SA Interview: Event-Driven Investing With Panther Investments

Jul. 01, 2018 7:30 AM ETXPEL, Inc. (XPEL)AIMT, SRG6 Comments7 Likes
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Summary

  • Panther Investments is focused on long/short investing with a value-oriented, event-driven focus.
  • How to develop mental filters to evaluate mispricings, what makes a credible takeover thesis and profiting on the long and short side of roll ups are topics discussed.
  • Panther Investments shares a long thesis on Xpel.

Feature interview

Panther Investments is focused on long/short investing with a value-oriented, event-driven focus. We emailed with Panther Investments about when to follow (and not to) high profile investors and management teams into a stock, how to determine if the only one to benefit from a spin-off is the parent company and why there are no shortcuts in the idea gen process.

Seeking Alpha: Can you discuss your investment-decision making process? How do you find special situations? What creates the mispricing? Can you give an example or two?

Panther Investments: My investment process is peripatetic in a sense - I don't have any particular methodology or approach for finding the situations I find interesting. I aim to simply read broadly across the news, SEC filings, value investing blogs, Seeking Alpha, and Twitter, among other sources. If you follow enough situations over the years, you get a sense for when a situation might be interesting and worth looking at further - I think this can only be done through reading over many years and following a lot of different situations and watching how they play out - this allows you to develop the necessary mental filters for characterizing situations.

The mispricing can be created by any number of factors - whether that be a spin-off with an interesting shareholder dynamic (i.e., shareholders of the RemainCo not wanting to hold on to the spin-off shares and being forced sellers and the spin-off market cap being much smaller than that of the RemainCo), or a time arbitrage where you are willing to hold on to an asset for a longer period of time than most investment managers who are judged quarterly and generally unwilling to own something that they think will trade poorly in the short-term (an example of this would be many people being scared of owning Seritage while there was the overhang of Fairholme liquidating its stake - of course someone like Warren Buffett is perfectly fine owning a piece of the company for the long-term even with some short-term volatility, but most managers are not positioned to be that long-term in nature).

SA: In your long thesis on Aimmune Therapeutics (AIMT), you made a compelling case for a takeover by Nestle – how can investors presenting a takeover thesis make sure it is fully supported and therefore more credible?

PI: I think when trying to assess a takeover thesis - it is really important to attempt to understand the incentives and roles of all of the players involved. For example, it's important to try to think about what the management team of the target company might be incentivized to do - is it a founder and CEO whose life's work has been building the company and has no intention of ever selling? Is it a mercenary CEO who has previously sold companies after turning them around or helping execute for a few years? Additionally, it is important to try to have a framework for understanding why buyers might be interested in buying the target company and how they would think about valuation.

An interesting case study for this can be seen from the Straight Path (spin-off of IDT) sale process - there was a bidding war between Verizon and AT&T because Straight Path's spectrum asset was highly strategic and given the total market cap of Straight Path was immaterial to Verizon and AT&T, they could afford to pay effectively any price for the asset.

Another key consideration is how the asset would fit into the broader strategy of any potential acquirer. Probably one of the best examples of where strategic M&A works really nicely is in beer/spirits - if a large company like Molson Coors or Constellation buys a small label, they can quickly ramp distribution, cut costs, and optimize marketing spending, creating tremendous synergies vs. the standalone sub-scale label. The same mental math can be done for financial buyers - you can try to gauge if the situation you are evaluating is similar to past deals the financial buyer has done - i.e., if you are looking at a restaurant stock that went from growth darling to bombed-out former growth darling and see that a particular PE firm has recently taken a stake and has previously acquired restaurant businesses in similar situations, then it might be reasonable to surmise that history may repeat.

SA: How can roll-ups be attractive for both long and short investors? What signs do you look for to tell if the strategy is working or about to fail?

PI: Roll-ups are tantalizing both on the long side and the short side. In its most basic form, a roll-up is generally an arbitrage of the market paying a higher multiple for a larger portfolio of assets than a single asset or smaller portfolio in the private markets. Additionally, roll-ups often take advantage of favorable capital markets where debt markets are willing to be more forgiving on cash flow conversion and GAAP earnings. Roll-ups are often built around an interesting insight, but oftentimes they get taken too far, at which point they have a tendency to become interesting shorts.

Probably the most infamous case in recent memory was Valeant - notably Valeant grew during the last ten years in the current low-interest rate environment whereby financing was easy to come by, especially for companies with great stories backed by savvy investors. The original insight underpinning the growth strategy was that most pharma companies spend too much on R&D and are not as disciplined as they ought to be about ensuring that they get an adequate return on investment with their R&D. Michael Pearson's insight was that it could be more attractive from a capital deployment perspective to acquire companies with proven pipelines rather than spend money on unproven early stage drugs. Obviously over time Valeant evolved into something entirely different and became more about continuing a rapid pace of deals and dramatically increasing prices to support overpaying for acquisitions.

The key to looking at a roll-up from the short side is waiting for the first crack to show - oftentimes this means a lack of access to capital to fuel future deals, failing to acquire a company that would stave off the appearance of organic declines (in the case of Valeant many people think the first crack was failing to win the Allergan deal), or new data that will force investors who have suspended disbelief in favor of a seductive story sold by a convincing management team to focus on real cash flow and real earnings. The question you have to ask is what data point will change the mind of the bull who has owned the stock for a long period of time and believes deeply in management's narrative. The key to looking at roll-ups is to know which part of the cycle they are in - oftentimes there is money to be made on both sides of the trade.

Also, the reason roll-ups are so seductive in the first place is some of the best performing stocks of all time have been roll-ups. You could argue John Malone's TCI and Liberty Media were both roll-ups - it was reported at one time that John Malone did a deal every two weeks in the peak of his cable deal-making days.

