Dane Capital Management Fund letter to investors for the period ended July 31, 2015.
For the month of July Dane Capital Management Fund (the “Fund”) returned -0.03%, net of fees and expenses, bringing the Fund’s 7-month 2015 performance to 7.4%. In the 10 months since inception, the Fund has returned 11.1% net of fees and expenses.
July continued the trend of heightened volatility with continuing uncertainty regarding Greece and worries about the decelerating growth in China. These issues could have contagion effects, both on other financial markets and on foreign economies, however, we’d expect a lesser impact on the fundamentals of companies whose business is primarily domestic. Most of our small-cap holdings generally have significant domestic exposure, benefit from lower energy costs, and feel little impact from changes in FX or commodity prices.
While the S&P and NASDAQ recorded gains of 2.0% and 2.8% respectively, the Russell 2000 – the segment in which many of our investments are concentrated – declined 1.2%. While we remain keenly aware of macro trends, we apply a bottom-up approach, with a focus on stocks that we believe are mispriced versus their intrinsic value.
While broader indices were higher in July, the strength was narrow, and driven by a select group of large-cap stocks which significantly outperformed, including Amazon, Google and Netflix. At the same time, many small-caps continued to under-perform, despite continued healthy fundamentals. Investors are lowering exposure to higher Beta stocks, and particularly to small-caps.
While we always consider macro conditions, at Dane Capital we are not market timers. We are focused on identifying securities that are meaningfully mispriced relative to their intrinsic value. We have many friends who work in real estate. As we’ve often discussed with them, when a snow storm hits one of their properties, they don’t mark down the value by 20%. With the stock market, that’s often not the case. Temporary issues often cause severe changes in valuation despite no true change in a company’s worth, or change in the company’s ability to generate cash flow over time.
Our primary focus is developing a portfolio that will meaningfully outperform indices over time. We believe our best chance to produce outperformance is by concentrating our investments in our highest conviction ideas – those which we believe offer a highly asymmetric risk/reward profile. We are the largest investor in our fund, and have our children’s, parents’, and extended family’s money invested in our fund – our success is aligned with that of our LPs.
July was an interesting month for Dane Capital. Many of our longs performed poorly despite generally solid results and outlooks. We attribute this largely to the aforementioned current move away from small-cap stocks. Importantly, we continue to feel confident in our idea generation, including several new holdings discussed below.
Much of the reason for our flat performance for July, despite a difficult month for many of our holdings, was the buyout of Magnetek by Columbus McKinnon for a 55% premium to Magnetek’s stock price, which contributed over 2% to our monthly performance. Magnetek is a company that we discussed in our 4Q 2014 letter as a top-5 holding based on our view that street numbers from its sole sell-side analyst were too low (Magnetek beat 4Q and 1Q EPS estimates by 40% each), and that the company’s mid-teen unlevered free cash flow yield was unduly (and unsustainably) high – we estimated fair value of $50, which happened to be the buyout price. Shares of Magnetek rallied from $32 to $45 between November and December of last year. In 2015, despite excellent results in 1Q (40% upside to EPS), a strong outlook for 2Q, improving margins, and shares trading at 7x EPS in a space that trades at twice that multiple, shares were back at $32. Over the past several months we’ve continued to closely analyze the company and we had added to our position. If the Magnetek acquisition had been announced in August, we likely would have been down a couple percent in July.
Dane Capital runs a fairly concentrated portfolio. We can’t predict when a stock’s market value and intrinsic value will converge – it may be months, quarters or years (we prefer months) – however we believe that if we buy securities at a material discount to intrinsic value (and short securities trading above fair value) we will outperform markets over time. We recognize that this can result in lumpy performance, but we believe this is our best strategy to maximize the Fund’s long-term performance.
Dane Capital Management Fund - Marketing/Investor relations
As we have previously noted, we are pleased that each month additional LPs have invested in the fund and several initial investors have invested additional assets. We have visibility for additional new assets for September 1st. While we remain below $50 million in AUM, we will be closing Series “A” (“Founders Class”) interests with preferential terms on January 1, 2016. As always, we are available to discuss questions about our strategy and our portfolio.
Dane Capital Management Fund - New Positions
Lindblad Expeditions (LIND)
Lindblad Expeditions is a highly profitable, $400 million market cap, adventure cruise line, with a 35+ year operating history, which has an exclusive relationship with National Geographic (recently extended through December 31, 2025). Lindblad became a publicly traded security via a merger with Capitol Acquisition Corp II, a SPAC, in July. While many institutional investors are inclined to avoid SPACs because of the poor performance many SPACs experienced in the 1980s and 1990s – in part because of economics that massively benefited the sponsors, even for poor ideas (a situation that has since changed) – we believe this bias creates an opportunity in a largely underfollowed investment segment. In the case of Lindblad we note that this is the 2nd SPAC for its sponsors, who have produced a mid-teens IRR with their 1st SPAC over half a decade. More importantly, we believe Lindblad is a unique asset, with a deep moat, due to its exclusive relationship with National Geographic, which reaches over 650 million people per month through its magazines, TV channel, etc. Our view is that just like it’s hard to find anyone who doesn’t like puppies, it’s hard to find anyone that doesn’t have a favorable view of National Geographic. Lindblad currently trades at 8.9x 2015 EV/EBITDA, over 4 EBITDA turns less than larger players including Carnival, Norwegian, and Royal Caribbean despite a faster growth rate over the last 5 years, a faster projected growth rate, and lower capital intensity. Lindblad has a daily room rate that is 5x that of these larger competitors. Lindblad differentiates itself with world class naturalists, scientists and photographers in an intimate setting, with a reputation established over 35 years. This also allows them to use older ships or build lower cost new ships – new builds are estimated to have an ROIC in excess of 20%, well above the company’s cost of capital. Lindblad can self-fund new ship-builds from cash on its balance sheet and operating cash flow, with new ships planned for 2017, 2018 and 2019 (the ’17 and ’18 ships are scheduled to be ordered in 3Q). With a cost of $40 million and EBITDA by year 2 of $8+ million,