JDP Capital Management’s letter to limited partners for the fourth quarter 2014.
Dear Partner,
For full year 2014 we were up 27.34% net to limited partners versus 13.68% for the S&P 500. For the fourth quarter, the fund was down 0.22% net versus 4.93% for the S&P 500. Since inception in October 2011, we have earned 88.39% after all fees and expenses, or 21.52% annualized.
JDP Capital Management: Review and Outlook
Going into 2014 we felt that continued multiple expansion of the S&P was inevitable in order for the index to catch up to valuations we were seeing in private equity, commercial real estate, and other cash flow producing assets. Although we were bullish on US equities, we felt that the average US stock did not have enough meat on the bone to justify venturing beyond a concentrated portfolio of our highest conviction ideas.
The Partnership’s full year return of 27.34% was earned in the first three quarters of the year. Large, lumpy moves are expected in a strategy like ours where investments begin life in our portfolio categorized somewhere between distressed and unrecognized growth, with a private-investment-like time horizon. The benefit of infrequent trading and compounding unrealized gains far outweighs the psychological turmoil of quarterly volatility.
In the first half of the year we returned 16.18%, driven by investments made in 2012 and 2013 including DirecTV (DTV), Hartford Financial (HIG/HIG-WS), InfuSystem Holdings (INFU) and CyrusOne (CONE). We also benefitted immediately from our Q2 2014 investment in ALJ Regional Holdings (ALJJ). We sold Quality Systems (QSII), Lanxess AG (LXS) and Vicon Industries (VII) after the fundamentals eroded beyond our comfort level.
In the second half, we returned 9.63%, driven by new holdings in Liberty Global PLC (LBTYA) and Perry Ellis International (PERY). ALJ Regional Holdings (ALJJ) also continued moving up-and-right, all the way through year end, which minimized the impact of declines in C&J Energy Services (CJES), Genworth Financial (GNW), and Bank of America
(BAC/WS/B).
Going into 2015 we continue to raise the bar on the risk/return profile and quality attributes we require for new investments. In our view investors are facing a fully priced market where average stock-picking mistakes could be magnified in a correction.
The best opportunities we see today are special situations of all sizes birthed in the extremes of corporate capital allocation decisions fueled by a low-rate-M&A-centric environment. In fact the majority of our holdings became opportunities due to a busted buyout, failed organic expansion, an over-leveraged balance sheet—or the opposite—an ultra high-value acquisition strategy that the market has not fully recognized.
We also expect to see new opportunities from the impact of a strong US dollar. Globally recognized non-US operating companies with US dollar-denominated debt are on our radar.
JDP Capital Management: Portfolio Update
No major changes were made to the portfolio in Q4. Commentary on our largest holdings:
ALJ Regional Holdings
ALJ is our largest holding and the stock was up 172% over our cost in 2014. This privately negotiated investment was a rare low-risk, high return scenario, so we backed up the truck. Stabilized earnings of $0.50 per share is achievable in 2015 or 3.2x our cost of $1.60.
ALJJ’s low-cap ex, high free cash flow subsidiaries Faneuil and Carpets N More are doing an excellent job absorbing the remaining $164 million of NOLs (net operating losses) created by a defunct tech company unrelated to current management. We expect cash to continue piling up faster than the market expects, especially now that Carpets has been resurrected from years of private equity ownership and adequately capitalized for growth.
Perry Ellis International
PERY became our second largest holding in July after Legion Partners and CalSTRS filed a joint 13D disclosing their intentions to engage the company. To make room for the investment we sold our long-time position in Hartford Financial (HIG and HIG-WS) realizing a 97% blended return.
PERY manages a portfolio of 33 men and women’s clothing brands with ~$900 million in sales. As of year end the stock was up 45% from our initial price of $18. We think the Legion/CalSTRS activist effort is just getting started and that
significant upside remains.
See full PDF below.
