SA Interview: Special Situation Investing With Andrew Walker
Summary
- Andrew Walker is a portfolio manager at Rangeley Capital LLC.
- Why a common theme in his investments is incentives, the elevator pitch for the cable industry and SPACs are topics discussed.
- Andrew Walker shares a long thesis on WideOpenWest.
Feature interview
Andrew Walker is a portfolio manager at Rangeley Capital LLC. He's also the founder of https://yetanothervalueblog.com/ and the Yet Another Value podcast. We discussed merger arb ideas, taking the other side of high profile short sellers and why simple value is not enough.
Seeking Alpha: Walk us through your investment decision making process. What area of the market do you focus on and what strategies do you employ?
Andrew Walker: That's a tough one, as it really depends on the type of company and investment I'm looking at. Am I looking at a SPAC trading below trust? Then I just want to get comfortable with the terms of the SPAC. Am I looking at a great company that I think has a long runway of profitable growth ahead of them? Then I want to get really familiar with the industry and understand where my view is differentiated / non-consensus. That said, increasingly I think a common theme through my investments is incentives. I want to be betting on the outcome that management is most incentivized to achieve, so I spend increasing amounts of time going through proxies and looking at how management gets paid. Do they get paid for revenue growth? Well, then they might be more incentivized to do value destroying acquisitions just to increase revenue. Or do they get paid for share price appreciation? Then they're probably a little more on my side.
SA: What's the elevator pitch for the cable industry in general and what are the best stocks to play it? What are the bears missing about this trade? How much (if at all) should the cable companies be worried about losing broadband customers to Starlink or 5G and why?
Andrew Walker: The pitch for the cable industry is that you pay them <$100/month for internet access, and that internet access literally is the life blood of modern society. The consumer surplus on that payment is enormous, so over time the cable companies should have above-inflation pricing power. The bear case for cable has morphed a lot over the years; for a while it was companies overbuilding them with fiber (Google Fiber, AT&T U-verse, Verizon Fios). Then it was video cord cutting. Then it was 5G overbuilding. Today it's increased regulation. All of those are certainly concerns, but the bottom line is the cable infrastructure is the best infrastructure out there for the modern world, and it has huge cost advantages. I don't think cable companies need to be super concerned about Starlink or 5G overbuilds. We've heard rumors of fixed wireless / mobile attacking home broadband for literally decades; if you search, you can find stuff from the turn of the century about mobile providers launching home internet powered by 3G. Cable offers a better and more reliable product at a cheaper price than a wireless or satellite play could hope to achieve because cable has already laid a wire into your home to connect you into the internet. That wire is super reliable and has almost no marginal cost; It's tough for a new competitor to beat that.
SA: How do you separate the winners from the losers in SPACs? Can you discuss any special situation opportunities here (including how these mispricings are created and how you find them in the idea gen process)?
Andrew Walker: What a difference a few months makes; recently, there have been nothing but losers in the SPAC space. The fact is that most SPACs, in the long run, are losers. A SPAC is a very, very expensive process to go public; remember that a SPAC is just a pile of money, so the way most of them win deals is by being the high bidder. That subjects SPACs to "the winner's curse," but it's actually worse than that for SPAC shareholders since the founder's promote dilutes SPAC shareholders by ~20%. In effect, SPAC shareholders who hold through a deal are looking at the deal and saying, "yup, I'd like to own this company for at least 20% more than anyone else was willing to pay." Paying over top dollar for companies is generally not a winning strategy long term!
That said, SPACs can be interesting. What you really want is an aligned sponsor with a track record of value creating deals and some proprietary deal flow. So consider something like Liberty Media's SPAC (LMACA). As we write this, they're trading for ~$10.20/share, or 2% over trust value. Liberty has a long history of unique and value creating deals, and their relationships mean they can bring something to the table other than just money. So I think that's an interesting trade: buy LMACA and get a "free" look at whatever deal they announce. If it's a bad one, just sell or redeem your shares for trust before the merger closes and you'll only lose a percent or two. But, if Liberty pulls a rabbit out of their hat and announces a good deal, the upside could be substantial. Plus, the team is aligned with shareholders here: in addition to the promote, Liberty has agreed to buy $250m of LMACA alongside whatever deal they announce!
SA: You've published a number of merger arb ideas (including an excellent call on Collectors Universe) - from the entire universe of announced mergers, how do you narrow down the list to these types of ideas? What are typical signs there could be a bidding war and/or higher bid? What are signs the downside could be limited in the event of a deal break?
Andrew Walker: Looking for a bump or a bidding war has a lot of similarities to looking for undervalued or mismanaged companies. You want to look for deals that look too cheap or where the management team has incentives that don't align with maximizing shareholder price. It often helps if the assets that are getting acquired are unique or strategic, as those tend to be the type of assets strategic buyers are willing to overpay for or at least pay premium multiples for. So it's really just about casting a wide net and just looking at / thinking through deals.
As far as downside, it's tough to say upfront. In general, your base case is the downside in a deal break tends to be the price the stock was trading at before deal announcement / rumor. However, each case is unique; in general, deals tend to break because the buyer gets cold feet. That's generally driven by the seller's business deteriorating, so when the deal breaks you get hit with the double whammy of all of the deal premium bleeding out the stock and the market adjusting to a much more grim reality than the company was facing when the deal was announced. Not fun.
SA: Have you ever bought a stock (or just found the bullish side more convincing) that was the subject of a high profile short seller report? If so, which one and why? What is your general process for evaluating claims made by short sellers to see if they have merit and/or are priced in already?
