Q3 2023 180 Degree Capital Corp Earnings Call
Executive officer, and portfolio manager and I would like to welcome you to our call. This morning.
All participants are currently in a listen only mode. Following our prepared remarks, we will open the line to ask two questions if you'd like to ask a question. Please type star six on your phone or click the ask a question icon. If you are participating by your computer I would like to remind participants that this call is being recorded and that we are we will be referring to a slide deck that we've posted.
On our Investor Relations website at IR Dot 180 degree capital Dot Com under financial results.
Please turn to our Safe Harbor statement on slide two.
The presentation may contain statements forward looking nature relating to future events statements contained in this presentation that are forward looking statements are intended to be made pursuant to the safe Harbor provisions of the private Securities Litigation Reform Act of 1995. These forward looking statements are subject to inherent uncertainties in predicting future results and conditions. These statements.
It reflects the company's current beliefs and a number of important factors could cause actual results to differ materially from those expressed herein.
Please see the company's filings with the security and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the company's business that could affect the companys actual results, except as otherwise required by federal Securities laws 180 recap of Corp undertakes no obligation to update or revise these forward looking statements to reflect new events or uncertainties.
I would now like to turn the call over to Kevin. Thank you Daniel and good morning, everyone I want to leave you with a few key thoughts this morning.
Our business transformation is essentially complete after this past quarter, 97% of our assets are now in public companies.
While it took over six years to get to this point. It is over for those that are keeping track since I arrived in 180 came to be in 2017, we have generated nearly $3 per share or specifically $2 70, 777 cents and gains from our new strategy, we have had losses over the same period.
Time of $2 28.
From the historic legacy positions of Harrison Harris to be candid this business probably wouldn't exist. If we haven't changed our stripes in 2017 and while the last seven quarters have been a challenge for our public holdings the market and specifically the Microcap indices, we now have a liquid easily transparent balance sheet.
<unk> to be able to understand our AAV is easy to calculate.
Therefore, as we said from day, one the discount our stock trades at relative to our NAV should be far less than it was when our book was 80% privates to that end, we announced the discount management program that Daniel will speak to later in this call. It is important that the reality of our discount mirrored the thesis we had for it when we first.
Jordan.
To be clear the most important thing we can do is invest in companies that rise in value. So the absolute value over any declines there is a reason our stock traded at close to $9 per share at the end of 2021. It was because we grew our AAV to over $10 per share from where it was when we started.
While the last seven quarters have been a challenge for our holdings in the Microcap Index in General we believe this period has set us up to once again grow our niv as we look beyond this incredibly volatile and bearish market. In fact, we're going to use the rest of this call to show you an illustration for them why we believe this is the right time to be invested in micro caps.
And as a result turn.
You're going to show you a series of charts and data that highlight just how undervalued. We believe our investment universe is and therefore, how much upside. We believe there actually is for the companies that we own I think this is one of the better buying opportunities for what we do than at any time since I've been here. The rest of this call will offer the rationale for why I think.
That is the case for the topics that we normally discussed on these calls I recommend reviewing our shareholder call slides that are posted on our Investor Relations website I won't speak to every chart included in this presentation, but I'll speak to a bunch of them and encourage you to flip through the presentation that shareholder letter for a complete discussion.
On slide four just shows that the ratio of U S. Small cap performance to large cap performance is it at the lowest level in almost a quarter of a century and yet at the same time. This level of under performance is nothing about the fundamentals of the businesses that comprise each index given the fundamentals have actually held up better for many microcap.
Companies than the index performance would suggest.
On slide five this argues that not only have the stocks of smaller companies underperformed the relative price to earnings ratio are back to levels not seen since $2019 78, what's interesting about 1978 was that was also a time of inflation.
As has been the case in the last few years. The question for US as has the CPI peaked and are we at the end of the fed tightening cycle. The answer that we have for both of those questions is yes, and yes, I do know the CPI has gone from nine 1% to three 7% and perhaps like 1978, which was the bottom for <unk>.
