Mittleman Brothers Q1 2016 Letter: Long HC2 Holdings, Revlon, Carmike Cinemas, Sberbank
Mittleman Investment Management, LLC’s composite gained 9.4% net of fees in the first quarter of 2016, versus an advance of 1.4% in the S&P 500 Total Return Index and a 1.5% decline in the Russell 2000 Total Return Index.Longer-term results for our composite through 3/31/16 are presented below:
The three biggest contributors to our Q1 2016 performance were Revlon (REV): $27.84 to $36.41 (+30.8%),Carmike Cinemas (CKEC): $22.94 to $30.04 (+31%), and Sberbank of Russia (SBRCY): $5.79 to $6.94 (+19.9%).
The three most impactful detractors from our Q1 2016 performance were Pacific Exploration & Production (PRE CN): $1.24 to $0.55 (average sale price at which we exited position) (-56%), Clear Media (100:HK): $1.03 to $0.86 (-16.5%), and HC2 Holdings (HCHC): $5.29 to $3.82 (-27.8%). The larger percentage decline from HCHC was less impactful than the smaller percentage decline in Clear Media because HCHC held a smaller position weighting in the portfolio.
While it is refreshing, to say the least, to have had our first quarterly out-performance in more than one year, we recognize that we still have a long way to go to reclaim our high water mark. After losing money in both 2014 and 2015, a -22.6% cumulative loss, even after Q1 2016’s +9.4% rebound, we still need a further 18% gain from here to get back to where we were on 12/31/13. Fortunately, our portfolio appears to offer over 64% upside potential if marked at our conservative appraisals of fair value for each of our 19 holdings, so we are very well-positioned to exceed our high water mark and more.
The weighted average valuation of our portfolio remains very low compared to the S&P 500, with an Enterprise Value (EV) to EBITDA multiple of 6.8x, versus 10.7x for the S&P 500, both based on 2016 estimates. And on a price to Free Cash Flow (FCF) multiple comparison, our portfolio appears to be at 10.9x, versus 18x for the S&P 500. Not only do our holdings appear to be vastly undervalued relative to the S&P 500, but we believe the businesses in which we’ve invested have a much less cyclical business profile on average, with over 60% of the portfolio invested in businesses that are highly recession resistant, and in some cases recession-proof, as well as having discernibly better long-term growth prospects.
While a rebound in emerging markets gave us a boost in Q1, the bulk of our out-performance came from our two largest holdings, Revlon and Carmike Cinemas, both of which are domestically domiciled companies, and both of which had better than expected earnings reports, and news relating to merger and acquisition activity, or the potential for such.
Revlon (REV) has no brokerage firm analysts covering the stock, but their Q4 2015 earnings report, released on February 26th, was much stronger than we anticipated, leading us to raise our 2016 estimate for Revlon’s adjusted EBITDA from $340M to $372M, which assumes that 2016’s EBITDA will be flat at the 2015 level. The stock ran up on that February earnings report, which built on the price gain achieved after the January 15th announcement that Revlon’s controlling shareholder, MacAndrews & Forbes (a Ron Perelman-owned holding company), was exploring strategic alternatives for their Revlon stake. But expectations that this change in stance might lead to a sale of Revlon were tempered by the announcement that their 47year-old CEO Lorenzo Delpani was stepping down, followed a month later by news that his replacement was hired. The new CEO at Revlon, Fabian T. Garcia, a 56 year-old Venezuelan hired away from Colgate-Palmolive after 13 years there, seems to have the requisite experience, but he is the 9th CEO that Revlon has hired in the just over 30 years since Ron Perelman bought control of the company in 1985, so it remains to be seen if he will finally be the one who is both worthy and capable of sticking around for the long-term. Perelman has had 5 wives over roughly the same time frame, so either he changes his mind a lot, or he is difficult to get along with, or maybe some combination of both. Regardless, we like the business and the valuation remains overly penalized, we believe, primarily due to the Perelman factor. We estimate Revlon’s fair value at $63 (+73% from $36.41 price on 3/31), which is 13.5x the $372M in EBITDA produced in 2015. Most major cosmetics firms change hands at around 15x EBITDA, so I think we’re being conservative with this appraisal. For many years now the mass market cosmetics business (which is Revlon’s market, selling through drug stores and Wal-Mart) has experienced a slower growth rate than the prestige brands (selling through department stores and Sephora). But with upward pressure on the minimum wage, and income inequality becoming an increasingly prominent issue, maybe we are at the inflection point when the mass market customer starts to make a bit more money, which would make growth in this segment a little easier than it has been over the past 15 years.
Carmike Cinemas (CKEC) also had a very strong Q4 2015, which they reported on February 29th. But, before the stock could fully adjust to the good news, just three days later, Carmike announced a definitive agreement to sell the company to AMC for $30 per share in cash, a modest 19.5% premium to the $25.11 pre-announcement price, and well below our bare-minimumestimate of fair value at $35. Mittleman Brothers has held a position in Carmike since late 2007, and we were stunned by the low valuation at which Carmike’s CEO and board of directors agreed to sell. We have thus shifted our stance from passive investors and filed a 13D indicating our intent to vote against this deal and encourage other shareholders to do the same. As clients you have received all three of our 13D letters to Carmike, which detail precisely why we feel that this is a terrible deal for CKEC shareholders. Rather than rehash all of those points here again, we’re happy to send those letters to you upon request. We have received encouraging support from other large Carmike shareholders who share our opinion that even at $40 per CKEC share that AMC would be getting an outstanding and undeniably accretive deal on Carmike, but at $30 it is just outrageous. If AMC does not raise its offer substantially (we will not accept a price less than $35 in AMC’s stock, or $40 in cash) then we expect the deal will be voted down. We would not expect Carmike’s stock price to drop much if at all under such a scenario as the results in Q4 2015 were outstanding and the report for Q1 2016, due out on May 2nd, should be similarly strong. So we think $30 is where Carmike should be trading in the open market without any control premium. We expect this situation to be resolved within the next six months.
Sberbank of Russia