180 Degree Capital (TURN) is a closed-end investment fund listed on the Nasdaq with a Market Cap of $75 million that is trading at a roughly 30% discount to NAV, as of publication of the Q4 results on Feb 19 ’21.
Flying under the radar, the strong performance of its actively managed portfolio of small and micro-cap stocks has been masked by the weaker performance of an illiquid portfolio of legacy private assets that are being heavily discounted by Mr. Market. For the patient and margin-of-safety conscious investor this presents an opportunity to gain access to a skilled portfolio manager specializing in US small and micro-caps, paired with some free call-option like exposure to a basket of private-market Tech and Life Sciences companies.
Background
180 Capital was formerly an underperforming venture capital fund focused primarily on the Tech and Biotech startup sector. It was transformed in 2016 when the board fired the management and brought in a new manager by the name of Kevin Rendino, giving him the remit to completely change the fund’s strategy.
Before joining 180 Mr. Rendino had a successful 20-year track record of managing value-focused funds at Blackrock and Merrill Lynch. When he took over, the fund was restructured into a closed-end structure and the strategy changed to one focused on public market securities in the small and micro-cap space. Since 2016, the team at 180 have been searching out undervalued companies with quality management teams, and where appropriate will engage in constructive activism. They describe their approach to activism as ‘constructive, collegial, and collaborative’ and they are self proclaimed Graham and Dodd Value Investors.
Over the last few years they have gradually shifted the portfolio away from privately held companies by selling them and then reinvesting the proceeds into public markets. In the 4 years since this change of approach the portfolio balance has shifted from approx 25% public securities to 60% today. The majority of this shift has occurred through appreciation and outperformance of the public market investments. The gross total return of the Public Portfolio since inception in Q4 2016 is an impressive 251%, massively outperforming any of their benchmarks.
From Q4 2020 Investor Call Slides
Sadly, the picture painted by the Private Portfolio is less impressive and we can see from the slide how various write-downs over the last few years have been a drag on overall NAV growth, which has managed only a 32.2% increase. Whilst they have successfully exited some of their legacy private investments during this time, they have stated on numerous occasions that they are prepared to be patient and not sell any of these holdings for less than they deem them to be worth. Indeed, to date, they have actually managed to exit some of them at premiums to their carrying value, the most recent of which was Petra Pharma Corp in Q2 2020 which was sold for twice it’s most recent valuation.
The Public Portfolio covers a wide range of industries (with the notable exception of anything to do with Energy or Commodities) and is concentrated, with less than 15 holdings currently. Positions include
- Quantum Corp – a provider of offline secure data storage solutions for data centers.
- The Maven – a digital media, publishing, advertising and distribution platform
- Alta Equipment – a provider of industrial and construction equipment and related services.
- Sonmin Technologies – provides ultra-rugged mobile phones and accessories designed specifically for task workers physically engaged in their work environments.
- Synacor – a digital technology company, providing email and collaboration software, cloud-based identity management platforms, managed web and mobile portals, and advertising solutions in the United States and internationally
- Lantronix – a global provider of secure data access and management solutions for IoT assets.
- Potbelly – a well-known sandwich and casual dining chain found primarily in the Eastern US States.
As of 02/19/21, 180’s Total NAV was $10.55/share of which $3.73 related to the Private Portfolio. The biggest position in the Private Portfolio is AgBiome, accounting for roughly $0.43 of NAV/share.. AgBiome is an Agriculture Technology Company that has developed a database of over 70,000 soil microbe genomes and bought to market various products, such as fungicides that use plant and soil genomes that cause less environmental damage than traditional chemical-based products. This is a potentially high growth industry as the world looks for more efficient and environmentally friendly ways to produce food. The rest of the private holdings are mostly BioTech or Tech related.
Valuation
180 Degrees’ shareholder letters and slides helpfully provide a sum of parts valuation. As of 02/19/21, the value of the Public Portfolio was $6.43/share vs a stock price of $7.09. As per the table below we can see that the market was ascribing just $0.27/share to the value of the remaining Private Portfolio, which is just 7.2% of the $3.73/share valuation that 180 are putting on these assets.
From Q4 2020 Investor Call Slides
Is this level of discount justified? It is not unusual for a closed end fund to trade at a discount to NAV, especially if the fund has a history of underperformance. As noted previously the Private Portfolio does have a history of assets being written down, although the recent disposals at above book value should also be taken into account.