Mark apps. This is the bottom for small caps today, because the CPI is long past peak you can review the CPI numbers. This morning, they were a little softer than expected.
Slide six shows that not only are our small cap value and small cap core equities. The cheapest segment of U S equities on a relative basis. It is also remarkable that these two categories are the only ones that are below their 20 year 25 year average valuation every other index in this chart.
March shows that those indices traded premiums to their 25 year averages, but small caps.
Slide seven shows that small caps trade not only at a discount to the large cap peers of the discounts are incredibly high for example, the performance cap is 41% on a trailing fee 39% on price to book of 30% on price to sales. This is neither normal nor justified based on the App.
<unk> performance of the company's fundamentals.
Slide eight shows the historical returns of market indices at least in 2008, when the economy actually did meltdown most indices were down about the same amount.
Back in 2008, the S&P 500 index was down 37%. The NASDAQ composite index was down 40. The Russell 2000 Index was down 34, and the Russell Microcap Index was down 40, how is it that today the NASDAQ100 could be up 37%, while the Russell Microcap index is downturn.
The S&P 500 would be 3% from its all time high with the Russell Microcap index was down 38% and the Russell.
Microcap growth index is down 49% from the high.
While we understand the bearish effect of today's world of higher interest rates and a set of significantly greater effect on small caps relative to the 2008 economic environment, where nearly one trillion dollars of losses occurred from categories of loans and related securities issued in the United States secured primarily by residential real.
Dave 2008 was an economic Pearl Harbor as Warren Buffett said at 2023 is not the same economic calamity the disparity in performance between the size of companies is the widest it has ever been and it makes no sense to us this is not 2008.
Skipping ahead to slide 10, the above chart depicts bearish sentiment other problems in the world. Yes. There clearly are a number of pressing issues higher interest rates a war and a crane now award in the Middle East inflationary pressures, there's many concerns but bottoms in stock markets nearly always occur when bearishness says.
Is at its highest levels in the opposite of course is true of Pops in markets. We are near the high end of bearish sentiment as depicted in this chart.
Skipping ahead to slide 13. This shows the historical P/e ratios of the Russell 2000, and it isn't only about relative valuations of one asset size to the next the above chart for voice investment partners shows that the actual P. For the Russell 2000 has gone down measurably over the last few years.
Now one would expect that higher interest rates would lead to lower p/e multiples, but the multiples are now lower than the long term growth rates, arguing for an inexpensive asset class. Additionally, given we believe that the fed is likely near the end of its interest rate hiking cycle. It is possible that rates have hit or a close.
The hitting a peak and therefore are multiples should be close to or at a trough.
Referring back to my prior comments, while one would expect multiples to be given lower to be lower given interest rates are higher why is it that the only small cap unit. What why is it that the only indices. The small cap universe has lower multiples why every other asset size company has higher multiples.
Based on its 25 year average that is completely incongruent.
Slide 16 shows flows in different Etfs for 2023 never underestimate the effect of flows of Investor capital on the value of public market assets, especially equities as you can see above there was $5 $1 billion of inflows into the Ishares core S&P 500.
Third ETF and the Vanguard S&P 500, ETF, while at the same time, there was a combined outflow of a $1 billion from small cap funds in the case of the Russell 2000 value ETF. The outflow has been a staggering 11, 4% of the entire asset base. There is almost no.
And that the price dislocation that we've seen in the small cap universe is a direct result of indiscriminate selling by Etfs and other funds facing redemptions again. This trend is normal for equity market bottoms and knit tops.
Slide 17 shows U S indices returns by size and in this chart you can see the effects of the outflows on specific performance of stocks based on size through September 30th 2023, there is a historically large 3000 basis points disparity between small and.
Large industries I've, yet to see that in all my career of investing.
Slide 18, what is the most important excellent excellent.
Excellent Tory power, sorry about that over long term returns for an index. We have long stated that the price you pay for the business. We buy is a key factor in determining one's ultimate success in an investment if you buy a good business at the wrong time, you may lose money, if you buy a less than good company at the right time, you may make.
