Greenhaven Road Top 2 Small-Cap Picks by Activist Stocks

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The New York hedge fund, Greenhaven Road, ran by Scott Miller has had success with being a small fund, and staying small. The fund embodies what we do with Underrated Small-Cap Stocks, looking for off-the-beaten-path value stocks.

In the first quarter, the fund was down 3%, underperforming the gain on the Russell 2000 of 2%. This type of performance comes as the Greenhaven Road runs a fund that’s not meant to mirror the market, with none of its top 5 holdings in the S&P 500. Still, over the last three- and five-years, it’s managed to handily beat its benchmarks. Here are two of the most interesting ideas we found in the Greenhaven Road portfolio this quarter.

Greenhaven Road

Greenhaven Road’s most interesting top 5 holding

Halogen Software – This is a Canadian-based software company, trading on a Canadian exchange, selling talent management software to mid-sized companies, primarily in the U.S. This is a simple math story: 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 Greenhaven Road 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.

The valuation is not demanding. The largest problems with Halogen are that customer acquisition costs have risen and growth has slowed. By Greenhaven Road estimates, 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.

The 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.

Greenhaven Road’s most interesting new stock

In the past quarter, Greenhaven Road made three new investments. This is the most they have ever made in a single quarter and is partly a reflection of the market’s volatility and growth in available funds.

The most interesting new buy is RMR Group – Asset managers can be wonderful businesses that benefit from recurring revenue and operating leverage. The biggest risk with an asset manager is that when assets decline, the operating leverage works in reverse. In other words, if assets decline by 50%, often earnings will decline by more than 50% because there is a base level of fixed costs. Asset managers that are unlikely to lose their assets should be highly prized and trade at a premium. RMR Group is an unusual situation with many ingredients for meaningful appreciation. Let’s start with what they do.

In the company’s words, “RMR is an alternative asset management company with $21.0 billion of assets under management, including more than 1,300 real estate properties. The RMR business primarily consists of providing management services to: Four publicly traded REITs, three real estate operating companies, and one real estate securities closed end fund. RMR has over 400 professionals in its corporate headquarters in Newton, MA and 25 offices throughout the U.S.” I love asset managers and I had never heard of RMR Group before reading about the company in David Brown’s “Value Investor Insight” January interview, since the company did not exist in its present form before December 2015.

Let’s turn back the clock just a little bit to 2007… Scott Miller was working in an operating business and having a lot of success investing in a personal account. He had decided that he wanted to work at a hedge fund to better monetize his skills and learn from others. Because of the laws of supply and demand, this is easier said than done. There are a lot of people who want to work in potentially high-paying places, and there are just not that many hedge funds that are hiring. After months of looking, a college roommate (and current investor in Greenhaven Road) got him in for an interview with a fund in which he was invested. I knew it was essentially a courtesy interview, but it was a foot in the door, and the only door that was opening even a little bit. As part of the interview process, the portfolio manager asked him to analyze TravelCenters of America. This company is a truck stop operator recently spun off from a REIT. I spent an enormous amount of time visiting truck stops, learning the ins and outs of the truck stop business, and looking at TravelCenters of America from top to bottom, which was about as sexy as it sounds. I then began looking past the numbers and started to think about the motivations of the different parties, concluding that TA was burdened with leases that were very favorable to the parent company. It was as if the REIT wanted as much of the economics as possible to flow back to the parent company at the expense of the newly public company.

If Scott had to invest in TravelCenters, they were more interested in the parent company than the spinoff. He also learned the fund he was interviewing with was a top 5 holder of TravelCenters of America, and it was one of their largest positions. It did not take a genius to figure out the portfolio manager liked the company. The portfolio manager did not agree with his analysis, and he did not get the job. The stock later went from $30 to $2, and the leases were renegotiated. The reason for bringing up this anecdote is that the holders of those

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