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Arquitos Capital Management 3Q18 Commentary – Long ENDI

Arquitos Capital Management commentary for the third quarter ended September 30, 2018.

Meanings are not determined by situations, but we determine ourselves by the meanings we give to situations. – Alfred Adler

Dear Partner:

Arquitos returned -6.6% net of fees in the second quarter of 2018, bringing the year-to-date return to -12.6%. Our annualized net return since the April 10, 2012, launch is 26.8%. Please see page four for more detailed performance information. Individual performance may vary.

2018 has been an interesting year for the portfolio for a variety of reasons. As I explained at our annual meeting last month, we have had strong operational performance from most of our larger positions, particularly MMA Capital and Westaim. The price of their shares, on the other hand, has not been commensurate with that operational success. This is not surprising because there is no reason to believe that markets should be efficient over short time periods. Though it is, perhaps, easier to remind you to ignore short-term changes in value of the portfolio when that value is going up!

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Enterprise ENDI
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This reminder becomes more difficult when the portfolio diverges significantly from the S&P 500, as it has this year. The S&P 500 returned 10.6% through the end of the third quarter. In other words, we trailed the markets by 23% this year through September 30. Things can change very quickly, though, as we have already seen in October. In the span of 24 days since the end of the third quarter, the S&P 500 has turned negative on the year and Arquitos has made up some of our deficit to the market.

To keep things in perspective, we beat the S&P 500 by 42% in 2017 and by 43% in 2016; and the portfolio is still positive over the past 12 months.

Enterprise Diversified/ENDI (OTCQB: SYTE) Update

Arquitos controls approximately 27% of ENDI’s outstanding shares. I had been acting as CEO since we took over the company in December 2015. Over the past six months, it has become clear that ENDI has grown to a size where a full-time CEO is necessary. Thankfully, we had the perfect candidate internally to take on the role.

On October 5, 2018, ENDI appointed Michael Bridge to be our new CEO. He will also be appointed to the board at our next meeting in a few weeks. Michael previously was ENDI’s general counsel. Prior to that, he had been a long-time senior vice president and general counsel at a multibillion-dollar technology company. He also has managed corporate accounting and finance departments. He began his career as a corporate and securities associate for a large global law firm. Michael’s knowledge, temperament, corporate experience, and commitment to ENDI make him the right person to lead the operations of the company. I am excited about the change.

I have been elevated to chairman, where I can focus on the company’s long-term strategy. That strategy will involve building out ENDI’s asset management subsidiary, Willow Oak Asset Management. We have a great group of partners at Willow Oak, including being associated with three existing investment funds: Alluvial Fund, Bonhoeffer Fund, and Willow Oak Select Fund.

If you would like to learn about any of these three funds, please join us on November 14, 2018, in New York City, for a happy hour event from 5:00 p.m. to 7:30 p.m. at Casa Nonna (310 W. 38th St). Our friend Thomas Braziel from B.E. Capital will also be presenting, and I will be there on behalf of Arquitos. To RSVP, please send an email to Jessica Greer at jessica@willowoakfunds.com.

Willow Oak Fund Management Services

As part of growing Willow Oak, the company is developing an outsourced operations offering. The idea is to allow the portfolio manager to fully focus on security analysis and for Willow Oak to take all other responsibilities off their plate.

I am happy to announce that Arquitos will be the first outside fund to sign up for this service.

Willow Oak Fund Management Services will be taking over all management company responsibilities including investor relations, marketing, compliance, and non-fund administration. The fund will retain its current service providers (administrator, auditor, legal, etc.), but Willow Oak Fund Management Services will be their point of contact going forward.

This relationship will provide a multitude of benefits to Arquitos. It will free me up from non-portfolio issues. It will provide economies of scale with service providers. It will allow for the application of best practices. This will help me do more—and better—security analysis. I will continue to be a one-man investment committee, as my friend Scott Miller calls it, and Willow Oak will be in charge of operations.

The other thing that this relationship does is ensure that Arquitos will be a permanent fund. If something were to happen to me, Willow Oak would take over the fund and appoint a new portfolio manager. My family would retain a royalty on all future fees that the fund generates as a sort of life insurance policy. If something were to happen to me, investors would not be forced to participate in a fund liquidation as would have happened prior to this relationship. As a fund manager, this provides a lot of comfort that both investors and my family will be taken care of in any scenario.

This service is not yet available to other outside funds, but Willow Oak hopes to begin offering it over the next year. If you are a fund manager and would like to learn more, please let me know. It is a win-win all the way around, especially for investors.

There has been little change to the makeup of the portfolio over the past quarter. We remain concentrated, as we have been since the launch of the fund in 2012. We ended the third quarter with 16 positions with our top five holdings making up 78% of the fund. Our largest positions remain ENDI, MMA Capital, and Westaim.

One notable item since the quarter-end is that I have re-entered a long-dated options trade with Berkshire Hathaway. This was something I had previously done in the spring of 2016. That position had worked out very well for the fund (Arquitos made a 50% return with it over four months). Conditions exist for this new position to also work out extraordinarily well.

In July, Berkshire announced that they were amending their share-buyback program. The program previously provided that Berkshire could buy back shares if the stock price dropped below 120% of book value. The new program states that the company can buy back shares on the open market at any time that both Warren Buffett and Charlie Munger “believe that the repurchase price is below Berkshire’s intrinsic value, conservatively determined.”

Buffett said in an interview on CNBC on August 30th that the company had bought back some shares. We’ll know how much and at what price when Berkshire reports their third-quarter earnings on November 2nd. I believe Berkshire is buying back shares below $307,500 for the A shares and $205 for the B shares. B shares, which the options track, ended yesterday below $200 after getting crushed over the past few weeks.

While our options positions are small and won’t expire until January 2020 and January 2021, they have the potential to be meaningful contributors to performance over the next year.

The volatility in the markets during October unearthed some great opportunities for us, both in a few current positions like this Berkshire strategy, and with a few companies that had long been on my watch list. If you have been thinking about adding to your Arquitos investment, now is the time.

Thank you again for your investment in Arquitos. I look forward to continuing to compound funds on your behalf.

Best regards,

Steven L. Kiel

Arquitos Capital Management