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The following segment was excerpted from this fund letter.
Countryside Partnerships (OTC:CUSPY)
Countryside, our UK based homebuilder, is in the midst of exiting its asset intensive operations in order to focus on its asset light operations. The original thesis as introduced in our YE’21 letter was predicated on a belief that asset light home building is simply a better business than asset intensive homebuilding. Secondary to this thesis was a belief that near term downside to Countryside’s stock would fuel intermediate and long-term upside as the company had committed to using the cash obtained from the runoff of its asset intensive operations to repurchase shares of the remaining company.
Through most of May the thesis was largely intact, with recent results having been more disappointing than expected, but the company taking advantage of this weakness by buying back more stock than expected.
However, in late May, Inclusive Capital, a large shareholder and well-known activist, publicly announced that they had submitted a bid to take the company private. Subsequently, the company announced that they would be suspending the buyback and running a formal sale process, but not for several months.
It seems clear that Inclusive Capital’s bid was opportunistic, as the company is presently dealing with near-term problems (that are worse than I anticipated), that have been weighing on shares. In brief, I believe many of these problems can be tied to an interim CEO and a board that was under attack by activists (that we supported) trying to grow at any cost in order to stave off the activists. Essentially, in this business the CEO’s job should be primarily about capital allocation.
If there are two projects available, and one offers the potential for a 40%+ ROCE (in line with Countryside’s Partnership’s business history) and the other offers the potential for a 15% ROCE, capital should be steered toward the higher ROCE opportunity. However, if the interim CEO and/or board believe that growth regardless of ROCE is the solution to their immediate term problems with activists, they may be tempted to pursue low return projects just for the sake of growth.
I believe some version of this problem, combined with poor corporate communication during a transition period, led to the market excessively punishing shares of Countryside. At the same time, the company’s decision to announce a sale process – but not for several months – seems designed to allow these low ROCE projects to roll off, so that the normalized earnings power of the business can be more accurately captured by the financial statements prior to a sale process.
A sale process has a few consequences of note. First, as mentioned above the company has stopped buying back shares, so the second leg of my initial thesis is clearly broken: lower prices in the near term will no longer lead to higher prices in the long term. Second, the company has been conducting a CEO search, and has been reluctant to lay out a clear vision for the future prior to filling the CEO spot. It is hard to imagine that a high-quality CEO will sign on to lead a company that may be for sale in a few months, so it seems likely that corporate communication will continue to disappoint.
Lastly, if the company will soon be for sale, the valuation lens should shift to view the company as a potential acquiror would. I believe there are several strategic buyers that could realize somewhere between $60-$80M GBP in synergies by eliminating corporate level and regional level administrative costs. If one were to adjust the company’s current enterprise value by the assumed cash value of the remaining runoff of the company’s legacy asset intensive division, and then note that U.S. asset light homebuilder NVR Inc. has often traded at 10-14x EBIT, then the value of the potential cost savings alone far exceeds Countryside’s adjusted enterprise value. In other words, at current prices, a strategic acquirer could theoretically get the actual business for less than free.
I do believe that if Countryside were to remain public as a pure play asset light homebuilder hell bent on returning capital to shareholders a la NVR, eventually the market would figure out that perhaps NVR’s multiple is relevant to Countryside. However, in the immediate term I admit that this is clearly an optimistic view, as Countryside has not yet proven to the market that it deserves a similar multiple to NVR.
Regardless, even applying Countryside’s historic multiple as a mixed asset light / asset heavy business to the potential savings a strategic acquirer could realize suggests that a sale of the business could result in ~100% upside from recent prices. While this might sound exciting vs. the uncertainty of broader markets, a 100% return from current prices would be a disappointment versus my initial expectations that Countryside would be a business that we could own and compound for years to come.
But at this point, how cheap is cheap enough? Should we not own shares at a price that suggests that a buyer could buy the actual business for free by just capitalizing the potential savings at a reasonable historic multiple? Must we wait until a buyer could buy the business for significantly less than free?
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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