SCC Q1 2020 Portfolio Update
The following is an update on Q1 earnings and other news for SCC's top-4 equity positions (PSHZF, SDI, MACK & CCUR), which currently constitute just over half of the value of the overall portfolio:
Pershing Square Holdings (PSHZF), 26% position: Up 22% on the year as of Friday's close, PSHZF is not only the largest, but has also been the 3rd-best performing, position in the SCC portfolio. YTD through 5/26, PSHZF's NAV had increased nearly 27% due mainly to portfolio manager Ackman's brilliant late February / early March CDS trade, which turned $27MM in premium payments into $2.6B in profits in approximately 2.5 weeks (see PSHZF's explanation of the trade here). This translates into a CAGR of something on the order of 190,000%(!) Rather than trying summarize PSHZF's portfolio's Q1 performance in this blog post, investors can check out the transcript of Pershing's recent conference call here. Below are the most recent NAV statistics:
Standard Diversified (SDI), 13% position: Down 13% on the year thus far, SDI was originally bought to obtain a derivative interest in Turning Point Brands (TPB) at a discount, since SDI owns approximately half of TPB's outstanding shares. It will shortly become a direct ownership interest in TPB, as each share of SDI's outstanding stock is expected to be exchanged for ~0.51 shares of TPB sometime next month at a valuation equal to 97% of TPB's prevailing market price (see PR announcing the merger here, as well as the preliminary merger proxy here). TPB, a leading U.S. provider of Other Tobacco Products and adult consumer alternatives, reported Q1 2020 earnings on April 28th (see full PR here):
Despite the coronavirus pandemic hitting the United States (TPB's sole market) with full force in March, and despite the fact that the momentum of its vaping operating segment had largely been stifled by government restrictions in Q3 & Q4 of 2019 owing to the supposed (mainly media-hyped) "vaping crisis", TPB's sales were only down 1% in Q1 2020 versus the prior year, an incredibly strong result for a consumer product company in such a challenging environment. Notably, due to the virus, the FDA has delayed the deadline for TPB and other manufacturers to submit their pre-marketing applications for e-cigarettes and similar devices until September 9, 2020. TPB expects to spend $15-18 million in total on this process, which hopefully should result in the approval of vaping products from TPB which are far safer from a public health perspective than traditional cigarettes (440,000 Americans die every year from tobacco exposure, mainly via cigarettes). Revenues at TPB have increased at a robust 13% CAGR (from $197MM to $362MM) over the past five years; if they receive FDA approval for multiple new products, one would expect TPB's growth to be super-charged going forward.
TPB projects the 2020 net sales to be $338 to $353 million and 2020 Adjusted EBITDA to be $69 to $75 million (with no upside assumed from the FDA's PMTA process in 2020), versus a current market cap of $469 million and EV of $637 million. Thus, TPB trades at the following forward multiples: EV/Revs = 1.85 (per company guidance); EV/EBITDA = 8.84 (same); and P/E = 12.7 (per single analyst estimate).
Merrimack Pharmaceuticals (MACK), 7% position: Up 5% during 2020 so far, MACK is a classic "discount to the sum-of-the-parts" play. It can be good to have one or more of these plays interspersed with one's general long holdings, since (theoretically, at least) investors should view them without regard to rises or falls in the overall market. With no debt and a cash runway which the company claims should last until 2027, and with underlying business operations at the company having basically ceased, MACK retains approximately $500MM of face value worth of contingent value rights (or CVRs) on its balance sheet, representing a maximum potential value to MACK holders of up to $37/share, compared to a recent stock price of $3.40. If the company fails to monetize the CVRs in the near term by selling them to a third party buyer, shareholders will likely have to wait 2 to 3 years for the underlying drug trials to read out in order to determine whether and how much the CVRs will pay out. Interestingly, insiders were buying fairly heavily in April (see here). According to MACK's 2020 proxy statement, however, the company has squandered literally millions of dollars of the shareholders' money on payouts to senior executives over the past 2 years (source):
This might explain why the voting results at last Thursday's annual meeting indicate that MACK investors appear to be increasingly fed up with the company's lack of progress in monetizing the CVRs (source):
The company has now reported five straight profitable quarters, including the most recent one (despite the virus), which is significant given CCUR's prior history of relentlessly losing money. In addition, on March 9, 2020, CCUR paid a special one-time cash dividend of $0.50 per share. CCUR shares remain depressed, trading at a 43% discount to the company's $6/share book value. Eventually, one would assume that investors will bid CCUR back up to book value, given management's demonstrated skill at generating high returns on the company's assets (not to mention their other shareholder-friendly actions, such as paying out the large special dividend).
Conclusion: Buy & Hold is the only realistic way a so-called "value investor" (aka fundamental investor) can outperform the market: Generally speaking, "buy & hold" investing seems quaint in an era dominated by algorithmic and day trading. However, the above portfolio report shows why Warren Buffett's "Never Sell" approach (for which, see further below) is, in fact, the best method to use for a skilled fundamentally-oriented individual (i.e., non-computer) investor to achieve alpha. First, if one never sells winning positions, one's portfolio inevitably becomes weighted more and more over time towards one's highest quality holdings, which is precisely the goal of investing (Rule #1: Never forget what one is trying to do in the first place, namely concentrate your net worth in truly great businesses). For example, at the start of 2020, PSHZF was the 3rd largest position in the SCC portfolio, with a 14% weighting. Due to adding to the position in March, as well as its subsequent share price increase, PSHZF now represents over 26% of the overall portfolio. Thus, despite PSHZF constituting only ~1/3rd of the aggregate amount of equities added during Q1, its weighting in the overall portfolio has nearly doubled (the cream rises to the top). Meanwhile, those portfolio holdings which are not increasing their intrinsic value gradually become a smaller and smaller part of the portfolio, since stock prices inevitably track intrinsic value. (For a real-life example of this phenomenon playing out, see a retrospective "what could have been" analysis of Whitney Tilson's YE2011 portfolio here).
The end result of this practice is (1) a portfolio dominated by the highest quality companies and (2) consequent outperformance versus the indexes as time goes on. The only events that can interrupt things are either (A) the portfolio manager selling, or "trimming", winning positions, usually for illogical reasons such as that they "have gone up too fast", are "overweighted" or "overbought", etc, or (B) large positions being bought out (although at least in this scenario, one should theoretically be fully compensated by the control premiums paid by the acquirers). Too much of a good thing can be wonderful. Second, the "buy and hold forever" strategy is far more tax efficient than a "trading and trimming" strategy. Under prevailing tax law, (i) taxes on capital gains are only due upon selling, which means that $1 in taxes paid twenty years from now is the equivalent of paying half of that amount in taxes today ($1 due in 20 years, discounted at the risk-free rate of 3.5%, is the equivalent of $0.50 today), (ii) deferring these taxes allows an investor to compound the deferred amounts over time at high rates of return (due to the inevitable high-grading of the portfolio described above), and (iii) long-term capital gains are taxed at a lower rate than short-term capital gains (0-20% for long-term versus the regular income rate, i.e., 10-37% at the federal level, for short-term, respectively). SO STOP TRADING, PEOPLE - ALL IT WILL DO IS MINIMIZE YOUR GAINS (BOTH BEFORE AND AFTER TAXES).
Postscript: Warren Buffett, on when to sell winning holdings (source)...
DISCLOSURE: Long all of the above.
