Jiyi/iStock via Getty Images
Dear Partners and Friends,
Steel City Capital, LP (the “Partnership”) declined 7.9% in the third quarter of 2022, net of fees and expenses, and declined 18.2%, net of fees and expenses, for the first nine months of 2022. Most of the quarter’s decline was concentrated in August when several of our larger short positions rallied aggressively against us. Without providing specifics, we have clawed back some of this performance in October and early November, but I am hesitant to count our chickens before they hatch.
Given the somewhat tardy nature of this letter, it’s not my intention to draft a missive articulating, among other things, my views on the economy. On this topic, a lot of ink has already been spilled and I’m not sure I can add many intelligent thoughts. Consensus seems to change on a daily basis which is driving significant market volatility. The buzz word is no longer “transitory” but “pivot.”
Will the Fed “pivot” and begin cutting rates at some point next year? Does “pivot” simply mean a slower pace of rate increases? What if there’s no “pivot” in sight, and rates are on course to be higher for longer than anyone expects? Who’s on first? You got a pitcher on this team? It’s a dizzying exercise, but what is clear is the Fed is in the driver’s seat and the rest of us are just along for the ride.
Virtually all of the Partnership’s year-to-date decline emanates from our long book. In aggregate, our short positions have partially offset this performance. Outsized declines have come from EchoStar (SATS) and Anterix (ATEX).
With SATS, I think we “bought well” in the sense that our position was established at an average price of $23.40 vs. the most recent price of $17.40. There certainly remains the risk we’ve invested in a “value-trap” / “melting-icecube,” but I’ll try to explain why I think that outlook isn’t completely accurate.
I tend to think of SATS as an iceberg whose peak – the portion visible above water – reflects only a small part of its totality. The visible portion is the company’s legacy satellite broadband business that, at the current time, is shedding customers at an unhealthy clip. The main culprit is most likely Elon Musk’s Starlink, which currently offers more attractive speeds (100 Mbps) and lower latency.
Maybe I’m being pollyannish about the situation, but I believe when SATS brings its Jupiter 3 satellite online next year, and is capable of delivering the same speeds as Starlink, churn will not only slow, but subscriber counts should begin to rebound. SATS will never be competitive with respect to latency, but that doesn’t keep me up at night. That’s not to discount the draw of low latency, which is important for use cases such as video conferencing and gaming, but when your target customer base is scraping by with max speeds of just 25 Mbps, the prospect of 100 Mbps should be highly attractive.
Moreover, as I’ve discussed in prior communications, the financial case for Starlink is unproven and it remains to be seen whether or not Musk can ever make the unit economics work1.
Under the waterline is EchoStar’s vast S-Band spectrum holding. This spectrum asset will likely play a critical role in the expected use of satellites to provide 5G connectivity to devices that are outside the reach of traditional terrestrial networks. Potential use cases include consumer connectivity in remote areas, connectivity for IoT devices in industries like agriculture, transportation and supply chain logistics, and various defense-related applications.
Earlier this year, a key industry standard-setting body (3GPP) crystallized a set of standards that should accelerate the development of devices (chipsets, modems, terminals, handsets, etc.) to be rolled out over the next 2-3 years.
SATS enterprise value is $1.2 billion, before accounting for nearly $600 million of construction in progress related to its Jupiter 3 satellite. Cash and investments total nearly $1.7 billion, fully offsetting either the company’s market cap ($1.4 billion), or its debt ($1.5 billion). Current annualized EBITDA is ~$630 million and should bottom out in the low $500 million range before rebounding after Jupiter 3 is placed into service. This implies a forward looking EV/EBITDA multiple of ~2.4x off of trough EBITDA.
This is quite low considering SATS is a critical infrastructure like asset with recurring revenue. The company’s bonds trade slightly below par, but hardly at the kind of distressed levels one would expect for a company with float-adjusted short interest in the thirty-percent range. Like I said above – maybe I’m being pollyannish – but I think our chances of realizing an attractive return over the next 2-3 years are quite good.
As for our other spectrum darling – Anterix – I frequently field calls from other despondent investors who have or are looking to throw in the towel on their positions. Asked why I don’t do the same, I typically provide two reasons. First, at recent prices (ATEX recently bounced around at ~$30), substantially all of the company’s market cap is covered by 1) proceeds expected from existing deals and 2) the expected value of certain LOIs[1] entered into by the company.
Second, I believe in the long-term value proposition of the company’s spectrum holdings and I don’t see much benefit in trading around the timing of announcements (no matter how few and far between they are). Selling shares, only to re-enter after another contract announcement, smacks of timing the market / buying high and selling low. And speaking of contract announcements, ATEX announced an 20-year spectrum lease agreement with Xcel Energy roughly a week ago.
By my math, the $80 million agreement works out to ~$1.45/MHz-Pop, which like previous contracts, reflects a premium to the level implied by ATEX’s current valuation. The stock has rallied off of its lows and I am hopeful that additional contract announcements will sustain this momentum.
Liberty Latin America (LILA) has been a dog this year, declining nearly 45% through the end of the third quarter. The business is highly predictable so there haven’t been any surprises on the operational front, and virtually of its floating-rate debt has been swapped, thereby protecting it from this year’s rapid rise in interest rates.
