May 15, 2017
Dear Partners,
News in the first quarter of 2017 was dominated by the initial activities of the new administration. Since the election in November, investors have been anticipating tax cuts, repatriation of stranded corporate profits, the announcement of massive infrastructure spending projects, and the dismantling of troublesome and expensive environmental and financial service regulations. The “Trump Bump” has propelled stocks higher.
The U.S. equity valuations are now at all-time highs, and as you have learned from our 2016 year-end letter, we have adopted a very tempered return outlook for the overall market. However, as an actively-managed fund with a value-oriented, opportunistic investment approach, we remain optimistic about the long-term prospects for our portfolio.
PORTFOLIO COMMENTARY:
The first three months of the year were largely uneventful since the predominant number of ideas in our portfolio are still relatively new (purchased at the end of 2016) and have not had a chance to work out yet. Whenever we acquire a position in a company, we typically have at least a 3-5 year investment horizon. We have noticed in a lot of our investment ideas that the biggest payoff comes after about a 18-20 month holding period.
In some cases, the value gets realized much sooner as it did in the month of April, which has been very good for Rowan Street Capital. Our largest position, Akorn (AKRX), announced that it was getting acquired by Fresenius Kabi, a global health care company based Germany. They had agreed to acquire Akorn at $34 per share, which is a 73% premium to our average cost basis of $19.60.
Akorn (AKRX)
Akorn is an industry leader in the development, manufacturing and marketing of generic pharmaceutical products in alternative dosage forms. In particular, they focus on difficult-to-manufacture sterile and non-sterile dosage forms including ophthalmics, injectables, oral liquids, otics, topicals, inhalants and nasal sprays.
We started accumulating shares in November of 2016, after the stock fell to $20 per share from its peak of $57 early in 2015. Akorn had been pummeled by a flurry of bad news, which prompted such a ferocious price decline from the highs. First, it was the announcement that they need an extension to file its 10K for 2014, followed by a modest restatement of financial statements. Their eventual restatement could have returned investor focus to sales growth stemming from acquisitions and FDA generic drug approvals, but the Form 483 disclosure and DOJ investigation into generic industry price collusion, kept investors on the sidelines.
We like to invest in good companies at the maximum point of pessimism, not because we like pessimism, but because we like the prices it produces. Such a point came in December of 2016 when Goldman Sachs assumed their coverage on the company with a ‘Sell’ recommendation and a price target of $20. The stock plummeted further on that day and we took advantage of the fear in the market to add to our position. We had spent a considerable time researching the company and building our conviction in its long term prospects, and our research indicated that AKRX’s expected return was at least 20% annualized for the next 5 years, based on the price offered to us by Mr. Market at the time. We had also suspected that there were good odds that Akorn will be a potentially attractive acquisition candidate in a consolidating generic space given its relatively small size, attractive pipeline, high tax rate, and relatively clean balance sheet.
In this case, our expected returns were “front-loaded” and the company was acquired only 4 months after we started buying the shares.
FUND PROGRESS
We have made significant progress on the capital raising front, growing our capital by 90% since the beginning of 2016. We are mostly excited about finding like-minded partners for Rowan Street Capital that share our passion for concentrated, long-term ownership of high-quality businesses.
As our fund’s capital continues to grow, all our partners will continue to derive a direct benefit in terms of our cost structure. Our annual operational costs are expected to remain constant and become immaterial in relation to the size of our growing fund, thus not having much effect on your future investment performance.
CLOSING
We would like to close this quarterly letter with a great quote from a legendary investor Warren Buffett:
“Stock market is a highly efficient mechanism for the transfer of wealth from the active to the patient.”
We are committed to staying patient, disciplined and rational with your capital that you have entrusted us with.
Thank you for your confidence and trust in our investment discipline. Should you have any questions or comments, we would be very happy to hear from you.
Sincerely,
Alex and Joe