Greenhaven Road letter to investors for the first quarter ended march 31, 2016.
Dear Fellow Investors,
It was another productive quarter in the maturation of Greenhaven Road. We continue to grow our assets at a measured pace while remaining committed to staying small enough to invest across market caps in off-the-beaten-path value opportunities. We feel many larger funds are struggling to perform because size has limited their opportunity set. At Greenhaven Road, we have long-duration capital that allows to patiently find asymmetric opportunities where the long-term rewards are the greatest, and through our partnership with Stride Capital Group, we have the back office and infrastructure capabilities of an institutional fund. The fund’s performance in the first quarter was -3%. This is compared to a gain of 1.4% for the S&P500 and a decline of less than 2% for the Russell 2000. While we do not spend a great deal of time comparing our results to a benchmark, preferring to focus our energies on the fundamentals of each investment, it is notable that none of our top five positions are in the S&P 500, making the Russell 2000 a better point of comparison. I think you will also find we own a very compelling collection of companies that over time have the potential to appreciate significantly. Our three- and five-year returns are above all relevant benchmarks. The headline number is not indicative of the volatility experienced during the quarter. Limited Partners, please reference the Halpern and Associates statement for your actual performance.
Greenhaven Road – Top 5 Positions
When I look at our portfolio, I see several companies that could easily be up 20%, 30%, or even 50% and I would not bat an eye. For example, if you walked into my office and said Fortress Investment Group is now a $7 stock (or up 50% from where the quarter ended), my reaction would be that the company is still reasonably priced. My reaction would be the same with Halogen Software, Fiat, or Diamond Resorts. Let’s look at each of the top five in a bit more detail. Careful readers will note that four companies are discussed below. Diamond Resorts is a top five position that is discussed in detail later in the letter.
Halogen Software: Halogen is a Canadian-based software company, trading on a Canadian exchange, selling talent management software to mid-sized companies, primarily in the U.S. Later in the letter, we discuss the importance of simple math. In the case of Halogen, part of the simple math relates to currency conversion. Halogen’s share price is denominated in Canadian dollars; with today’s exchange rates, a Canadian dollar equates to around 80 U.S. cents. Other than share price, every other number for Halogen – including cash on the balance sheet and revenues – is valued in U.S. dollars. When converting the currency properly (not clear that everyone does this basic math correctly), Halogen has just about the lowest Enterprise Value (Market Cap less Cash)/ Revenue of any company we know of that is not facing some sort of terminal decline. Specifically, at $7 (CAD) – where we bought a lot of additional shares – the company had an EV of less than $85M USD and revenue (growing 10%+) of $65M, so it was effectively at an EV/Rev of 1.3X when SAAS companies will typically trade anywhere from 2X-8X depending on growth rates, margins and the competitive landscape. We would typically focus on cash flow, but in the case of a growing SAAS software company with strong unit level economics (positive lifetime value of a customer), sales and marketing to acquire even more customers is expensed immediately (not capitalized) and distorts the Price to Earnings and Price to Cash Flow metrics. The valuation is not demanding. The largest problems with Halogen are that customer acquisition costs have risen and growth has slowed. By my estimates, which I shared with management, Halogen is paying approximately $55K to acquire each new customer, but the company was only being valued at less than $40K per existing customer when using the public market enterprise value/# of customers. My argument to management was that it is cheaper to buy back stock than go and acquire new customers. The company has since put in place a large buyback for 1.2 million shares (5% of the outstanding shares), and fortunately, given the large cash balance, Halogen can buy back shares and still acquire new customers. The new CEO is outstanding and has embraced a partnership model to acquire customers more efficiently. I think he is making very sound decisions and look forward to the progress the business makes. The combination of a low multiple and improved marketing efficiency could be a powerful catalyst for future returns. The HR software space is undergoing consolidation as companies go from offering piecemeal solutions, such as payroll, benefits management, or talent management, to offering a complete suite of solutions. Given the current valuation, the corporate overhead that could be stripped out by an acquirer, and the lowered customer acquisition costs if folded into a larger company with an existing customer base to sell into, the economics for an acquirer would make sense even at twice today’s share price.
Fiat Chrysler: This was an interesting quarter for Fiat Chrysler because they completed their spin off of Ferrari on the first day of the quarter. We sold our shares in Ferrari shortly after the spinoff. There is a strong case to be made for Ferrari to grow earnings through increased volumes, pricing, licensing, and reduced R&D. There is also an argument that the company is a luxury goods company and should command a luxury multiple. I think they are both valid, but when I am honest with myself, I am not comfortable owning a luxury goods company at a luxury goods multiple. Recognizing this bias meant that if and when the multiple was ever tested, I would throw in the towel and sell on the weakness. The price decline would test my skepticism of the multiple and I would inevitably sell. Given that Fiat itself is so inexpensive, I put additional funds into Fiat. I think Sergio Marchionne has made the right move at just about every turn – from acknowledging that auto companies need to be better stewards of capital, to calling for industry consolidation, to emphasizing the higher margin Jeep products. In the first quarter, the company gained access to Chrysler’s cash, which had previously been “ring fenced,” creating a situation where the company was paying interest on more than 20 billion euros in debt while simultaneously having billions in Chrysler cash earning virtually nothing. When the ring-fenced cash is accessed, the debt significantly reduced. Just accessing the Chrysler cash will save the company several hundred million euros per year, which is meaningful for a company with adjusted EBIT of €4.8 billion in 2015. The company is nearing the end of a long investment cycle and is making significant operational improvements. The shares are trading at less than 2X earnings management put forth in their 2018 plan. We are caught in a situation with short-term earnings improvement from all of management changes, which are very positive, but at the end of the day it remains a cyclical business with compressing