Meson Capital partnership letter for the third quarter ended September 30, 2015.
Our net performance for Q3 was (1.5)% vs. indices (in order of relevancy for comparison) of: (4.4)% Barclay Hedge Fund Index, (12.2)% Russell 2000 and (6.9)% S&P 500. Our YTD performance is (0.8)% vs (1.2)% Barclay Hedge Fund Index, (8.6)% Russell 2000 and (6.7)% S&P 500. Our portfolio averaged approximately 20% net long on a dollar basis for the quarter and 20% net short on a beta adjusted basis relative to the market. This is due to our shorts being high beta, speculative low-quality stocks. Given the breadth of available short opportunities, we continue to think it wise to hedge and position ourselves for a profitable outcome when an inevitable (real) market correction finally arrives. Having purchasing power when others do not during market dislocations is the best source of returns in the long run.
The most recent market “correction” is still minor, leaving overall valuations highly elevated relative to historic levels. Based purely on our bottoms-up search process and not due to any view on market timing, our positioning has become slightly more net long as there are still a breadth of worthless, overlevered short opportunities available at reasonable borrow rates. Unless the market shoots up to new highs, these are highly likely in our view to go to zero or decline with significant dilution.
Our focus lately has been letting our extensive accumulated research on numerous names in our short book help mostly – but not quite fully – protect our downside. Meanwhile, we roll up our sleeves on our more concentrated long book, particularly on activist positions where we can create business value regardless of market fluctuations. InfuSystem stock declined along with virtually our entire long book this quarter despite reporting an excellent quarter where our growth has been accelerating and we announced our first acquisition of a smaller competitor. The IT investments we have built over the last two years depressed our earnings and have now put us head and shoulders above competitors: now we look to harvest the benefits as activists that play the long-game, to use Jeff Ubben’s phrase. We additionally have a new project that I will be discussing in more detail in our year end letter or before.
Though our short gains were broad based, one success on that side this quarter included Unilife, a company we have mentioned before but not by name. They have for years been touting a high growth business model that makes no sense: competing with a strong near-monopoly in a healthcare niche. Unilife claims they would be able to achieve high margins despite extreme customer concentration. There are numerous lawsuits and SEC investigations in the mix as well but suffice it to say it is a “show me” story with a growing debt load. Their stock declined significantly this quarter after they announced they were seeking “strategic alternatives” (i.e. “throwing in the towel”) while facing near term violation of their debt covenants for a third time and Jeffries cut their outlook on the stock.
Another catalyst-driven short that declined meaningfully this quarter was Lifelock which purports to sell identity protection services to consumers. Similar to Unilife, there is an extensive litigation trail (we find investors rarely dig into court documents which can be vastly more informative than SEC filings) that paints a very different picture than the IR department. You probably once saw an advertisement of the CEO putting his social security number in a WSJ ad and offering a $1 million guarantee as a publicity stunt. It worked (partly). Their subscribers and cash flow soared as consumers bought their “protection”, however less well known is that CEO’s identity was stolen 13 times and the maximum they have ever paid out on their $1mm guarantee is about $2500. The FTC made a large ruling against them in 2010 and then when they allegedly violated the conditions of that order they returned a year ago and commenced action this last quarter – driving the stock down 50%. We are generally wary of shorting profitable businesses that are solely poor value propositions for consumers as betting on the sheer rationality of consumers is a tenuous idea. BUT in this case there were numerous overlapping negative catalysts including the introduction of FREE competing services from most all credit card companies. We continue to patiently wait for our old friend OMEX to have their second public hearing of their Mexican undersea phosphate mining project. They have recently restructured their growing debts so they are all due in December which should lead to an interesting month. Even with the stock down nearly 90% since our initial short the company enterprise value still (!) exceeds a number of our long positions with growing revenues and larger addressable markets.
Meson Capital - Positioned for a Challenging Market Environment
Even with the recent market volatility and slight drawdown, we continue to see data indicating the market is at or near all-time high valuations which means low return expectations for the average investor going forward 5-10 years. We have spent the last 6 years building a cumulative toolkit and reputation to be anything but average, with occasional demonstrations of capability along the way. While the opportunity set for passive investors has shrunk with the rising market, our ability to actively create business value while protecting ourselves with our short book gives us plenty to work on. After achieving a 3X return in HearUSA and InfuSystem, I’m confident in our newest activist project. I continue to have virtually all of my net worth invested alongside investors in the Partnership. We have also recently expanded the firm with a new full time Chief Operating Officer.
Please email me at [email protected] or call at 607-279-5382 if you have any questions or are interested in investing with us or co-investing in our upcoming new activist idea. As always, thank you for reading.
Meson Capital Partners LLC