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The best hedge fund that you've never heard of and how to profit from watching it



July 15, 2014 – Comments (15) | RELATED TICKERS: NOV , DNOW , CBI

In industry lingo it's called "Whale Watching."  The term essentially means looking at the portfolio moves that are being made by so called super investors, a group that is comprised of mostly hedge fund managers that have posted an impressive track record of market-beating returns.  Anyone who engages in this activity seems to have a favorite, for many it's the big names like David Einhorn or Bill Ackman.  Me personally, I like to follow the moves by someone that you may have never heard of before...Kevin Byun.  Who you ask?  He is the manager of the special situations-oriented Denali Investors, a fund that has returned nearly 34% year-to-date after posting a 66% return in 2013.  Since inception Danali has beaten the S&P 500 115% to 37%

For people who are as into special situation investing as I am, Denali Investors' quarterly letters are the equivalent of Warren Buffet's annual letters to shareholders.  I literally cheer when I see that it is available.  They're well-written and choc full of interesting investment ideas, almost all of which have some sort of specific catalyst that will unlock value in what is believed to be a significantly undervalued stock.

Denali Investors' quarterly letter was published yesterday and it didn't disappoint:

Denali Investors - Second Quarter 2014 Investor Letter

Interestingly, it seems as though there is an increasing level of overlap between Denali's portfolio and my own.  This gives me some excellent confirmation bias :).  Last quarter I already owned the Dover (DOV) spinoff Knowles (KN) and Rayonier (RYN) before he spoke about them in is quarterly letter.  This quarter I already own another of the three stocks that he profiles, National-Oilwell Varco (NOV), NOW (DNOW) and Chicago Bridge and Iron (CBI).

Denali said following about NOV and DNOW:

"National-Oilwell Varco, Inc. (NYSE:NOV) – We first identified NOV as a potentially interestingname in Q3 2013 when the company announced plans to spinoff its DistributionNOW (DNOW) business. We established our position in Q1 2014 ahead of the spinoff expected to occur in Q2 2014. The spinoff was completed in early June 2014.

New NOV provides equipment, components and services used in oil and gas drilling and production industry. New NOV will reorganize its two remaining segments, Rig Technology and Petroleum Services, into four reporting segments: 1) Rig Systems, 2) Rig Aftermarket, 3) Completion & Production Solutions, and 4) Wellbore Technologies. New NOV will be able to highlight the significantly higher margin profile and substantial FCF of its core business. It should be rewarded with the higher valuations of similar margin competitors. We expect more dividend increases (dividend was doubled in Q2 2013 and nearly doubled again in Q2 2014) and continued accretive acquisitions. We believed New NOV would be worth more without DNOW obscuring the value of the core business.

NOW Inc (NYSE:DNOW) provides the supply chain management, distribution and transmission of maintenance, repair and operating supplies and spare parts to drill site and production locations worldwide. DNOW is now the second largest for the energy industry. It is similar to an Autozone for the energy industry but operates in an industry that remains highly fragmented. DNOW’s current industry structure is similar to Autozone’s before its consolidation phase as well as that of New NOV itself before its own consolidation phase. At the risk of history repeating itself, DNOW’s industry is ripe for consolidation and we believe DNOW will be the company to do it.

Unlike most spinoffs, DNOW will begin with a favorable net cash position and a $1b revolver to help fund future acquisitions. Interestingly, the highly regarded NOV Chairman & CEO is moving to DNOW. The management has a long track record of structuring favorable deals and seemed deliberately quiet about the spinoff prospects. At our cost basis, we believed that DNOW was being created for free and that New NOV was priced at a substantial discount. This has turned out to be the case...."

No it doesn't build bridges and it isn't based in Chicago, but Chicago Bridge & Iron (CBI) is an interesting investment at this level after the shorts took it down 20% or so, accusing the company of accounting misdeeds. I was already very familiar with CBI after owning it and doing a write-up on it back in 2008 (It’s not a bridge builder from Chicago, but it is an excellent investment opportunity).  Right after the recent dip in the stock happened I personally established a position in CBI in my real portfolio and here in CAPS. Here's what Denali had to say about CBI:

"Chicago Bridge & Iron Company N.V. (NYSE:CBI) – We first identified CBI as a potentially interesting name inlate Q2 2014 when a short selling focused research firm released a detailed white paper that triggered a 20% price drop over a short period. CBI is familiar to our partners due to our investment in Shaw Group (SHAW), which was purchased by CBI in 2012. We initiated our position in SHAW in 2011 when it traded at a 0x EV/EBITDA multiple and first analyzed CBI during that period. Upon the merger announcement, we conducted a thorough analysis and believed that the deal terms substantially undervalued SHAW and would be disproportionately beneficial to CBI.

Our extensive analysis regarding SHAW and the CBI merger can be found here: Letter to Board December 2011, Letter to Board August 2012, Press Release September 2012, Press Release October 2012, and Main Presentation – Demanding Fair Value October 2012.

The current short thesis centers on the Purchase Price Allocation (PPA) and Goodwill (GW) adjustments as well as recent reduction in cash flow (CFO) metrics. Our conclusions differ regarding the severity of the PPA/GW/CFO implications and consequences, as well as the ultimate valuation. The next material catalyst will occur in the near term during the upcoming earnings call this month, which will provide management with an opportunity to address the issues."

