Fresh Ideas From Q4 Investor Letters

Futures down, Coronavirus cases up.  I’m not a doctor nor an epidemiologist. I have no idea how bad the Coronavirus could get.Here's what I do know. Erratic price movements based on non-fundamental factors present buying opportunities. Remember, volatility a friend to those with level heads and rational behavior.We’re covering three new Q4 letters this week. But before we do, check out our latest podcast episodes:

• • Episode 13: Moses Kagan, Adaptive Realty (NEW)
  • Episode 12: Rob Koyfman, Koyfin.com

Also, if you have the time, please subscribe and leave a rating/review of the podcast on Apple Podcasts. It goes a long way in spreading the word about the show.This week’s letters:

• • Saga Partners
  • Agman Capital
  • Tyro Capital Management

We’ve also got valueDACH’s latest video presentation.Let’s get it!—February 26, 2020COVID-19 Update: Here’s the latest update on COVID-19 from the New York Times (written on 02/24):“South Korea reported hundreds of new infections, and Iran said at least 12 people there had died. In Europe, Italy is working to contain a spike in cases. Right now [Monday Morning] a fifth person has died in Italy as a result of the coronavirus, and at least 219 people in the country are confirmed to be infected.”Wash your hands and don’t touch your face, people!__________________________________________________________________________Investor Spotlight: Letters Cont.

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There’s no shortage of new ideas in these letters. We’ll cover as many as we can while keeping length in mind. I urge you to read each letter in its entirety. What I find is what interests me, your mileage may vary.Let’s start with Saga Partners.Saga Partners: +65.6% in 2019Joe Frankenfield, CFA runs Saga Partners. His firm returned 23.9% in Q4 and 65.6% for the year. He crushed it. This year isn’t out of the ordinary for Saga’s outperformance. The firm’s generated 25.2% annualized returns since 2017.Frankenfield covers a few names in his annual letter:

• • The Trade Desk (TTD)
  • Trupanion, Inc. (TRUP)
  • Linamar Corporation (LIMAF)
  • Facebook (FB)
  • LGI Homes (LGIH)
  • VSE Corporation (VSEC)
  • Carvana (CVNA)
  • Dropbox (DBX)

For our purposes, we’ll highlight TRUP, VSEC and DBX.Trupanion (TRUP)Saga’s Take: In Trupanion’s business, and in other subscription-type business models where the future cash flows of customers are very predictable over the life of the customer, it makes sense to think of sales and marketing expenses to acquire new customers as growth capex. As in every investing equation it comes down to what cash you lay out today and what stream of cash flows you expect to get back in the future.By eliminating the pain points and providing a comprehensive product that is easy to use and understand, establishing veterinarian relationships through its territory partner network, and integrating its software to improve the reimbursement process, Trupanion is set up to continue to succeed in this growing market. Let’s take a look at the charts …The stock’s gone nowhere since October 2018 -- stuck within a trading range between $23-$37.TRUP’s grown like a weed. Over the last five years they’ve:

• • Grown EBITDA from -$14M to +$4M
  • Shrunk Operating Losses from -$17M to $1.57M
  • Increased Revenues from $146M to $383M

Traditional GAAP accounting won’t work for valuing TRUP, as Saga explains:“Adjusted operating income is a better proxy of Trupanion’s performance over time than net income because of significant investments being made in future growth that are expensed at the time they are incurred versus being capitalized over the life of the investment.”VSE Corporation (VSEC)Saga’s Business Description: “VSEC’s segments are not especially high-flying organic growers but they are fairly stable, recession resistant, and require little operating capital. Historically the company has used the cash generated from its segments to make acquisitions that complement its core competency in maintenance, repair, and overhaul service.” VSEC is cheap on most quantitative metrics. The company trades around 9x earnings and 6x EV/EBIT. 6x EBIT gets you a double-digit ROE business generating over 7% EBIT margins in a low maintenance cap-ex model. That’s interesting.Current market prices assume little (if any) top-line revenue growth over the next five years.Let’s take a look at the charts …The stock’s down nearly 25% since 2020. Here’s how Saga thinks about the company’s future:“Overall, VSEC has strong, stable cash flow generating ability with modest growth prospects and sells for a very attractive price relative to its earning power (~5x expected 2019 adjusted net earnings and 6x on an EV/EBIT basis).”And when Saga says stable cash flow, they mean it. VSEC hasn’t reported an operating loss in over 14 years (going back to 2004). In fact, operating income increased during the Great Financial Crisis.DropBox, Inc. (DBX)Saga added DBX as a new position in 2019 as a smaller position. Today it’s “more of a full position” for the firm.Saga’s Business Description: “Dropbox was started in 2007 as an online storage and file sharing platform. It quickly won over consumers with its easy to use interface that provided a simple way to back up files and access them anywhere across a variety of devices. Through viral marketing, Dropbox built its end user base to over 600 million plus registered users today and was one of the fastest software as a service (SaaS) companies to reach >$1 billion in revenue.”Let’s take a look at the charts …DBX has a market cap of roughly $9B with $1B in net cash (EV of $8B). At the current price you’re paying around 21x FCF for the company. Is that cheap? At face value, I don’t think so. But here’s Saga’s explanation:“Rarely does one find companies growing at a faster rate than the market and such an attractive free cash flow yield. We were very excited to have the opportunity to add this prior SaaS decacorn to our portfolio last year at such attractive prices.”I’m not sure if a 5% is “an attractive free cash flow yield”, but there is room for DBX to run:

