Alta Fox Opportunities Fund Q1 2022 Quarterly Letter
Summary
- Alta Fox Capital is a long/short hedge fund.
- In Q1 2022, the Alta Fox Opportunities Fund produced a gross return of -11.71% and a net return of -11.91%.
- In the long run, our strategy of buying high-quality and underfollowed businesses at cheap prices will deliver attractive absolute and relative returns.
- Amid the market weakness, we have been refining our fundamental estimates, stress-testing them for a variety of macroeconomic scenarios and are sticking to our disciplined underwriting process.
Dilok Klaisataporn/iStock via Getty Images
Limited Partners,
In Q1 2022, the Alta Fox Opportunities Fund ("the Fund") produced a gross return of -11.71% and a net return of -11.91%. The Fund's average net exposure during the quarter was 82%. Since inception in April 2018, the Fund has produced a gross return of 561.70% and a net return of 371.16% compared to the S&P 500's return of 84.18% and the Russell 2000's return of 42.39%.
Alta Fox Opportunities Fund, LP | Relevant Index Returns | |||
Gross Return | Net Return | S&P 500 (SPY) | Russell 2000 (IWM) | |
Q1 2022 | -11.71% | -11.91% | -4.60% | -7.53% |
YTD | -11.71% | -11.91% | -4.60% | -7.53% |
Since Inception | 561.70% | 371.16% | 84.18% | 42.39% |
Annualized | 60.39% | 47.33% | 16.50% | 9.24% |
As always, Alta Fox strives to ignore short-term price fluctuations and instead focus on the intrinsic value growth in our portfolio holdings, which should converge with portfolio performance over time. We encourage limited partners to do the same both in times of outperformance and underperformance. I firmly believe that in the long run, our strategy of buying high-quality and underfollowed businesses at cheap prices will deliver attractive absolute and relative returns. Most importantly, our process remains disciplined with strict risk controls, minimal gross leverage, and a sound research process.
Market Commentary and QTD Key Portfolio Drivers
The start of 2022 has not been kind to the markets-or our portfolio. The market (for good reason) is worried about rising interest rates, significant inflation, and slowing consumer demand, among other concerns.
Alta Fox entered this year admittedly cautious about the global markets. While we maintained high net exposure to the market, our exposure has largely been to businesses with competitive advantages that are producing significant free cash flow and are trading at reasonable multiples. We have not had any meaningful SAAS exposure or theses predicated on a high revenue multiple valuation methodology. Thus far, this conservatism has not mattered: many of our portfolio companies have sold off materially as macroeconomic concerns have far outweighed idiosyncratic theses year to date. In the short run, changes in multiples can dominate returns, but over longer periods of time, fundamental growth is the most important driver of returns.
Our caution at the beginning of the year has now turned to optimism as many excellent businesses are trading down meaningfully from the beginning of the year. While we do not claim to have any special foresight in predicting near-term inflationary or broader macroeconomic trends, we believe, from a bottom-up fundamental perspective, there is far too much pessimism priced into many of the businesses we know well. The market's broad selloff of entire sectors and industries has created opportunities for long-term investors focused on fundamentals. Amid the market weakness, we have been refining our fundamental estimates, stress-testing them for a variety of macroeconomic scenarios and are sticking to our disciplined underwriting process.
We feel very confident about our current collection of portfolio companies. Below, we share a few examples of companies we believe have been unfairly beaten down by the market.
NeoGames S.A. (NGMS)
NGMS has declined over 70% from all-time highs. The stock now trades at 9x 2023 P/E and 6.7x 2024 P/E for a business that should organically grow revenue at ~20% per year and operating profits even faster.