There is nothing wrong with a roll-up in concept it is just that there is huge opportunity for shenanigans given the accounting can get messy and it can be exceptionally difficult to truly track organic performance of the underlying business.

If I can give one word of caution on roll-ups it would be that they are most dangerous in the financials space - this is because financials have probably the most challenging accounting (both from the company's perspective and the investors' perspective), and the base rate over time is quite bad (note that I am only referring to "balance sheet" financials, not service-based businesses like Fidelity National, etc.). Ocwen is a great case study in what can happen to a roll-up in the financials space.

SA: How does the involvement of certain investors or management teams increase your confidence in a long thesis? Which types of investors are most/least meaningful?

PI: The involvement of certain investors or management teams can be strong support of an investment thesis - some might even be willing to invest in a company without knowing much more than the fact that a certain CEO or investor is involved in the situation. In terms of coat-tailing other investors, it is important to be sure that the investment they have made matters to them and they are not the type of investor to trade very actively - i.e., seeing certain hedge funds being invested in a company may not mean much if they have very high turnover and may only be playing for a quick move. In terms of management teams, you want to back management teams who have had proven success in similar situations - a classic mistake can be investing with a good management team who is facing a task that their skill may not be able to overcome - this was famously the case when Bill Ackman recruited a very talented Ron Johnson from Apple to try to turn around J.C. Penney, but he failed quite drastically.

Another important box to check is to ensure that the management team is invested both financially and reputationally in the situation, and not just doing it for a Chairman role or something that is more show than substance. A recent example of a situation where someone investing seemed very meaningful was Warren Buffett investing in Seritage with his personal money (i.e., separate from Berkshire) was very interesting as it has been fairly rare to see him make personal investments outside of Berkshire and he bought a fairly large stake in the company - even relative to Buffett's substantial net worth - this is the type of investment that can be used as a strong vote of confidence - someone of Buffett's stature would not bother to make that sort of investment unless he really thought it was compelling.

SA: The long case for spin-offs is well-known but what about the short case? How do you tell if the only one to benefit from a spin-off is the parent company?

PI: Once upon a time spin-offs were a virtual guarantee because the situation was almost always the same - large company getting rid of a non-core asset that hasn't been run optimally - putting in place a new management team with the proper incentives to perform, and a legacy shareholder base being forced sellers because they have no interest in maintaining ownership in the spun-off business; additionally, before there was a bevy of funds and sophisticated investors who evaluate almost every spin-off, there was no logical buyer for spin-offs - so based on pure volume dynamics alone spin-offs would be oversold in the period after a spin-off. I think investing in spin-offs has become a far more popular strategy and thus the historically attractive returns have been competed down to an extent. In some ways, the success of investing in spin-offs historically has been its own undoing.

Additionally, the quality and types of assets being spun-off depends on cycles in the economy - just as M&A occurs in waves, spin-offs usually occur in a cycle that occurs several years after an M&A cycle peaks - many companies find that the deals bankers sold them on didn't end up working quite so well and the hoped-for synergies failed to materialize (Buffett has talked a lot about this dynamic over the years). One of the problems with a spin-off is that sometimes the most knowledgeable party about the asset is the former parent company and there is a reason they are spinning off the asset - probably one of the biggest warning signs is when a company tries to sell an asset, fails to do so, and subsequently decides to spin the asset off - sometimes this can mean no one wanted to buy the asset because it is low quality in nature or has toxic liabilities.

Nevertheless, even what may seem like bad assets or assets with toxic liabilities can be attractive at the right price, but you need to make sure you invest at a compelling valuation, rather than simply assuming spin-offs are usually undervalued. In the current, more competitive environment, spin-offs should be seen as neither automatic good investments nor automatic bad investments - investors should exercise caution and do as much diligence as they can to understand the motivation for why the company is being spun-off and if the story checks out.

SA: What’s one of your highest conviction ideas right now?

PI: One of my highest conviction ideas right now is Xpel (XPLT) - I think it is exceedingly rare in the current market environment to find a business with as strong a moat as Xpel's, growing as quickly as Xpel is, and demonstrating operating margin improvements, trading at such a low multiple of normalized earnings power.

One of the reasons Xpel is so mispriced in my opinion is there was a lawsuit by 3M that seemed to have the potential to seriously damage the company - the overhang pressured the stock for a long period of time. This lawsuit was finally resolved last year; additionally, the legal costs and general distraction on management's ability to focus on the core business caused problems for the duration of the lawsuit. Xpel's most recent quarter was the first quarter the quality of the business and the size of the market opportunity became really apparent - revenues effectively doubled year over year and operating margins improved materially - this makes this a uniquely attractive investment in my opinion. I think this is a classic case where even though the stock is up substantially since the last earnings report - the stock should actually be up even more given the multiple ascribed to the business should be higher as the market realizes the long runway for growth that is available as well as the underlying quality of the business. The main catalyst is continued operating performance, as well as a potential listing on one of the bigger U.S. exchanges as the stock currently trades in Canada and OTC in the U.S.

***

Thanks to Panther Investments for the interview. If you'd like to check out or follow their work, you can find the profile here.

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This account publishes the weekly PRO fund manager interview, which is available only to PRO subscribers. These are interviews Seeking Alpha authors and fund managers in the industry about their investing philosophy, recent ideas they have published on Seeking Alpha and elsewhere, and their current favorite ideas. The account will also occasionally repost other interviews we have done with authors or investors.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Check with individual articles or authors mentioned for their positions. Panther Investments is long XPLT and AIMT.

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