• • Converting free users to paid users
  • Pricing power over competition
  • Stickiness of product with end customers (high switching costs)
  • Predictable recurring revenues

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Agman Capital: +23.4% in 2019This is Agman’s first appearance on the newsletter. The fund returned 23.4% in 2019 and a cumulative return of 5.3% since 2017.The Fund’s performance looks nothing like the benchmark (for better and worse). That’s because it’s nothing like the benchmark. Take a look at some of Agman’s portfolio stats:

• • 3 of 16 portfolio companies are in the S&P 500
  • Less than 1% of the Fund’s portfolio overlaps with either the S&P 500 or Russell 2000

The Fund highlights their top five positions (in descending order):

• • Coherent (COHR)
  • EnPro Industries (NPO)
  • XPO Logistics (XPO)
  • Graham Corporation (GHM)
  • NIC (EGOV)

We’ll highlight Agman’s top three (COHR, NPO, XPO).Coherent (COHR)Agman’s Business Description: “Coherent is the dominant supplier of lasers used in OLED production. OLED is widely expected to be the next major iteration of display technology improvement as it provides superior color and clarity along with the potential for flexibility (i.e., folding or contoured applications) … Coherent’s materials processing segment (~28% of revenues) provides cutting and welding lasers for industrial use.”It was a rough 2019 for COHR, to say the least. To get an idea:

• • Revenue declined 25%
  • Gross Margins slashed >800bps
  • Operating Margins cut by 13% (20% to 7%)

So what’s to like about COHR? Agman thinks these issues -- the ones that reduced revenues, earnings and margins -- are temporary hiccups. Agman explains:“While the company’s two key segments have struggled recently and may recover slowly in the short term, Coherent continues to maintain an exceptionally strong balance sheet, strong free cash flow, high margins, and attractive long-term growth prospects.”Here’s the chart …XPO Logistics (XPO)Business Description: XPO Logistics, Inc. provides transportation and logistics services in the United States, North America, France, the United Kingdom, Europe, and internationally. - TIKR.comAgman’s Take: “Technology represents a key differentiation opportunity for large-scale operators in the transportation and logistics industry, and XPO continues to invest hundreds of millions of dollars annually in its best-in class technology infrastructure. These investments have driven consistent improvements in operational efficiency and have insulated XPO from the soft macro backdrop in trucking that led to a surge in smaller competitor bankruptcies during 2019.”According to XPO management, there’s a clear path for the company to do an extra $1B in profits over the next three years.Let’s take a look at the charts …XPO trades at 8x EBITDA and 27x earnings. These figures may be lower than the company’s actual cash flow capability. Agman explains saying, “In addition, XPO’s actual free cash flow potential is masked by the company’s spending on growth initiatives that could be paused if necessary in the event of a broad downturn.”EnPro Industries (NPO)Business Description: EnPro Industries, Inc. designs, develops, manufactures, and markets engineered industrial products worldwide. They have three segments: Sealing Products, Engineered Products and Power Systems.Agman’s Take: “EnPro continues to generate prodigious amounts of free cash flow, and while we believe the management team is capable of allocating cash in a value-creating manner, the company has a limited recent M&A track record.”What’s Mr. Market’s price-tag for this prodigious cash flow generator? Around 9x EBITDA and 25x earnings. These trail industry peers (with an average of 13x EBITDA and ).Agman believes a “new” EnPro is taking shape. The Fund has a few reasons to believe this idea:

• • Two tuck-in acquisitions
  • Increasing product offerings within pharmaceutical segment
  • Divest power systems to private equity for $450M cash
  • Net leverage ratio trimmed to 1.1x

Here’s the charts …

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Tyro Capital Management: Did not disclose performanceThis is Tyro Capital’s first appearance in the newsletter, and we’re glad we found them. The Fund is run by two founders: Daniel McMurtrie and D Alex Draime.The letter discusses the following investments (longs):

