Olesen Value Fund 2013 letter to investor.
Olesen Value Fund letter.
Dear friends,
We earned 2.7% in December, ending the year up 23.1% (both returns are after fees). During its first 5 years of existence, the fund has generated an annualized return of 22.3% after fees. The Q4 investor letter follows the monthly update below and is also attached here for better readability.
During the month, I bought additional shares in one of our existing portfolio companies. During the first half of the month, the stock price declined approx. 20% following a mediocre earnings announcement. However, it seems likely to me that the earnings weakness is mostly or entirely temporary and the decline in the stock price is a buying opportunity. The price we paid for the additional shares we bought in December was only a little over 7 times adjusted trailing earnings. The company is fairly small, but reasonably diversified in terms of customers, types of services offered, reliance on key people, etc. The company is debt-free, operates in an attractive industry, and consistently generates lots of free cash flow. I wish I had been able to acquire more shares before the price started rising in the second half of the month.
I think 2014 will be an interesting year, with the market having reached new highs and some risks lurking. There will no doubt be some “corrections” or dislocations in certain financial assets, which should give rise to profit opportunities for us. However, my efforts are mostly concentrated on finding opportunities in idiosyncratic, special situations and the few areas of the market that are out of favor.
Olsen Capital Management Letter to Partners
Dear Partners:
In the fourth quarter, we earned 6.7% after fees. The following table shows our historical returns after fees alongside those of global equity markets since the fund’s inception.
Contents
Portfolio Updates:
Began Accumulating Stake in Illiquid, Profitable, Asset-Rich European Company
Stock Rises Dramatically Despite Highly Dilutive Equity Offering
Raised Stake in Company After 20% Drop Due to Mediocre Earnings Report
Grant Thornton Retained as Our New Auditor
Conclusion
Portfolio Updates
Began Accumulating Stake in Illiquid, Profitable, Asset-Rich European Company
During the fourth quarter, I began accumulating shares in a very small and illiquid European company. For the most part, the company generates recurring revenues from products that are critical to the customer’s business and have high switching costs. As a result, the company has been consistently profitable for many years.
The business generates a lot of free cash flow, much of which has accumulated in the company’s coffers, and the firm has no debt. The excess cash plus the value of some other non-operating assets that are being sold amounts to a majority of the market cap. The stock trades at a modest multiple of earnings, but if the excess assets (which are generating negligible earnings) are netted against the market cap, the result is a low single-digit multiple of earnings, which I think represents compelling value.
In many cases where a company has an extremely large excess cash balance, the market (correctly) implicitly applies a significant discount to the cash balance, because it will likely be invested in value destructive initiatives, such as overpriced acquisitions, and/or probably won’t be returned to shareholders for a long time and therefore must be discounted due to the time value of money. In this case, I think the company is unlikely to destroy a significant amount of value with bad acquisitions, given the company’s track record in this regard. I also think it is possible that a large portion of the cash is returned to shareholders within the next couple of years, as it has done before. For these reasons, I think it makes sense to apply only a modest discount to the company’s cash for valuation purposes.
If a large amount of capital is returned to shareholders, the stock should perform very well because a discount will, of course, no longer be applicable with respect to any capital that is paid to the shareholders. If, on the other hand, a lot of the cash is spent on acquisitions, it will presumably be accretive to earnings, which should also help the stock price. In the mean time, the company pays a dividend yield that is well above average, and the intrinsic value of the company is increasing steadily due to retained earnings. Moreover, the very large cash balance provides very good downside protection for us.
I find the stock to be a very attractive investment at the current price, which is most likely due to its very small size, low liquidity and lack of attention from the investment community. I expect to be accumulating it for a very long time, as it is extremely illiquid, and therefore I unfortunately can’t reveal the name of the company to you.
Stock Rises Dramatically Despite Highly Dilutive Equity Offering
One of our portfolio companies completed an equity offering in Q4, which was somewhat expected. The degree of dilution and the offer price were worse than expected and hence destroyed more shareholder value than I had assumed. However, I think this company was so dramatically undervalued in the first place that even after taking into account the greater than expected dilution, the stock was still very cheap at the price we initially paid for it.
Unlike most equity offerings, which result in a slightly lower stock price due to the increased supply of stock and the negative “signal” inherent in management’s decision to sell equity, this stock actually rose dramatically after the equity offering, becoming our best performer in the fourth quarter. This was perhaps due to the increased awareness the equity offering created about this small, under-the-radar company, as there were several institutional investors who participated in the offering, the likelihood that the stock will become far more liquid as a result of the very dramatic increase in the number of outstanding shares, as well as an improvement in conditions in the industry this company operates in.
At the same time, the company’s somewhat leveraged balance sheet was strengthened as a result of the capital raise, which is a positive development for us, because avoiding companies with weak balance sheets (and consequently a potential for permanent loss of equity value due to financial distress) is one of my most important risk management practices. Note, however, that the improved balance sheet was most probably not a reason for the positive stock price reaction to the equity offering, because the balance sheet was not weak enough to warrant this.
I am reevaluating this investment in light of the drastically increased stock price and greatly diluted intrinsic value.
Raised Stake in Company After 20% Drop Due to Mediocre Earnings Report
In December, I bought some additional shares in one of our existing portfolio companies. During the first half of the month, the stock price declined approx. 20% following a mediocre earnings announcement. However, it seems likely to me that the earnings weakness is mostly or entirely temporary and the decline in the stock price is a buying opportunity. The price we paid for the additional shares we bought in December was only a little over 7 times adjusted trailing earnings.
The company is fairly small, but reasonably diversified in terms of customers, types of services offered, reliance on key people, etc. The company is debt-free, operates in an attractive industry, and consistently generates lots of free cash flow.
I wish I had been able to acquire more shares before the price started rising in the second half of the month.
Grant Thornton Retained as Our New Auditor
During the fourth quarter, I retained Grant Thornton as the fund’s new auditor. There were no disagreements or problems with the previous auditor, Opis Fund Services. However, at this point in the fund’s development, I think it makes sense to work with an audit firm that has deeper and broader capabilities and is more familiar to most investors. Grant Thornton is the 6th largest accounting firm in the United States as well as globally, and the firm has a respectable hedge fund practice in the U.S. The firm’s first assignment will be the audit of our results for 2013, which I expect will be completed in February or March. They will also prepare our K-1s, which should be ready before the end of March. I hope to have a long-lasting and productive relationship and look forward to working with Grant Thornton.
Conclusion
I think 2014 will be an interesting year, with the market having reached new highs and some risks lurking. There will no doubt be some “corrections” or dislocations in certain financial assets, which should give rise to profit opportunities for us. However, my efforts are mostly concentrated on finding opportunities in idiosyncratic, special situations and the few areas of the market that are out of favor.
Please don’t hesitate to call or email me with any questions, comments or concerns. Also feel free to visit the web site www.OlesenValueFund.com, which has additional information about the fund, including previous quarterly letters. Let me know if you need the password to the web site, which is required by SEC regulations.
Sincerely,
Christian Olesen, CFA
President
Olesen Capital Management LLC, general partner of Olesen Value Fund L.P.
