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Expensive Companions,
Efficiency and Positioning Overview – FY 2022
By YE 2022, McIntyre Partnerships returns have been approx. 0.3% gross and -1.2% internet. This compares to the Russell 2000 Worth’s decline together with dividends of -15%. As well as, whereas we sometimes don’t touch upon intra-quarter returns, there was vital information within the fund’s largest holding, Sotera Well being (SHC), and because of this the partnership is up ~29% YTD as of the writing of this letter. This brings the partnership’s CAGR since inception to 22% gross and 17% internet. The remainder of this part will concentrate on our 2022 yr finish evaluation, and I’ll deal with SHC in a separate part.
Within the winners column, CC, our China Tech basket, VAL, OSW, GTXAP, and file labels (UMG/WMG) contributed 100-500bps every, whereas danger arbitrage conditions (SAVE, TWTR, TRQ, ATCO, MANU) contributed over 500bps. Within the losers column, TPHS misplaced 100-500bps, whereas MSGE misplaced over 500bps.
In comparison with our benchmark, 2022 was a robust yr for the partnership. I’m significantly glad we had robust outperformance in a down market. I’ve lengthy argued that the basics of our firms supply robust draw back safety; nonetheless, this was tough to point out throughout a five-year bull market with solely speedy, short-lived selloffs. On this protracted bear market, our differentiated views and elementary analyses got time to play out. As an example, coming into 2022, GTXAP and CC have been two of the fund’s largest positions. As an auto provider and a chemical producer, these two companies display screen as excessive beta, and lots of would count on cyclical companies to underperform in a bear market. Nonetheless, the 2 securities completed 2022 roughly flat on the yr, which I attribute to GTXAP’s excessive dividend yield and the numerous reset in CC’s consensus earnings estimates. By choosing securities with a mix of development, engaging valuations, and idiosyncratic catalysts, my aim is to create a portfolio that outperforms with robust alpha, not simply levered beta. Additional, by limiting our drawdowns, I hope to place the fund to capitalize on the numerous alternatives typically discovered throughout bear markets. I imagine our 2022 and early 2023 outcomes converse to that.
Relating to our portfolio, 2022 was a yr of great change. Generally, I’d describe 2022 as a yr through which I rotated capital from our holdings that strongly outperformed right into a handful of exceptionally high-quality names that I imagine have been unfairly dragged down within the broader market selloff – the proverbial “infants with the bathwater.” This has resulted in CC falling out of our prime 5 positions for the primary time since 2019, and I’ve decreased our GTXAP funding from a considerably concentrated one to a median measurement. Going ahead, I imagine the fund’s three new prime 5 positions – SHC, OSW, and the file labels – are exceptionally robust duopoly/monopoly companies with vital development potential. If their shares proceed to rally and I can discover reinvestment alternatives, I’ll rotate capital but once more. The store is open each weekday at 9:30 AM. Nonetheless, given their defensive traits and robust development outlook, the bar for brand new concepts is excessive, and I might see our new holdings remaining in our prime 5 for a big interval.
Moreover, the fund had success in danger arbitrage investments final yr, with a number of particular person concepts contributing over 100bps. My danger arbitrage technique is to establish rumored/introduced/hostile deal conditions the place the value inaccurately displays the chance/reward skew. As I count on at the least a few of these investments to fail – say 15-25% – our danger arbitrage investments are usually a smaller measurement than core holdings, thus I imagine it is smart to report their PNL collectively fairly than individually. Nonetheless, and with unlucky irony, I imagine my largest mistake in 2022 was one among omission, not fee, in that I didn’t make TWTR a prime 5 place measurement. I’m at all times cautious and danger targeted when investing, significantly when it turns into a prime 5 holding, however when a rock-solid merger settlement is met with skepticism resembling “Do US courts have the flexibility to implement the legislation?” and “Will the world’s richest man develop into a political refugee in Texas?”, it’s time to put out the buckets, not the thimbles, and, in hindsight, I imagine we must always have made greater than the 200bps we generated on the commerce. Thankfully, although, our general danger arbitrage technique was robust and, if 2023 is one other yr of market volatility, there needs to be additional alternatives.
Lastly, and sadly, the fund had a big loser in MSGE, whose share value fell 36% final yr. For MSGE, 2022 was a irritating yr in that, whereas I don’t imagine my elementary evaluation is incorrect, my timing has been horrible. In our massive investments, I at all times goal vital catalysts. Coming into 2022, I felt tax loss promoting following the poorly acquired merger with MSGN supplied a beautiful entry level.