The bulk chart was published by Bank of America, and it shows that while valuations tend to be a poor short term timing indicator they do matter for longer term returns.
Note that this chart represents the relationship between the relative P/e for the Russell 2000 versus the Russell 1000, and subsequent rolling return differentials simply put valuation has the highest explanation power over long term returns and we know today that small caps or historically.
They are using that metric.
And finally on slide 20, the above chart above and commentary below was again attributed to Royce investment part partners I Love any statistic, which has a 100% success rate and this one does small caps historical return pattern showed that below average return periods have been followed by those with above average.
Return periods with a much lower than average frequency of negative return periods, specifically the Russell 2000 had positive annualized three year returns are 100% of the time that is an all 86 periods, averaging an impressive 17, 5% following five year periods of less than.
5% annualized returns at the same time five year returns had positive annual returns of 100% of the time that is an all 81 periods, averaging 14, 9%. So while the future may be different in the past it's hard to ignore this trend given its accuracy today.
We can debate opinions, but we can't debate fax every chart depicted above shows historically low valuations as significant underperformance was small cap stocks. While we are very comfortable with our view that our stocks have discounted a lot of bad news that quite simply has not occurred in 2023, maybe the newer.
Will come next year and maybe they won't.
Either way, we expect the management teams of the companies we own to adapt to whatever environment. We're in and we will use our collaborative and collegial activism, if need be in an effort to unlock value for all our stakeholders. We are not naive enough to not be aware that there are bear cases for why small cap companies will underperform for the next decade.
I am sure there are a myriad of investors who have charged the bolster their bearish thesis I've often told you that the price you pay for the visit Dubai is the first one key factor in determining whether or not you'll be ultimately successful in that particular investment it would be an understatement at this point to say that we may that we own many companies who.
Prices and valuations, we believe materially understate the true values of those businesses. The starting point is price and we believe the price is right for the potential for material upside in our portfolio.
Do you believe I'm right you should own turn them your portfolio. If you don't then you shouldn't.
I currently own 680000 shares and Daniel currently owns 229000 shares you can certainly expect that our ownership levels will continue to grow in the future through open market purchases one day I hope to be able to reference this call is the bottom.
As always thank you for your support and I'll now turn the call over to Daniel Thank you Kevin.
Please turn to slide 22.
While many of 180 degrees pour current portfolio companies, who have generally been swept up in the recent vicious market selling particularly for Microcap companies, we do not believe the businesses and the balance sheets of many of these holdings reflect the distress that they are falling stock prices indicate this slide provides examples of some recent announcements from our portfolio.
Companies that show that clearly show and our view is that these companies are continuing to execute on their business plans.
And we believe are set up well for value creation for shareholders, including 180 <unk> capital for example, Potbelly announced a new shop development agreement for 36 shops in for re franchise shops that brings its new contracted franchise shops to 150, and also announced a record average unit volumes and continued growth in shop level margins and gain in March.
Sure.
Synchrony has sold its noncore assets and now as a pure play cloud service company that is currently expected to generate material positive free cash flow and 25% EBITDA margins in 'twenty four.
Arena agree have signed a definitive agreement to merge with bridge media company owned by the founder and owner of five hour energy that will result in a combined company with 100 are owned and affiliated stations and over the top partnerships across 46 states.
The assets that arena brings to the combination.
<unk> is in the final stages of certification for its new trio tool with its partner Corning Plantronics announced that its beginning volume production of its smart meter project for grids for Ts Marino.
Is expected to drive, 30% plus organic growth and material profitability in 2024.
In summary, these are all positive news for each of these companies.
While our performance has been challenged over the past seven quarters. After five years of strong performance the notes above or just a portion of the reasons. We believe our portfolio is positioned well for the creation of value for shareholders in 'twenty four and beyond we will use this period to rack that ramp to ramp up our collegial and constructive activism.
We are keenly aware that hope is not a strategy activism is.