A discount can also be justified if the underlying assets are highly illiquid or by the impact of fees and expenses on NAV growth. In the case of 180, fees are still quite high relative to AUM (more on this below) and this has weighed on overall NAV growth. Most of the skill and value-add that management provides is associated with the Public Portfolio, so perhaps we should think about the fees solely in relation to the Public Portfolio performance. As an exercise, if we subtract the full amount of fees charged over the last 4 years ($1.40/share) from NAV growth attributable to gains on the Public Portfolio and Carried Interest ($4.42/share) we still have growth of approx 10% per year net of fees for the Public Portfolio, which is pretty decent.
Having separated out the impact of fees from the Private Portfolio the question then is whether an effective value of just 7.2% of the Private Portfolio’s underlying value is fair? In the most recent earnings call, Mr Rendino alluded to the fact that the current market frenzy for SPACS has created an environment that is looking more favourable for the prospect of a buy-out of Ag-Biome in particular. He was careful not to make any promises and it wasn’t clear if what he was saying was more speculation than a hint of something tangible occurring behind the scenes, but a takeover of Ag Biome via a SPAC would be a great outcome for 180 releasing lots more cash to be deployed into public markets and further narrowing the discount to NAV.
“as most of you know, we carefully choose our words when we’re talking to you. I just think there’s a better chance of something happening this year than I would have said it was a possibility in 2020. Again, that’s not a promise, but we’re, for sure, more optimistic on the potential for monetizations of our private portfolio”
“there is a lot of activity taking place with private companies and the proliferation of SPACs, and we own a bunch of private companies. So hopefully, many — some of them are having those conversations and how it plays out will remain to be seen.”
Kevin Rendino, Q4 Earnings Call
More on Costs
Under the previous management, running costs were exceptionally high. When Mr. Rendino took over, the head office was relocated from an expensive Manhattan office building to the suburbs of New Jersey, helping to cut costs. That being said, the expense ratio is still pretty high, typically running at between 3-5% of net assets over the past 3 years. Management has stated that most of the cost reductions have taken place and are now largely fixed and that further reductions in the expense ratio will come through growing net assets. It should be noted that in 2020 they won a mandate for a separately managed $25M pension account which so far has brought in $2.4M of carry, enough to cover the majority of their day to day operating expenses before bonuses. Over time the net expense ratio should come down; one would hope to around the 2% range as the asset base grows and/or they add more separately managed accounts. In the meantime we have to accept that running costs will drag on shareholder returns and likely keep some degree of NAV discount in place.
Insider Ownership
Insider ownership is significant, with Mr. Rendino owning 3.37% of shares outstanding and Daniel B Wolfe, who serves as a portfolio manager under Mr. Rendino as well as Chairman, CFO and chief compliance officer, owning 1.16%. Both Mr. Rendino and Mr. Wolfe were active purchasers of shares during 2020 with Mr Rendino purchasing approx 125K shares since March 2020. The fact that Mr Rendino has been in the habit of putting the entirety of his after-tax remuneration into open market purchases of 180 stock could also be seen as at least partially offsetting the high expense ratio.
Q1 2021 Update
On April 5th 2021, 180 released a preliminary update on its Q1 performance. They had a fantastic Q1, achieving a 28% gross total return in the Public Portfolio, equating to $1.60/share in value. The public securities and cash are now worth $7.13/share, and with the stock hovering around $7.50 the discount being placed on the Private Portfolio has barely narrowed at all. In the release they stated again that they ‘remain cautiously optimistic regarding the potential for monetization events in our private portfolio to occur in 2021.’
Conclusion
Much has been written about the underperformance of value and small-cap value strategies during the current market cycle. 180’s style and benchmark fall into this category and it is impressive that they have managed to buck this trend in their public securities portfolio. Should we see a return to the historical outperformance of value over the coming years (or just a little bit of mean reversion) then this could provide a tailwind to 180’s Public Portfolio. However, even if this doesn’t come to pass, their approach of bottom-up fundamental analysis combined with active engagement with the management teams of their holdings is likely to serve them well, just as it has since 2016. On the private side, some patience may be required to see them fully realize the value of these assets, however the current market environment (febrile though it is) could provide shareholders with some nice surprises over the coming months. Overall, considering the discount and the excellent and motivated management the chances of suffering a permanent loss of capital here seem pretty slim. For investors who are put off by the expense ratio or other issues, I do believe that this is one that is at least worth watching closely. Mr Rendino writes an excellent and entertaining shareholder letter and is likely to be a good source of stock ideas in the micro-cap space over the coming years.