Greenhaven Road Capital letter to partners for the third quarter ended September 30, 2015.

Dear Limited Partners,

The fund endured its first “down” quarter in over two years, but is up just over 4% for the year through September 30 after all fees and expenses. This compares favorably to the S&P 500 that is down more than 5% over the same period. When considering our fund’s performance year to date, I would like to highlight two items of note. First, with the fund’s six percent hurdle rate, as of September 30 investors have not accrued any performance fees in 2015. Second, as the largest investor in the fund, my family took the same losses in the quarter as you did; we are in this together. This will not be the last down quarter. We will have more down quarters and years and sustained periods of under-performance in the future. However, as long-term investors, we view the volatility as a creator of opportunities which we try to seize. Nothing happened this quarter to make me believe that markets are efficient. I continue to believe that our small size and broad investing universe provide ample opportunity to generate substantial returns over the long term, even with down quarters and years along the way.

I want to take a moment to put the performance in context. Unfortunately, investors who joined the partnership this quarter are “down” on their initial investment through September 30th. You will pay no fees until wee exceed our 6% annualized hurdle rate. Unfortunately, investing is rarely just a straight line up. The year to date out-performance of 9% (+4% vs -5%), if sustained, would be heroic because of the power of compounding small differences over long periods. $1 that earns -5% per year over 30 years shrinks to $.21 while a dollar growing at 4% a year grows to over $3.24. This is a 15X difference. To be clear, the vast majority of funds don’t generate any out-performance, and I am not promising 9%, but what appears to be a ho-hum absolute performance number is very meaningful on a relative basis. With a long bias we will typically go down with the market, but a little bit of out-performance over an extended period of time will have a huge impact on the where we end up in the long run.

Greenhaven Road Capital – A Tale Of Two Companies

Charles Dickens wrote the famous opening sentence to the A Tale of Two Cities,

“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair.”

I don’t think the situation that I am about to describe quite lives up to Dickens’ description, but as a long/short fund, we are trying to own (be long) high-quality companies and sell (short) low-quality companies. It sounds easy in theory. Even my three-year-old daughter gets the idea of keeping the good and giving away the bad. She would like to be long lollipops and short veggies. However, in practice when it comes to investing, lollipops are hard to find and when you try to feed the veggies to the dog you can have your hand bitten. Below I am going to describe a company that we were long and a company that we were short at a moment in time – August 31. These letters rarely discuss shorts in detail or by name, but I think this discussion is illustrative of the differences in quality of the companies we are long versus those that we are short, and how those differences may not be reflected in price over a short time period. Here we go.

We will start with the “short.” This will be interactive. What would you pay to purchase 100% of the following company? I mean the most? The most – like you had a billion dollars sitting in the closet? The company has two employees and declining revenues; last quarter the revenues were $44,000 (no zeroes missing) down from $81,000 a year ago. The company has not been aggressively investing in R&D. In the first six months of 2014, the company spent a grand total of $38,928 on research and development. The company’s marketing budget for the first half of 2015 was $9,047 or just over $1,500 a month or $400 a week (again no zeroes missing). The company operates within the technology industry with much better-funded competitors including Citrix and Logmein, not to mention Microsoft. Do you have a maximum number you would pay for this operation? I assume the amount of cash they have may factor into your valuation. The answer is less than $5M. Some people will ask, “do they have valuable patents?” The answer is no. Ok – what would you pay? Most people conclude cash + $10 or $20 million would be pretty generous for a company with almost no revenue that is losing money and has little chance of making money real money in the foreseeable future.

Our “worst of times” company being described above is Code Rebel (CDRB). At the end of August, the shares were priced over $14, providing a market capitalization (the amount required to buy the whole company) just shy of $200M. Anyone want to argue markets are efficient? The fact is even if Code Rebel did have a good product, and all indications are they do not, they don’t have a sales and marketing infrastructure, and they don’t have a support infrastructure. Companies are comprised of people working together. Success is reliant on the pieces coming together. There needs to be an offering, the offering needs to reach the market so that it can be sold, and the offering needs to be supported going forward. As best I can tell, Code Rebel has none of the attributes required to build a long-term business. However, they do have a stock hype machine. Press releases are their specialty. They have a video with a “futurist” who speaks of how the Code Rebel solution solves problems that vexed him while at Apple. He leaves out the part that he left Apple in the 1980s. The one press release they did not put out recently is for their earnings. Their earnings had no conference call and no press release – just a quiet Friday night filing with the SEC. I think it is very likely that almost everybody who owns Code Rebel stock has not bothered to open a single SEC filing like a 10Q that showed actual sales numbers or details on the business. We will return to Code Rebel in a minute.

Greenhaven

See full PDF below.