Besides interesting stock ideas, perhaps the biggest thing that I have taken away from keeping an eye on Denali is the importance of allocating money to your best ideas.  Denali has absolutely crushed the market by knowing which stocks are its best ideas and loading up on them.  This is something that I have been working on lately.  As you can see by my 200 stock CAPS portfolio, I come across a lot of interesting investment ideas in all of the reading that I do.  I have been working in my real-life portfolio to sell off stocks that are "good" ideas, and reallocating those funds to "great" ideas.  The key to super-sized returns is to know which ones tomake asignificant part of your portfolio so when the catalyst that you were looking for does happen it has a meaningful impact upon your portfolio.


15 Comments – Post Your Own

#1) On July 15, 2014 at 11:44 AM, boozalex (< 20) wrote:

Loved the letter, myself.  

Along the same lines, so what are your "best" ideas now?

What are you getting rid of? 

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#2) On July 15, 2014 at 3:33 PM, TMFDeej (97.76) wrote:

Hey boozalex.  I've been selling a basket of demutualizations that I put together as an experiment.  Not all of them, I've kept a few such as FFNW, TFSL, EBSB.  I also sold STAG.  I like the company, but they were like watching paint dry so I replaced them with "better" stocks that I believe have near-term catalysts, including CBI, EXETF, NCT and until recently RYAM.


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#3) On July 15, 2014 at 4:08 PM, boozalex (< 20) wrote:

Thanks Jason.  I bought CBI today.  

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#4) On July 16, 2014 at 2:04 PM, cavrad (< 20) wrote:


Have you read the bear case for DNOW on VIC?  The author is claiming it is overvalued based on fundamentals...




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#5) On July 16, 2014 at 2:58 PM, TMFDeej (97.76) wrote:

Thanks for sharing David.  I'm headed over there to read it right now.  I certainly wouldn't be short DNOW and bet against NOV's former management building a distribution powerhouse.


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#6) On July 16, 2014 at 3:00 PM, boozalex (< 20) wrote:

Could someone summarize the bear case presented for DNOW?

Added to NRF today.   

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#7) On July 16, 2014 at 3:22 PM, TMFDeej (97.76) wrote:

No offense to "snarfy" but he built a pretty weak short case.  If DNOW is the most overvalued stock that he can find to short in this market then he's not looking very hard.  He argues that a multiple of 16x 2015 and 13x 2016 earnings is way too expensive and that a multiple of 10x is more appropriate.  Has he been looking around?  The comp that the author used, MDC is trading at nearly 22x current earnings.

He also assumes that we are at a peak for the oil market and demand for DNOW's services.  I personally find that to be highly unlikely.  Trying to time a commodity cycle is a tricky game.  Furthermore, the author completely ignores the fact that DNOW services other sub-segments of the energy sector besides drilling, such as mid-stream and refining.

In fact, one could argue that a temporary slowdown in drilling could actually be a good thing for DNOW shareholders who don't freak out and sell because it would enable the company to use its immaculate balance sheet to implement its growth strategy buy buying out competitors at lower prices.

Apart from nitpicking all of the financials here, the thesis behind buying DNOW is that as an independent company it will be able to improve margins and grow rapidly and it has management that has proven to be extremely capible in the past at the helm.  The current valuation isn't that bad and the metrics don't even paint nearly as rosy a picture as what I believe will come to fruition.


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#8) On July 16, 2014 at 3:51 PM, cavrad (< 20) wrote:

Thanks for taking the time to read the write-up.  I actually agree with you and I'm long DNOW.

 David, aka cavrad, aka "not snarfy" 

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#9) On July 17, 2014 at 11:17 AM, boozalex (< 20) wrote:


 I think LXU at $35 is a good deal.  Especially with Starboard on the board.  

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#10) On July 17, 2014 at 12:54 PM, TMFDeej (97.76) wrote:

Hey boozalex.  I remember that you were looking at it.  As I mentioned I have an initial position in it.  It does look very cheap at this level.  It's gotten pretty beaten up in July.  I may end up adding to my position at some point, especially if it continues to drop.  I think that there is a very good chance that Starboard unlocks value here.  Activists are having a ton of success lately.  Look at what ValueAct did with DRC today.


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#11) On July 17, 2014 at 1:18 PM, boozalex (< 20) wrote:

Thanks.  Don't recall ever seeing DRC.  

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#12) On July 18, 2014 at 12:52 PM, boozalex (< 20) wrote:

Does Denali have to file with SEC?  Or are they too small? Wanted to see their 13-F.

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#13) On July 21, 2014 at 12:26 PM, boozalex (< 20) wrote:

Are you surprised to see a dividend announcement by RYAM today?  Thought they would be more focused to re-invest back in the business.

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#14) On July 21, 2014 at 8:55 PM, TMFDeej (97.76) wrote:

Not really. The dividend is really tiny and I think that they mentioned it previously. The best thing about RYAM is that it has already spent the money that it needs to grow. The market just needs to catch up with its excess capacity. 

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#15) On July 25, 2014 at 10:24 AM, boozalex (< 20) wrote:


You see any news out on CBI?  Thought the earnings were solid.


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