CA - Black Bear Value Partners Q1 2023 Letter

April, 11 2023 09:30 PM CA Inc.

2023-04-11 21:30:00 ET

Summary

Black Bear Value Fund, LP is an opportunistic, concentrated and fundamental value investment partnership.
Our short of Silicon Valley Bank and the risks of low rates.
Top 5 businesses we own.
Increased investment in energy.
Upcoming presentation during Berkshire annual meeting weekend.

Banking is a very good business if you don’t do anything dumb. – Warren Buffett

To My Partners and Friends:

Black Bear Value Fund, LP (the “Fund”) returned +0.8% in March and +2.9% YTD.
The S&P 500 returned +3.7% in March and +7.5% YTD.
The HFRI Index returned +1.2% in March and +4.5% YTD.
We do not seek to mimic the returns of the S&P 500 and there will be variances in our performance.

Note: Additional historical performance can be found on our tear-sheet.

Our concentrated investments in energy have been a drag on our YTD performance. As you are aware, the Partnership is not managed with the short-term in mind, and presuming our thesis remains intact, we use shorttermism to our benefit by purchasing more of the businesses we like. As discussed below, Paramount Resources, a Canadian energy company, joins Civeo in our top 5. Our main themes of investment on the long side are fairly concentrated within the energy space, homebuilding, auto dealerships and general industrials. We underwrite our investments presuming an eventual weakening economy so if/when it strikes, we can take advantage of others’ short-term fear.

A large bifurcation still exists between the businesses we own and the businesses we are short. In other words, good businesses still seem VERY cheap given macro-worries and lousy businesses seem extremely expensive as remaining hangers on hope for a return to easy money and low interest rates.

Shorting Silicon Valley Bank/Equity Short Discussion

We have been short Silicon Valley Bank since 2022. I do not typically name our shorts unless we have fully exited and do not plan on re-shorting but given the bank’s demise it seems safe to discuss.

A bank run and the rapid disintegration of the business was considered a super low (sub 5%) outcome that was not central to our thesis. SIVB was symptomatic of a general theme in our short book…low rates created perverse behavior whose outcomes were hard to predict. While the mark-to-market on their securities book looked ominous, my timelier worry was the low-cost nature of their deposits and whether the money was sticky (i.e., wouldn’t move to another bank). When rates are low nobody cares what they earn on their money. A large portion of their capital was effectively free. As rates moved up it seemed likely that they would have to raise their funding costs to keep customers. The path I thought this would take was lower earnings for many years due to higher interest costs….and likely a dilutive equity raise to fix the hole from their securities.

As witnessed, leverage can accelerate loss recognition and given the ability to instantaneously redeem capital (aka withdrawing deposits) things got bad very quickly. The notion that short-sellers created or exacerbated the bank’s issues is both disingenuous and false. It’s troubling that podcast hosts and others with high listenership/viewership/readership spread misleading untruths knowing full well they are just trying to excite the audience.

Silicon Valley Bank went out of business because too many depositors tried to withdraw their money at the same time. While there are many VC companies, there are not that many VC allocators. A handful of VC allocators told their companies to get their money while they could, leading to a bank run and the banks’ demise. I am not here to judge that advice but only to objectively point out what happened. We can all learn more by being truthful and avoid problems in the future. Blaming a short seller on the bank run does not create a teachable moment.

Our short book thematically rhymes with SIVB. Several industries have relied on low-cost funding in order to fund the growth of customers, properties, employees etc. They include but are not limited to real estate development companies, data centers, online retailers, financial service providers etc. The bill for this will come due at various points in the coming months and years. As evidenced by SIVB it’s hard to predict the specific catalyst which spooks the market. Always keep in mind that debt (even cheap debt) eventually has to be repaid…

As a reminder we do NOT take large concentrated short positions as the risk-reward does not work in our favor.

Top 5 Businesses We Own

Asbury Group ( ABG )

Asbury Group operates auto dealerships across the United States. While much attention is paid to the number of cars sold, the strength of the model comes from the back of the house in parts and services where more than 50% of the profits come from. We are exiting a period of high margins on new and used car sales. Shortages of inventory have allowed dealers to make record profits when selling a car. As inventories normalize and interest rates rise, I fully expect the dealers to make less profit (called the GPU) when selling a car. Car prices cannot go up ad-infinitum and at some point, there will be buyer pushback.

Less discussed is while profits per car are at all-time highs, the volumes sold have mirrored prior recessions. My expectation is that dealers will likely make less per car but will mitigate some of that pressure by selling more cars, especially used vehicles, as prices drop.

When an auto dealer sells a car to a consumer, they capture both the trade-in (inventory to sell) and the relationship for parts and services. It is a razor-razorblade model in a highly fragmented industry (many dealerships are owned privately by families). The large dealer groups have transitioned to an omni-channel model where much of the selling/pre-buy activity can be done online reducing the need for headcount and making the transaction smoother for their customers. The lower operating costs of the business are not appreciated by the market. They are appreciated by us and the management teams as most dealers, including ABG, have been buying in lots of stock with their free-cash flow.

