Denali Investors letter to shareholders for the first quarter ended March 31, 2015. Kevin Byum‘s hedge fund is off to another strong start (even if the numbers are not as absurdly high as prior years). See the letter below and stay tuned for part II.
Denali Investors: General Comments
During the fourth quarter, we were able to generate positive returns in a volatile environment. We benefited from a number of catalysts during the quarter. The outperformance was generated while maintaining significantly less exposure due to our large cash position as well as our high position level and market hedges. We were able to add to a number of positions including Liberty Broadband (LBRDA) and KLX Inc. (KXLI), among others. The special situations pipeline for 2015 remains robust and we expect Q2 to be a very busy period. There are numerous specific and understandable catalysts with attractive risk/return profiles.
Denali Investors: Select Portfolio Positions
Liberty Broadband (LBRDA) – LBRDA consists of interests in Charter Communications (CHTR) and Time Warner Cable (TWC), among other assets. At the end of March 2015, CHTR announced the acquisition of Bright House Networks (BHN). The BHN acquisition was contingent on the completion of the CMCSA/TWC/CHTR/Greatland transactions. BHN is controlled by Advance/Newhouse and serves 2m subscribers in Florida and the Midwest. The transaction was valued at $10.4b ($5.9b common units, $2.5b convertible preferred, and $2b cash) and 7.6x EBITDA. Pro-forma, CHTR shareholders would own approximately three-fourths and Advance/Newhouse one-fourth with LBRDA adding $700m to its position bringing its stake to 19.4%. Through a voting arrangement, LBRDA would maintain 25% voting control, however.
Not surprisingly, the timing of the CMCSA/TWC/CHTR/Greatland transactions had been moved to mid-2015. Previously, we stated that we believed the pending resolution of the Comcast (CMCSA) and Time Warner Cable (TWC) merger, should additional concessions be required for approval, would benefit CHTR, and by proxy LBRDA, and create another interesting investment window. That window is now upon us.
Last Friday on April 24, 2015, it was announced that the CMCSA/TWC merger was terminated. As a result, the contingent deals, both Greatland/CHTR and CHTR/BHN, are also terminated. We believe that the remaining parties are incentivized to reach a favorable transaction and would mutually benefit by acting quickly. Congruent with our previous view, we believe LBRDA stands to benefit disproportionately under a number of potential outcomes.
For background, LMCA completed the full spinoff of LBRDA in November 2014. One share of LBRDA was distributed for every four shares of LMCA held. The LBRDK (LBRD Series C common stock) rights offering was for one right for every five LBRD shares held (whether LRBDA, LBRDB, or LBRDK). Subsequently, the LBRDK rights offering was completed in January 2015 for a subscription price of $40.36 per share. New LMCA mostly consists of Sirius (SIRI) and Live Nation (LYV), among other assets.
Denali Investors: FNF Ventures (FNFV)
FNF Ventures (FNFV) – FNFV has continued to unlock value. On February 23, 2015, FNFV announced a tender offer for approximately 13% of shares outstanding. The offer totaled $185m at a range of $14.30 to $15.40. The tender offer was completed successfully, having been well oversubscribed, on March 23, 2015, with the repurchasing of 12,333,333 shares of FNFV at $15.00 per share. The tender offer was advantageous as we believe FNFV trades at a significant discount to its underlying value. We did not participate in the tender offer but appreciate other participants for doing so.
The developments during Q1 2015 follow the Comdata sale to FleetCor (FLT) in November 2014 and the distribution of REMY shares at the end of December 2014. Of note, FNFV is expected to spinoff J. Alexander’s Holdings (JAXH) in mid-2015 which we believe will be another positive development.
Denali Investors: KLX Inc (KLXI)
KLX Inc (KLXI) – B/E Aerospace (BEAV) announced the spinoff of KLXI in June 2014. The spinoff is the outcome of strategic alternatives that were announced earlier in 2014. The spinoff of KLXI was completed in December 2014 with one KLXI share distributed for every two BEAV shares. The market and event driven community elevated pre-spin BEAV shares from ~$80 to ~$100 per share with the expectation of a potential buyout at $120 to $140 per share. Those holders were disappointed by the June 2014 announcement of no near term sale with plans to spinoff KLXI instead. BEAV shares traded down to the low $70s. This backdrop is what renewed our interest in the situation.
Interestingly, the main catalyst occurred during the heart of this window. Coincident with the back half of 2014 already being very challenging for event driven funds, BEAV shares were abandoned for the remainder of 2014 with the spinoff occurring at $74 per BEAV share, below the preannouncement price. We believed the combination of post-spin selling pressure and a deteriorating oil pricing environment could result in creating KLXI at an attractive valuation.
KLXI consists of two segments: 1) Aerospace Solutions Group (ASG) provides fasteners, consumable products, and logistics services to over 4,700 aerospace customers globally. 2) Energy Services Group (ESG) provides services and logistics for remote oil and gas drilling sites. KLXI revenue is split three-fourths ASG and one-fourth ESG.
KLXI shares traded down 20% in the first two months as a standalone company. In February 2015, the company suspended 2015 guidance as a result of oil price uncertainty impacting the energy complex and therefore the smaller ESG segment. KLXI’s exposure to energy through ESG has created uncertainty and obscured the value of the core ASG business. However, at the current price, we believe the market is ascribing a significant negative value to the ESG segment and that the core ASG segment is being created at a large discount even if we assign no value to the ESG segment or the valuable tax assets.
Tellingly, Khoury moved to KLXI. Khoury was the founder (July 1987), Chairman, and Co-CEO of BEAV. He is now the Chairman and CEO of KLXI. He is also remains the Executive Chairman of New BEAV.
Denali Investors LLC
Denali Investors letter to shareholders for the first quarter ended March 31, 2015.
H. Kevin Byun founded Denali Investors in 2007. The firm employs an opportunistic special situations and value-oriented framework. Denali seeks to identify catalyst driven situations that will unlock value and produce market agnostic returns. Mr. Byun has a triple major from Rice University and an MBA from Columbia Business School.
Denali Investors: Framework
Value + Special Situations (Catalysts): Denali seeks to identify value-oriented and special situation investment opportunities at substantial discounts with definable catalysts or by being the catalyst through proactive methods. Our special situations focus and experience has generated outstanding market agnostic returns.
Fundamental Research + Analysis: Denali’s research and analysis have consistently produced a high rate of success. Our investment process uses a combination of thematic and rigorous fundamental research on individual companies and catalyst driven situations.
Portfolio Construction + Risk Management: Denali invests in only its highest conviction ideas. Concentration into 5 – 15 very attractive, non-market correlated investments is an advantage. Our opportunistic style of investing allows the firm to select investments with highly favorable risk-reward profiles. We structure the portfolio to have favorable asymmetric characteristics that we believe will provide substantial upside yet preserve capital in a downturn.
Flexible & Opportunistic Mandate: Denali has a flexible mandate that allows the firm to look at opportunities across the spectrum. Unlike other funds that are designed to fit into a limited ‘style box,’ we are opportunistic generalists focused on special situations. Our flexible approach has resulted in numerous outstanding investments.
Net Cash = Fortress: Cash is a valuable strategic asset. Our cash has typically averaged 20% to 35%. Cash remains the default in the absence of greater opportunities.