As Kevin noted earlier in this call and we announced in a press release yesterday <unk> Board has initiated the discount management program with an initial two measurement periods beginning January one 224 to the end of 'twenty four.
In January one 'twenty five to June to June 30. After 25 showed a 180 or your capital's common stock traded an average daily discount to NAV of more than the current average trading discount of other equity closed end funds, which is about 12%.
Either of these measurement periods and 180 degrees for it we'll consider all available options, including but not limited to significant expansion of our buyback program.
We're wanting any repurchases stock through open market trends cash distributions in the forms of dividends or returns of capital depending on in your gains were a tender offer where shareholders will be able to decide if they wanted to sell a portion of their holdings back to 180 <unk> at a price per share that is set by 184.
To be clear any decision regarding actions taken at the end of each measurement period. As a result of this program remains with 180 degree Capital's board.
It has not been made today, we believe that the existence of the program and its associated measurement periods demonstrates the continued focus of both 180, <unk> Board and management team I'm, taking active steps to minimize any persistent discount and 180 share price in the future. One eighties board may or may not determined to extend the program beyond June 25.
These measurement periods as Kevin mentioned, we fully expect the management will continue to purchase <unk> stock in the open market.
To be clear and reiterate what Kevin said the most important thing we can do is find investments to materially increase value. So that NAV. There is as a result nab increases from its current values.
We believe that we will have the most impact that will have the most impactful factor positive factor in <unk> stock price and returns for our shareholders. Lastly, I would like to note that we included the sides. We normally present in these calls in an appendix at the end of the slide deck on our website, we're not going to discuss them on today's call, but we'd happy to answer any questions on them anytime.
We would now like to open the line for questions. If you have a question. Please press star six on your phone or click the ask a question icon. If you are participating by a computer.
We will give a second for the queue to fill with any questions that there are.
Yeah.
Hi, Oliver Please go ahead.
Okay.
Oliver.
Okay.
Okay. So I will move to our next question.
Hi, Denis Please go ahead.
Dennis If your line is on mute you may have to turn it off of mute.
Sorry.
Since there's been a large decrease in the value of AG biome in a short period of time could you. Please just go over what happened there.
Yeah Dennis.
It's Dan I'll be happy to provide some additional detail.
As you know the venture industry is.
And somewhat disarray, especially with follow up financings with later stage companies.
<unk> raised a significant amount of capital in there.
We've as 'twenty, one or 'twenty.
And.
They have a business that requires a substantial amount of capital to continue operations.
They embarked on.
Concerted effort with a bank to raise capital and thus far that has not been successful there were indications that they in mid year that they were making progress on that effort. We did actually the valuation has come down significantly since the beginning of the year, reflecting both status.
Their business as well as the financing environment and recently they also put out a press release, our debt and cap rate at least for that do a government filing regarding the potential as they may need to downsize and so our valuation reflects the risks that the company now faces.
In light of not being able to raise capital at this time.
So I would add that.
You know this is exactly why we are not in that business anymore.
We were too small we didn't have scale, we had no controlling stakes, we couldnt control outcomes.
And as a result, what you've seen.
Since basically I came out of retirement to do this with Daniel is that we've we've had over $20 million worth of losses in that portfolio since I agree since we arrived.
Because we can affect outcomes.
And.
What you get in this kind of environment is when companies need to raise money and you're trying to raise money in this kind of environment.
The valuations can get squeezed.
So you know.
I hate to beat a dead horse on this topic.
Because.
No I'm not I don't believe in.
In and constantly harping on the same thing over and over and over again, but it is true.
Not sure we would be here today, if we didn't change our stripes.
Because we would have run out of cash and be forced to liquidate many of these holdings.
At prices that would have ended up unfortunately, resulting in potentially turn start going away.
Harris <unk> Harris start going away. So it's been a struggle to get to this point.
We've never been able to make appropriate investment decisions or strategic decisions really until now because now 90% <unk>, 7% of our assets are in the strategy and then public companies that we can control.
