Sahm Adrangi was selected as one of The Hedge Fund Journal’s Tomorrow’s Titans in the 2014 survey, sponsored by EY. His firm, New York-based Kerrisdale Capital Management, has followed a spectacular growth trajectory – it has grown assets from $1 million in 2009 to c.$300 million in late 2014, and has done this without the help of any seeder. He has also multiplied day-one investors’ capital by a factor of 10, net of fees, achieving double-digit performance every year since inception. Year-to-date through the middle of October, Kerrisdale is again beating the S&P 500 by 1,000 basis points. This entrepreneurial success story offers a tremendously refreshing break from the constant cacophony of complaints that regulations, rising costs and institutionalization of the hedge fund industry have resulted in barriers to entry making it impossible to sustain a hedge fund without hundreds of millions of dollars on day one.
Adrangi is most famous for short selling, taking an activist approach and publishing research, particularly on Chinese companies, which contributed to his 180% return in 2011. All of these differentiators are true, but none of them is a basis for making generalizations about Kerrisdale. The fund is currently long-biased and expects to remain so in the future – Adrangi says, “We would never run net short; we think that’s highly risky. Shorting long-term is not optimal, not an ideal strategy, and it’s not as easy to compound wealth shorting as opposed to investing long.” That said, roughly half of Kerrisdale’s percentage returns have come from the short side, since inception. Most positions are passively held without any activist agenda; Kerrisdale does not publish research on most of its names, and the majority of the portfolio is not invested in Chinese companies.
Nonetheless, Adrangi states, “publishing research makes Kerrisdale unique,” and the Canadian national’s first job after graduating with an Economics degree from Yale University was as a trainee journalist at Toronto’s Globe and Mail. Kerrisdale’s corporate culture emphasizes writing – it hires strong writers, and analysts write detailed investment memos and reports both for internal and external distribution. The percentage of research published does vary over time, and Adrangi prioritizes external publication for under-followed longs and overhyped shorts where he feels Kerrisdale can add value by correcting misunderstandings and educating the investment community. As well, Kerrisdale welcomes an open dialogue with readers about investments: he says, “We sometimes receive feedback challenging our thesis, giving us the opportunity to examine additional or new risk factors.”
Many of Kerrisdale’s followers are institutional investors, and its research is disseminated through a variety of avenues, including an email list; its own website, www.kerrisdalecap.com; Twitter; and third-party websites such as Seeking Alpha. “It is very time-consuming and labour-intensive to put out very high-quality research,” says Adrangi, and the firm’s recent report on Globalstar, Inc. took many months of research. Adrangi thinks the expenditure of time and effort was worthwhile, because Globalstar shares are down 50% since the report was published.
When it comes to publishing research, Adrangi has identified “best practices” by observing the behaviour of other activists. Carson Block of Muddy Waters was one of the first to start publishing reports upwards of 40 pages long, and detailed reports have since become commonplace. Andrew Left of Citron Research is also someone Adrangi respects, praising Left’s “prolific, high-quality research and tremendous decade-long track record”. Recently, in relation to Globalstar, Adrangi copied strategies employed by Pershing Square’s Bill Ackman on Herbalife. Kerrisdale rented the same auditorium, hired the same web-stream production crew, and created a similar website providing research on his subject company at www.factsaboutglobalstar.com. Adrangi keeps an open mind about collaborating with other activists, but for now Kerrisdale has carved out a niche as an independent thinker.
The Globalstar debate
“Putting out the highest-quality research pays dividends in the future,” says Adrangi, and cites its latest report on a short, Globalstar (GSAT), which Kerrisdale calls The Most Egregious $4 Billion Stock Promotion Since Sino-Forest. Adrangi says that his Globalstar report “lays out our strong grasp of the company and industry via a comprehensive and lengthy 60-page write-up”. He claims that, “Our Globalstar work is very sophisticated – and we believe that our understanding of Wi-Fi spectrum is better than even management’s”.