• • Altria (MO)
  • Recro Pharma (REPH)
  • Skyline Champion (SKY)
  • Super Micro Computer (SMCI)
  • Ubisoft Entertainment (UBI:FP)
  • Match Group (MTCH)

We’ll cover MO, SKY and UBI in this newsletter. I encourage you to read the entire piece for detailed explanations on their other long investments.Altria (MO)Tyro’s Take: “We do not need any upside from MO’s stakes in Chronos, JUUL, or AB InBev for this to be a successful investment. The cigarette business will continue to decline at a relatively predictable rate for years to come, with volume declines offset by price increases, and the company will throw off mountains of cash to be returned via dividends and buybacks. Given our strong dividend yield on cost, we are inclined to hold the position for the long-term, absent the market offering us a premium price at which to sell.”Tryo preyed on Mr. Market’s reaction towards JUUL safety, ESG concerns and headline risk. According to Tyro, the stock remains cheap:

• • Dividend Yield >7%
  • Forward FCF Yield ~ 9%
  • P/E of 10x

Let’s take a look at the charts …MO’s in the middle of a downward trend which started in the middle of 2017. It’s tested the 50MA multiple times throughout the last two years, but with no successful breakout.Investors in MO aren’t worried about stock price performance, per say. They know the cigarette business will die. The goal is shareholder returns via increased dividends and buybacks.Skyline Champion (SKY)Business Description: Skyline Champion Corporation operates as a factory-built housing company in North America. The company offers manufactured and modular homes, as well as park-models and modular buildings for the multi-family, hospitality, and senior and workforce housing sectors. - TIKR.comTyro’s Take: “The underlying business is continuing to perform to our expectations, even as the broader industry grew more slowly than we expected in 2019, with US industry unit shipment growth inflecting upwards into the back half of the year after facing difficult comps in the first half. All the fundamental industry tailwinds we have called out in past letters remain intact, including base demand from aging-out, new demand as alternative to site-built for millennials and retirees, use of manufactured units in new developments, and an improving regulatory and credit environment.”2019 was a banner year for SKY, returning 115%. Let’s take a look at the charts …Tyro believes current share prices offer an attractive price for the business:“Management has continued to deliver strong results, driving margin improvement and generating strong cash flow. At the time of writing, the company has an enterprise value of ~$1.6bn and trades at 11x consensus F2021 EBITDA, while peer Cavco trades at 15.2x. At parity, SKY would trade at $40.”Ubisoft (UBI:FR)UBI is a new position for Tyro, reflecting their broad bullish thesis on the video game industry. UBI’s stock has remained flat since April 2018. So what’s the deal? If the video game industry is set to pop off -- why the underperformance?Tyro offers a few reasons:

• • Poor commercial performance of Tom Clancy’s Ghost Recon Breakpoint
  • Underwhelming sales of Tom Clancy’s The Division 2
  • Product Delays

In going long, Tyro’s betting these short-term headwinds are simply that, short-term blips on the radar. If the company’s able to right the ship, they should command a higher multiple. Something more in-line with peers. Tyro explains:“UBI trades at an EV of €8.3bn, 7.3x consensus F2021 EBITDA. Meanwhile, Activision Blizzard trades at 16.8x 2020 EBITDA, Electronic Arts trades at 15.6x, and Take Two trades at 17.4x. On a P/E basis, UBI trades at 19.0x consensus F2021 EBITDA, while Activision Blizzard trades at 24.2x 2020 earnings, Electronic Arts trades at 23.0x, and Take Two trades at 25.5x. On a five-year average basis, UBI has traded at an EV/EBITDA of 14x and a P/E of 24x, which would imply share prices of $126 and $82, respectively.”Here’s the chart …__________________________________________________________________________Resource of The Week: I’d Like To Join The Turtle Club

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Andrew Brenton is the founder of Turtle Creek Asset Management. You know, the firm that’s returned 20%+ annually over the last two decades. No big deal.Anyways, valueDACH released a video of Brenton’s presentation at the 2019 International Value Investing Conference.It’s 31 minutes long and worth every second.__________________________________________________________________________Tweet of The Week:  “This Isn’t Good …”

This isn’t good. pic.twitter.com/4hcJGQSJoP

— Steve Burns (@SJosephBurns) February 24, 2020

 That’s all I got for this week. Shoot me an email if you come across something interesting this week at brandon@macro-ops.com.Tell Your Friends!Do you love Value Hive?Tell your friends about us! The greatest compliment we can receive is a referral (although we do accept Chipotle burrito bowls).Click here to receive The Value Hive Directly To Your Inbox!