An extract from the Q1 2019 issue of Hidden Value Stocks. The issue features two interviews with emerging hedge fund managers, Gate City Capital Management and Breach Inlet. This is an extract from the interview with Breach Inlet.
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What traits are you initially looking for in an opportunity? To put it another way, what makes you say “yes” or “no that is too hard”?
We are generalists, but avoid companies heavily tied to commodities (such as the Energy sector and much of the Materials sector) because our thesis can be severely impacted by a factor that is difficult to forecast (the commodity price). We target businesses with high returns on capital deployed, proven capital allocators, attractive valuations, and low leverage. Our longs are often transitioning companies that are mischaracterized, holding a hidden asset, and/or complex to analyze. On the last point, while we absolutely do not invest in situations that are outside of our competency, we are attracted to opportunities where rigorous analysis reveals unappreciated value that is not apparent on a cursory review of the company.
Similar to Anthem, my favorite situations are those where we can buy the existing assets at a reasonable valuation and then have a free call option. Great Canadian Gaming is a good example because we only paid ~12x TTM cash earnings for its legacy assets (primarily British Columbia casinos). Plus, Great Canadian had recently been awarded the right to operate casinos in eastern Ontario and was bidding on rights to operate casinos in other Ontario regions. The potential earnings from the Ontario casinos were massive, but this had not flowed through the financials and the market was overly-focused on growth slowing at its legacy assets (instead of the Ontario opportunity).
Great Canadian was ultimately awarded the right to operate casinos in central and west Toronto. Hence, its run-rate cash EPS (which we define as EBITDA less cash interest expense less cash taxes less maintenance CapEx then removing the portion attributable to minority partners) and share price have doubled since our initial investment. But, we expect Great Canadian’s cash EPS to nearly double again as the company (and its development partners) deploys ~$2 billion into its Toronto casinos over the next three years. Great Canadian continues to be a top five position.
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