Mutoro Group Partners, LP
“Why shoot the breeze about it when you could be about it?” – Nasir Jones
Dear Partner,
The Fund was down 4.97 per cent for the calendar year of 2015. It should go without saying that I do not take pleasure in seeing the Fund in the red over any annual period. But I would be lying if I said this result troubled me. From my analysis it is clear that this decline is transient, arising from volatility in the price of our largest holding and unrelated to the fundamental prospects of our businesses. I think there is a very low probability it represents a permanent or long-term impairment of our capital.
At moments like this I try to remember the guidance of the investor Seth Klarman. On November 11, 2014, at the invitation of my good friends Larry Dworkin and Kristina Yang, I traveled to Philadelphia to hear Klarman speak at a symposium on the University of Pennsylvania campus. At the front of the room, Klarman relayed the opinion of one of the investors in his firm, the Baupost Group, after it declined 16.3 per cent in the 1998 Russian financial crisis. “Seth, he said, you’ve always been my best manager over any five-year period because you do not try to be my best manager over any one year period.” I think that is golden advice well worth remembering, especially for an operation focused on the long run like ours.
It is important that I update you on our largest holding, the pseudonymously named Company A, which I discussed at length in the third quarter letter. It constitutes 19.9 per cent of the portfolio. To jog your memory, Company A is an American media company with a highly profitable, monopoly-like position in the markets it serves. Company A’s share price had fallen because of renewed handwringing by its shareholders over the company’s substantial debt and declining top-line revenue. Our analysis of Company A’s competitive position and ability to repay its debt gave us enough conviction to take a stake in the business while other investors turned up their noses at it. Company A continues to deleverage ahead of schedule, with the majority of its debt maturing in 2022, reducing any near-term risk to our equity position from a refinancing. We took advantage of a decline in the share price of Company A in the fourth quarter to further lower our cost basis per share to a level 33 per cent below our original purchase price.
In January 2016 Company A unexpectedly received $31 million cash in an insurance settlement that it immediately earmarked for further debt repayment. Equaling 4.5 per cent of its outstanding debt at year-end, this is clearly positive to its equity owners, yet you would not know it looking at Company A’s shares. They rose dramatically on the positive news but a week later had barely budged. To be sure, I want to avoid adding complacency to our portfolio. There very well may be an excellent reason to be negative on Company A at the price we own it. I have not yet found that reason, though, and I continue to search for it.
We also initiated in the last quarter of the year a fourth investment. In Company D we find a technology business with unequaled R&D productivity, a highly diversified customer base, considerable recurring revenue, and a superior balance sheet. While I believe the companies we own are worth substantially more than the prices we have paid for them, and are appropriately sized relative to the rest of our portfolio, I do think I erred this past year in acquiring our stakes in them too quickly and not more gradually. Our stake in Company A is very attractively priced, but it could have been more so had I not overweighed our purchases to the first half of the year. Purposefully keeping substantial cash on hand helped us correct that issue when prices fell, but it still irked me. With the addition of Company D to the portfolio I tried to be more patient, sizing it at 10 per cent of our portfolio but leaving enough room for us to increase its size and lower our cost basis over time. This is important because of one of my fundamental beliefs about value investing done well: Never assume you are buying at the bottom. Instead, expect your purchases to fall, sometimes substantially, before eventually rising toward their intrinsic value.
The chart below depicts the makeup of the Fund on December 31st.
Portfolio Holdings
There were other important events in 2015 in the life of the partnership I think worth including here.
I became an uncle in March, joyfully welcoming to the world my nephew Gabriel, the beautiful product of my older brother Karani and his wife Sophal. Gabriel was a happy addition to my family last year as we in May sadly observed the one-year anniversary of the passing of my older brother George, who probably had the most confidence in me of any person I have ever known. Reflecting on George’s life and untimely death led me to no longer defer my dreams and to set out to form this partnership.
In October I joined a new private equity firm called Connor Capital SB as a Partner and its Chief Operating Officer. The “SB” in its name stands for Santa Barbara, California, where the firm is headquartered. My responsibilities include helping conduct diligence on potential private market investments and taking leadership on hiring and internal forecasting and budgeting. I met the founder of the firm Josh Connor in 2005 when I was interested in joining Morgan Stanley’s investment banking division, which had an exceptional team he was a member of focused on advising companies in the transportation industry. Josh was a rising star in a group full of stars, which over the years had been responsible for many front-page corporate financings and combinations, including the initial public offering of UPS, at the time the largest ever. Flash forward ten years. Josh left investment banking to create a private equity firm focused on the transportation sector and asked if I would like to join him. I was honored and enthusiastic about the idea because he is a jovial colleague, a creative and deep thinker, and, as an investor in the Mutoro Group, was fully supportive of me continuing to manage this partnership.
The logical question I would ask about my new position is “How does this affect your ability to run the Mutoro Group?” I think it significantly enhances my ability to manage and grow the Fund. The practical first: Connor Capital, like most private equity funds, has a ten-year term, and I will over time own five percent of it while earning a healthy salary. This means I have a stable base of income for the foreseeable future through whatever volatility emerges in the public markets. This is important if we also remember that I do not currently receive an income from the partnership at its current size. Our 1.5 per cent annual management fee goes toward operational expenses such as our third-party administrator (NAV Consulting Inc.) and auditor (Spicer Jeffries LLP). My new position allows me to invest more personal capital in the Fund and to truly think long-term about the investment merit of our current and prospective holdings, without taking any undue risks to create income to meet my personal expenses.
The next logical questions are “Will it distract you?” and “Are you moving to California?” Regarding the latter question: I am still based out of New York and not moving to California anytime soon. Josh and I have a great working relationship, communicating telephonically and via email often and have made plans for me to be in California and him in New York with some regularity. In considering the former question it is important to remember that the Mutoro Group is not a trading operation requiring me to forecast and anticipate the daily vagaries of the market. As it says on our website, we intend to be a patient, disciplined, and selective research operation. I assure you this has not and will not stop because of my new responsibilities. My schedule may be more full than it was previously but I am completely and unequivocally more engaged and excited today about this partnership than I was on its first day.
I firmly believe we are building something special at the Mutoro Group. I am emboldened by the prospects of the companies we own, the prices at which we own them, the downward trend of the markets recently, and the cash we have at our disposal to profit from this trend. The Fund can accept new capital every month. If you would like to make an investment, please let me know. I would be honored to have your confidence and partnership.
Very truly yours,
Godfrey M. Bakuli
Managing Partner