Stanphyl Capital letter to investors for the month ended December 31, 2015.
Friends and Fellow Investors:
For December 2015 the Stanphyl Capital fund was down approximately 1.6% net of all fees and expenses. By way of comparison, the S&P 500 was down approximately 1.6% while the Russell 2000 was down approximately 5.0%. For the full year 2015 the fund was down approximately 11.1% net while the S&P 500 was up approximately 1.4% and the Russell 2000 was down approximately 4.4%. Since inception on June 1, 2011 the fund is up approximately 73.4% net while the S&P 500 is up approximately 67.6% and the Russell 2000 is up approximately 42.8%. (The S&P and Russell performances are based on their
“Total Returns” indices which include reinvested dividends.) As always, investors will receive the Stanphyl Capital fund’s exact performance figures from its outside administrator within a week or two.
By several key metrics the broad market is now even more overvalued that it was at the peaks of 2000 and 2007…
…while Q4 S&P 500 earnings are expected to decline significantly year-over-year:
Stanphyl Capital's portfolio holdings
The Stanphyl Capital fund thus remains broadly hedged with significant short positions in the S&P 500 (SPY) and Russell 2000 (IWM), as well as (to our detriment this month) in the biggest equity bubble I can find, Tesla Motors Inc. (TSLA). Meanwhile I continue to buy, hold and add to interesting and inexpensive microcap long positions that I believe have considerable upside potential, many of which were down a bit this month due—I believe—to year-end tax-loss selling, as although I’ve bought these companies at prices well off their highs, others haven’t been as fortunate and have thus likely been booking some losses. Here then are the specifics…
New to the fund this month is a position in MRV Communications Inc. (ticker: MRVC; basis; $12.23; December close: $12.22), a pure-play optical networking company that just completed the sale of a low-margin network integration division. So this is now a roughly break-even, debt-free company with $92 million of 53% gross margin revenue (on an annualized run-rate basis) growing 5% a year with $37 million in cash and $380 million (!) of NOL carry-forwards (combined federal, state & foreign) for which we paid only a bit over 0.5x revenue on an EV basis (attributing no value to the NOLs), and I think it’s a potential buyout candidate at a multiple of several times that. In fact an activist tech investor (Raging Capital Management) recently upped its stake to over 30% of the company, and with MRV’s board chairman also being a partner at Raging Capital I think some shareholder-friendly actions could take place in the relatively near future.
Also “new” to the Stanphyl Capital fund this month is a position in Broadwind Energy (ticker: BWEN; basis: $2.09; December close: $2.08), whose primary business is manufacturing towers for the wind industry. We made a lot of money on Broadwind back in 2013 and now with Congress having renewed the Production Tax Credit with a gradual phase-out into the early 2020s (including project completion times), I think this company can do around $16 million in EBITDA for each of the next seven or so years, based on the $24 million the wind division did back in 2013 and then subtracting $7 million for corporate overhead, $1 million for stock-comp and assuming that the gearing division is EBITDA-neutral; a 5x multiple on that number would make BWEN a $5+ stock. One hitch is that the company needs to hire a new CEO, as the previous one was recently terminated for not fixing a series of production snags. (The CFO is temporarily serving in that position.) However, with the wind now at Broadwind’s back (no pun intended), I think it can begin announcing some very significant orders and the stock should move accordingly.
I added a bit this month to our position in RadiSys Corporation (ticker: RSYS; basis: $2.60; December close: $2.77) which in October reported a solid Q3 and gave excellent guidance for Q4 and—in general terms-- 2016. RadiSys recently underwent an extensive cost-cutting restructuring while simultaneously rapidly growing its high-margin software business, most excitingly to serve wireless carriers’ shift into voice-over-LTE. Although overall gross margin is only around 30%, the margin on the fast-growing software business (currently around 35% of overall revenue and showing 30%+ annual growth) is around 59% and should be well north of 60% next year. This "hidden growth" doesn't show up in the company’s overall revenue because RadiSys is deliberately allowing sales of its low-margin legacy products to decline, and once the market better understands this I think the stock can climb substantially. Perhaps most interestingly, the company has minimal (only a small amount of overseas) tax liability “forever,” as it has $170 million in federal NOLs, $90 million in state NOLs and a $17 million tax credit. Meanwhile, it’s cash-flow positive (with some quarterly fluctuation) and has over .20/share in net cash, and we bought it at an enterprise value of less than 0.5x estimated 2015 revenue before putting any value on those massive NOLs. Apparently the insiders think the stock is cheap too, as in August they bought a lot of it.
I added this month to our position in Echelon Corp. (Ticker: ELON; basis [following December’s 1:10 reverse split]: $6.16; December close: $5.64), an “industrial internet of things” networking company (now primarily focused on “smart” commercial LED lighting) that has been in a long decline, with a slowly eroding fab-less chip business and a stock price down roughly 98% (!) from its 2007 peak. We bought this $40 million revenue, 56% gross margin company for almost nothing, as its roughly $25 million in net cash is only a couple of million dollars below its market cap. The catch of course is that it’s burning that cash-- currently at a rate of around $4 million a year-- but with extensive restructuring and extremely fast growth in its nascent LED networking business, it looks as if it’s on a path to being cash-flow break in perhaps two years. If it gets there on $48 million of revenue with $19 million of remaining cash, at a strategic acquisition price of 1.5x revenue plus a reasonable value for its nearly $240 million of NOLs it would be worth over $20/share. If it doesn’t get there but cuts the burn enough to be profitable for a strategic acquirer (say, down to $1 million a year but with an additional $4 million of potential cost eliminations), it should still be worth around $10/share, as I think there would be some buyer out there who would pay 0.5x-0.75x revenue plus the remaining cash plus something for the NOLs for a $40 million/year, high gross margin business. I know there are some big “ifs” behind these numbers but considering that the cash in the bank gives the company at least six years to get to break-even, I think it’s an interesting proposition.
I added a bit this month to our position in