ABG should be able to earn $25-$35 in free-cash flow per share in a “normal” year. At quarter-end pricing that implies a 12-17% annual yield.

Berkshire Hathaway ( BRK.A , BRK.B ) (Same as year-end letter )

Below is the rough Berkshire on-a-napkin valuation. Again, this is a rough exercise.

Cash of ~$79,000 per class A Share o Down/Base/Up marks cash at book value to an 11% premium or $87,000
Investments based on December prices ~$252,000 per class A share o Presume a range of stock prices that result in:

- Down = $225,000 per class A share (-11%- assumes portfolio is overpriced)
- Base = $294,000 per class A share (+17%)
- Up = $382,000 per class A share (+51%)

Operating businesses that should generate ~$18,000 of pre-tax income per Class A share

- Down = 9x = $168,000 per share – equates to ~8% FCF yield
- Base = 11x = $205,000 – equates to ~7% FCF yield
- Up = 12.5x = $233,000 – equates to ~6% FCF yield

Overall (vs. $469,000 at quarter end) o Down = $480,000 (+2%) o Base = $586,000 (+25%)

o Up = $702,000 (50% underpriced)

We added a short of Apple vs. the Berkshire position. Apple has become a large part of the BRK business and wanted to limit our exposure to that investment as it seems expensive.

Going forward I expect Berkshire to compound at above average returns from this price.

Builders FirstSource ( BLDR )

BLDR is a manufacturer and supplier of building materials with a focus on residential construction. Historically this business was cyclical with minimal pricing power as the primary products sold were lumber and other non-value-add housing materials. Since the GFC, BLDR has focused on growing their value-add business that is now 40%+ of the topline. The company has modest leverage and has been using their abundant free-cash-flow to buy in over 30% of the stock in the last 18 months.

While mortgage rates are higher, they are not unusual versus history. The low rates of the last 5-10 years are the outlier. We have a structural shortage of housing in the USA. With existing homeowners locked into lowrate mortgages, the aspiring homeowner may increasingly need to find a home from a homebuilder. The next 6-12 months could be rocky as people adjust to the increase in pricing and rates. Eventually the housing market should adjust to the new normal (or rates could go down).

Normalized free-cash-flow per share looks to be in the range of $8-$12 per year. At quarter end pricing of ~$89 that implies a free-cash-flow yield of 9-13%. If we owned this business privately and someone offered us a this annual cash-flow yield, we would be jumping at it!

Civeo ( CVEO ) / Paramount Resources ( POU:CA )

We have a large investment across the energy & commodity spaces. The thesis is simple…we haven’t developed enough energy or commodity resources to satisfy the near- and medium-term needs of the world as well as provide for a renewable/less-carbon intensive future.

Civeo is a workforce housing company (mining and energy sector) for those who are living/working away from home in more remote locations. They provide lodging, food services, housekeeping and property maintenance in Canada, Australia and the United States.

CVEO went through a brutal stretch during COVID yet still generated the equivalent of 12% of its market-cap in cash in a lousy year. In the coming years this business could be worth 2-3x where it’s priced now as more development is needed in their end markets. It’s hard to predict any given year of this business but they should be able to earn $3-$5 in cash in most years which equates to 15-24% free cash flow yield.

Paramount is an ENP (exploration and production) in the energy space. It has no debt and ~$660MM in cash/securities (15% of the mkt cap). Management is fully aligned with us as they own 47% of the Company.

Over the next 2 years the company should generate ~9-10% in annual free-cash flow presuming fairly bearish energy prices. I tend to believe this is on the lower end as China reopens and the lack of worldwide energy developments becomes more pronounced.

Tax Discussion

K-1’s were sent out last month and are available on your investor portal. Long-term gains were 95%+ of our realized gains for the year.

Upcoming Presentation in Omaha

I was flattered to be invited as a guest speaker at BTIG’s Value-Investing Event in Omaha during the

Berkshire Hathaway annual meeting. Don’t worry!!! You don’t have to choose between me and Charlie/Warren as the event is Friday at 2PM at the Hilton Omaha. If you are in town and would like to attend, please reach out. There are some other fund managers speaking as well.

My daughter Zoey is a special presenter who is accompanying me to Omaha. She had business cards made up so if you see her, she would be thrilled to hand one out (she’s 8). Just don’t tell her I told you!

Thank you for your trust and support.

Adam Schwartz, Black Bear Value Partners, LP

THIS DOCUMENT IS NOT AN OFFER OF, OR THE SOLICITATION OF AN OFFER TO BUY, INTERESTS IN BLACK BEAR VALUE PARTNERS, LP (THE “FUND”). AN OFFERING OF INTERESTS WILL BE MADE ONLY BY MEANS OF THE FUND’S CONFIDENTIAL PRIVATE OFFERING MEMORANDUM (THE “MEMORANDUM”) AND ONLY TO SOPHISTICATED INVESTORS IN JURISDICTIONS WHERE PERMITTED BY LAW.

