gross sales have been roughly 10% of complete retail gross sales in Q3 2018, up from 9% in Q3 2017 and eight% in Q3 2016. They have been three.6% in Q3 2008. I feel that development will proceed for years and years. There’s no cause e-commerce couldn’t symbolize 30% of complete retail gross sales in 2030. Bodily retailers face a slew of points on this new actuality. Retail was already a brutal enterprise; now they should spend cash to construct out e-commerce whereas gross sales decline of their present higher-margin enterprise. I’ve shorted a handful within the area, and with out naming particular shares, I’m targeted on retailers who primarily promote “other people’s stuff,” versus branded retailers. In case you are Prada or Lululemon, you’re promoting your personal manufacturers and whereas location and comfort are necessary, you’re primarily competing on the product. But when your enterprise is shopping for blenders, TVs, and/or sneakers wholesale and making an attempt to out-compete Amazon on comfort and worth…. Good luck.
And one other basket outdoors of the first portfolio is the “Small-Cap Financials Basket.” What are your objectives for this basket?
Chris McIntyre: One of many few areas the place I feel diversification is sensible is in “easy” to determine statistically low cost financials.
A easy inventory display will return loads of low cost worth to ebook worth shares, which for financials resembling banks ought to theoretically be a proxy for liquidation worth. I spend numerous time wanting by means of these, hoping to discover a gem that may be sized for a critical guess. Nevertheless, most have a tendency to be illiquid, solely a modest low cost to e-book worth, and and not using a robust catalyst. My technique is to as an alternative purchase a number of in a basket, with 10% to 20% of the funds capital, the place the objective is to modestly outperform the market with below-market danger.
Conceptually, if we purchase three positions at a 30% low cost and two attain internet asset worth whereas one drops one other 10% to 20%, we’ll do fairly properly. By shopping for a number of of them in modest measurement, we will understand the overall good points from shopping for undervalued securities, improve our non-cyclical publicity, and, each time one continues to fall, as low cost shares with out catalysts typically do, we have now room to considerably improve our place.
Of word, we strongly favor investments with minimal leverage – an fairness with a 30% low cost to truthful worth with no debt is wildly totally different from an analogous low cost with 10x leverage. The financials basket can also be extra micro-cap targeted than our general portfolio. Our giant investments are sometimes working corporations, the place scale issues and micro-cap companies are structurally deprived besides in uncommon niches. The other is true in finance; very similar to hedge funds, banks and REITs arguably face disadvantages from scale as their alternative set decreases.
Might you give a case research of a inventory within the basket that showcases your goals for the basket?
A current instance is Owen’s Realty (ORM).
Chris McIntyre: Owen’s is a mortgage REIT. Initially, Owen’s was a personal fund targeted on bridge loans that suffered steep losses within the Nice Recession.
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