NeoGames is the leading iLottery player in North America. iLottery is an attractive industry because it represents only ~5% of the total U.S. lottery spend today while it represents closer to 50% in other developed countries. Over the next decade, more states will likely legalize iLottery, revenue per capita will grow for existing states, and NeoGames revenue and profits should multiply significantly. Finally, the iLottery market is a healthy oligopoly. Only three companies have ever won a significant U.S. state lottery contract due to the risk-averse incentives of state government officials awarding contracts and the highly technical and regulated format in which lotteries operate.
The stock ran to over $70/share in June of 2021 as investors became excited about the company's long-term growth prospects and the potential for a meaningful new state contract win (Ohio). At the peak share price in June 2021, the stock was trading at over 100x forward P/E and north of 40x EV/EBITDA.
Just as the stock got ahead of itself last summer, NGMS' valuation has recently slumped to levels that imply far more pessimism than we can realistically envision. An opportunity to buy the leading iLottery company in the U.S. for ~9x 2023 P/E strikes us as an incredible bargain as we believe this company has more than a decade of highly profitable growth ahead of it.
We have identified two main explanations for NGMS' significant decline. First, the market environment has not been kind to high-multiple names with low liquidity. NGMS is already a small-cap stock, but it also has ~50% insider ownership, which means the float is even smaller and more restrictive than other small-cap names. When the market starts selling first and asking questions later, high-multiple and low float stocks like NGMS can experience significant selloffs that are divorced from the fundamentals of the business. Second, the market has struggled to appreciate the rationale of the company's recent meaningful acquisition (not yet closed) of Aspire Global (OTC:ASPGF - ASPIRE), a business we know well.
We have a contrarian take on the Aspire acquisition and believe it will significantly strengthen the consolidated business. In fact, we were already independently a significant investor in Aspire, so we had a head start in understanding the business fundamentals of the pro forma combined entity. Our confidence in the strategic rationale of this deal stems from several factors. First, NGMS was actually developed within Aspire and spun out in 2014. The founder and current Chairman of NGMS, Barak Matalon, has created a tremendous amount of value having founded both Aspire and by extension, NGMS. Matalon knows the asset better than anyone-and insiders agreed to accept a majority of their consideration in the Aspire deal in the form of NGMS stock at $38/share, even though NGMS was trading at $24/share at the time of the deal announcement. Today, NGMS trades at $12.50.
Second, Aspire is a B2B iCasino provider. By combining Aspire with NGMS, NGMS is now a full- service solution without any gaps in its product portfolio. This should create meaningful revenue synergies-which we do not give the company credit for in our base case forecasts.
Third, given the longstanding relationship between both companies, NGMS had several business arrangements with Aspire and used some of Aspire's technology. This shared technology and R&D structure made both NeoGames and Aspire less attractive acquisition targets as standalone assets. Now that the assets are merging back together, we believe it makes the pro forma entity much more attractive to a potential acquirer looking to gain a strategic foothold in iLottery in North America and buy best-in-class iGaming technology. Our research suggests that there are likely several interested strategic acquirers in NGMS.
Matalon bootstrapped this business from its founding into what is now a market cap greater than $400M (at prices that we believe are currently depressed). This has been an incredible self- funding business and Matalon will retain ~23% ownership in the pro forma entity. We believe that this is a management team worth betting on, and that, at today's prices, investors will be handsomely rewarded for doing so. At 20x our 2024 and 2025 base case EPS assumptions, a discount to current B2B iGaming peer multiples, NGMS would trade between $40-$50. With the stock at ~$13 today, we are confident in the risk/reward.
Daseke (DSKE)
DSKE has fallen 35% from all-time highs and now trades at a ~20% normalized forward free cash flow to equity yield based on our estimates and <7x 2022 PE.
Daseke is the largest flatbed/specialized trucking company with ~1% market share in an extremely fragmented $100B US flatbed/specialized market (transport industrial, military and energy materials/equipment). Scaled operators have meaningful competitive advantages over small, independent carriers. These advantages include better contract terms, higher asset utilization, and preferred pricing on equipment, fuel, and insurance.