We have permanent capital so in a year like to leave this year, while theres liquidations and people selling and tax loss selling we don't have to sell.
And so.
I'm not happy that we got to the end of our transformation with that volume getting written down this quarter, but it is what it is I signed up for this when I got here in 2017, and it's over now I don't have to worry about it anymore.
Because like I said, 97% of the assets or in a public company. So we have other things to worry about but the private portfolio is not one of those anymore.
Thanks Daniel.
Youre welcome anything else.
Okay.
And again, if you have a question. Please type star six on your phone.
Hi, Jack go ahead.
Hey, Good morning can you hear me.
Yes.
Tape.
Yes.
I appreciate the conviction in the strategy and the cheapness of the <unk>.
Asset class. So I guess my question is.
What if anything is the board doing.
Are you guys doing to help with the scale problem.
I see.
Now we have 5% risk free you got a 5% expense ratio.
You don't include these bonuses.
And that's I mean, that's that's.
That's a big hurdle.
Even if this asset class in Europe performance.
Turns up so I'm curious.
Is the board looking at trying to find partners to merge into.
The possibility of a rights issue or anything else, where you guys can actually act on that conviction.
Shareholder benefit because this hurdle seems seems very high for you guys declared.
Okay.
So I think you know that one if you don't when we first got here, we meaningfully cut our expenses overnight.
We moved that in Manhattan.
We left a lot of people go.
I don't have an administrative assistant our teeny budget got cut by 95%.
We've done everything that we can do.
On an absolute level to reduce our expenses and the ratio now is to your point.
Is it dependent upon our ultimate level of assets.
So a year ago.
The ratio that you referenced was half of what it is.
Because we had more assets. So as you would as you would think and.
And we just had a board meeting last week the <unk>.
<unk> is actively engaged in.
Discussing with management ways to increase our assets, whether that's our ability to fund raise on the outside which we've done as you know we had a.
One gigantic pension fund that we managed.
That unfortunately has been redeeming because rates have gone from basically zero to 5%. So their asset allocation strategies change. So what I think the peak, Daniel we had maybe 35 or $40 million $40 million in outside capital.
They decided that they no longer wanted on equities.
There is nothing we can do about that so we're always looking for ways to raise capital.
And we will continue to do that.
And from a strategic perspective, we're a public company if somebody wants to own us.
Certainly.
Give us a call.
You know we're shareholder friendly.
We can certainly entertain merging with anybody to gain a greater.
But remember a lot of those transactions have to be done at MTV because of.
<unk> 40 act funds require that other other than.
They have to get a shareholder vote.
So those.
Mergers between closed end funds historically bdcs have been few.
And far between Daniel would you, yes, I mean, they are not.
Very they don't happen extraordinarily often because of all the hurdles that Kevin mentioned and the fact that most almost all of them trade at some level of discount. They can vary transactions would have to take place at NAV.
And then you also have the issues that.
A lot of the externally managed to closed end funds, we've actually reached out to us on the externally managed closed end funds because they only for internal can manage and we've reached out to some of the smaller ones to see if there is an interest in maybe doing something and there is very little.
There's very little inertia for those funds and those managers to give up that management fee.
And so.
Those conversations really haven't gone anywhere, but we continue to explore a variety of different options.
Yes.
So.
We're shareholder friendly around here I mean, I don't own 700000 shares for.
So not create some cannot.
Cannot create value I will say that.
Despite the fact that in the last.
Our first five years. Despite the fact that we had almost $3 a share and losses from our private portfolio, we more than doubled our equity price. So it's not like we cant do that again, we can.
And now we don't have we don't have the headwind that we had seven years ago, because our portfolio is all public companies at what we think are ridiculous prices. So our ability to meaningfully generate a return for our shareholders. In the next three years is higher today than it was.
Seven years ago.
But you can expect our board to be actively engaged in all.
Discussions around how to create value, whether that's an organic growth or organic growth.
Alright, thanks for the color guys I appreciate it.
