Why Leaping Off Fun Locations Makes You a Better Investor
They discovered ancient Egyptian chariots here … Hurghada, Egypt
Beneath the ocean floor, a little way offshore, submerged chariots dating back to 1446 BCE.
Recognize that date?
Its unlikely most of us do.
It was the year of the Exodus from Egypt!
Yip, these chariots (apparently) are the selfsame that the Red Sea came crashing down on when the Egyptian army chased the departing Hebrews into the parted Sea.
But that’s not why I was there.
For me it was merely a convenient LEAPING OFF point. After sailing down the Nile from Luxor to Aswan, Hurghada was the narrowest point between mainland Egypt and Sharm el Shek in the Sinai Peninsula.
Who knows, maybe it was true!
The same guidebook also pinned the exact location of Gamul Musa otherwise known as Mt. Sinai – now a hippie camping spot.
Speaking of leaping off, let’s get back to our 7 unusual lessons from 20 years of investment failures … Part 1, which contained 4 lessons, can be found here. Recall we were using the narrative of a manager due diligence for Wendywood Partners and its owner Steven Skinner (names changed to protect the innocent and not so innocent…)
Part deux follows:
Lesson #5: Your managers need to have baitsim
Translation: baitsim is the Hebrew word for Eggs aka. Stones or B*lls
Like me, Steven is in the business of handicapping managers. – he runs a fund of funds.
Here’s his approach … notice it is somewhat different to your normal manager selection process:
In order to achieve asymmetric portfolio returns (part 1 lesson #4) one, by necessity, must engage smaller more niche/opportunistic emerging managers.
His average manager size is less than $250M and they’ve generally been in the business a long time plying their unique trade.
Q: If they’ve been in business so long why are they sub $250m in AUM?
A: Great question padawan you’ve discovered the secret sauce
For managers that have experienced a setback or a blow up and whose numbers are bad quiz them incessantly on the matter:
- What were you thinking, why?
- What’s a reasonable expectation for future returns
- Catalyst for future returns and most important;
- What did the manager do during the drawdown [Steven likes to see a manger NOT derisk after the drawdown has occurred but acknowledge the mistake and ride it back up fully invested … ballsy]
This approach is not without its drawbacks.
Steven has been snared by 2 frauds.
- Bay Hill Opportunities and
- Seashore Equity Long/Short
Luckily neither was big enough to implode his fund and no gate has ever been employed.
In order to prevent any further catastrophe he hired Carlito Rove @ HedgeProtect to do back office due diligence. At $20k per manager it is money WELL spent … Carlito is extremely thorough!
In addition, this approach to investing requires some protection from the terms of Wendywood Partners fund itself.
- one year hard lock than quarterly liquidity with 90 days’ notice;
- Diversified client base of 30+ family offices and high net worth individuals with no client > $3m;
- Get this –Class A Investor has a 1% base fee and a 10% carry with a high water mark.
Class B Investor has a 2% base fee, a 50% hurdle rate, and a 50% carry with a high water mark (talk about b*lls; Steven only offers such terms because he knows he can get these kind of returns!)
Lesson #6: Numbers are the language of business, numbers don’t’ lie, reduce everything to numbers however imprecise
The Big Binary Elephant bet at the moment is …
The Story of a Loan-to-Own Strategy
In the world of investing there are few strategies more predatory than loan to own.
In a game of chicken an investment manager lends money to a corporation at higher than usual rates in exchange for a large portion of assets pledged as collateral. The manager’s aim is for the company to default on the debt and assume control of the assets!
A corporation will typically only use such usurious lending as a last resort when other traditional avenues of financing are no longer available OR expediency makes it more attractive.
From the investment manager’s perspective the ideal corporation is one in a cash burn situation (making it necessary to come back to the well in the future) with cash generation prospects in the near future … why?
Because the manager can charge a sufficiently high rate and if a restructuring takes place there is an opportunity to grab the cash that the company could potentially be generating.
Hence the manager prefers a late stage startup with a unique product or service protected via patent or some other moat.
Ari Gold is one such manager and is a master at analyzing, structuring and executing complex transaction during different business and market cycles as evidenced by his $2B asset under management since 1996.
Let’s not kid.
The makeup of such an investor tends to be quirky to say the least. Usually not very personable, mathematically orientated, a WONK.
Such a character is usually found amongst other similar characters which I had alluded to in Part 1 Lesson #3. Tyler Carson, a difficult dude and cut from the same cloth as Ari was the kingpin in introducing Ari to Steve!
Complex transactions necessarily contain hair. Sometimes lots of hair.
Which is why Ari has been sued a number of times.
The Wimbledon Pension fund sued Ari in a separate lending matter – a case in point.
A lending strategy turned out to be a Ponzi scheme long after Ari had removed himself and clients from the situation. Now the matter resides in the courts where creditors are aiming at Ari’s fund for restitution of ill-gotten profits. The matter is pending.
“The confluence of perfect original lending conditions, combined with patience and tremendous execution will begin to generate eye popping returns” – Steven Skinner February 2011 Partners letter.
In 2006 Ari began making loans to a number of corporations … two in particular will feature in this docket … Wendywood joined the party in 2009 by investing in Ari’s fund Wayward IV LP. As of the date of this writing this investment comprises 80% of Wendywood Partners.
The Loan-to-Own strategy marched through the financial crisis of 2007 – 2009 and two portfolio companies had to endure a bankruptcy under the hands of Wayward.
Said companies received post-bankruptcy valuations by external valuation agent Dude and Phillips (D&P) in 2013 of 3.6X the original debt outlay by Wayward.
Vaulting Wendywood to the top of the league tables for that year. Of import here are two overriding valuation assumptions administered by D&P:
- A 25% haircut for both companies as they are considered to be level III Illiquid assets;
- A cash flow discount rate / weighted average cost of capital of 28%;
Both ‘assumptions’ applied as penalties for illiquidity, lack of cash flow and access to outside capital — a full redress of which will result in a 10x increase in valuation from current prices!
And that’s why we joined the fray!
Our research & analysis indicates a high probability that these companies are going to start spewing cash … and a follow on revaluation of the same or larger magnitude awaits in the not too distant future.
In part-3 of the series we discuss the companies, our analysis and share our final unusual investment Lesson #7!
Until then….may the investment winds be at your back
Thank you for reading my post. I regularly write about private market opportunities and trends. If you would like to read my regular posts feel free to also connect on LinkedIn, Twitter or via Atlanta Capital Group Investment Management.
Nothing in this article should be interpreted as a recommendation to buy any security. Please conduct your own due diligence.
Greg Silberman is the Chief Investment Officer of Atlanta Capital Group Investment Management [ACGIM]. Atlanta Capital Group Investment Management specializes in creating custom private market solutions for RIA/Family Office clients.
Advisory Services offered through Atlanta Capital Group Investment Management.