JDP Capital Management letter to limited partners for the first quarter ended March 31, 2015.
For first quarter we were down -2.46% net to limited partners versus 0.95% for the S&P 500. Since inception in October 2011, we have earned 84.05% after all fees and expenses, or 19.04% annualized.
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JDP Capital Management – Review and Outlook
As a value investors there are times when we are much better off doing nothing. The first quarter was one of those times for us due to multi-week periods of market panic around the potential impact of oil prices, interest rates, and global currencies on corporate earnings. Trying to “adjust” the portfolio for market conditions would have been a mistake because several of our biggest decliners in a single month, have ultimately outperformed year-to-date. This concept is especially powerful over long periods of time.
The broader market is priced for low returns with limited padding to absorb negative macro headlines, which will result in increased volatility. However a more efficiently priced
environment tends to help our concentrated value strategy shine compared to a 2011 – 2013 period when stocks of all qualities shot up indiscriminately. Today when unrecognized value makes its way to an earnings release, the market is much more likely to respond quickly and favorably.
Our competitive advantage is in our willingness to look deep into out-of-favor stocks, make independent judgments around operational outcomes of the business, and then invest large portions of our capital when we feel the market has missed something big.
This approach keeps us focused on investments with an above average potential to outperform, with a margin of safety, over multiple years, allowing unrealized gains to compound as underlying fundamentals improve. Our challenge in running a fund is to avoid major mistakes that permanently mask otherwise excellent individual investments.
Going into the second quarter we are working on two new ideas that could become core holdings—one mid cap ($500+ million), and one micro cap (sub $50 million), both financial services. We have been working on the micro cap idea for more than 8 months and it would involve us leading a recapitalization of the company at an attractive valuation to fund growth.
No major changes were made to the portfolio in the first quarter.
We continue to be excited about our basket of assets that we believe has significant upside due to valuation of
future cash flows. Although seemingly counter-intuitive, a concentrated approach to position sizing is the most logical way to reduce the risk of broad market diversification, especially in a fully priced market.
Our portfolio is focused on less than 10 positions, with a weighted average market cap of $5 billion, and plenty of liquidity to absorb new capital. As of quarter end our allocation by market cap was: 24% large cap, 17% mid cap, 24% small cap, and 35% micro cap.
This market cap range is a result of individual opportunities. Large, analyst-covered companies can become just as misunderstood and dislocated as obscure stocks generally associated with small funds. When risk vs.
upside is similar between two ideas, we would rather load up on the larger, higher quality option.
JDP Capital Management – Performance drivers
Largest contributors to our Q1 2015 performance measured in total dollar contribution:
Comments on the first quarter’s performance outliers
JDP Capital Management – CyrusOne
We continue to be impressed by CONE’s ability to grow sales at a high teens rate while maintaining 18% unleveraged development yields. We were not surprised to see the stock rise over 11% in the quarter. The sustainability of the CONE’s earning power has become obvious, and the stock price is responding accordingly. Our dividend yield is now over 6%, equal to our limited partners’ hurdle rate before a performance fee is earned.
We discovered CONE while reading though Ted Weschler’s hedge fund’s last 13F before he joined Berkshire Hathaway in 2011 to pick stocks. At the time CONE was a gem buried within a distressed Cincinnati Bell (NYSE:CBB). Weschler must have expected a spin or IPO of CONE, which ultimately happened, in January 2013. We bought the stock several months after the IPO for an average price of $20 per share and made the position a 12% allocation.
At the time, traditional REIT analysts were negative on the company and investors were spooked by CBB’s stated intent to sell their control stake at an unknown date to pay down unrelated debt. Today, if CONE were valued closer to the EV/2015 EBITDA of its smaller pure play peer CoreSite Realty (NYSE: COR), it would worth around $50 per share.
CONE’s economics are supported by broad-based trends in enterprise-class data center outsourcing by large companies, and CONE’s competitive advantage around barrier to entry, reputation, scale, efficiency, and owned real estate.
The company has a long runway to continue reinvesting capital at high rates of return especially in areas of the country where it owns raw land for expansion around its existing footprint. We expect CONE to be a core holding of the Partnership for the foreseeable future.
JDP Capital Management – Bank of America warrants
The first quarter was heavily impacted by the decline in our Bank of America (BAC) TARP warrants, both A and B. The bank continues to be one the cheapest high quality companies in the US market, on a number of metrics—each not requiring much creativity to see.
With a market cap of ~$900M for the A’s, and ~$60M for B’s, the small size limits ownership to smaller investors despite Bank of America (common stock) being one of the largest, most liquid companies in the market.
The warrants give us the right to purchase BAC stock for $13.20 in January 2019 (A’s) and $30.79 in October 2018 (B’s). As discussed in the 2014 Letter to Limited Partners, we think the stock could trade in the mid-30’s by expiration, based on ~1.25% net return on total assets of $2.2 trillion and a 15x multiple of earnings. The result would be a healthy triple-digit return for the warrants from today’s prices.
Uncertainties around BAC’s post-2013 valuation dislocation from peers have largely abated (settlement with DOJ, adequate capital for stress tests, bloated cost structure, everything Countrywide, etc.). We think today’s uncertainties are more macro-oriented and out of the Bank’s control, which is why we like it (interest rates, GDP growth, housing, government policy).
We see BAC through the lens of a cash flow growth story selling for a wide discount to earning power versus the more common debate around book value. However it is comforting to know that if the stock doubled today (to $31 per share) it would still only be valued at 1.4x book value.
Thank you for your support.
Jeremy Deal Managing Partner