JDP Capital letter to limited partners for the third quarter ended September 30, 2016.
[drizzle]For the third quarter the JDP Capital Fund was up 8.80%, and up 4.48% year-to-date (net). Including dividends, the S&P 500 was up 3.85% in the third quarter, and 7.84% year-to-date. Since inception in October 2011, we have earned 90.75% after fees and expenses, or 13.8% annualized.
Please see the 3Q 2016 Portfolio Review & Strategy Presentation for more detail about our holdings and their performance.
JDP Capital – Overview, Thoughts & Outlook
Primary contributors to our third quarter performance ranked by attribution were: TerraForm Power (TERP) +35%, Liberty Broadband (LBRDA) +19%, Carrols Restaurants (TAST) +12%, Bank of America (A warrants) +33%, ALJ Regional (ALJJ) -6%.
Being a smaller fund today is a greater competitive advantage than when we started five years ago. Capital is rotating out of traditional large hedge funds and into “me-too” ETFs, indexing and retails models. This puts added pressure on the top 10% of the market that is closely watched and picked over. As the saying goes, you can’t outperform the market if you are the market.
In the third quarter the majority of our holdings benefited from strong second quarter results that caused their valuations to stand out. Although we were paid a bit, the bulk of the portfolio’s upside remains more tightly coiled than at anytime this year.
While the popular narrative around a “fully valued market” controls the headlines, our portfolio’s excitement does not stem from a bet that the market will move higher or lower. Instead, we are positioned to benefit from big changes happening within our holdings. Valuations rise as operational progress translates to screenable GAAP earnings.
Investments begin life in our fund with a price dislocation resulting from a transition (merger, strategy or regulatory shift, reorganization, misunderstood accounting, etc.). Other investors may also see what we see, but decide to sell cheap to avoid uncorrelated volatility or surprises, particularly in the absence of positive analyst consensus and thought leadership.
Selected Portfolio Update – Carrols Restaurants (NASDAQ: TAST) +85% return since initiation
How can we enthusiastically own TAST, but be indifferent about the fast-food sector?
TAST is in the early stages of a multi-year transition from an unknown niche operator to mass consolidator of Burger King franchisees. We have owned the stock for 2.5 years (since $7) and see a clear path to $20+ per share.
The market struggles to understand the power of TAST’s insulated potential as a consolidator of Burger King franchisees controlled by Burger King Worldwide and 3G Capital. The stock also suffers from the perception as a franchisee with lower returns on capital compared to a franchisor.
But we see a business with a decade-long runway to redeploy and compound incremental capital at 20% – 25%, trading for a single-digit multiple of next year’s cash flow. Other would-be public comps are more leveraged to GDP and dependent on opening new stores for growth. TAST’s growths earnings by acquiring other stores at low multiples of cash flow, harvesting operational inefficiencies, and remodeling. The M&A pipeline is protected by a Right of First Refusal contact for all franchisee sales within a 20 state footprint.
To highlight the disconnect between TAST and the broader market—the stock fell 17% in the second quarter on negative growth sentiment in the fast food industry, concerns with traffic declines and continued menu price wars among the major fast food operators.
The stock then dramatically recovered within 5 days of 2Q earnings that showed a 34% rise in YoY earnings, same-store-sales growth that beat the high water market created by the “feared” comp of 10.3% the year before, and raised full-year guidance. TAST has acquired ~30 restaurants so far this year, and should complete 85 – 90 remodels by year-end.
We see the current price war among Big-3 QSRs reversing within the next year as the menu value proposition narrows with higher priced competition. Even a partial return to more normal menu pricing will have an enormous incremental impact on TAST earnings. Although a nearterm swing is outside our thesis, we think that a return to a more normalized pricing environment is inevitable especially given the sense of urgency, creativity and scale of Burger King’s controlling shareholder 3G Capital.
Selected Portfolio Update – TerraForm Power (NASDAQ: TERP) +35% return since initiation In mid-2015 TERP traded for three times the current price with 2/3 of the asset footprint. At our cost of $10 per share we own the assets for a discount to run-off value and get the growth potential for free. Our believe that TERP will re-rate to a going concern price level is stronger today; the fight for control of this trophy asset is now dominated by the premier solar/wind development companies in the world.
While lackluster sell-side coverage focuses on picking apart financials while in distress, our conviction comes from a perspective that values TERP’s normalized earnings power with a new and improved DevCo owner. We see significant opportunity for any of the current DevCo bidders to fix the company:
- Refinancing and restructuring of debt
- Reinstatement of project acquisition pipeline
- Swap out counterparty risk and lower fees
- Improved corporate governance
- Reduction in SG&A expense
In addition, a new DevCo owner could participate in the IDR payout of special dividends that were set to begin within several quarters of SunEdison’s bankruptcy filing. This unusual set of circumstances aligns the winning bidder of control for TERP with TERP’s public stockholders by reinstating growth and maximizing the dividend payout.
Despite this compelling setup, virtually no traditional institution or retail investor can own TERP regardless of valuation, while SEC reporting is halted and control of the company is in limbo.
Welcome Seth Lowry, CFA
Seth came on board full time as our Senior Analyst in July after working part time for us on special projects throughout the year. Seth’s drive and acumen have quickly become very valuable to our research process. Seth attended the US Air Force Academy originally to become a fighter pilot before ultimately finding his passion in capital markets and investing.
Seth started his finance career at Merrill Lynch where he spent four years working on both an Institutional Investor Ranked research team, and in investment banking.
He then spent three years at Citi as a transportation analyst where much of his work focused on the largest concentrated value and activist funds including Pershing Square, Children’s Investment Fund, and 3G Capital. These experiences inspired him to pursue a career in value investing.
Launch of JDP Offshore
JDP is launching an offshore feeder fund in response to interest in our strategy from outside the US. JDP Offshore will begin trading on January 2, 2017 as a tax-neutral Limited Company domiciled in the British Virgin Islands (BVI) that invests directly in our existing US fund. Offshore will have the same terms as the US fund. Please send us an email if you are a non-US qualified investor, or a US tax-exempt organization and would like more information.
JDP Capital – Concluding remarks
We have a strategy, process, and alignment of interest with our investors that encourages out-of-the-box thinking, regardless of market cap,