Interim Investment Letter
March 1, 2015
As of the February close, YTD the 17 Mile portfolio is up 17.5% gross and 13.1% net versus a 2.9% return for the DWCFT benchmark. Since its June 15, 2014 inception, the portfolio is up 46.9% gross and 35.1% net versus 9.8% for the benchmark. At February month-end, in descending order of position size, the portfolio looked as follows: VRX, DISH, CRC, ATLS, V, BAC/JPM, ZTS, YHOO, FNMAS.
While February is a relatively odd time to provide a portfolio/strategy update, I wanted to document my thinking with the portfolio at peak performance. After a smoking hot February, I sense a growing confidence in my decision making ability; typically a bad sign…
…VRX is playing out precisely in line with my thesis, and I could not be more bullish on what Mike Pearson can do with the business over the next three to five years; the CRC/ATLS energy basket is also performing in line with expectations, with the ATLS/TRGP transaction set to close this weekend more than $5 higher than the original purchase price, and CRC recently reporting an industry-leading plan for dealing with the low oil price environment and paying down debt; Pershing Square has obtained Board representation at ZTS, creating high probability “event” potential over the next 12 to 24 months; and after the recent conclusion of the AWS-3 auction, not only is there a reference marker in place for the value of DISH’s spectrum holdings, but DISH can now begin discussing monetization strategies with potential partners.
Because I feel good about these positions, more than likely they will represent at least a near-term drag on performance. As such, I would like to document my current thinking regarding the management of these positions going forward in light of the high probability of underperformance.
VRX. After returning ~38% YTD, VRX is set for multiple months of consolidation as the market digests the Salix acquisition. Had VRX remained an out-sized position thru this recent rise, a reduction in the position would be warranted; but since the position is at it target weight, no action is required at this time, as I am comfortable with near-term downside volatility.
CRC. Oil had a heck of a run in February, so it would not be a surprise to see some near-term weakness; in line with that weakness, CRC could very well make its way back into the $5 to $6 range. Depending on general market conditions and where other holdings are trading, an increase to the CRC position could be warranted. Recent outlined here, CRC is a long-term “Generals” position that I envision holding for a number of years, as I believe oil will eventually revert to its long-term marginal cost of $80 to $100 per barrel.
ATLS. This position will de-risk itself once the $9.12 of cash per share from TRGP is received, which represents over 35% of cost and almost 29% of the current position size. What will remain is a moderate size position in TRGP and a very small position in “New Atlas”.
Given the scarcity of publicly-traded GPs, I believe TRGP will more than likely be taken over; if not, in line with my bullish long-term outlook for oil, TRGP will be worth more over time as it continues to grow its base of business and commodity prices normalize.
“New Atlas” could end up being rather interesting over time. It will start out with a market cap of less than $300MM, a dividend yield of over 6%, and a management team in place with an extremely impressive track record of assembling energy assets in a shareholder-friendly manner. I anticipate this position getting pounded post-spin given its small size and the hideous operating environment it will be entering. While more than likely a buying opportunity, I manage the portfolio as if there was at least $1B under management, and thus avoid taking large positions in small caps. But at its indicated size in the portfolio, I am comfortable holding it over time.
ZTS. Of the highlighted positions, I am most comfortable with ZTS, as I believe a sale of the Company is a high probability event in the next 12 to 24 months. And if a sale is not in the cards in the medium-term, it is likely Pershing works with ZTS to cut costs and grow thru acquisitions, providing reasonable downside protection to the position.
DISH. With VRX now re-rated, DISH is now tied for my #1 pick and likely to move in line with VRX (position size) sooner rather than later. However, given the intense headline-driven nature of the telecom industry, Ergen’s lack of clarity, “looming” buildout requirements and the lack of cash flow generation from the spectrum portfolio, the stock will be volatile, especially in a relatively weak market. With very recent weakness in the stock, and a market due for some consolidation, I anticipate having the opportunity to add to DISH below $70. At that point the position would be at target – in the event it declines significantly from there on company-specific concerns or broad market weakness, I would strongly consider super-sizing the position, much like I did with VRX. But all that said, I do not want to get cute with the position – this is a $150 stock within two years, so it is dangerous to play ticky-tack with $5 here, $5 there.
Cash. After a small capital raise next week and the $9.12 ATLS distribution, over 11% of NAV will be available for deployment. At this point in time, this cash is designated for further DISH purchases. Though depending on market conditions, this plan could change.
FNMAS. I am itching to add to this position. I contemplated rolling the ATLS proceeds into it, but I do not want to tie up margin capacity where the ATLS proceeds will reside; and, FNMAS has run up a bit, and with some broad market weakness I believe I will get another shot below $4. In the event FNMAS goes below $4, I have committed to trimming the Visa position slightly in order to add to FNMAS. For now, as stated above, the ATLS proceeds are designated for DISH.
Other. BAC is at the top of the list of existing positions to add to in size, if for example CRC re-rated closer to FV and/or ZTS worked out; YHOO is also becoming interesting again, and could very well gain downside momentum if BABA continues to slide; HTZ and CHTR are of high interest to re-enter in a weak market environment; and MSFT, DD and GILD are at the top of the new ideas list. Bottom line – too many ideas and not enough capital.
Please see the November 2014 17 Mile Letter for a full description of the Market Mosaic.
Economic Conditions. Extremely low probability of recession in the United States coupled with improving global economic conditions creates a highly favorable environment for U.S. and global equities over the next 12 to 18 months. Bullish.
Market Model. Remains in a highly bullish HOLD mode. Bullish.
P/200dma. The S&P 500 currently trades for approximately 1.06 times its 200dma – not too high, not too low. Bullish.
200dma Direction. The S&P 500 200dma is over 12% higher than it was 200 days ago, and is currently rising. Bullish.
Monetary Conditions. Global ZIRP + ECB/BOJ QE + record low corporate borrowing costs + record safe corporate balance sheets = extremely favorable monetary conditions. Bullish.
While it is difficult to overstate the bullishness of the medium-term market environment, the one key near-term offset is surveyed investor sentiment. On paper sentiment is at record high bullishness and record low bearishness. But, as the last several years have proven, sentiment surveys have an extremely poor medium-term track record. In fact, it appears that a well-established overweight in either direction – bullish or bearish – merely confirms the primary trend in place. For example, sentiment survey bullishness was at sky-high levels long before the 1987 peak; and by the time low bullishness readings appeared, the market was higher than it was when bullishness records were initially breached. So, rather than use sentiment readings to manage medium-term portfolio exposure, I tend to use them to ever so slightly manage near-term buy & sell decisions.
Long-term valuation is obviously a concern, as demonstrated by GMO’s latest projected asset class returns. Jeremy Grantham has indicated approximately 2200 on the S&P 500 would meet the GMO bubble definition of 2 standard deviations higher than fair value. With global monetary policy in emergency mode alongside an expanding global economy, I strongly believe we will blow past 2200 before this business cycle ends. As such, I could not be more ecstatic about this market environment…
…A) We have a market, in the medium-term, that is highly supportive of individual stock picking generally, and event-driven investing specifically (low rates driving shareholder-friendly capital markets activity); and 2) a record high market that in the longer term will almost inevitably produce another 50% market debacle as the low-rate experiment unwinds, creating an opportunity to not only profit on the way down, but pick up bargains on the other side. Clearly this cannot be neatly timed; but using the above “weight of the evidence” approach to analyzing the market environment, I believe I can capture the bulk of the dominant medium-term trend.
As always, thank you very much for reading, and please feel free to contact me anytime via email or Twitter.