Corsair Capital letter to limited partners for the first quarter ended March 31, 2016.
Dear Limited Partner:
Seth Klarman: Investing Is Art First, Craft Second And Science Third
For the first quarter ended March 31, 2016, Corsair Capital was down an estimated 0.7%* net, after all fees and expenses. Corsair Select was down an estimated 1.7%* net, after all fees and expenses. Since inception in January 1991, Corsair Capital’s compounded net annual return is 12.7%. Since inception in January 2004, Corsair Select’s compounded net annual return is 10.7%.
“The world faces a crisis in the Middle East and the United States faces the prospect of a recession. With that in mind, I think it is important to remember that the financial markets reflect what the future will bring as opposed to what the past has been and thus, the before-mentioned concerns are already in the price of most securities. My job will be to invest in those securities where the market has over discounted such fears and to avoid those where the market has not discounted these or other events enough.” – Corsair Capital Partners Inaugural Letter, January 2, 1991
The first quarter of 2016 marks Corsair's 101st quarterly letter as we celebrate our 25th anniversary. Looking back at our long-term performance, our Corsair Capital Partners fund has generated 12.7% compounded net annual returns since inception with significantly lower volatility than the S&P 500 and Russell 2000 equity indices. Corsair has grown an initial $1 million investment since inception into over $20 million, with over 90% of the realized gains coming as long-term, tax efficient capital gains.
In short, our investors have benefitted from high quality, risk adjusted net returns for 25 years and we are optimistic about our future.
While over the course of 25 years we have seen significant shifts across our industry in strategies, technologies and regulations, we are proud to be investing in the same pool of special situation equity opportunities as we were back in 1991. Our strategy is focused on three key themes:
1) We do not use leverage. In fact, we hold a material cash balance to both protect our downside in volatile markets, but still capture significant upside when the market rallies. Corsair’s relatively low gross exposures have allowed the fund to protect itself from forced selling at the bottom of bearish markets and even allowed us to add to high conviction opportunities during those times. We believe a key measure of risk lies in the levels of gross exposure, not just net exposure.
2) We run a diversified portfolio. Sizing our core investments between 1-3% at cost allows Corsair to avoid concentration risk in any particular stock, sector or industry. While we invest with strong conviction, we also know that we do not know everything as humility is an important part of investing. Since 2005, we have had only 2 stocks negatively impact a single calendar year by 120bps or more versus 24 positively impacting attribution by the same magnitude. We believe our pipeline for opportunities remains robust and we are confident we can produce a similar batting average going forward.
3) We focus on buying companies with predictable cash flows, defensible business models and healthy balance sheets, led by activist management teams. These value creators allow us to be true partners and patient investors, providing multiple catalysts to drive a higher stock price over time.
However, the past few years have been an extremely difficult time to own value stocks, especially in the small and midcapitalization sectors. A look at event driven indices, peer returns and business headlines show a particularly unusual environment for the kind of stocks we invest in. Most of the companies we own have performed well; executing on financial targets and capital allocation initiatives. Yet, many of these stocks have not traded in-line with underlying performance. While we are not satisfied with our recent returns over the past two years, we believe we have done a solid job managing risk during this difficult period. As shown below, our risk, as measured by volatility, has been meaningfully lower than the Russell 2000 since 2014:
We think this is of paramount importance. Recent market volatility is forcing investors to reassess their portfolios relative to how much risk they have actually been taking. Corsair’s differentiated portfolio construction is built to withstand difficult equity markets that emerge from time to time. Therefore, we believe Corsair is a core equity fund that can be added to during market declines.
Corsair Capital - Taxes:
Our 25-year track record of achieving higher returns while taking lower risk is accentuated by our tax efficiency. As noted above, our investment strategy requires patience as we look for multiple catalysts to unfold for our stocks. This patience results in higher stock prices, but also in long-term capital gains for our limited partners. To illustrate our tax management, we assume an investor began with $1 million at inception:
Of course, the most exciting news for original Corsair investors is how much economic income we have generated. However, tax payers appreciate that we have done a good job with our short-term gains coming in at only 6.73%. We suppose that peers who focus on short-term trading likely have a significantly higher percentage of short-term gains. Additionally, we have recently gotten even better at tax management. Here is what an investor with a $1MM investment at inception has paid in short-term gains over the past 10 years:
Tax efficiency is a natural outcome of our investment strategy. As we consider after-tax dollars the measure of true returns, we believe Corsair has proven over the course of 25 years that our investors have a strategic advantage; they get to keep more of the dollars we have earned for them. As we look forward, we are not expecting a change in our investment philosophy and, therefore, expect to continue to generate minimal, if any, short-term gains for our investors.
