Wholesale Investor recently caught up with Michael Goldberg, Executive Director and Portfolio Manager at Collins St Asset Management (“CSAM”). CSAM’s fund, the Collins St Value Fund, has experienced an amazing 2019 with an approximately 36% gross return and a top 5 finish across a range of industry performance surveys for the year.
Michael credits this success to the Investment team’s pragmatic and ‘value’ oriented investment philosophy as well as what is considered by many to be a refreshingly differentiated approach to portfolio construction.
“While most managers are concerned with their returns relative to the broader market, our only goal is to generate absolute returns.” Says Michael.
How portfolios are built
As opposed to owning a broadly diversified portfolio of stocks to represent the market, the Collins St Value Fund has a high conviction portfolio of the firm’s best ideas.
According to Michael, “The Fund tends to own around 12 positions at any given time, and though that occasionally means that we see more volatility in our unit price than we would if we owned the market, owning only our best ideas means that when our thesis on a particular company is proven right, our returns from that outcome are meaningful.”
When Michael and the Investment team cannot find any ideas that meet their strict valuation requirements, they happily hold cash to preserve capital rather than take a risk on an idea they don’t have complete conviction in.
Though the team at Collins St Asset Management have the freedom and flexibility to look and invest in any sector and market cap range they can find value in, they tend to gravitate towards larger industrial companies.
“Opportunities don’t always exist precisely where we’d like but investing in mid to large cap businesses allows the Fund the flexibility to move in and out of its investments without concern for finding sufficient volume or affecting share prices,” says Michael.
The Investment team are also not shy when it comes to investing in the ‘boring’. “We like companies that are boring because they are unlikely to have a premium built into their share prices. We like industrial companies because unlike commodities, industrial companies can differentiate themselves through service rather than just price,” explains Michael.
How stocks are researched
Based on the Fund’s strong performance since inception four years ago, the Investment team at Collins St Asset Management have become well known amongst investors and listed companies alike for the quality, consistency and objectivity underpinning their research process.
Investments are initially identified using a bottom up research model where the Fund seeks out businesses, irrespective of sector, that appear cheap. Once they have identified those companies, they use their proprietary model to assess what they believe the company is worth.
“As a rule of thumb, we consider the discounted value of the company’s cash flows, we look for businesses with low debt, a high return on equity, and trading on a low Price to Earnings Ratio.”
“Once we have established that there is enough value in the company to justify the effort, the team will seek to qualify the company as ‘quality’ based on a qualitative set of criteria. This includes an assessment of management (and their interests), the quality of staff, the company’s position in the industry, and the attractiveness of the offering.”
The due diligence that goes into this part of the process occurs over several months (sometimes even longer) and involves visiting the business’s operations, talking to key staff, major customers, and relevant competitors. Where appropriate the Investment team will also engage the company for the service they provide, or to buy the items they sell to see if the business case is as compelling as it first appears.
“We have found that there is no better way to get a sense of customer experience than by becoming a customer. Plus, there are few people who have as much insight into a company as its staff and competitors,” explains Michael.
Expanding on this point, Michael said that “In our investing process, we test and challenge our conviction at every turn, ensuring that every concept is contested with a designated devil’s advocate within the team.”
Point of difference: Quality and background of the Investment team
The members of the Collins St Asset Management Investment team have extensive experience managing real businesses, including investment research firms, retail businesses, international hospitality business and a leading global digital publishing company.
“It’s this experience that provides the team with a unique view of the world and drives our thinking when looking at investments. Our personal experience and willingness to challenge management on the operation of their businesses allow us to gain insight that others cannot,” says Michael.
Point of difference: Alignment of interests
Collins St Asset Management differs by aligning their interests as absolutely as possible with their investors. This alleviates the issue of conflicting interests when it comes to investor monies.
According to Michael:
“The challenge investors consistently face is in identifying whose interests are being met by the actions of those they have entrusted with their money. As investors in the ASX, we’ve often identified management teams whose incentives were at odds with their investors. When we find those situations, we ensure that we stay clear of them. This includes avoidance of management team bonuses in line with revenue growth and the traditional 1-2% p.a. fee structures and instead structuring the Fund to only benefit the manager when clients see real returns.”