The ongoing shift in consumer demand from goods to services has caused a violent sell-off in dry van related trucking companies (transport consumer packaged goods) as dry van spot rates have declined by over 20% YTD. Daseke's stock, being the only publicly traded flatbed/specialized pure play operator, has been the "baby thrown out with the bathwater" and has sold off alongside dry van operators. Meanwhile, flatbed spot rates continue to hit all-time highs as the US industrial economy recovers and leading indicators like new housing starts further increase.
As Daseke's new management team continues to execute on its ongoing restructuring efforts (reducing operating companies from 11 to 4 and further optimizing fleet utilization) we believe that EBIT margins can improve by ~600 basis points through the cycle from current levels.
Finally, as we look to 2023, Daseke will be a key beneficiary of the US infrastructure bill (a generally underemphasized macro theme) and should see $500B of incremental government spend bolster its end markets over the coming years. We expect this to provide a multi-year tailwind to flatbed/specialized trucking demand.
In the context of ongoing internal improvements, Daseke's competitive advantages, and a comparatively exciting macro setup when looking across the broader market, we believe Daseke's <7x PE multiple (vs dry van peers at like KNX/WERN at 9-10x and HTLD at 14x) is far too cheap. We have recently encouraged management to initiate a meaningful buyback to take advantage of these depressed prices. Our full published analysis can be found here.
XPEL, Inc. (XPEL)
XPEL has fallen 60% from all-time highs and now trades at 16x Alta Fox 2023 estimated EPS.
XPEL was one of Alta Fox's inaugural portfolio holdings and we hold the company's CEO, Ryan Pape, in the highest regard. He is an incredible value creator that took a business on the verge of bankruptcy, funded it in desperate times on his own credit card, and has built an incredible business. When I had a chance to first meet with Pape early in our diligence process several years ago, he gave me a tour of their warehouse. Pape knew every worker on a first name basis, and it was clear that every employee at XPEL deeply respected him. Under Ryan's tenure, XPEL has been over a 100-bagger, making it one of the best performing stocks in the world.
The paint protection film ("PPF") market remains in early innings of penetration - we estimate that PPF is applied to ~5% of U.S. luxury vehicles and is applied on less than 2% of U.S. total vehicles. Not only do we believe that PPF penetration for luxury vehicles will multiply from current levels over the next decade, but we believe that PPF usage will continue to expand to other non-luxury vehicles as well. Moreover, PPF usage is not limited to just cars. Experts estimate that the residential/commercial PPF/tint market could be just as large, if not larger than the potential PPF auto market. We believe XPEL is best positioned to continue to gain market share in the rapidly growing PPF market due to its best-in-class brand, product, and PPF application software.
XPEL's stock price has been cut in half in the last 12 months as its NTM PE multiple has compressed from a peak of 60x+ to 18x FY23. Additionally, supply chain headwinds have negatively impacted auto production and have resulted in empty dealership lots and a lack of new vehicles needing PPF. As a result, organic sales growth began to decelerate sequentially throughout the 2H of 2021. However, we believe a reacceleration is just around the corner. OEMs are citing continued improvement in semiconductor availability and vehicle deliveries continue to improve. Even the U.S. auto SAAR was up 11% q/q. As vehicle unit sales at retail begin accelerating and inventory levels at dealers begin to build, XPEL should see organic growth accelerate this year and next year as it benefits from pent up auto demand that will take many years to work through. Meanwhile, XPEL has taken price double digits and is renegotiating its manufacturing terms with its main supplier. We believe the net result of these efforts will be a return to 20-30% top-line growth with gross margins expanding from 35% in Q4 2021 to 40%+ by Q4 2022.
We believe 16x FY23 PE is far too cheap for a business growing topline 20%+ a year in early stages of TAM penetration exhibiting significant operating leverage with attractive reinvestment opportunities and a best-in-class CEO.
