Uncovering Alpha In Microcaps And Special Situations: Q&A With Peter Rabover, Artko Capital by Khai Nguyen, LinkedIn Pulse

Peter Rabover is the principal and portfolio manager of Artko Capital LP. His focus and expertise lies in value investing, small caps, special situations and M&A. Prior to founding Artko Capital, he was a Senior Analyst for a large San Francisco mid cap value fund and a Santa Cruz large cap value fund, as well as stints in the Peace Corps as an Economic Development Volunteer and various private equity/M&A consulting roles.

Peter holds a B.S. in Finance from Duquesne University and an MBA from University of Virginia’s Darden Graduate School of Business. He has also attained the Chartered Financial Analyst designation. He splits his time between San Diego and San Francisco, California.

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Khai Nguyen: I’m here today with Peter Rabover, Portfolio Manager at Artko Capital. Peter, welcome.

Peter Rabover: It’s great to speak with you.

KN: Peter, can you begin by telling us your background and how you got started in the world of investing?

Peter Rabover: My family and I grew up in Russia and moved to the United States in 1991. I remember having to do all the stereotypical things that Americans got to see on television in the 1980s: bread lines, communal living, etc.  My mom took me to stand in that famous Moscow McDonald’s line when it opened in 1989. That really stood out as my first real “capitalist” interaction, which I loved.   Since then, I’ve always been interested in how things worked economically, even if I didn’t really understand it.Sometime during my undergraduate years, things clicked for me when a professor gave me Peter Lynch’s “One Up On Wall Street” and Warren Buffett’s essays and I really fell in love with value investing.

After college I did corporate finance and M&A work for US Steel and a two-year stint in the Peace Corps in Kazakhstan as Economic Development Volunteer and where I finished my CFA program and got to launch one of the first microfinance lending funds in Kazakhstan. When I came back, I was ready to jump into my investment management career with Hahn Capital Management, a great mid cap value shop in San Francisco, with close to $2 billion under management. The firm gave me the opportunity to really immerse myself in the field.  John Schaeffer, the Director of Research, was a great mentor. I spent five years there as a generalist, leading up to and during the 2008 financial crisis, which really broadened my experience as an analyst and as a value investor.  I learned the importance of not only having a mindset focused on capital preservation, but also of an event driven philosophy, concentrated on value creating catalysts, to not fall into the dreaded value trap. I appreciated the opportunity of owning a portion of the portfolio in my 20s and had the ability to incorporate some of my own investment ideas in the portfolio, and of course to learn from my mistakes.

After completing business school at the Darden School at University of Virginia, I worked for another fantastic value shop, Scharf Investments in Santa Cruz, California with close to $5 billion of assets under management. Scharf Investments has a strong focus on investing in quality companies and a valuation mean-reversion philosophy which they have used successfully for many years. During that time, I also really got into endurance sports, including triathlons and trail ultra-marathons which provided ample time to sort out my thoughts, investment philosophy and theses on the trail.

KN: That’s quite impressive and fascinating, particularly the ultra-marathons. Any parallels between that and investing that you’ve found through your experience?

Peter Rabover: I’ve found that ultra-running (running long distance trail races of 30 to 100+ miles) has a direct correlation/parallel to value investing with respect to the mental mindset needed for success.  Both require a long term vision to achieve big goals,knowing that that you’ll be running for 30+ hours or expect to be in an investment for three to fiveyears, while ignoring short term pains with the constant ups and downs, and maintaining focus on finishing the race or waiting for the investment thesis to develop.  Another parallel that I like just as no trail or run is the same, whether it’s running in the mountains at night or running in the desert in the blazing heat during the day, no investment is the same either.  The key is to prepare well, understand the conditions and adjust on the fly when things aren’t going as you expect.  And of course experience counts for a lot and knowing yourself and how to react to conditions and events around you to not repeat the same mistakes over and over again.

KN: How would you describe your investment philosophy or style?

Peter Rabover: I am definitely not afraid to paint myself in the value corner, with a rather large focus on buying high-quality companies with a very large margin of safety.  I like to have low downside risk, which I characterize as permanent impairment of invested capital, and not as price volatility.  I am cognizant that I am human and humans make mistakes. My goal is to make sure when mistakes do happen, they are few and far between and the losses on those mistakes are minimal.  The way I control for that risk is by being very patient on the buy-in price and investing in quality companies with consistent earnings or cash flows, strong balance sheets, great management, high returns on capital and strong competitive advantages and moats.

On the other side of the equation, I probably shifted from Buffett 1.0 of getting excited to buy super cheap assets and just sitting on them for years waiting for Mr. Market to catch up, to more of a Buffett 2.0 in whichnot only do I want a great price but also a great company. However, since I don’t own these companies like Warren Buffett can and don’t have complete control, I want visible upsides or likely events to create those upsides to be present in my investments.  Those events or value creators can take many forms, from market-specificlike a rebound from cyclical lows, to company-specific like recapitalizations, special dividends, division sales and spinoffs, expansions in ROICs, among many others.

KN: Can you talk about Artko Capital and the fund’s investment strategy?

Peter Rabover: The fund strategy is what I would call Enhanced Value in which the vast majority of the portfolio is invested in 10 to 12 high-quality companies with a significant margin of safety, and I’m looking for a 100-200 percent upside in the next three to five years.  The Enhanced portion of the portfolio is invested in more special situation securitiesfor which I see the upside as significantly higher but the probability of loss of capital is also increased.  These investments will be smaller than the core value portfolio in the 2 to 4 percent range on average and with a short one-to-two-year holding period.  These are more “off-the-beaten-path” investments, where Artko Capital might well be the only institutional investor with no competition, with low liquidity/size such as warrants, converts, preferreds, and an occasional short. In general, I’m looking to size my positions in which in

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