Michael went on to say that “If our investors don’t profit, nor do we. This structure ensures that we are always looking after the best interest of our investors, and in doing so generates a good outcome for all.”
Ideas brought to life: Two stock that have generated > 100% returns in the Fund
Two of their most successful case studies to date include Warrego Energy and Paradigm Biopharmaceuticals.
Longstanding professional relationships within the Energy sector opened up a door that led to an investment opportunity with Warrego Energy (ASX:WGO). In short, Warrego Energy planned to drill at one of their sites to see if some identified pockets of gas were economic to extract.
Based on all the information available, the site appeared to be highly prospective and the Collins St Value Fund was able to originate, negotiate and execute an investment into the company by way of a convertible note. The WGO Convertible Note had a 12 month term with interest capitalised upfront, convertible based on the 10 day Volume Weighted Average Price (VWAP) prior to conversion.
According to Michael:
“We were attracted to the concept of a 10 day VWAP because it would allow us to take advantage of news flow. Once the company announced its specific findings to the market, we anticipated that the share price could rise considerably. At that time, we’d be able to convert our notes into shares based on the previous 10 day’s share price. To protect the downside our interest payments were received upfront, and in the event that the company did not discover the gas deposits as expected we could convert our notes gradually at market price.”
Reflecting upon the way risk was managed within the transaction, Michael noted that “This was a highly asymmetric offer. If things didn’t pan out as well as we’d like, we would walk away after 12 months having earned a reasonable amount of interest on our investment. However, if events did pan out as hoped, we believed our returns could be better than 100%.”
As it happened, things went well. Not only was the target area proven to be highly economic, but along the way pockets of additional economic gas were identified. By the end of July 2019, Collins Str Value Fund converted half their notes to equity after Warrego announced a gas pocket on the way to the main target. They were able to convert at 9c when the share price was over 16c. They went on to sell some of those shares over the next few days at 17-18c per share.
When two weeks later Warrego announced results from the main target, they converted the balance of their notes at 19c while the prevailing share price was 32c.
“This was obviously a wonderful outcome, and one that was only available to us due to our nurturing of relationships with industry insiders and experts.” Said, Michael.
A chance meeting with Paradigm Biopharmaceuticals (ASX:PAR) occurred due to a member of one of the Investment team’s family requiring knee surgery for arthritis. They were informed of a company doing trials on a drug with positive results and hence Paradigm was discovered.
From an investment perspective PAR was in a unique position. Unlike most other drugs that require three expensive and time-consuming sets of clinical trials before doctors or regulators would be willing to allow patients to be treated, Paradigm were repurposing an old drug.
“This meant that the drug had an established safety profile and was available to patients via a Special Access Scheme (SAS) managed by the Australian regulators,” said Michael.
Even while the company was undergoing its clinical trials to confirm the efficacy of the drug, they were treating patients with the same drug in the real world and reporting on the outcomes.
“Having spoken to several doctors and many patients involved in the treatment, given that better than 90% of patients in the SAS had seen an improvement in their pain since being treated, and that approximately 50% reported that their pain score had more than halved, we gained the confidence needed to invest in the company before the Stage 2 clinical trial results were released.”
“Our thinking at the time was that this drug, which had an addressable market of over $100 billion annually, has a known safety profile, and is currently working in real world treatment, was worth materially more than the $100 million market cap at the time” explained Michael.
About 18 months ago Collins St Value Fund ‘corner stoned’ a capital raising by Paradigm at 68c per share. The share price has since reached as high as $4.34.
In terms of their five-year plan, Collins St Asset Management anticipate that the Collins St Value Fund may have a capacity constraint at around $400 million at which point they will need to soft close the fund. As Michael puts it, “there is no value for any parties to simply grow the Fund for the sake of getting larger. If we can’t generate the returns we want, there is no value in raising more capital.”