This brief article is nowhere near long enough to do justice to the nuances, subtleties and technicalities of the debate. But anyone with an interest in Wi-Fi and mobile telephony should read Kerrisdale’s report, and Globalstar’s responses, which are both freely available online. Nonetheless, we will touch on some points of contention to give readers a taste of Kerrisdale’s research. Globalstar is misunderstood, according to Adrangi. The bulls’ thesis rests on three premises: the FCC will approve repurposing Globalstar’s spectrum to enable a new offering called Terrestrial Low Power Service (TLPS), partly to alleviate Wi-Fi congestion; this asset will attract buyers who want a private Wi-Fi network; and buyers will ascribe valuations to the spectrum in excess of GSAT’s enterprise value.
Kerrisdale has gathered opinions from dozens of industry experts, including Wi-Fi engineers, and methodically refutes each pillar of the bulls’ case. While Globalstar claims that Wi-Fi is congested, Kerrisdale’s report argues that Wi-Fi congestion can be resolved in the vast majority of environments by utilizing modern technology and proper network planning.
Kerrisdale is of the opinion that Globalstar’s TLPS channel is worth zero, even if the FCC does approve repurposing GSAT’s spectrum as a paid-for Wi-Fi channel. This is due to the wide availability of 25 Wi-Fi channels that are available for free. Kerrisdale summarizes its argument with the catchphrase, “Competing with free while selling an inferior product: this is the TLPS vision.” Kerrisdale’s report claims that there are already plenty of these 5GHz channels available for free, and “a whole ecosystem already revolving around them”. By contrast, Globalstar does not think that 5GHz will supersede or render obsolete 2.4GHz, for various reasons, including coverage issues.
Kerrisdale also points out that GSAT’s channel, if authorized, will only be approved for “low-power” usage, which it says would require a larger and more expensive network of access points than the base towers that currently provide higher-power cellular services. The cost of building out a nationwide footprint of these access points is another reason to question the value of the spectrum, according to Kerrisdale. In contrast, GSAT says its TLPS channel has “build-out cost advantages compared with 5GHz,” and could be made immediately accessible.
Differences of opinion are perfectly normal in cases of short selling – Adrangi himself has been on the other side of Bill Ackman’s short in Herbalife.
Although Kerrisdale is known best for its work exposing US-listed Chinese frauds, and Adrangi believes that numerous public Chinese companies are continuing to commit fraud, lately Kerrisdale has been focused on other areas. In a sense, Kerrisdale has been a victim of its own success here – in alerting the Western investment community to questionable Chinese companies, Kerrisdale has made it harder for fraudulent Chinese firms to obtain excessive valuations! Yet Kerrisdale is finding no shortage of overvalued companies closer to home.
For instance, Kerrisdale published its short thesis on Bank of Internet (BOFI) earlier this year. Unlike many other Kerrisdale shorts, BOFI is a “well-managed business that has grown over time,” says Adrangi – after all, this was once a Kerrisdale long position. The concern lies with its valuation. At four times tangible book value, the company’s market multiple is much too high, according to Adrangi. The key arguments are that internet banks have to pay high interest rates to attract funding, whereas bricks-and-mortar banks such as J.P. Morgan have a much lower cost of funding. Online banking, furthermore, is becoming a commoditized business, where customers are less sticky and will gravitate to whichever online savings account is offering the highest savings rates.
Adrangi is wary of over-crowded shorts. Unilife and Plug Power are two companies that Kerrisdale is short which Adrangi characterizes as being mainly vehicles for management to raise capital from investors, rather than bona fide businesses. Adrangi states that they are “stock promotions”. While Kerrisdale published on these companies earlier in the year, the position sizes were relatively small partly due to the high short interest.
