Steve Kiel’s Arquitos Capital Partners investor letter for the third quarter ended September 30, 2016. Impressive returns!
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Create a big dream. Keep it simple, easily understood, and measured. Attract the right people who work well together. Measure results consistently. You can create, run, or improve anything with this formula. – Jorge Paulo LemannVoss Value Sees Plenty Of Opportunities In Cheap Small Caps [Exclusive]
For the first quarter of 2022, the Voss Value Fund returned -5.5% net of fees and expenses compared to a -7.5% total return for the Russell 2000 and a -4.6% total return for the S&P 500. According to a copy of the firm’s first-quarter letter to investors, a copy of which ValueWalk has been able Read More
Arquitos Capital Partners returned 14.6% net of fees and expenses in the third quarter of 2016, bringing the year to date return to 38.2%. Our annualized net return since the April 10, 2012 launch is 26.9%. Please see page four for more detailed performance information.
Thank you to those who attended our annual investor dinner last month. I enjoyed seeing everyone and providing an update on the portfolio and my work with Santa Monica Partners and Sitestar Corporation. If you were unable to attend this year, I hope you’ll consider joining our community next year. That event was followed up a week later by our first shareholder meeting for Sitestar. Sitestar’s directors and I were happy to meet shareholders and answer questions about the company.
Leading Sitestar has been an interesting and rewarding experience. Sitestar’s directors and I have consciously tried to apply lessons that we have learned from other companies that we admire, both current and historical. I have always tried to approach business decisions with common sense and an open, curious mind. It has been surprising how much we have accomplished simply by being thoughtful about decisions and self-aware of their consequences. Of course we have, and will continue to make mistakes. The key is that we judge whether a decision was a mistake from the process and not the result.
It would be difficult to do better than the 10 business lessons below from 3G Capital, the Brazilian private equity group famous for owning several iconic American brands.
- Invest always – and above all – in people.
- Sustain momentum with a big dream.
- Create a meritocratic ownership culture with aligned incentives.
- You can export a great culture across widely divergent industries and geographies.
- Focus on creating something great, not on “managing money.”
- Simplicity has a genius and magic to it.
- It’s okay to be a fanatic.
- Discipline and calm, not speed, is the key to success in a time of potential crisis.
- A strong and disciplined board of directors can be a powerful strategic asset.
- Seek mentors and teachers, and connect them together.
For more background on 3G Capital, I highly recommend “Dream Big: How the Brazilian Trio behind 3G Capital – Jorge Paulo Lemann, Marcel Telles and Beto Sicupira – acquired Anheuser-Busch, Burger King and Heinz,” by Cristiane Correa.
The model we have adopted at Sitestar centralizes capital allocation decisions at the corporate level and allows for decentralized operational decision-making among our subsidiary companies. Subsidiary managers are fully responsible for their decisions and incentivized to focus on things that the company feels are important. Generally the most important metric for us is sustainable free cash flow.
The importance of decentralized operational decisions cannot be overstated. Doing this allows for quicker, more informed decisions. It dramatically increases the commitment level of managers and employees. It builds trust and loyalty to the organization. It also encourages ethical behavior as managers must act as leaders. Not everyone is motivated by autonomy and accountability. At Sitestar, and at Arquitos, we look for employees who are.
The company now has four diverse subsidiaries: Heating and air conditioning (HVAC) operations, internet operations, real estate, and asset management. I view each of the subsidiaries in a similar way as I view companies in the Arquitos portfolio. The difference is that I get monthly financials from them instead of quarterly, and we hold internal board of manager meetings with the subsidiary managers. Clearly I have more control over the subsidiary companies when compared to our passive investments through Arquitos, but the analytical approach is similar.
Getting insight into operational decisions has been a valuable experience and has enhanced my stock picking and business analysis skills. This operational experience has shown me that even with my nontraditional perspective, I have still underestimated how important a company’s culture is, how important incentives are (both good and bad as we have seen with the recent Wells Fargo fake account scandal), and how much information is known to insiders that is unknown to passive investors.
Arquitos Capital Partners – Portfolio Review
An appreciation for that last point has led to our biggest gains. Two quick examples:
Last quarter I wrote about our investment in Intrawest Resorts Holdings (SNOW). I dramatically increased our position in January after the company announced a tender offer to buy back approximately 12% of the company. Its largest shareholder, Fortress Investment Group, was not selling shares as part of the tender. Clearly they thought the stock was worth a lot more than what it was trading at. Just as clear is that Fortress, which owns more than 60% of the company, knows more than we as passive investors do. We should remain humble about what we actually know about the inner workings of the company and their potential. Fortress’s decision was a screaming buy signal.
The second example is ALJ Regional Holdings (ALJJ). In 2013 ALJ sold their previous operations and was a shell company holding cash only. They also carried out a large tender offer and their CEO, who owned approximately 25% of the company, did not participate. Like Intrawest, this was an indicator that good things were likely to come. I dramatically increased our allocation at the time. That decision led to significant gains for the portfolio in 2013 and 2014.
I have found that investors actually know dramatically less than what they think they know about the companies they invest in.
My experience with Sitestar also reinforces the importance of the psychological aspect of investing. Investing is art, not science. The most important thing to be a successful investor, by far, is to cultivate and preserve your intellectual honesty.
It goes without saying that investors must understand how to analyze financial statements and some quantitative aspects of finance. After that, your success depends on your ability to effectively make dozens of qualitative assumptions about the future of a company. If you cannot be humble about the information you can know, intellectually honest about the reality of your judgments, and curious about the company, its people, industry, and current situation, then it will be extremely difficult to outperform the markets over long time periods.
My approach has been to find companies and situations where there are as few variables as possible, and then to try to determine the upper and lower range of potential results in the variables that do exist. From that, I have tried to remain humble about the information that I actually know. Often, like in the Intrawest and ALJ examples above, I have given the benefit of the doubt to the inside, control investors who know the most about the company.
The benefit of this approach is that our exposure to overall market risk is lower while our exposure to specific company risk is higher. That has generally worked out well for us.
Thank you again for being an investor in the partnership. I appreciate your long term commitment to the investment strategy and look forward to continuing to compound funds on your behalf.
Steven L. Kiel
Arquitos Capital Management