Asset Plays and Volatility
When do I get my money back?
On this day 2 journal entry I am pleased to report that my holding in Seaport group ($SEG) reported what I believe to be overwhelmingly positive data, meanwhile, the stock has fallen. I am unsure as to whether I will increase my position or not, I would more than likely do so if we ever touch 20 again.
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In summary, Seaport Group was a spinoff from Pershing Square’s Howard Hughes Corporation and consists of a hodgepodge of various leisure and entertainment assets. My main risk to the thesis was cash burn, which the company seems to be controlling well due to cost containment at The Tin Building. Given how depressed the valuation is, trading at less than 2/3rds of book, the business at least still has a net-cash balance sheet and the ability to monetize assets, which I believe will help the business realize value at close to book value by 2027. The other positive piece of news is the stock’s uplisting into the Russell 2000 and Russell microcap indexes, which should drive liquidity over the medium term.
Seaport represents a play that I think many value investors are familiar with: Asset plays. Buying a company below net asset value has been a popular strategy since Ben Graham, and there is no shortage of investors who want to buy every REIT trading below 2/3rds of book value that they can find. But two things have to actually go right in order for this thesis to play out. 1: The asset basis cannot shrink too far. 2: the assets have to be monetized. If you buy a stock at 7 dollars with 10 dollars of net assets that is great, but if the company burns capital, forcing them to use cash, sell assets, or take out debt, the 10 dollars shrinks. Secondly, the assets have to be monetized. In essence, the company has to actually make money with the assets somehow. That can either mean boosting the cash flow at the asset level as is the case with Seaport group, or selling the assets, as is the case with Net Lease Office properties. If I bought a patch of raw land, put it in a real estate trust and took it public, yeah it may at times sell for less than the net assets, but if the trust stays stagnant I have no reason to believe the gap would close.
Due to my inclination towards smaller companies it is very common for me to see large swings in both directions, especially relative to the S&P500. I prefer to use the Russell 2000 as a benchmark as I foresee more of the funds opportunities coming from outside the large-cap space. This index is also noticeably more volatile from the S&P. Most value investors will tell you that volatility is not risk. And they are right. But that statement requires some nuance. Buffett’s definition of risk is related to permanent capital loss. Which is arguably a more confusing metric. How do you know when the loss is permanent?
In the long run companies operate on fundamentals. If you hold a stock that exceeds market expectations long enough, you will come out ahead. If you hold a stock that underperforms expectations long enough, you will sell at a loss. Permanent capital loss comes from holding a stock that has fundamentally declined relative to when you purchased it. Volatility is a type of information. If your portfolio’s volatility has a negative skew, then you are holding underperforming businesses. If you are holding outperforming businesses, you will have a positive volatility skew. The goal is to assess market expectations relative to your beliefs and cross-check both to data. A tremendous example of this is Jeld-Wen. I bought the business at what I thought was very cheap. A door manufacturer that had been destroyed after a string of bad news. But even with the bad news they were trading under book value at what I perceive as a bottoming out in the housing cycle. The business had a cost containment plan and I predicted a generous re-rating should the company surprise to the upside. Well I bought it, liberation day happened, the stock fell off a cliff and I was down 40% at the trough. I re-underwrote my idea and found that my thesis was more dependent on the business fixing idiosyncratic headwinds than it would be on tariffs. Over the next few months was rewarded. Jeld-Wen still shrank marginally but their cost containment was so successful that they smashed bottom-line expectations. I’m decently up even from my original cost basis. I believe my fear of doubling down prevented me from greater gains. But my fundamental thought process was correct.
There are also times I can analyze things incorrectly. I used to own shares of Alta Equipment,. I felt the business was fundamentally solid and misunderstood. But when that stock got crushed I hastily sold when management forecasts significantly broke with my thesis. Since then, the stock has rallied and I would be up. Having not kept up with it since selling, I still believe I did the right thing, but good investors have to acknowledge that volatility contains information about expectations. The point of a margin of safety is to minimize the probability of a negative volatility skew and maximize high volatility skew.
Yesterday I wrote about how the traditional broadcasting industry is waking up due to changes in ancient regulations. Nexstar and TEGNA merging SHOULD be a great sign for the industry. But there is a problem. Nexstar is already the biggest player, and Tegna is the second or third largest depending on how you account for it. Tegna also had the strongest balance sheet outside of Nexstar. Gray, Scripps, and Sinclair all have debt to equity at least exceeding 2 while Tegna’s is under 1. If Nexstar and TEGNA merge the combined entity would conservatively control approximately 70% of local television broadcasting. Arguably up to 80% This leaves Gray, Scripps, and Sinclair fighting over scraps if we do not see a steep drop in interest rates or other deal activity. I believe in Gray in particular. The company has been acquisitive, and its capital allocation has generally been very intelligent. A decline in interest rates in the next twelve months would free up approximately 14 million dollars for every 25-basis-point cut in interest rates, in other words, 2% of the market cap at current levels.
However, I do not ever want to build a thesis dependent on the macroeconomy. I still have a strong conviction in Gray Media. However, if the company has to compete against a merged TEGNA/Nexstar, it cannot survive as a standalone entity.
My takeaways for today are that investors must remember the market dynamics of whatever business they are in. Don’t try to compete with a monopoly. Volatility works both ways; try to maximize for positively skewed volatility. Safety comes from buying solid businesses with a low probability of disappointing the market but a high probability of pleasing it.