Undervalued and overlooked longs
While Kerrisdale is well known for publishing on shorts, the firm also releases research on long holdings. Often the longs on which Kerrisdale publishes have limited sell-side research coverage, are undergoing a complex financial or operational transformation, feature a hidden asset, or are otherwise underfollowed or misunderstood by the market. Last year, the firm published on AMERCO (UHAL), which operates the United States’ leading do-it-yourself moving brand, U-Haul. Since Kerrisdale’s first report on the company in February 2013, the stock is up more than 150%, an impressive performance for a relatively unlevered company.
Kerrisdale has also engaged in more traditional corporate activism, and earlier this year ran a proxy contest to replace the directors of Morgans Hotel Group. His slate won approximately 45% of the shareholder vote, with two directors being elected to the board. Activism on the long side remains an occasional option to generate returns, but it is not a core part of the firm’s strategy. Adrangi believes that “impacting perceptions of a company’s valuation is a more attractive strategy for us than effecting changes within the company.” Long-oriented shareholder activism is not a central part of Kerrisdale’s strategy because “changing management and directors is very time-consuming”, and “typically involves problematic companies where there is something wrong with the company.” Adrangi prefers to invest alongside strong management and attractive business models.
On the long side today, Adrangi sees value in UK real estate brokers trading at discounts to their US peers. He is also selectively venturing into some emerging markets, including Russia and Brazil, in the search for neglected value. “Sberbank is a very cheap stock with strong deposit growth in an under-levered economy,” he says, and argues that a valuation of three times book value could be more appropriate than the prevailing 0.8x valuation. A Brazilian retailer also features in the top 10 positions. India has been a source of long positions, although Kerrisdale has taken profits recently, partly in response to the post-Modi rally. Longs also contain US-centric companies such as fund administrator SS&C Technologies, which Kerrisdale finds appealing for its superior business model that can be purchased at an attractive 5% free cash flow yield.
Team and process
Kerrisdale’s investment process may be different in part because Adrangi started his financial career in credit – performing high-yield debt refinancings and post-bankruptcy refinancings, as well as advising creditor committees in bankruptcy and out-of-court restructuring situations. This experience was at Deutsche Bank and Chanin Capital Partners LLC, and subsequent to his investment banking experience, Adrangi spent several years at a multi-billion-dollar distressed debt hedge fund, Longacre Management. Although Kerrsidale does not focus on distressed debt, the credit-oriented employment positions provided “a great training background in more complex companies and capital structures.” In particular, they gave Adrangi a focus on cash flows, whereas he finds many equity investors can fixate on reported earnings that may diverge materially from actual operating cash flows.
Adrangi may be the public face of Kerrisdale, but the firm’s heavy-duty research is very much a team effort. “We have a great team across the board,” he says. Kerrisdale likes to hire experienced professionals with investment banking, private equity, and hedge fund backgrounds. Director of research, Jordon Giancoli, has been with the firm for several years, having previously worked at corporate finance boutique Ondra Partners and HSBC Securities. Principal and senior analyst, Navi Hehar, came with a hedge fund and investment banking background, having stints at Royal Capital Management and Genuity Capital Advisers. Analyst Shane Wilson was hired from hedge fund QVT Financial, while analyst Isaac Ahn came from Tailwind Capital, a middle-market private equity firm. Trader Mathew Petrocelli has worked for two hedge funds: Diamondback Capital and Steve Cohen’s SAC Capital (now known as Point72 Asset Management).
As well as scouting for overvalued short candidates, the research process seems to involve many of the typical steps of fundamental equity research – reviewing financial statements and filings, speaking to competitors, customers, and suppliers, financial modelling, and creating internal projection models.
The 180% returns achieved in 2011 could only be repeated “if we hit a few home runs,” he says. Right now Globalstar seems like a perfect example of one of those home runs. Since launching the fund, Adrangi has had one “tenbagger”, BOFI. Kerrisdale is always “looking for the next big trade, and every year there are dislocations we can take advantage of,” he says.