Corsair Capital - Q1 2016:
Our investment pillars served us well in the first quarter of 2016 as fear and uncertainty took hold in what was a tumultuous period for equity investors. Equity indices ended the quarter mixed, with the S&P 500 up a bit and the Russell 2000 index recording a small loss. However, the ride was anything but smooth. Markets seemed to have been blindsided by reports of a much weaker financial and economic backdrop in China, which combined with plummeting oil prices and weaker global demand, led to greater concerns of a global recession. The situation was exacerbated by the fear that the Fed was discounting the financial market’s gyrations, potentially leading to higher interest rates and an even stronger dollar (negative for the competitiveness of U.S. companies). As discussed in our year-end letter, it seemed as if no one was bullish on equities and the S&P 500 started the year with its worst beginning since 2009 as fear and uncertainty took hold.
March, however, took on a decidedly more positive tone as oil rebounded and as China fears receded from the headlines. While some US economic data did show continued weakness in the industrial sector, strong employment data gave reason to believe that our consumer based economy was still growing. Finally, a dovish speech by Janet Yellen at quarter-end helped assuage the markets that the Fed would consider the greater set of global risks when setting monetary policy. In particular, Yellen noted, that “foreign economic growth now seems likely to be weaker this year than previously expected.” The markets, in turn, took this as a signal of a more gradual approach to interest rate increases by the Fed.
We were cognizant of the multitude of global and domestic risks at the root of the jittery markets. But as the market priced in more and more negativity, we continued to receive feedback from CEOs in various industries and managers of private equity portfolios that their businesses were performing well. The word “disconnect” was uttered many times to describe the dichotomy between Wall Street and Main Street. In addition, we also took note of the many dividend increases and increased share repurchase authorizations – signals that management teams did not believe the economy was as lifeless as the headlines suggested. Therefore, we did not feel the need to reduce our net equity exposure during the quarter. Furthermore, due to our portfolio construction, Corsair, unlike funds with high gross exposures, was not forced to “de-risk” at the market lows either.
Corsair Capital - Portfolio Review
The largest contributors and detractors for the quarter were:
Aon PLC, (“AON”) increased 13% during the quarter on the heels of announcing strong Q4 2015 profitability. Aon operates a high-quality insurance brokerage and consulting business where management estimates that 90% of sales are recurring or repeat business. The company has consistently executed on its strategic plan, with the largest value creators being the acquisition of Hewitt in 2010 and its 2012 move from the US to the UK (with an IRS sign-off letter). Aon believes these building blocks will drive organic growth, margin expansion and materially increase free cash flow. Over the past three years Aon has repurchased over $4.9B of its owns shares (vs. a $28B market cap), clearly indicating management believes it will continue to execute. We see the company generating ~$8/share of free cash flow in 2017 and based on its strong business fundamentals, solid balance sheet and activist management team, the shares could trade at 18-20x or $144-$160/share. Aon closed the quarter at $104.45/share.
Orora Limited (“ORA AU”), a company we featured in the Appendix of our Q1 2014 investor letter, rose 11% in the first quarter, driven by an earnings beat for Q4 2015 and a dividend increase from $0.08/share to $0.09/share. The company, led by activist CEO Nigel Garrard, continued to demonstrate great operational execution as it gets closer to fully achieving its cost savings plan, as laid out in December 2013 prior to being spun off from Amcor (“AMC AU”). With the business running more efficiently, management’s focus has now turned to growth and in Q1 investors applauded the announcements of a bottle capacity expansion in Australia and a small tuck-in acquisition in the U.S. ORA has proven be a classic Corsair investment over the last 2 years – it was a small division spun off from a conglomerate, with potential margin expansion from a cost savings program, and led by a CEO with a history of value creation who was buying stock personally in the open market. As we expected, the dividend has increased by 50% and significant shareholder value has been created since the spinoff in December 2013. ORA shares finished the quarter at a price of $2.50.
Ferroglobe PLC (“GSM”), fell 18% during the first quarter. On Dec 23, 2015, Globe Specialty Metals completed a transformational merger with Grupo FerroAtlantica, creating a leading silicon metal and silicon alloys producer. Market conditions for silicon metal have been difficult since the deal was announced in Q1 2015, with prices falling sharply due unexpected shifts in supply. Specifically, European manufacturers have been able to maintain production despite lower pricing given the decline in the Euro (contract pricing linked to the USD) and it is believed that China has been dumping silicon metal into Europe. However, we still believe GSM offers excellent risk-reward. We believe silicon metal prices have bottomed and we have already seen industry capacity curtailment and expect more to follow. Most importantly, we think the market is ignoring the significant synergies and strengths of the “new” GSM. We view GSM as trading at under 7x trough EBITDA and under 4x mid-cycle adjusted EBITDA. Unlike its peers, GSM has a solid balance sheet putting management in pole position to continue to create shareholder value by acquiring distressed assets at discounted prices. Between financial and cost synergies, a reversal in silicon metal pricing and the opportunity for further accretive acquisitions, we believe 2016 should be an inflection point for GSM stock which could move up materially as the company executes. GSM closed the quarter at $8.81.
