Steel City Capital was up 2.7% for the first quarter. Founder Michael Hacke said he was “disappointed” that the fund “didn’t fully participate in the robust rebound experienced by all of the major U.S. indexes.” However, he also said they identified a number of opportunities during the quarter and emphasized that he’s focused on long-term investment horizons. He expects the positions they have bought recently will reward the fund “handsomely in the years to come.”
eBay is “unloved, underappreciated and misunderstood”
Hacke highlighted several positions in his Q1 letter to investors. eBay captured a large chunk of the attention. He compared the company to The Brady Bunch‘s Jan Brady, who lived under the shadow of her older, more popular sister Marcia. He sees eBay as Jan Brady to the far more popular Amazon, or Marcia Brady, but he argues that eBay is a better investment than Amazon.
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For example, he noted that eBay's focus is on facilitating transactions between buyers rather than holding inventory like Amazon does. This means low capital intensity, and the company's capital expenditures are scalable, so growth doesn't depend on continual investment in its platforms. Due to these factors, Hacke said eBay's operations generate "a lot" of cash, even beating management's own guidance for cash flow. In fact, the company beat management's guidance for cash flow slightly in fiscal 2018 even though cash flow was depressed by the taxes linked to the sale of its Flipkart stake to Walmart.
He started considering eBay early in the first quarter when the stock was trading around $31 per share, which is significantly lower than its 52-week high of $43. Excluding the $9.50 per share in cash eBay had on its balance sheet in the third quarter and based on 963 million shares and $2 billion in free cash flow, he estimates eBay's valuation at only $2.05 per share, which he said was "hardly a demanding valuation for an asset-light two-sided marketplace that supported nearly $100 billion worth of merchandise sales during the year and is the second largest online marketplace in the U.S. behind Amazon."
Hacke also noted that eBay is now working on building its own payment platform to replace PayPal, so its payments to PayPal are expected to end in mid-2020. He estimates that this move could add $375 million to eBay's bottom line. Additionally, eBay has been buying back shares, which makes its stock look even cheaper.
He also examined the company's other businesses, like StubHub, which racked up $1.1 billion in revenue with a 22.5% take rate on $4.8 billion worth of tickets sold. He also noted that eBay's international classifieds website portfolio is relatively unconsidered by U.S. investors because the websites are in other markets like Germany and the Netherlands.
Thus, these other websites aren't as well-recognized as StubHub, and their revenue is dwarfed by eBay's core Marketplace revenue. However, he believes both StubHub and the classifieds businesses offer "significant value on a standalone business." Using a sum-of-the-parts analysis and subtracting out the valuations of the other businesses, he estimates that the market is only valuing eBay's core Marketplace business at about 6.7 times, which he says is "incredibly cheap on both an absolute and relative basis."
Hacke also pointed out that activist investor Elliot Management bought a stake in eBay in late January, so the company should benefit from activist involvement as well.
Roadrunner Transportation Systems
He also mentioned Roadrunner Transportation Systems, which Steel City has taken a long position in. The company has been battered by headline pressure relating to fraud charges against some of its executives. Hacke also explained why he believes that the uncomfortable feeling of investing in a company with negative publicity presents "an opportunity to make money."
Interestingly, Elliot took a stake in Roadrunner in early 2017, and since then, the company has been working to rebuild after a pair of de-listing notices from the New York Stock Exchange. Roadrunner completed a rights offering, and Elliot was involved in it by backstopping the offering, or buying all unsubscribed common shares. After the offering, the activist investor owned 90.4% of the company.
Steel City also participated in the rights offering by fully exercising its rights and its oversubscription right, which enabled it to subscribe for additional shares and double down on its commitment. Hacke added that like eBay, Roadrunner is "a collection of businesses" in the trucking industry. He's clearly still bullish on the company, and it's still early in his thesis.
The only short position Hacke outlined was Boingo Wireless, which posted a huge miss on its 2019 revenue and EBITDA guidance. The stock plunged 20% initially but has since rallied as sell-side analysts came to its defense. Nearly all of the miss was related to the contracts with the NY/NJ Port Authority. It was due to a change in the amortization of deferred revenue, which now will occur over a longer period of time.
"Management correctly pointed out that the change would have no impact on cash flow during the year which helped assuage investors' initial concerns," Hacke explained. "To me, this illustrates management's and investors' schizophrenia when it comes to assessing the company's performance and prospects. Does the non-cash nature of revenue and EBITDA matter or not? Perhaps only when it's convenient."
Steel Capital also remains long on Steel Company of Canada, which posted strong Q4 earnings results. Hacke believes the company is overvalued compared to its North American industry peers, especially including the expected sale of extra industrial land in Ontario.
Other key long positions include GAIA and XPEL Technologies.
This article first appeared on ValueWalk Premium