jebmo’s posthaven

Feature interview

Angry Uptick is a special situations-focused value investor. We emailed with Angry Uptick about the importance of knowing what you own, the value of active strategies and how headline risk creates opportunities.

Seeking Alpha: How do you define - and find - a special situation? Can you give an example or two of a special situation idea that played out?

Angry Uptick: I think of a special situation as an investment opportunity where there are non-fundamental factors that help misprice a security in our favour. If we take a step back, I consider myself a value investor. Like many value investors who read the famous book The Intelligent Investor by Benjamin Graham, I subscribe to the notion that a business has a certain (range of) intrinsic value and the market is manic/depressive. Therefore, there are times when a business could be significantly undervalued/overvalued because of the wild swings in an auction-driven market. What The Intelligent Investor does not address, however, is why a security can be severely mispriced. In other words, many of us can have a seemingly insightful investment thesis on a security, but the toughest question to ask yourself is: "Am I the only one in the market place that has this unique proprietary information and analysis, or is there some other reason the security is mispriced?" I would say the majority of the time it is very difficult to honestly say one's analysis is truly unique and unknown to the market. Instead, it is critical to understand factors leading to why the investment opportunity exists - which is also why my favourite investment book of all time is Joel Greenblatt's "You Can Be a Stock Market Genius". The book explicitly answers the question of why securities can be significantly mispriced in situations where there are forced sellers (or buyers) associated with a spin-off, restructuring, merger, index inclusion/exclusion, etc. Over time, I started adding other special situations to my toolkit, such as when income-oriented securities cut (or expect to cut) dividends/distributions, leading to a wave of forced selling by yield-oriented investors.

In terms of finding special situations, I do not have a set formula, but rather, am constantly "fishing" for them via: reading the news, using screeners, talking to other investors, naturally being attuned to some sectors I follow more closely and generally doing a lot of reading.

OCI Partners (NYSE:OCIP) would be a special situation idea that played out quite well. As background, OCIP is a single methanol/ammonia plant MLP created to distribute income to unitholders. With operational challenges and low commodity prices, OCIP was forced to cut its distribution, leading to likely forced selling by income-oriented investors and a depressed unit price. What initially attracted my attention was the major shareholder of OCIP's parent company, OCI NV, began accumulating units - and shortly thereafter, OCI NV made a bid for OCIP. With concerns over the bid's fairness and unable to get OCI NV to raise its offer, the deal fell through, leading OCIP to drop to its pre-bid price - typical of how merger situations trade when the deal breaks. However, the market seemed to completely miss the fact that: 1) methanol prices recovered meaningfully since the bid; and 2) the takeover attempt was a very opportunistic one that likely undervalued OCIP. Interestingly, OCIP decided to buy more units at ~$8.4 in late 2017, which is a likely attempt to orchestrate a squeeze-out when its ownership reaches 90%.

SA: Many MLPs have attractive characteristics (e.g., fee-based contracts, high yield) - how do you determine which ones offer the greatest opportunity? What are red flags investors should look out for when analyzing MLPs?

AU: As background, MLPs were created as an attractive tax-advantaged vehicle with a high yield and fairly stable business attributes. As a special situations value investor, MLPs in general were of little interest to me until their business models were stressed by falling commodity prices, risks to fee-based contracts (i.e., take or pay) and/or an over levered balance sheet. When MLPs' distributions were cut, eliminated or perceived to be at risk, many MLPs traded at much lower valuations, sometimes driven by yield investors indiscriminately dumping the units. This is precisely when I get excited at the possibility of doing the homework and determining the value of the underlying business, whether or not a distribution is paid.

In terms of red flags, investors should be aware that MLPs are partnership structures where the entity may owe a lesser fiduciary duty to the investor and may have an inherent conflict of interest with the MLP's sponsor (i.e., general partner). Essentially, understanding the incentives of the MLP and GP is of paramount importance. Some clues would include: the GP's ownership level of the MLP, the structure of how distributions are split between the MLP and the GP (i.e., incentive distribution rights), the track record and character of the management team, etc.

