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