Nonetheless, as soon as via its early 2022 tax loss rally, MSGE lacked a significant catalyst till 2023, when the Las Vegas Sphere opens and MSGE spins off the MSG Area. Different buyers had no motive to purchase shares to date prematurely, significantly when the markets have been unstable, and MSGE shares frustratingly drifted decrease with all of the indicators of the dreaded worth lure. I reiterate my thesis beneath. Whereas I can recognize why some might view MSGE as a price lure, I imagine my long-term thesis is appropriate and MSGE has robust catalysts in 2023. I plan to keep up a big funding.
Portfolio Overview – Exposures and Focus
At quarter finish, delta adjusting for our rate of interest hedge, our exposures are 109% lengthy, 5% quick, and 104% internet. Our 5 largest positions are GTXAP, SHC, MSGE, file labels (UMG NA, WMG), and OSW, and account for roughly 83% of property.
Portfolio Overview – New Positions
Sotera Well being Firm (SHC)
After I initially sat down to write down this letter, I deliberate to write down a bit on SHC that may have been considerably completely different than the one I’m writing now. Just a few weeks in the past, my thesis was primarily centered on SHC’s litigation, and I believed that SHC’s fundamentals, whereas wonderful, have been solely a minor driver of the inventory. Nonetheless, in mid-January, SHC settled considerably all its worrisome litigation, sending shares up ~110% in a couple of days. Now, I imagine there may be little to speak about on the legal responsibility aspect, although I feel the market has not absolutely processed the extent to which the overhang has been eliminated. Regardless of this fast reversal in share value and story, I proceed to imagine SHC is a wonderful funding. Whereas remaining bullish when a inventory is up over 100% appears past the partnership’s worth investing roots, I’m not alone in my considering. The beneath excerpt from a latest Wolfe notice matches my ideas:
Sometimes a inventory ~doubles and nonetheless might be undervalued by at the least ~half. Following scrub of mannequin, together with add-in of anticipated borrow to cowl proposed settlement, and recent evaluation of broader comp universe, we see a whole lot of room for this a number of to proceed recovering as proposed IL settlement progresses to remaining and elementary deserves return as focus (i.e., substantial moat, actual pricing energy, favorable trade construction and development, long-duration contracts). Inventory appears higher arrange now than ever to be a ‘reverse LBO’ fairness story which, based mostly on our prior expertise, is a beautiful descriptor. We body new $25 year-end 2023 goal value as 15 instances 2024 adjusted EBITDA. Versus our provisional vary, we rolled time horizon ahead and used excessive finish of quoted multiples. Even nonetheless, room for the uber-bulls to squint and see potential for extra.
To clarify our SHC funding, I’m going to stroll via how I got here throughout SHC, the enterprise’ fundamentals, and my considering on the legal responsibility. I’ll then clarify why I feel it stays a robust funding going ahead. The fund additionally has a big presentation out there upon request.
I initially got here throughout SHC within the fall of 2021 when it was written upon a preferred funding concept web site. I used to be instantly drawn to the thought for 2 causes: it appeared to be a wonderful enterprise and it had a authorized legal responsibility, which I take into account be an space of experience. Relating to the enterprise, SHC offers outsourced sterilization companies for medical gadget producers, the place it shares a duopoly with Steris (STE). Med gadget volumes general develop within the 4-6% vary, with minimal cyclicality, and as a service supplier to med gadget producers, SHC doesn’t take product design or reimbursement danger (i.e. the chance Medicare decides to decrease the value they’ll pay), the 2 greatest points which have beforehand stopped me from investing within the med gadget area. Additional, SHC’s companies are mission-critical, as you can’t promote an unsterilized coronary heart stent, and altering sterilizers typically requires FDA approval, but sterilization makes up below 1% of med gadget producers’ whole prices. This low share of COGS mixed with excessive switching prices creates substantial buyer lock in, and SHC boasts a 100% renewal charge with prime accounts whereas constantly pushing 3-5% annual value will increase. The result’s a enterprise with 10% natural gross sales development, de minimis cyclicality, and 50% working margins.