This document is confidential and for sole use of the recipient. It is intended for informational purposes only and should be used only by sophisticated investors who are knowledgeable of the risks involved. No portion of this material may be reproduced, copied, distributed, modified or made available to others without the express written consent of Black Bear Value Partners, LP (“Black Bear”). This material is not meant as a general guide to investing, or as a source of any specific investment recommendation, and makes no implied or express recommendations concerning the matter in which any accounts should or would be handled.

The returns listed in this letter reflect the unaudited and estimated returns for the Fund for the periods stated herein and are net of fees and expenses, unless stated otherwise. Black Bear currently pays certain fund expenses, but may, at any time, in its sole discretion, charge such expenses to the Fund.

Please note that net returns presented reflect the returns of the Fund assuming an investor “since inception,” with no subsequent capital contributions or withdrawals. You should understand that these returns are not necessarily reflective of your net returns in the Fund, and you should follow-up with Black Bear if you have any questions about the returns presented herein.

An investment in the Fund is speculative and involves a high degree of risk. Black Bear is a newly formed entity with limited operating history and employs certain trading techniques, such as short selling and the use of leverage, which may increase the risk of investment loss. As a result, the Fund’s performance may be volatile, and an investor could lose all or a substantial amount of his or her investment. There can be no assurances that the Fund will have a return on invested capital similar to the returns of other accounts managed by Adam Schwartz due to differences in investment policies, economic conditions, regulatory climate, portfolio size, leverage and expenses. Past performance is not a guarantee of, and is not necessarily indicative of, future results. The Fund’s investment program involves substantial risk, including the loss of principal, and no assurance can be given that the Fund’s investment objectives will be achieved.

The Fund will also have substantial limitations on investors’ ability to withdraw or transfer their interests therein, and no secondary market for the Fund’s interests exists or is expected to develop. Finally, the Fund’s fees and expenses may offset trading profits. All of these risks, and other important risks, are described in detail in the Fund’s Memorandum. Prospective investors are strongly urged to review the Memorandum carefully and consult with their own financial, legal and tax advisers before investing.

The development of an investment strategy, portfolio construction guidelines and risk management techniques for the Fund is an ongoing process. The strategies, techniques and methods described herein will therefore be modified by Black Bear from time to time and over time. Nothing in this presentation shall in any way be deemed to limit the strategies, techniques, methods or processes which Black Bear may adopt for the Fund, the factors that Black Bear may take into account in analyzing investments for the Fund or the securities in which the Fund may invest. Depending on conditions and trends in securities markets and the economy generally, Black Bear may pursue other objectives, or employ other strategies, techniques, methods or processes and/or invest in different types of securities, in each case, that it considers appropriate and in the best interest of the Fund without notice to, or the consent of, investors.

Performance returns compared against benchmark indices are provided to allow for certain comparisons of Black Bear’s performance to that of well-known and widely-recognized indices. Such information is included to show the general trend in the markets during the periods indicated and is not intended to imply that the holdings of any of the applicable accounts were similar to an index, either in composition or risk profile. The indices represented herein are the S&P 500 and the HFRI EH: Fundamental Value Index (“HFRI EH FVI”). The S&P 500 is a free-float weighted/capitalization-weighted stock market equity index maintained by S&P Dow Jones Indices, which tracks the performance of 500 large companies listed on U.S. stock exchanges. The HFRI EH FVI reflects fundamental value strategies which employ investment processes designed to identify attractive opportunities in securities of companies which trade a valuation metrics by which the manager determines them to be inexpensive and undervalued when compared with relevant benchmarks.

This presentation contains certain forward looking statements. Such statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward-looking statements and projections. Prospective investors are cautioned not to invest based on these forward-looking statements.

Furthermore, many statements in this presentation are the subjective views of Black Bear, and other reasonable persons may have differing views. Unless it is unequivocally a statement of fact, any statement herein (even if not specifically qualified as an opinion (i.e., with language such as “in the opinion of” or “we believe that”)) should nevertheless be understood and interpreted as an opinion with which reasonable persons may disagree, and not as a material statement of fact that can be clearly substantiated.

The information in this presentation is current as of the date listed on the cover page and is subject to change or amendment. The delivery of this presentation at any time does not imply that the information contained herein is correct at any time subsequent to such date.

Certain information contained herein has been supplied to Black Bear by outside sources. While Black Bear believes such sources are reliable, it cannot guarantee the accuracy or completeness of any such information.

This Presentation has not been approved by the U.S. Securities and Exchange Commission (the “SEC”) or any other regulatory authority or securities commission.

This Presentation does not constitute an offer of interests in the Fund to investors domiciled or with a registered office in the European Economic Area (“EEA”). None of the Fund, Black Bear or any of their respective affiliates currently intends to engage in any marketing (as defined in the Alternative Investment Fund Managers Directive) in the EEA with respect to interests in the Fund. Receipt of this investor presentation by an EEA investor is solely in response to a request for information about the Fund which was initiated by such investor. Any other receipt of this investor presentation is in error and the recipient thereof shall immediately return to the Fund, or destroy, this investor presentation without any use, dissemination, distribution or copying of the information set forth herein.

Original Post

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.

For further details see:

Black Bear Value Partners Q1 2023 Letter

Company Name:	CA Inc.
Stock Symbol:	CA
Market:	NASDAQ

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