JDP Capital Management Q4 And Full Year 2015 Letter to Limited Partners
For the fourth quarter the Fund was up 5.60% net, and down 3.22% net for the year. Including dividends the S&P 500 was up 7.04% for the fourth quarter and up 1.38% for full year 2015. Since inception in October 2011, we have earned 82.57% after all fees and expenses, or 15.22% annualized.
JDP Capital Management – Review and Outlook
The fourth quarter return was driven by ALJ Regional Holdings (OTC:ALJJ) +16%, and CyrusOne (NASDAQ:CONE) +15.6% adjusted for dividends. C&J Energy Services (NASDAQ:CJES) was up 30% before we sold out in early December. The balance of the portfolio was flat in terms of stock price, despite reporting overall impressive Q3 business results.
The full year return was primarily driven by Carrols Restaurant Group (NASDAQ: TAST) +54%and CONE +41.2% adjusted for dividends, offset by declines in our Bank of America warrant basket -28.5%, CJES -64%, and a flat-ish ALJJ +5%.
In December we sold half our stake in CONE due to valuation, realizing a compounded annual return of 31% over three years. We also sold CJES for a 64% loss after roughly the same period. This capital was redeployed into TAST, Bank of America, and two toehold positions in special-? situation French and Mexican small caps that I will detail if the ideas evolve further.
CJES was a multi-?year holding (3 years) that we wrote about in multiple letters. Ultimately we became too concerned about the disconnect between oil prices and the cost to service even the least-?intensive wells. We still believe in the company’s vision, best-?in-?breed management, and that the majority shareholder Nabors Industries could contribute new equity if needed. But today C&J is a
zombie company and its economics are not within the company’s control.
JDP Capital Management – Our strategy
It has been a while since I wrote about our strategy and how we think about investing. As in any business, it is important to revisit, reiterate, and discuss your strategy because it helps identify mistakes, and learn from them. This process also helps keep you grounded and on track, especially when the crowd tells you otherwise.
The greatest competitive advantage we can have in investing is time. Our willingness to take a longer-?term view than the market will produce sporadic returns when measured in months or quarters, but
should outperform over time with less risk. This does not mean we ignore market concerns, or that we believe something has to go up just because it went down.
Among the ~8,500 US-?headquartered public companies there is always a large degree of permanent value destruction occurring under the sheets any given time: bad management, poor capital allocation, disruptive competition, etc. Our job is to try and handicap this uncertainty and get paid appropriately for the business risk we take.
But real business is lumpy, full of uncertainty, and dependent on a human element that is often overlooked. Understanding global-?macro economic factors that affect the fundamentals of our portfolio is always part of the investment process. But these inputs tend to carry less weight in our strategy because they can dangerously oversimplify the decision making process and lead to knee-?jerk reactions.
We look for companies where we think earning power is greatly mispriced due to a transition that we understand and identify with. Transitions we like are often spawned by a degree of distress. The value opportunity comes when investors (ourselves included) misjudge the time that big changes take to bear fruit, if at all. So markets often prefer a “sell now, wait and see” attitude which can lead to very attractive pricing.
Our approach to investing rewards a focus on studying business challenges that specific companies are facing, and not necessarily the broader market. Examples include strategy shifts, mergers, financial restructuring, and changes in capital allocation and/or management quality.
The price we pay for anything is a justified by a multiple of estimated future cash flow, varied based on a degree of outcome certainty, compared to other opportunities on our desk. We target an unleveraged return of 100% over 2 to 5 years per idea. This filters out the traditional higher risk ”15% to 20% potential upside” ideas that are more market driven than fundamental.
We prefer ideas that have the potential to become large, concentrated positions. The dominating characteristic we look for here is a demonstrated runway for a company to continuously recycle its own earnings back into the core business and earn a predictable return that we think the market will eventually pay up for. This package needs to come protected by a reasonable competitive advantage, a shareholder friendly board, and an appropriate capital structure for the business’s size and industry.
We generally find these qualities in companies that have emerged out of a transition into a much stronger position than the market is willing to pay for ”today”. These are pre-compounders where we can deploy lots of capital, without paying retail.
Identifying investments takes time, and often starts with a ”toehold” or small position that gives us a front seat to get to know the company better after our initial research. When we get an investment wrong, it is generally around being too early in a recovery, or simply misjudging the situation altogether.
Managing an investment is a balance between long-term patience and close monitoring. Once we own something, we build a funnel of information flow around that company and industry. This part of the process helps us track business progress versus our thesis and timeframe. In the end, the decision to sell is valuation driven, not volatility driven.
JDP Capital Management – Selected Portfolio Update
ALJ Regional Holdings-(OTCBB: ALJJ) FY 2015: +5%
ALJ continues to transform itself into a diversified investment vehicle fueled by excellent deal making, unique management incentives, and multiple years of federal NOLs that minimizes tax expense. Q3 earnings had only ”45 days of contribution from the Phoenix Color acquisition in August. But it is clear that the transaction was transformational, and the market is ignoring it. We think ALJ’s cash flow could more than double in 2016 bringing leverage down from the current 2.5x and setting the foundation for a favorable future refinance. Part of this potential comes from Faneuil, the call center subsidiary purchased from McAndrews & Forbes.
Faneuil is a sleeping giant and is benefitting enormously under ALJ’s ownership. As of Q3 2015 backlog had risen to $290 million, up from $110 million last year. Using historical EBITDA margins of around 8% implies the subsidiary could boost ALJ’s total company EBITDA by 10 12% above our 2016 base case.
ALJ recently announced plans to list on a mainstream exchange in 2016. Up-listing will open the stock to mainstream investors, create more liquidity, provide a potential currency for future acquisitions, and allow for a larger scale buyback program.
We presented our thesis and history with the company at the 2016 ValueConferences Best Ideas conference on January 13, 2016. Our presentation was organized around an interview I did with ALJ’s Chairman Jess Ravich on December 23, 2015. Here are links to both presentations which are also posted on our website.
Presentation on ALJ Regional Holdings 2016
Interview with ALJ Chairman Jess Ravich, December 23, 2015
Carrols Restaurants-(NASDAQ: TAST) FY 2015: FY 2015 +54%