Unsurprisingly, companies with such favorable traits are inclined to commerce at excessive valuations, and in fall 2021, SHC was buying and selling at 25x ahead P/E and 17x ahead EV/EBITDA, although shares have been at a reduction to look STE, which traded 30x ahead P/E and 21x ahead EV/EBITDA. Whereas I’ve no agency guidelines for what a number of I’ll pay for a inventory, SHC’s valuation was modestly greater than the place I’m sometimes comfy initiating a place, although I do acknowledge some really nice companies compound for years with out ever getting less expensive.
Nonetheless, what really gave me each pause and curiosity was the potential volatility surrounding SHC’s authorized liabilities. SHC makes use of two main strategies of sterilization, ethylene oxide ((EtO)) and gamma radiation, and SHC had been sued at three EtO services following an unfavorable EPA report. The authorized points included private harm lawsuits alleging SHC’s EtO brought about cancers at two separate services in Illinois and Georgia, and the Illinois private harm instances have been scheduled to start first in mid-2022. Illinois is among the most plaintiff friendly jurisdictionswithin the USA, and Prepare dinner County, the place the instances have been filed, has made the Institute for Authorized Reform’s checklist of the “Cities or Counties with the Least Truthful and Affordable Litigation Setting.”
As I’ve written earlier than, I regularly take a look at securities with authorized liabilities as I’ve earlier expertise investing in them and lots of buyers merely lump all authorized liabilities within the “too onerous” bucket, no matter what the precise legal responsibility is. After analyzing SHC’s authorized scenario, I got here away largely agreeing with the bull case that the EtO litigation would finally show manageable. Nonetheless, as I wrote in my put up on Sunday Idea’s BrunchI shared a couple of months in the past, private harm litigation when it will get to a jury is the very best danger second in litigation evaluation:
In my view, private harm litigation is by far the toughest authorized legal responsibility to estimate, and the very best danger conditions are when litigation reaches jury trials within the USA. In US private harm litigation, juries can award each compensatory damages for emotional struggling and punitive damages, that are arbitrary ideas that may end up in staggering sums. You may debate the information of a case all you need, however the actuality is that when it goes a jury, if they arrive again with a giant quantity, it’s an issue. A lot of the authorized liabilities which have materially impacted firms have been private harm litigation, resembling asbestos and Spherical Up.
Whereas I agreed the legal responsibility could be manageable, I discovered many buyside and sellside buyers have been a bit flippant of their dismal of the litigation, significantly given IL’s plaintiff pleasant courts. It’s one factor to take a look at the information and conclude the science is on SHC’s aspect, but it surely’s a wholly completely different animal to grasp statutory limits on punitive damages, litigation technique, the place the legal responsibility sits in a chapter, and so on. As an example, dealing with mass tort litigation, firms typically intentionally bankrupta subsidiary, and I questioned what number of development healthcare buyers really had the experience to grasp that dropping nine-figure verdicts after which submitting for chapter will be an fairness optimistic occasion.
Given my considerations on valuation and the litigation path, the fund initiated solely a small SHC place in H1 2022 and I adopted the litigation, seeking to construct an even bigger place if there was a settlement and/or if the inventory grew to become materially cheaper. As destiny would have it, SHC misplaced its first case in dramatic vogue, with a jury awarding the primary plaintiff ~$350MM in compensatory and punitive damages, and SHC shares fell 60% within the following two days. Whereas I cannot go into element right here on my buying and selling choices and legal responsibility evaluation, the fund constructed a considerable place throughout This fall. Once more, companions are welcome to take a look at our presentation laying out my technique and thesis.
Coming into 2023, whereas conscious a settlement might occur at any level, I had a technique to trace the instances as they developed, together with counsel and “eyes and ears” within the courtroom room, and I used to be considering understanding of Chicago half time to be in courtroom on sure days. Nonetheless, SHC and the plaintiffs settled nearly all IL litigation in mid-January, sending shares sharply greater. Whereas the transfer is dramatic, I imagine the market continues to be underestimating the diploma to which the authorized overhang has been eliminated.
The IL private harm instances have been by far SHC’s largest authorized legal responsibility attributable to their measurement (~850 instances vs. ~300 instances in GA) and the character of IL courts. The settlement resolves over 90% of instances in IL, and extra importantly, the IL settlement was for roughly $400k/case, which was inline with my estimates. Whereas future IL litigation is probably going as some residents develop most cancers at later dates, I imagine there will likely be below 20 legitimate instances filed per yr, which at $400k/case is immaterial within the context of SHC’s earnings, which I forecast to achieve $700MM in 2025 EBITDA. Relating to GA, the state has a stricter customary of causation than IL, which the GA plaintiffs haven’t but met, and punitive damages are capped at $250k/case in GA. Past these two instances, SHC faces no additional private harm litigation, thus I imagine SHC’s authorized danger going ahead is not any completely different than most American firms.