IAC (“IAC”), a company we featured in the Appendix of our Q3 2014 investor letter, fell 22% in the quarter despite reporting Q4 2015 EBITDA above consensus expectations. Bullish results and commentary for HomeAdvisor and Tinder, plus significant margin expansion at The Match Group (“MTCH”) expected for 2016, was not enough to offset perceived negative news. Investors were seemingly disappointed to learn that the company removed its regular dividend and gave 2016 guidance of “flattish” net dating subscriber growth at MTCH excluding fast growers Tinder and Plenty of Fish.
IAC CEO Joey Levin made it clear on IAC’s Q4 2015 earnings call that the company will opportunistically re-deploy its war chest of over $1B in net cash (or $12+/share) toward acquisitions and stock buybacks as its top priorities. Given Chairman Barry Diller, a legendary value creator, decided to repurchase over 3% of the company in the open market in Q1 2015 at an average price of $67.68/share, we believe it is likely that the company has been buying back stock in the $40-$50 range. We agree with management that there is a unique opportunity today to buy IAC shares for significantly less than intrinsic value. Excluding the 85% stake in MTCH and excluding net cash on the IAC balance sheet, the market is currently pricing the remaining businesses at IAC for just over $5/share. We believe that the true value of the stub, which includes the company’s Search, HomeAdvisor and Vimeo divisions, is worth at least $23/share.
Regarding MTCH, management is currently in the process of updating its mobile version of certain assets including match.com and expects net subscriber growth to re-accelerate in late 2016 or early 2017. With rapid subscriber and revenue growth at Tinder and Plenty of Fish, margin expansion and a steady base of match.com EBITDA, we believe overall MTCH EBITDA will grow from below $300MM in 2015 to over $400MM in 2016 and $500MM in 2017, materially above consensus estimates. With that in mind, our view is that MTCH is mispriced as well at just over 8x 2017 EBITDA. On a Sum of the Parts basis, we estimate that MTCH is worth $17/share, or 60% more than its current market price. Therefore, to IAC shareholders, the 85% stake in MTCH would be worth $47/share.
Our sum of the parts: adding our IAC stub valuation of $23/share to $47 in the MTCH stake, plus net cash of $12, we arrive at a valuation of $82.00/share. IAC ended the period with a stock price of $47.08.
Voya Financial Inc (“VOYA”) declined 19% during the first quarter amid a rout of financial related stocks. In February the company announced in-line Q4 2015 results and the completion of a $1.5B share buyback program. Furthermore, the company put in place a new $700MM share buyback program for 2016, representing approximately 12% of the current market cap, and noted it still has an additional $400MM of excess capital to deploy. The company remains committed to its goal of 14% ROE in 2018, which would translate into more than $4.50/share of EPS, a number we expect will increase if the company can repurchase a significant amount of shares at current levels. While numerous risks have emerged since mid-2015, including risks from lower interest rates, weaker equity markets, a new Department of Labor fiduciary rule and losses from oil and gas investments, we believe these are more than reflected in the current share price.
Despite repurchasing ~$2.3B of shares, removing a large shareholder overhang and strong financial execution since its IPO in 2013, at $30/share VOYA trades at under 10x current earnings, under 7x 2018 estimated earnings and under 0.6x tangible book value. Accordingly, management has continued to meet or beat its previous financial goals and we expect the company will continue to execute. We believe over the next 18 months the market should recognize the benefits of this massive transformation and the stock should trade materially higher. VOYA closed the quarter at $29.77.
As of April 1, 2016, the five largest positions in Corsair Select were AON PLC, KAR Auction Services, Orbital ATK, Ryman Hospitalities, and Voya Financial Inc.
“Of course, in the short-run the financial markets will have much to say about our investment returns. However, in the long-run I hope our asset allocation and individual security selection will allow us to exceed the financial indices.” - Corsair Capital Partners Inaugural Letter, January 2, 1991
Thank you for your continued support and confidence. See the attached Appendix for a write-up of a current core investment. Please feel free to call us with any questions you may have at 212-949-3000.
Corsair Capital Management, L.P.
See full PDF below.