Thanks Mac.
Hi, David Please go ahead.
Hi, Dan.
Can you can you help us understand.
The discount management program, how will actually works is it.
Each quarter and then you judge.
How far the discounting is and then what are you likely to actually do.
Yeah. Thanks, Dan.
So the way that we've designed it is really looking over a period. The first period would be 24, and I think historically if you look at 181 of the big problems was that you didn't have you had all these privately held investments that were really hard to understand and and you had fair values.
You didn't know where they moved on a daily basis in.
You didn't have a reference in the public markets and so.
And also you Didnt have liquidity right that you can count on from those to be able to take any type of action that we're talking about so we are now in a position from an asset base that we've never been in before and so it'll be interesting to see how the discount for form is during that period and so we will be.
Looking actively at that on a daily basis.
Over the next year through the end of next year and then at that point the board will determine what the steps are.
The first steps will be to address that is kind of it's greater than 12%.
The reason that the board Didnt lock in on something right. Now is because for example, if you were to say we plan to tender at the end of a discount management program from the point when you say that to the point when you actually do the tender you.
The company is not allowed to buy back stock, but even worse and in our view is that management.
It is not allowed to buy stock in the open market.
Yes.
Basically restrict the management from which I think is shareholder friendly from being able to buy stock in the open market and show their support and continue to increase their holdings of the company given we cannot issue equity as compensation there were not allowed to under the 40 Act.
That didn't seem appropriate and then also if you said all we're going to do a dividend or a distribution well. The issue. There is is that depending on where we're at in the year in terms of gains or losses. If we were in a gain position then that return of cat that distribution could be a dividend rather than a.
Return of capital and it also depends on if we're a.
If we're.
Rick or not Greg.
And so that's been a company for tax purposes, or if we end up being taxed as a C corp. So theres a lot of complexities in there to lock in what will happen at the end of the pro at the end of the first measurement period, but I think you can be confident that.
Everyone is aligned to have the discount be as narrow as possible and to generate as much value for shareholders as possible cabinet somebody on AD. So one we've got to find it.
Just like we've done for the first seven years not withstanding the last seven quarters fine companies, whose stock prices materially rise our LTV will rise on an absolute basis. Most important thing we can do that.
<unk> said it in 27 quarters of me being here that the discount should be narrower or if you've got more liquid public transparent.
LNG of public companies versus what we had when we got here and if that's not the case in a year.
Then we need to take action on the discount but again that's just.
And if people want to potentially think we're gonna.
Tender at a 5% discount or something like that then they can orbit and the discount is going to narrow between now and then and we're serious about creating value for our shareholders on an absolute basis and we're also serious about the discount.
We're serious about both.
And so we'll make sure that in a year's time, we'll we'll look at it.
And see if my thesis is right.
The words, we should trade at a narrow discount because everyone understands what our NAV is on a regular basis versus what they thought they thought the NAV was before.
Then what anybody could have valued our private we I mean, we valued our private properly, but I think it was hard for investors to really understood stand what we owned so we'll look at it in a year and then we'll look at it six months from now and we are serious about it.
That's helpful. Thanks, a lot.
Thanks, Dan.
I think that is the end of the call.
So thanks as I said earlier this we did it a little different way of doing this call where.
You can look at the appendix at the end of our presentation to get a full understanding for the quarter.
We do think this is a unique time in the marketplace for what we're what we do for living both in terms of the indices and the names that we own to Daniel's point about hope is not a strategy, we are not going to sit around and hope for eventual outcomes I think you'll see over the next few weeks few months.
How we will engage with the companies that we own.
Hopefully create value for their shares and as a result create value return shares. So look forward to speaking with you. When we report Q4, we wish you nothing but the best.
Investing for the next month and a half and we'll speak to you in a few months.
Of course, if anybody has any questions that they wanted to discuss it right about this quarter. The program that we announced this morning feel free to reach out.
Thank you all very much you can now disconnect.
Okay.
Goodbye.