So I’m not quite sure why it has underperformed the broader market so significantly. This year’s free cash flow guide is for $120 million (ex. SBC) and there’s a line-of-sight to $300+ million (ex. SBC) by 2024, meaning shares have been trading in a range of 4-6x price to free cash flow. The Partnership has been a buyer at these levels.
News Corp. (NWSA) and its sister company Fox News (FOX) recently announced the formation of special committees – at the urging of major shareholder Rupert Murdoch – on the their respective boards to consider a potential combination of the two companies. Such a transaction would reflect a reversal of the companies’ 2013 separation.
It’s early days in the process so I’m withholding judgement at the moment. From a corporate governance best practices perspective, I’m hoping NWSA’s special committee recommends any transaction will require the approval of a “majority of the minority” so that Murdoch doesn’t steal our shares away from us well below fair value[2].
The Partnership has established new positions in two companies, both outside of the U.S. One is a small/micro-cap whose operations are competitive with one of our existing holdings. Nearly 70% of its market cap is covered by cash, and until recently, its topline was growing at a double-digit clip supported by secular adoption of its offerings.
On the downside, this company will generate negative EBITDA through 2023 (thus eating into its cash balance), although there is so much low-hanging-fruit in the form of potential cost reductions that I’m not extremely worried about their ability to ultimately generate positive cash flow. Given the considerable white space opportunity ahead of them, I am quite optimistic about this investment opportunity.
The other position is a special situation of sorts following its spin-out from a much larger parent company. The company benefits from long-term contracted revenue; U.S. Dollar based contracts; CPI-linked revenue escalators (a good thing in today’s inflationary environment); good cash flow conversion; and decent prospects for organic growth.
Shares have sold off following the spin-off and I think there’s a good chance for additional forced selling in the coming days and weeks for non-fundamental reasons. Shares are trading below the private market value of its assets (as supported by a long chain of historical transaction comps) and at roughly 9.0x EBITDA, which is hardly demanding for a contracted infrastructure asset with decent organic growth prospects.
I think there are multiple ways for this investment to work out, including:
- accretion of equity value at a constant multiple if the company reduces debt,
- organic growth in the coming years, and,
- a re-rating of the company’s multiple towards peer trading levels.
For the time being, I’m not going to “name names” as I continue to accumulate shares in each, but if Partners have questions about either of these positions, please reach out and I would be happy to provide specifics.
As I write, Carvana (CVNA), a long-time short, is circling the drain. After reporting earnings, shares have been roughly cut in half while the company’s bonds are now priced anywhere from 35- to 45-cents on the dollar, with yields ranging from 25% to 40%. While the shares already experienced a steep decline during the past year, the postearnings sell-off appears to reflect investors finally acknowledging the company’s near-term liquidity issues. Raising capital – debt or equity – seems unlikely, if not impossible.
Bulls had been holding on to the hope CVNA would meet its stated “goal” of generating “significantly positive EBITDA in FY 2023,” but management walked back that aspiration last week. I always thought the word “goal” reflected squishy language that never carried the same weight as “guidance” and drew conclusions accordingly. The difference is much the same as me telling my wife I have a “goal” of having washboard abs vs. “guidance” that I will have them by swimsuit season.
The language was deliberate (and probably highly lawyered), and in my estimation, reflected an effort to give bulls something to cling on to without the company exposing itself to a lawsuit when they (inevitably) missed.
Elsewhere in our short book we have had decent success this year with TRUP (the perennially unprofitable insurance company whose shareholder base is as dense as CVNA’s), BYND) (the negative gross margin fake meat producer), DUOL (a scarcely-profitable, advertising-dependent GrowthCo still valued on the basis of EV/Sales), CSV (a funeral services provider that is lapping a COVID bump) and YELP (an advertising-heavy online platform whose shareholders ignore the massive expense of SBC).
I know these updates are long, but I believe it is vitally important for partners and prospective partners to understand my thought process and rationale for making investments. I am available for any questions, comments, or concerns that you may have.
If you are an accredited investor who would like to learn more about becoming a partner, please reach out to me and we can arrange a time to have a more in-depth conversation. Please also know that even if an investment in the Partnership isn’t for you, the highest compliment that you can pay me is an introduction to someone who might be a good fit.
I want to thank those of you who have already joined as partners of the Fund. I am grateful for the opportunity to grow your assets alongside mine and appreciative of your trust.
“It is not from the benevolence of the butcher, the brewer,
or the baker, that we expect our dinner, but from their regard to their own interest” – Adam Smith
Sincerely,
Michael G. Hacke, CFA, Steel City Capital Investments, LLC
[1] I know, I know, LOIs aren’t contracts.
[2] As was our experience with TCP and BWP. Perhaps the third time is the charm?
