Arquitos Capital Partners commentary for the second quarter ended June 30, 2016.
The goal of investment is to find situations where it is safe not to diversify. — Charlie Munger
Dear Partner:
Arquitos Capital Partners returned 19.2% net of fees and expenses in the second quarter of 2016, bringing the year to date return to 20.7%. Our annualized net return since the April 10, 2012 launch is 24.6%. Please see page four for more detailed performance information.
Before we get into the portfolio, a thought on Brexit. There is nothing more important than liberty, no matter the economic consequences. The EU’s top down decision-making and increasingly oppressive bureaucracy is stifling to personal freedom and offensive to human nature. Will there be a negative economic impact from Brexit? Most definitely in the short term. But in the long term the exit will lead to more individual freedom and more liberty. That should be cheered.
Arquitos Capital Partners - Portfolio Review
When I wrote to you last I discussed our top seven holdings. I explained that our performance would likely be dependent on these core holdings. That was mostly true. We saw nice gains from ALJ Regional Holdings, Berkshire Hathaway, and MMA Capital. Our biggest gains, however, came from an unexpected opportunity that popped up earlier in the year in a company named Intrawest Resorts Holdings.
Intrawest has the ticker SNOW, as befits a ski operator. We first bought into the company in a small way in March 2015. I did not consider it one of our core holdings, and still do not.
Intrawest gave us a tremendous opportunity in January 2016. The company sold their time share operations and allocated approximately $50 million of those sales proceeds to the repurchase of its common stock. This was about 12% of all shares outstanding. The company carried this repurchase out through a tender offer. Tender offers always cause my ears to perk up, especially when the largest shareholder does not participate, as they did not in this case. We bought more shares and elected to not tender them.
Intrawest’s operations are mildly interesting. The more interesting part is Fortress Investment Group’s ownership. Intrawest was originally taken private by Fortress in 2006. Fortress brought it public again in 2014 but shares have never traded high enough for Fortress to trim its 60% stake in the company.
In 2014 Fortress brought on Tom Marano as the CEO. Historically Intrawest had been run by ski guys. Marano is a finance guy who has demonstrated strong capital allocation skills since taking over. His decisions have provided a great benefit to shareholders.
We significantly increased our position in January and February after the tender offer was announced. Shares have gone straight up since then. In fact, since the beginning of the year through June 30, shares have risen from $7.82 to $12.98, a 66% gain. They’ve continued to go up since the end of the quarter and stand at $14.01 as I write this letter.
Ramping up our position in Intrawest was an unexpected opportunity that has paid off in a big way for the portfolio.
Our other big winner so far in 2016 is Berkshire Hathaway. Berkshire’s B shares rose from $132.04 to $144.79 over the first six months. We primarily owned the company through long dated options that were purchased at an opportune time. In January 2016 we bought options at the $120 strike price that expired in January 2017 and January 2018. The average purchase prices were $16.40 and $21.25, respectively. As Berkshire’s stock price rose, we sold all of these options in May for $26.00 and $32.00, respectively. This provided us with gains of 59% and 51%. We retain a very small position in Berkshire common shares.
This is the second time I have put a trade like this on over the past few years. I have explained this trade to dozens of other investors and they respond, after the fact, that it was a no-brainer given the valuations at the time of purchase. However, no one ever follows me into the trade at the time I put it on. This is a good example of why I believe investing primarily is a mental game. We bought into this position when sentiment was negative and valuations were very cheap. Four months later sentiment shifted and we made a nice gain because of it. There was not a doubt that sentiment would shift at some point. We just got a bit lucky with the swiftness of the change.
Incidentally, this was not the first time we were lucky with timing on this type of trade. The last time I put this Berkshire trade on was in February 2014. We sold six weeks after that for a 79% gain.
The third place prize for the first half of 2016 went to MMA Capital as their shares rose from $14.45 to $18.15.
An interesting article came out on June 28 in the German edition of the Business Insider website. The article was a brief interview of Ted Weschler. Weschler, along with Todd Combs, manages a portion of Berkshire Hathaway’s investment portfolio.
The interview was interesting for its brevity and Weschler’s simplistic answers. This simplicity hid how insightful the answers really were. An example:
BI: As you have been a very successful investor for years: Is there a recipe to it?
TW: There is one, but I am not telling you [laughing]. Investing is kind of a game of connecting the dots. The nice thing about it is the longer you are in the business, as long as you are intellectually curious, your collection of data points of dots gets bigger and bigger. That is where someone like Warren is just incredible. He has had a passion for investing for well over 70 years. He started by the age of 10 or 12. He keeps building that library of data, the ability to recognize patterns in data. Being a successful investor you need to be hungry, intellectually curious, interested, read all the time. Read a lot of newspapers. You need a certain level of randomness in order to connect things that might give you an insight into where a business is going in five years that somebody else might not see.
When it comes to wholly owned businesses among other factors it is about pricing power. You have something that is so attractive to the consumer that they pay a premium to walk into your store and do something. There is a number of attributes like that. But you can never just point to one thing. It is a mosaic of all sort of different things. If then you read the book of a business you can pretty quickly find out if that is a good business or not.
This echoes comments that Warren Buffett has made: “Finding ideas is a function of cumulative knowledge over time. Something just comes along…”
The key is to read a lot, to read broadly, and to read with an open mind.
One other thing about the Weschler interview, which you can read here: “Interview with Warren Buffett's investment manager Ted Weschler: The recipe for financial success.” Before being recruited to Berkshire, Weschler ran a $2 billion fund with just a secretary and a research assistant. He did not need a team of analysts or a large amount of infrastructure or overhead. It was an entrepreneurial venture where he owned a small number of companies over an extended time period.
Thank you again for being an investor in the partnership. Please don’t hesitate to contact me if you have any questions. I look forward to continuing to compound funds on your behalf.
Best regards,
Steven L. Kiel
Arquitos Capital Management
