Margate Capital Management , the hedge fund founded last year that is betting on a wave of Tech consolidation, generated a return for investors of 2.4% during the second quarter. This positive performance has taken the firm’s launch-to-date return to 7.4% net of fees outperforming the HFRX Equity Hedge Index by 2.8% but underperforming the S&P 500 Total Return index by 6.1%.
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Margate Capital Management , which was founded by Samantha Greenberg, an alumna of Goldman Sachs Group, Paulson & Co., and one of the few prominent female hedge fund managers, Was wounded by the broad Tech sector sell-off that dominated markets during June. At 58% of gross exposure and 55% of net exposure, Tech comprises the firm’s largest sector exposure, so its fortunes are highly correlated to those of the industry.
During June, the Technology sector and semiconductor sector declined by 5% and 10% respectively and this decline caused realized volatility for the sector versus the wider market to be 40% higher than its highest occurrence over the past 10 years entering July according to Margate’s second quarter letter to investors, a copy of which has been reviewed by ValueWalk.
Margate Capital Management – Tech consolidation makes sector attractive
Despite this decline, Greenberg and team remain optimistic about the outlook for the sector. The team has mapped out periods of similar sector volatility in recent years, and has discovered that these unwinds are generally “severe, lasting from 1 week to 42 days” but “history has shown stocks re-take their pre-unwind highs in approximately the same time period as the drawdown lasted.” With this being the case, Margate has been selectively adding to positions on weakness throughout the turbulence and has even increased exposure through long dated close-to-the-money call options in names with “strong catalysts over the next few months, giving us extra leverage to exploit a small snapback in performance.”
At the end of 2016, in one of her first letter to investors, Greenberg explained that Margate Capital Management is hoping to profit from a wave of consolidation in the Tech sector, which will unfold as companies look to acquire peers to improve growth, spend rapidly growing cash piles and gain access to new Technologies. The firm is targeting companies “with attractive valuations and expected positive earnings revisions, but also free optionality as these companies sit in the “sweet spot” of size and desirability for strategic and financial buyers.”
While some investors might have their doubts about such a strategy, the fund argues that Tech stocks remain attractive despite their rally over the past few years. According to the second-quarter letter, at the end of the second quarter Technology stocks’ valuations (EV/EBITDA, FCF Yield and NTM P/E) relative to the wider market was at its 10-year median, while the S&P 500’s metrics are over one standard deviation above its 10-year average. In fact, on some metrics, the Tech sector looks more attractive than the wider S&P 500 trading at a free cash flow yield of 5.4% compared to the index’s 4.3%. Meanwhile, Tech’s projected revenue growth for 2017 is 12% compared to the S&P 500’s 7%.
Comprising 7.6% of Margate’s portfolio, Cadence Design is the fund’s largest position, and it seems Greenberg’s favorite stock in the Tech sector. A provider of design automation software, Cadence has grown rapidly over the past six years with net profit expanding at a compound annual rate of around 23%. This year, earnings per share growth of around 26% is projected as the company capitalizes on rising demand for its services brought about by increasing automation in the manufacturing process.
The hedge fund also likes what it calls internet “Left for Dead SMID-cap” stocks such as ETSY as opposed to hot FAANG or FAMGA.
Greenberg likes the new management and notes that the hedge fund had lucky timing on the purchase of stock.
The letter states:
Just two weeks after Margate took its position in ETSY, private equity firm Texas Pacific Group and growth equity firm Dragoneer filed 13-Ds, noting their purchase of a combined 8% stake in ETSY and offering to “discuss strategic options.” It is unusual to see a PE firm make an unsolicited investment with public filing, and demonstrates the strategic value and compelling valuation of ETSY. A recent press article stated ETSY has been approached by several private equity firms, and that ETSY is in the early stages of a strategic review aided by Goldman Sachs to evaluate its strategic and operational plans.
Margate Capital Management is also bullish on video game makers such as ATVI, EA and TTWO on “Increasing Engagement, Improving Financial Model and Nascent Sports Opportunity”, and notes that teens are spending more time on video games and eSports are growing in popularity and have surpassed the NBA and NFL according to some metrics.
Margate Capital Management believes one of the big game makers is a takeover target.
The letter states:
TTWO is the last small, non-controlled, publicly-traded video games publisher in the industry, and we think TTWO is a highly attractive takeover target for a number of logical acquirers.
Alex Shaftal previously of Paulson & Co has joined Margate Capital Management l as an analyst.