DISCLAIMERSteel City Capital Management, LLC (the “General Partner”) is not registered as an investment adviser with the Securities and Exchange Commission. On July 2, 2018, the Pennsylvania Department of Banking and Securities approved the General Partner as a Registered Investment Advisor within the Commonwealth of Pennsylvania. The limited partnership interests (the “Interests”) in Steel City Capital, LP, (the “Fund”) are offered under a separate private offering memorandum (the “Offering Memorandum”), have not been registered under the Securities Act of 1933, as amended (the “Securities Act”), nor any state’s securities laws, and are sold for investment only pursuant to an exemption from registration with the SEC and in compliance with any applicable state or other securities laws. Interests are subject to restrictions on transferability and resale and may not be transferred or resold except as permitted under the Securities Act and applicable state securities laws. Investors should be aware that they could be required to bear the financial risks of this investment for an indefinite period of time. THE INFORMATION FURNISHED IN THIS DOCUMENT IS IN ALL RESPECTS CONFIDENTIAL IN NATURE AND MAY NOT BE REPRODUCED WITHOUT PRIOR WRITTEN PERMISSION FROM THE GENERAL PARTNER. DISSEMINATION OF THIS DOCUMENT OR DISCLOSURE OF ANY KIND MAY CAUSE SERIOUS HARM OR DAMAGE TO THE FUND AND THE GENERAL PARTNER. PAST PERFORMANCE IS NOT INDICATIVE OR A GUARANTEE OF FUTURE RESULTS. The information contained herein reflects the opinions, estimates and projections of the General Partner as of the date of publication, which are subject to change without notice at any time subsequent to the date of issue. The General Partner does not represent that any opinion, estimate or projection will be realized. All information provided is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. The Fund has an economic interest in the price movement of the securities discussed in this letter, but The Fund’s economic interest is subject to change without notice. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. The Fund terms, performance returns, and portfolio characteristics reflected in this document are not indicative of future returns or portfolio characteristics and do not modify the terms of the Fund as detailed in the Fund’s Offering Memorandum. Positions reflected in this letter do not represent all the positions held, purchased or sold, and in the aggregate, the information may represent a small percentage of activity. The information presented is intended to provide insight into the noteworthy events, in the sole opinion of the General Partner, affecting the Fund. Certain information contained in this document constitutes “forward-looking statements” which can be identified by use of forward-looking terminology such as “may,” “will,” “target,” “should,” “expect,” “attempt,” “anticipate,” “project,” “estimate,” “intend,” “seek,” “continue,” or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to the various risks and uncertainties, actual events or results in the actual performance of the Fund may differ materially from those reflected or contemplated in such forward-looking statements. The General Partner is the source for all graph and charts, unless otherwise noted. A prospective investor should only commit to an investment in the Fund if such prospective investor understands the nature of the investment and can bear the economic risk of such investment. The Fund is speculative and involves a high degree of risk. The Fund may lack diversification, thereby increasing the risk of loss. The Fund’s performance may be volatile. There can be no guarantee that the Fund’s investment objectives will be achieved, and the investment results may vary substantially from year to year or even from month to month. As a result, an investor could lose all or a substantial amount of its investment. In addition, the Fund’s fees and expenses may offset its profits. There are restrictions on withdrawing and transferring interests from the Fund. In making an investment decision, you must rely on your own examination of the Fund and the terms of the Offering Memorandum and such other information provided by the General Partner to you and your tax, legal, accounting or other advisors. The information herein is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice or investment recommendations. You should consult your tax, legal, accounting or other advisors about the matters discussed herein. The Fund’s ability to achieve its investment objectives may be affected by a variety of risks not discussed herein. Please refer to the Offering Memorandum for additional information regarding risks and conflicts of interest. No representations or warranties of any kind are made or intended, and none should be inferred, with respect to the economic return or the tax consequences from an investment in the Fund. No assurance can be given that existing laws will not be changed or interpreted adversely. Prospective investors are not to construe this document as legal or tax advice. Each investor should consult his or its own counsel and accountant for advice concerning the various legal, tax, ERISA and economic matters concerning his or its investment. This document is being furnished to you on a confidential basis and may not be used for any other purpose. Any reproduction or distribution of this document or accompanying materials, if any, in whole or in part, or the divulgence of any of its contents is prohibited. The information set forth herein does not purport to be complete and no obligation to update or otherwise revise such information is being assumed. It is meant to be read in conjunction with the Fund’s Offering Memorandum prepared in connection herewith, and does not constitute an offer to sell, or a solicitation of an offer to buy, by anyone in any jurisdiction in which such an offer or solicitation is not authorized or in which the making of such an offer or solicitation would be unlawful. Such an offer to sell or solicitation of an offer to buy interests may only be made pursuant to definitive subscription documents between the Fund and an investors. The information contained herein does not purport to contain all of the information that may be required to evaluate an investment in the Fund. The information herein is qualified in its entirety by reference to the Offering Memorandum, including, without limitation, the risk factors therein. An investment in the Fund has not been approved by any U.S. federal or state securities commission or any other governmental or regulatory authority. Furthermore, the foregoing authorities have not passed upon the accuracy, or determined the adequacy, of this document, the Offering Memorandum or limited partnership agreement associated with the Fund. Any representation to the contrary is unlawful. Past Performance Is Not Indicative or a Guarantee of Future Results. |
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
Be the first to comment