Alta Fox/Activism
Alta Fox prefers to collaborate with management teams and public company boards for the benefit of all stakeholders. We have done this successfully many times in the past-often behind the scenes- in order to help create shareholder value. Even some of the best operators can benefit from understanding the investor perspective because operating expertise and capital allocation expertise are very different, but they are equally important for driving long-term outperformance.
Good management teams and public company boards tend to appreciate the investor perspective. On the other hand, entrenched boards are in it for themselves, become personally offended by capital allocation critiques, and spent inordinate amounts of shareholder capital to resist any attempts at meaningful change. In these problematic company boards, one will often find extremely tenured directors with very little engagement, troubling compensation practices, and a toxic board culture that promotes the status quo.
The growth in passive investing has helped entrenched boards maintain control as passive votes have generally been friendly votes for management. However, the tides are changing. The large passive holders have invested significantly in the last several years in increasing their engagement and better understanding alignment and compensation issues. Moreover, the use of the "universal proxy card" starting next year should be a big benefit to activists and a useful tool in helping keep underperforming boards accountable to shareholders.
Alta Fox will always strive for collaboration with portfolio companies to maximize long-time shareholder value. However, chronically underperforming public company boards must be held accountable. We believe that knowledgeable active shareholders engaging in activism has never been more important given skyrocketing compensation for executives, continued cronyism among many corporate Boards, and the growth of passive investing.
Business Updates
This month marks Alta Fox's four year anniversary and since 2018, we have grown from a one-man band to a thriving team of seven as our recent recruiting efforts have led us to two highly qualified colleagues (research and operations), that will formally join our team in Q2. We look forward to formally announcing these additions in our Q2 letter. As the Alta Fox Opportunities Fund remains closed to new investment until March 2023, our operations team is focused on supporting the research team and our valued LPs by maintaining and improving on our institutional quality back- office framework. Despite the Fund's closed status, interested and aligned prospective LPs should not hesitate to contact us. We are always open to discussing the strategy and getting to know investors who could be a good fit for the Fund when we reopen.
Conclusion
We are humbled that you have elected to invest a portion of your assets with Alta Fox. We continue to strive to improve all aspects of our research and operational processes in our pursuit of building a world-class investment firm.
Sincerely,
Connor Haley
APPENDIX: HISTORICAL PERFORMANCE FIGURES
Alta Fox Opportunities Fund, LP Net | S&P 500 | Russell 2000 | |
Since Inception | 371.16% | 84.18% | 42.39% |
Annualized | 47.33% | 16.50% | 9.24% |
Alta Fox Gross Return | Alta Fox Net Return | Alta Fox Net Exposure (Avg) | |
Q2-2018 | 7.82% | 6.05% | 79.31% |
Q3-2018 | 17.12% | 13.68% | 85.44% |
Q4-2018 | -13.57% | -11.52% | 77.23% |
2018 | 9.13% | 6.67% | 80.66% |
Q1-2019 | 35.41% | 28.10% | 83.00% |
Q2-2019 | 12.39% | 10.23% | 83.45% |
Q3-2019 | -2.21% | -2.10% | 79.07% |
Q4-2019 | 9.96% | 8.29% | 77.86% |
2019 | 63.63% | 49.70% | 80.84% |
Q1-2020 | -26.77% | -26.98% | 75.12% |
Q2-2020 | 66.65% | 60.47% | 75.17% |
Q3-2020 | 37.38% | 30.77% | 85.36% |
Q4-2020 | 58.32% | 50.44% | 85.86% |
2020 | 165.41% | 130.52% | 80.37% |
Q1-2021 | 26.24% | 20.78% | 93.70% |
Q2-2021 | 21.75% | 17.93% | 83.75% |
Q3-2021 | -0.91% | -0.99% | 75.58% |
Q4-2021 | 3.82% | 3.04% | 76.48% |
YTD 2021 | 58.11% | 45.30% | 82.38% |
Q1-2022 | -11.71% | -11.91% | 82.04% |
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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