SA: What do you think about Bitcoin (and Bitcoin-related stocks) following the steep decline - is this an attractive entry point for bulls who missed out on the ride up, or does it have further to fall? Is it possible to value Bitcoin, and if so, how?

AU: I really don't have much of a view on Bitcoin or the other cryptocurrencies. I wrote the SBI Group article because it is a very interesting special situation where there is a lot of upside if the Ripple company and the XRP coins are worth anywhere near what XRP is trading at. And since one is not paying up for this option, the downside is also much less than buying XRP outright.

Theoretically, it is possible to value Bitcoin. If it were truly a currency on par with the global reserve currency, the U.S. dollar, then each Bitcoin would be worth ~$824,000. The theoretical calculation is simple. There is about $13.9 trillion in U.S. M2 money supply, versus 16.8 million supply of Bitcoin. Divide one by the other and you get ~$824,000. The chances, or degree, to which Bitcoin can function as a global reserve currency obviously is up for debate (store of value? medium of exchange? etc.) My guess is Bitcoin falls short in some of these aspects.

SA: What was - and was not - surprising to you about the sell-off last week? What are the key lessons learned?

AU: Well, it is surprising to the extent it couldn't have been predicted, and many are still trying to find an exact reason that caused it. I think the key lessons are twofold: 1) be at least somewhat cognizant of macroeconomic development and trends as an investor - it was not hard to see the S&P 500 had a decade bull run and the volatility index was running quite low; and 2) it is important to know what you own so that when a sell-off materializes, there is a game plan to hold, sell or buy.

SA: To follow up, does the sell-off and increased volatility put a pin in the idea that hedge funds are dead and everyone will index?

AU: At the very least, it should highlight the value of active strategies and the dangers of blindly investing in passive assets. Knowing what you own is very important, as highlighted by the fact that everyone rushed to check the prospectus of XIV, only to find out the ETN can be terminated after a certain % change in value. Further, indexing has its purposes, but I believe the pendulum has swung too far. When indexing is popular, it is really creating a momentum (rather than a passive) strategy where larger market capitalization names get more and more fund flows driving performance. A potentially dangerous "special situation" (to the extent it is driven by non-fundamental factors), so to speak.

SA: Are there any stocks mispriced due to unjustified “headline risk” - either because of a famous investor announcing their long or short position in it, or the media taking sides? Your bullish thesis on DaVita (NYSE:DVA) is a great case in point.

AU: I think paying attention to headline risk (to the extent it's overblown) is just an extension of finding non-fundamental factors that could help misprice securities. Yes, DaVita is a good example where headlines have already been particularly poor since the unraveling of Valeant (NYSE:VRX). On top of that, you had short-sellers and the media portraying DVA as ripping off private insurers. Those willing to do the work would realize: 1) the private insurers are only on the hook for high treatment costs for a short period of time, and 2) DVA implicitly discloses its revenue and cost per treatment, which is nowhere as egregious as suggested by the media.

SA: What’s one of your highest-conviction ideas right now?

AU: North American Energy Partners (NYSE:NOA) is one of my highest-conviction ideas right now. Speaking of headline risk, the immediate valuation discount NOA suffers from is its perception that it is an oil sands construction services company. With the downturn in energy and limited new oil sands projects sanctioned in Alberta, Canada, I believe the market is missing the amount of work NOA does in terms of oil sands opex and maintenance work. In addition, they've secured construction work for various mining operations as well. The perception has gotten so bad the company announced recently it will change its name from North American Energy Partners to North American Construction Group! Of course, the fundamentals are appealing too, trading at a low forward EV/EBITDA multiple of 4x, with meaningful insider ownership and a CEO that has de-levered its balance sheet and bought back shares right through the energy downturn. I hope to write this idea up for readers in the near future.

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Thanks to Angry Uptick for the interview. If you'd like to check out or follow their work, you can find the profile here.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Check with individual articles or authors mentioned for their positions. Angry Uptick is long NOA, SBI Holdings (8473 JP), DVA.