Whereas SHC’s catalyst path has definitely modified, I imagine SHC stays a compelling funding. SHC shares are actually buying and selling 17x and 14x my 2023 and 2024 EPS forecasts and 12x and 11x EBITDA. Whereas solely a modest low cost to the market, I imagine SHC is compelling development story, and peer STE at present trades 23x 2023 EPS and 15x 2023 EBITDA. Additional, SHC is 60% owned by GTCR and Warburg Pincus, two properly revered PE companies who’re extremely incentivized to maximise worth. Because the authorized decision is best understood, I imagine SHC shares are prone to reweight at the least in the direction of STE’s a number of whereas rolling ahead onto 2024 estimates. If not, I imagine GTCR and Warburg Pincus will ultimately pursue a sale of the corporate as personal valuations for SHC have beforehand been considerably greater than SHC’s present a number of.
Portfolio Overview – Current Positions
Madison Sq. Backyard (MSGE)
I’ve written and spoken on MSGE extensively, and I cannot rehash the identical primary valuation arguments. For a refresher, please go to my public displays hereand here. As an alternative, I need to clarify why I imagine MSGE’s misfortunes will reverse this yr, particularly highlighting two massive 2023 catalysts: the spin of the MSG Area occurring in Q1 and the opening of the Las Vegas Sphere in H2.
For the previous two years, MSGE has been a black field to buyers. Intuitively, most buyers aware of the corporate perceive that MSGE owns iconic property, but the corporate is burning money as a result of they’re funding a big growth undertaking. Nonetheless, I imagine the complexity of teasing out profitability from the varied segments’ accounting, together with a maybe warranted concern that the Sphere is a cash pit, has saved many buyers on the sidelines who in any other case could be drawn to MSGE’s sturdy money flows. By yr’s finish, I imagine this complexity will dissipate, attracting a brand new cohort of buyers.
First, MSGE plans to spin the MSG Area, together with the Rockettes and some smaller venues, right into a separate firm in Q1. Beforehand, MSGE had meant to spin the MSG Networks enterprise as properly. Nonetheless, after discussions with shareholders, MSGE determined spinning their iconic property and not using a troubled one would maximize worth, and I agree with their resolution. Relating to the SpinCo, I imagine many buyers fail to grasp the underlying profitability of those companies and could be enthusiastic about proudly owning these secure property in the event that they absolutely understood the returns. As an example, greater than sometimes, different buyers have informed me that they don’t imagine the MSG Area is worthwhile, to which I reply, “they promote $40 vodka sodas, the place do you assume the earnings are going?” Fortunately, quickly this debate will likely be put to relaxation. The shape-10, containing pro-forma financials, needs to be filed in February and administration believes the spin will likely be accomplished by the tip of Q1. I imagine the SpinCo will earn $2-$3 in FCF/sh. and that many buyers will likely be attracted to those secure property on a standalone foundation. A 15x a number of yields $30-$45 in worth, with the caveat that MSGE shareholders will solely obtain 2/3rds of their SpinCo shares at first, with the opposite third possible distributed later. Whereas I can’t be positive precisely how the SpinCo will commerce, personally, I sleep comfortably proudly owning the MSG Area on an unlevered foundation at a >10% FCF yield.
For the RemainCo, the clear catalyst is the opening of the Sphere in Fall 2023. In contrast to the SpinCo’s secure property, the Sphere is an aggressive development undertaking with a wider array of potential outcomes. To the draw back, the Sphere might be a bust, with underwhelming crowds and an absence of star powered residencies, and MSGE administration might find yourself reinvesting within the undertaking for a couple of years within the hope of turning it round. To the upside, the Sphere might be a transformational Vegas asset with bought out crowds and an thrilling pipeline of future growth initiatives. There are, in fact, a wide range of blended outcomes between these two extremes. As a rule, in “moon shot” development investments, I solely make investments when I’m comfy underwriting to a worst-case situation, whereas being optimistic that its upside potential involves fruition. For RemainCo, in my worst-case situation, I worth the Sphere at $500MM, or ~20% of development prices, supported by my perception that the Sphere can generate at the least $50MM in excessive margin advertising and marketing {dollars} and solely a slight premium to the not too long ago accomplished Las Vegas T-Cellular Area, which value $375MM. I additionally assume a $200MM stub fairness worth for MSG Networks, regardless of its $1B fairness buy value 18 months in the past, which mixed with RemainCo’s different property and debt yields roughly $1B in fairness worth, or $30/sh. To the upside, if Sphere can obtain administration’s focused “double digit” return, I imagine a 20x a number of on $250MM in EBITDA is affordable, or roughly $150/sh. Whatever the final result, by yr finish, the market will obtain substantial updates and indications on the well being of the Sphere and I imagine the present pricing, at a reduction to my punitive worst case situation, is extreme.
