Gator Financial letter to partners for the month ended May 31, 2016.
Dear Gator Financial Partner:
We are pleased to provide you with Gator Financial Partners, LLC’s (the “Fund”) year-to-date 2016 investor letter. This letter briefly reviews the Fund’s investment performance for the first four months of 2016, discusses our views of the market, describes the investment thesis for two portfolio positions, and discusses the Fund’s current net exposure and positioning by sub-sector.
Gator Financial – Review of YTD 2016 Performance
As you know, the stock market went straight down for the first 6 weeks in the 1st Quarter of 2016. We came into the year expecting a rally as we thought our portfolio was full of underpriced stocks that were subject to tax-loss selling in December. We were quickly proven wrong as the stock market declined almost in a straight line until the afternoon of February 11th, when both stocks and crude oil made new lows, but then recovered partial losses after a Dow Jones Newswire story hinted about OPEC output cuts. Some market participants raised questions about the validity of the Dow Jones report, but the stock market seemed like it was looking for an excuse to rally. After the closing bell on February 11th, Jamie Dimon, the Chairman of JP Morgan Chase, filed a report with the SEC stating that he purchased $26 million of JP Morgan stock in his personal account. This helped spark a rally in financial stocks, the broader stock market, and the credit market that lasted through quarter-end and into April.
Through April 2016, the Gator Financial portfolio has returned a positive 1.81%. We’ve benefited from a rebound in a few underperformers from 2015 and a couple of new ideas. Syncora Holdings, Ambac Financial Group, and The Carlyle Group have helped increase returns in 2016. Each of these stocks hurt performance in 2015, so we view the rebound this year as recapturing some of the losses from last year. We think all three stocks have the potential to deliver multiples of their current price. In our note to you in January, we shared our investment thesis on Ambac. We updated and refined that write-up and published it on Seeking Alpha – Ambac: Undervalued Special Situation. Lastly, we benefitted from the timely purchases of two new positions: we purchased Cowen Group, a broker-dealer with a large alternative investment business, and OFG Bancorp, the 3rd largest bank in Puerto Rico. Both companies are performing well, but had sold-off drastically since last June. Both were trading at a steep discount to tangible book value and have since recovered some of their previous losses.
On the negative side of the portfolio, many of our bank holdings were down more than 10%: Citigroup, Morgan Stanley, Bank of America, JP Morgan warrants, SunTrust warrants, and Zions warrants. We continue to hold these positions as we believe each of these companies are improving their returns on capital, are returning excess capital to shareholders, and are very inexpensive compared to both their own histories and other opportunities in the stock market.
Gator Financial – General Comments about Value in the Market
We believe the stock market is a “market for stocks,” and have consistently focused on bottom-up stock analysis. We see many media articles about the overvaluation of the stock market would like to share a few observations about the current stock market.
Small Cap and Value stocks have underperformed Large Cap and Growth stocks. We think there are two main drivers of this: 1) a risk-off market environment has forced investors to reduce exposure to smaller companies and to focus on higher-quality large companies and 2) the accelerating shift from actively managed investment strategies to passive index strategies has driven investors to the largest stocks. We think this market environment is similar to the market during 1999 and early 2000 when a narrow group of large-cap growth stocks drove the market higher. Similar to today, the small cap and value stocks badly lagged the S&P 500. In 2000, when the Internet bubble popped, the situation reversed and Small Cap Value stocks outperformed the market.
We also believe on a historical and relative basis, stocks in the Financials sector are cheap. For example, Banks are trading at valuations similar to past financial crises, while balance sheets and capital levels are greatly improved. We believe there could be multiple reasons for Financials stocks to rise in price. They will benefit from additional interest rate increases, improved stock and bond issuance, improved M&A activity or returning additional capital to their shareholders.
Gator Financial – Investment Thesis Review
In this section, we share our high level thoughts on two holdings: Colony Capital and Voya Financial. We believe we could earn compelling returns in both of these holdings.
Colony Capital, Inc. (Colony) is a REIT focused on commercial real estate. In 2009, the company came public as Colony Financial and was a permanent capital vehicle managed by Colony Capital. The
company invested in distressed real estate debt and equity. Over time, this opportunistic strategy led Colony to invest in a portfolio of industrial properties and another portfolio of single-family homes. Colony also originates first and mezzanine mortgages for commercial properties. The company is regarded as a sophisticated commercial real estate investor.
We became interested in Colony’s stock in 2015 after the company acquired its external investment manager. The external investment manager advised a series of private equity real estate funds in addition to Colony Financial. Colony Financial was renamed Colony Capital and the combined company has improved economics because the investment manager is an asset-light business that earns a high return on equity and does not require capital to grow. The company can reinvest the earnings generated by this business back into the core real estate portfolio or increase dividends paid to shareholders.
The investment management business has the potential to grow. With the balance sheet of the REIT, the investment management business can seed new funds which will accelerate growth. We have seen evidence of this with the new launch of a global credit fund. Colony’s investment management business at $9.9 billion in assets is large enough that it is at scale and small enough that it can grow at an attractive rate.
We believe there are a few catalysts on the horizon for Colony to drive its stock higher. First, we believe Colony will sell or spin-off to shareholders its stake in Colony Starwood Homes in late 2016 or early 2017. Next, we think Colony will recycle capital from other low yielding investments into higher return opportunities. Another possibility is the company announcing a significant stock repurchase. Lastly, we believe each earnings report is an opportunity for the company to show improved fund raising in its investment management business and/or improved results in its real estate portfolio.
A new potential catalyst for Colony shares appeared in early May. Colony confirmed that it was in talks to acquire NorthStar Asset Management (NSAM). NSAM is the external manager for NorthStar Realty (NRF). NSAM also raises capital and manages several other non-public investment vehicles. We’ll have to wait to see if