Andrew Walker: Yes, several times. I'll start out by saying I have huge respect for short sellers, and in general it's not fun to be long a stock that a short seller puts out a report on. That said, short reports are a great place to look for ideas on both the long and short side. If the short report is right, the stock could be an interesting short. But if you read it and think the short report is wrong, the alpha on the long side can be incredibly high. Look no further than GameStop (GME) to see what happens when a big short interest runs into a little momentum or a shift in narrative! Obviously, that's an extreme example, but there are plenty of other recent examples where doing work and being on the other side of a short thesis created huge amounts of alpha.
One recent example I bought a small position in was
MultiPlan (MPLN). Muddy Waters published a detailed short report with lots of points to it, but the critical one was MPLN would lose UNH (their largest customer). I did a bunch of work and thought the risk was overblown; in particular, I couldn't imagine how a buyer could write a multi-billion dollar check without doing simple due diligence that UNH wasn't about to leave. So I took a small position on the thesis, "the stock is cheap and you're buying it way below the price insiders just transacted in it." So far, it looks like MW was right, as Multiplan joined a slew of SPACs that felt comfortable issuing five year guidance to get their deals done but then pulled the guidance once public. Still, it's early and it's a small position; it'll be interesting to see how it tracks and the UNH relationship evolves over the next year.SA: As a value investor, is value alone ever enough or do you look for catalysts (or on the flip side how do you avoid value traps)? For SOTP ideas, are there any common denominators in terms of the ones that work out versus the ones that don't?
Andrew Walker: Increasingly I don't think simple value is enough; you need a management team that has some commitment to unlocking or at least not destroying value. A great example is the MSGE / MSGN deal; it's pretty impressive for a group to announce an all stock deal that is so bad / poorly thought out that both sides of the transaction fall on announcement. Why is that happening? Because the controlling shareholder there (James Dolan) doesn't care about shareholder value; he cares about moonlighting as a musician and using MSGN"s cash flow lets him build arenas and stay connected in the music world.
So yes, you always want some value. But increasingly you need management that wants to realize that value or at least not actively take it away. One of the most unique areas to catch alpha is to find companies where management historically hasn't cared about value realization, but suddenly something changes and now they want to maximize value. The market can be slow to pick up on it, and a company going from trading with a conglomerate discount to no discount at all can realize a lot of upside!
SA: Your Yet Another Value podcast is a "must listen" - are there any notable takeaways or common successful traits of the investors you've interviewed?
Andrew Walker: Well, I certainly appreciate that, and I'd encourage all readers to check it out / subscribe (here's the YouTube channel, but it's also on all podcast platforms). It's tough to say because every guest is so different, and personality types make their interview styles different as well (i.e. some guests are extremely introverted, so their interviews will be a little different than a super extroverted guest). But I think one common theme you can hear from the best investors is that when I ask them a risk factor or a push back to their investment thesis, you can tell it's something they've already clearly spent time thinking about. Maybe they don't have a perfect answer (often because a perfect answer doesn't exist!), but they've thought about it before and have clearly quantified the risk. An example might illustrate this best: consider my last podcast with Francisco Olivera on Roblox (RBLX). I pushed back on a ton of risk factors, and you could easily tell that Francisco has put deep thought into considering them all. Did he have a "perfect answer" for all? No, probably not, but that was often because a perfect answer didn't exist. But he had thought through and quantified the risk, and decided that accepting that risk was worth the upside if the investment played out right.
SA: A recurring question in this interview series is about the mispricings created by the coronavirus and its short and long-term impact - can you weigh in on this?
Andrew Walker: It's tough because a lot of mispricings look obvious in hindsight but in the moment they weren't. For example, the reopening trade has boomed over the past six months, and with hindsight that seems obvious…. But the efficacy of vaccines was probably the absolute best case scenario. Is there another world where the vaccines aren't as effective, or the roll out of the vaccines was much more difficult, and the world had to stay semi-closed for several more years? Absolutely, and in that world a lot of reopening plays would have really struggled.
That said, I do think reopening plays as a whole are a little euphoric right now; just about every reopening play is trading for an EV higher than they were pre-pandemic and they all continue to burn cash. Consider something like PLAY; it's trading for ~2x its prepandemic EV and it's just getting back to cash flow breakeven. Even if you think they can return to pre-pandemic earnings levels, they'd be trading at a way higher multiple and I think it will take quite some time before they can have a fully open store base. It's tough for me to look at that stock and see any value or margin of safety, and I think there are a variety of things that could cause it to trade down quickly (reopening stalling, new competition from sports betting focused themes, etc.).
SA: What's one of your highest conviction ideas right now?
Andrew Walker: Given we talked cable earlier, I'll stick with that space. WideOpenWest (WOW) remains significantly undervalued. Rangeley named it our best idea for 2020 when it was at ~$7/share; as we speak it's around $12.50 so it's done well but I think there's a lot more upside. The basic thought here is simple: WOW has a significant amount of operational and financial leverage. The new management team is cutting back on capex and increasing margins; that combination plus the refinancing of some costly debt will cause cash flow to explode higher. In 2020, WOW did ~$35m in free cash flow to equity (~$0.42/share) if we simply define free cash flow as operating cash flow less capex. With some margin increase, the refinancing, and capex coming down, I think the company could earn $2/share in free cash flow in the near future. Industry M&A has generally been done at 13-17x EBITDA; WOW is currently trading for <8x EBITDA so in an acquisition shares could see a real pop. Their largest shareholder is a private equity fund who has been involved for ~6 years; while I don't think they are sellers in the near term, in the medium term I expect the company will be sold for a big premium.
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Thanks to Andrew for the interview.
Andrew Walker is long MPLN, WOW, MSGN, and LMACA.
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