Olesen Capital Management’s letter to shareholders for the fourth quarter 2014.
In the fourth quarter, the fund generated a return of 5.9%. The following table shows our historical returns after fees alongside those of global equity markets since the fund’s inception.
Olesen Capital Management: Excess Cash Balance Down to 7%; Net Exposure at 76%
As a result of a few new investments, our excess cash balance fell to 7% of our capital as of the end of the quarter. However, note that two of our new investments are arbitrage-type ‘special situation’ investments (one is a complex merger risk arbitrage situation and the other is a liquidation-type investment), which have short positions associated with them. Therefore, our net exposure (total investments minus short positions) was only 76% of our capital as of Dec 31.
The two new ‘special situation’ investments are both commodity–related, and the reasons these opportunities arose may be related to the recent decline in oil prices. This indicates that, as has historically been the case, we are more likely to find attractive opportunities when there are dislocations in financial markets and we are able to act quickly to take advantage of them.
Olesen Capital Management: Reflections on Our Portfolio in 2014 (and Beyond)
I am a little disappointed with our 8.9% return after fees in 2014, which happens to be exactly equal to the return for the MSCI All-Country World Index (incl. dividends), which we sometimes use for benchmarking. It was difficult to be a true value investor in 2014, because almost all asset classes had been bid up to rather “rich” levels. The buoyant market conditions made it difficult in both 2013 and 2014 to find attractive new investment opportunities, and it also caused us to sell many investments because they had appreciated close to fair value. Conditions were already challenging at the beginning of 2014, as indicated by our extraordinarily high cash balance, which was 40% of our capital at the time. Our challenge was to deploy this cash as well as replace additional sales of investments as they rose towards fair value without compromising our tough standards of value. Considering the buoyant market conditions, I think we did a reasonable job of this, primarily by focusing on corners of the market that receive little attention from sophisticated investors. All but one of our new positions in 2014 were in small companies in Europe or Asia, or in ‘special situations.’ I am very confident that our current portfolio is more attractive than it was at the beginning of 2014, even though the stock market rose during the year. This is simply due to the deployment of much of our cash balance as well as the proceeds from sales of moderately undervalued investments into securities that are significantly undervalued. This should bode well for our future returns.
In 2015, I think we will likely continue to find opportunities in overlooked corners of the market. It appears we are having continued success finding these kinds of opportunities. Also, we are actively accumulating three such investments which are not very liquid (two of them are described below, and the third one is a ‘special situation’ fixed income investment that we started buying after the end of the year). In addition, if volatility rears its head somewhere in the global financial markets in 2015, chances are good that we will quickly find some good investments. Note that volatility is actually our friend, not enemy, in the long run, because it enables us to buy when prices are temporarily depressed, and we can wait for the price to reflect the fundamental value.
Olesen Capital Management: Portfolio Updates
- Sold Havas at Substantial Profit After Both Margins and P/E Multiple Expanded
During the quarter, we sold our investment in Havas, a French company that owns a global network of advertising, media buying/planning, PR, and similar agencies. We first bought the stock at €2.82 in Aug 2011 and sold at €6.31.
Our original purchase price was approx. 10x adj. trailing earnings. The business has very low net capital requirements, which means it can grow without consuming much free cash flow – a highly valuable characteristic. In addition, the company was in the middle of an already very successful multi-year margin expansion following the replacement of senior management a few years earlier when the well-known French industrialist and activist investor Vincent Bollore got control of the company. I expected this would result in significant further margin increases. As expected, both earnings and the P/E ratio increased, which led to a very good return on our investment.
- 31% Gain on DeLclima; Disposal of Underperforming Business Unit
During the fourth quarter, we had a sizeable unrealized gain on DeLclima, which is one of our largest investments. DeLclima is a successful, growing designer, manufacturer and distributor of mid-to-high end air-conditioning and heating systems, mostly for commercial buildings and data centers. The company was spun off from the Italian appliance maker De’Longhi three years ago. Most of the revenues are generated in Europe and to a smaller extent China and some other emerging markets. The balance sheet is very strong, as net debt is close to zero. The company’s core business generates very high returns on capital and has apparently gained market share over time, but its smaller radiator business unit has performed poorly in recent years.
Consistent with our initial investment thesis, the company recently announced a program to dispose of the radiator business, which I think may be causing the market to better appreciate the value in the company’s core business. At our average cost of €1.40, we paid a little below 10 times earnings (excluding the losses of the radiator segment, because we thought they would eventually exit this business), which I think is too low for this high-quality business. Due in part to good results and in part to the announcement of the program to exit the radiator business, the stock price appreciated 31% in the fourth quarter.
- Invested in Mid-Sized European Company at 9x Adj. Earnings; Margins May Expand Significantly
During the quarter, we invested in a mid-sized European retailer. While retailing is generally a mediocre business, we think this company’s business model is less vulnerable to the fiercely competitive factors that affect most retailers. We also don’t think the Internet will ever displace this company’s business. The company trades at approx. 9 times adjusted earnings and has a good balance sheet. Most importantly, we think the company’s margins may well increase very significantly from current levels. This is based on our expectation that the company will simply continue to improve the results of underperforming businesses it has acquired over time.
- Gains on Two New Commodity-Related ‘Special Situation’ Investments
We also had significant gains on two other investments, both of which were added to the portfolio late in the fourth quarter. This includes a liquidation-type investment and a complex risk arbitrage situation. Both of them are commodity-related, and the reasons these opportunities arose may be related to the recent decline in oil prices. Both of these investments are hedged, but the return on one of them may be positively correlated with the market.
- Continued Accumulating Two Small, Illiquid Gems
We also continued to slowly accumulate shares in the