As a subscriber of Being and investments’ newsletter we are sending you this end of year market update, to share our view of the year that has passed, our current view on the market, and implications on where to find good investment in the current market environment. Our overall perspective is that the market is becoming increasingly driven by other things than company specific fundamentals. Instead, prices are driven by index-fund flows, interest rates and trend following. Being and investments view is that flows into and out of index funds during the year have pushed stocks in indices up or down. The rise of index funds has created a giant herd of capital that is not interested in fundamentals. As such, flows in and out of these funds, and inclusions or exclusions of companies in indices, have and is driving stock prices, rather than fundamentals. Low interest rates have inflated valuations of the stock-market in general and in growth and “dream” stocks in particular. Many hedge funds have been taking positions in growth stocks, with already elevated multiples, betting that multiples will increase even further as interest rates fall. One example is Google (Alphabet), who is trading at EV/EBITDA of 18, with 18-19% growth, with many hedge funds and other active investors piling in recently. Momentum is increasing, and investors are ever greedier, investing in companies who are believed to be in more demand in the future, rather than investing based on fundamentals. The opposite applies as well. Not even in 1999 did “value” underperform so much as it did in 2019. Not surprisingly, "value" stocks (if defined as low growth, “cheap” stocks) have underperformed significantly during the last years. We backtracked the returns of companies trading at below 5x EV/EBITDA and conclude that they have never during the last two decades underperformed as much as they did in 2019, not even during 1999 did “value” underperform so much as it did in 2019 (see below).
Our methodology, which is unmistakably value based, has resulted in cases which are indicative of the market landscape we are in. Our methodology is predicated on investing in undervalued securities where intrinsic value can be increased through active ownership. In our view, "value" can theoretically be found in growth cases ("price is what you pay, value is what you get"), but we find it increasingly hard in practice to find undervalued stocks in companies experiencing strong growth. So our methodology, combined with the market environment, is today resulting in cases that are characterized by low but predictable growth, in out-of-favour industries, or outside of the major indices, and where margin expansion is key to increasing intrinsic value. For example: Xerox (printing) and AMC Entertainment (Cinema) are both low but predictable growth stocks that are out favour, which are trading below what we deem to be intrinsic value. Blue Bird Corp (School Buses) is also a low but predictable growth stock. In all three cases, value creation in the coming years will not primarily come from growth, but from margin expansion, through cost take out and product mix shift, combined with a slightly accelerated growth. Small-, and medium-cap stocks, in “non-core” markets, outside of index funds’ reach, can also trade at attractive valuations. Two examples that were recently part of our holdings are Telepizza (until recently trading at BOVESPA, bought out by KKR) and Perion (market cap of ~ USD 100m at the time of investment, we exited at a 105% return in four months). Our pipeline is rich, but we are patiently building up our portfolio carefully. We have analysed and are tracking around 40+ cases with active owners. We have built preliminary investment cases on all these, but are awaiting a good entry price/situation. We are also currently analysing ten new cases, three of which are conglomerates, i.e., break up cases, a few resource plays (e.g., gold) and a handful of margin-expansion cases. Our recent investments are of to a strong start, and we have attractive cases in the portfolio: Exited case:
Telepizza (bought out by KKR) – Case predicated on undervaluation (8x EBITDA at 15% growth) and value creation (strategic alliance with Pizza Hut)
Xerox (we have until now made ~70% return compared to Carl Icahn who has made ~ 25% return) – Case Predicated on undervaluation (5x EBITDA, with additional hidden assets) and value creation through cost take out (50% EBITDA potential vs HP) and repositioning products medium term.
Perion (we made 105% in four months) – Case predicated on undervaluation, traded at 2,4 FCF at time of entry.
Cases in portfolio:
AMC (Cinema business with SilverLake) – Case predicated on value creation through partial change of business model (subscription), product mix shift (increased sale of food ), revenue management (pricing) and cost take outs (G&A after M&A activity). We estimate a 300-400% return in three to five years.
Senvion Debt (Wind Turbine Manufacturer/Service provider with Anchorage) – Case predicated on undervaluation: debt estimated to be covered in full by 10 year-long service contracts. Ongoing sale of service contracts re-affirms our thesis.
Blue Bird (School buses with American Securities) – Case predicated on value creation, company has ~90% of sales in COGS, with very low level of automation. More industrialized manufacturing and shift towards "green" buses to drive margin expansion.
We are raising capital with closing every two quarters, our next closing is planned for February 2020. If you which to invest behind the strategy, please contact us here. NOTE: Historic returns are no guarantee for future returns. The value of the fund units may fall as well as rise.