Some Ideas After Six Years and Enterprise Updates
It has been fairly a journey during the last six years, however after a whole lot of focus and onerous work, I’m pleased the partnership’s returns are exhibiting the fruits of our course of. After I launched, I mentioned the partnership’s targets have been 1) 1000bps of gross outperformance yearly versus our benchmark and a pair of) outperformance two out of three years. My aim is constant execution, fairly than swinging wildly at each pitch, with the acknowledgement that our long-term technique will inevitably encounter tough patches and should be measured over multi-year intervals. After a rocky 2019, I’m glad the partnership’s outcomes have matched my goals.
As well as, I’m pleased to welcome a handful of latest companions. Because of our development, whereas early within the course of, I’m trying so as to add extra assistance on the operations and investor relations aspect of our enterprise. If anybody has any suggestions, I’d love to listen to them.
As at all times, please be at liberty to contact me with any questions.
Sincerely,
Chris McIntyre
Footnotes(1) The Returns from January via August 2017 signify the efficiency outcomes of a private proprietary buying and selling account managed by the Founder with a technique just like the technique of the Fund. This info is introduced for illustrative functions solely, the above outcomes don’t replicate the precise outcomes of the Fund or the composition of its portfolio. From September 2017 onwards, returns are from the Fund. All internet returns are calculated utilizing a 1.5% administration payment, 20% incentive payment, and 5% onerous hurdle. |
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This presentation is just not a proposal to promote securities of any funding fund or a solicitation of presents to purchase any such securities. Securities of McIntyre Partnerships, LP (the “Fund” or “McIntyre Partnerships”) managed by McIntyre Capital Administration, LP (the “Funding Supervisor” or “McIntyre Capital”) are provided to chose buyers solely by the use of a whole providing memorandum and associated subscription supplies which include vital extra details about the phrases of an funding within the Fund (such paperwork, the “Providing Paperwork”). Any resolution to speculate should be based mostly solely upon the data set forth within the Providing paperwork, no matter any info buyers might have been in any other case furnished, together with this presentation. An funding in any technique, together with the technique described herein, entails a excessive diploma of danger. There isn’t any assure that the funding goal will likely be achieved. Previous efficiency of those methods is just not essentially indicative of future outcomes. There may be the potential of loss and all funding entails danger together with the lack of principal. Securities of the Fund are usually not registered with any regulatory authority, are provided pursuant to exemptions from such registration, and are topic to vital restrictions. The knowledge on this presentation was ready by McIntyre Capital GP, LLC, the final associate of the Fund (the “Common Companion”), and is believed by the Common Companion to be dependable and has been obtained from public sources believed to be dependable. Common Companion makes no illustration as to the accuracy or completeness of such info. Opinions, estimates and projections on this presentation represent the present judgment of Common Companion and are topic to alter with out discover. Any projections, forecasts and estimates contained on this presentation are essentially speculative in nature and are based mostly upon sure assumptions. It may be anticipated that some or all of such assumptions won’t materialize or will differ considerably from precise outcomes. Accordingly, any projections are solely estimates and precise outcomes will differ and will differ considerably from the projections or estimates proven. This presentation is just not meant as a suggestion to buy or promote any commodity or safety. The Common Companion has no obligation to replace, modify or amend this presentation or to in any other case notify a reader thereof within the occasion that any matter acknowledged herein, or any opinion, projection, forecast or estimate set forth herein, adjustments or subsequently turns into inaccurate. This presentation is strictly confidential and will not be reproduced or redistributed in entire or partly nor might its contents be disclosed to some other individual with out the specific consent of the Common Companion. |
Editor’s Notice: The abstract bullets for this text have been chosen by Looking for Alpha editors.
Editor’s Notice: This text covers a number of microcap shares. Please concentrate on the dangers related to these shares.