Mount Logan Capital Inc (MLCI) 2018 Q4 法說會逐字稿

(Operator Instructions)

And welcome to 180 Degree Capital Corp's Fourth Quarter 2018 Financial Results Call. This is Daniel Wolfe, President, CFO and Portfolio Manager of 180 Degree Capital; Kevin Rendino, our Chairman, Chief Executive Officer and Portfolio Manager, and I would like to welcome you to our call this morning. (Operator Instructions) I would like to remind all participants that this call is being recorded, and that we will be referring to a slide deck that we have posted on our recently revamped Investor Relations website at ir. 180degreecapital.com under News/Events.

Please turn to Slide 2 that contains our safe harbor statement. This presentation may contain statements that are forward-looking in nature related to future events. Statements contained in this presentation that are forward-looking statements are intended to be made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect the company's current beliefs and a number of important factors could cause actual results to differ materially from those expressed herein. Please see the company's filings with the Securities and Exchange Commission for a more detailed discussion of the risks and uncertainties associated with the company's business that could affect its actual results. Except as otherwise required by federal securities laws, 180 Degree Capital Corp. undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

I would now like to turn the call over to Kevin.

Good morning, and thank you, Daniel. Please turn to the summary of Q4 2018, which is number Page 2 on the slide deck. It feels a little odd to be reviewing the fourth quarter given we're in such a completely different environment just 2 months later. Essentially, through last night, as you can see from our public holdings, we have gotten back all the losses that we incurred in Q4, and a lot can change between now and the end of Q1, we'll have more on that later. Nevertheless, we do need to review Q4, so let's begin doing so.

Despite a 6% decline in our NAV, our share price declined 19%. This led to a widening of the discount our share price trades relative to our NAV. That discount was 23% at the end of Q3 and 34% at the end of Q4.

And as you know given the success we have had investing in the public markets over the course of the last 2 years that I don't think that's the right reflection of our business. And you also know that because between Daniel and I, we're pushing ownership of TURN to the tune of nearly 1 million shares, and almost all of that has been bought with our own money from our pockets.

We ended the quarter with $33 million cash and liquid securities of nearly $1.10 per share, more on that as we go along. Our public portfolio did have a challenging quarter and was led by declines in Mersana, Adesto, TheStreet and Airgain. Our private portfolio was basically unchanged from last quarter. For the most part, this part of our balance sheet has been a drag to our growth in NAV over the last 2 years. However, this quarter it helped cushion the blow of a very difficult market. Daniel will discuss the private portfolio soon.

It was a total wipeout for the market in Q4 led by fears of a trade war with China, interest rate fears, an inventory correction in the semiconductor space and overall slowing global growth led to weakness And the underperformance of both hedge funds and long-only equity funds and private equity funds led to massive redemptions at the end of the year. HFR Global Hedge Fund reports that investors redeemed $22.5 billion from hedge funds in Q4, while Lipper reported $57 billion in redemptions from equity funds. It was one of those markets where selling begets selling, begets selling, begets selling. It was the first time in history that the S&P ended the year down when, after the first 3 quarters, it was up. It was the worst December for the S&P since 1931 or during the Great Depression. The Russell Microcap index was down 22% for the quarter and 13% for the year. At one point from its high earlier in the year, the Russell Microcap index had declined by nearly 30%. So no, this was not your normal correction and not a normal selloff. This was a slower moving market crash just like the one that we experienced in 1987, this one just took longer to play out. Nobody likes to lose money. But against all of this, our public market stocks outperformed their benchmarks and were actually up in 2018.

In Q4, we are able to protect our balance sheet by having a greater than normal cash cushion, cash was intentionally greater than 10% of our assets because we too had building concerns about the market as we were ending the year. All in all, in the face of what was a clearly challenging 2018, we grew our book value. I know from looking at the Lipper data that you can count on one hand the amount of funds that generated a positive return to the shareholders. We are pleased to be one of them. We certainly survived the year.

Next slide please. This is a -- this slide shows our NAV over time. The Russell Microcap index is actually down for the 2-year period ending 2018, which is when 180 Degree started. Against that backdrop, we have grown our book value 13%. And this is after some restructuring charges we took on the eve of turning Harris & Harris into 180 Degree Capital. So all in all, we were up last year, and we were up over the course of the last 2 years against the Russell Microcap, which is down 1.5%.

Next slide please. This shows our NAV over time. The Russell Microcap index -- I'm sorry, the next slide is sources of changes of our net assets. We show you this slide every quarter, the sources of change in our NAV for the quarter. Firstly, we were aided by a reversal of an accrued bonus in Q4. What does that mean? We have repeatedly told you that our management team is aligned with its shareholders. If we meaningfully grow our book value, the management of 180 Degree Capital would share in that growth. And if we don't, we won't. It's as simple as that. Through 3 quarters, given where we were, given where our NAV was, there was an expected comp pool for the management team. And we accrued for that during the first 3 quarters of the year. Given Q4's performance, we 100% reversed that accrual and as such, there'll be no bonus pool for the investment team. Our public stocks cost $0.16 in the quarter, our private portfolio was down $0.01, our normal expenses of $0.02 led to an ultimate decline of $0.17 for the quarter.

Next slide, please. This slide is the source of change in our net assets for all of 2018. Led by a 10% gain of performance in our public holdings, we generated $0.12 of gains. Private portfolio cost us $0.01, normal expenses of $0.07 led to a total gain of $0.04 to our book value or 1.5%.

Next slide, please. Here's our scorecard for the 2 years since we started. As you can see, most of the gains generated here are on our public portfolio, $0.45 of gains to be specific. The private portfolio added $0.08 of gains, normal expenses lead to a 13% gain in our book value against a 1.5% decline for the Russell cap micro -- for the Russell Microcap index. Other than waiting for a big monetization event from the private portfolio, I don't even want to think about what would have happened to our business had we not turned Harris & Harris into 180 Degree Capital.

Next slide, please. Here's our weighted average return of our public portfolio in Q4, down 16%. Like the market, we suffered as well, not as much but still very painful. As I look at this, I would say we have been negatively hit more so by the trade war chatter than anything else, specifically, as it relates to our exposure in the technology space and IoT, in particular. We clearly think the market has overshot its concerns here. And as such, we spent 30% of our cash in the quarter on both old and new names. We'll have a few comments to make on these names in a second. But as always, if you have a question in any of these, please ask them when we're done with our prepared remarks.

Next slide, please. Our public positions absolutely had a tough Q4 of 2018. Mersana decreased by nearly $0.05 a share or 59% in the quarter. There was really no company-specific news in the quarter that could be identified as the cause of the decline other than the NASDAQ Biotech Index declined 20% in the quarter. And the last thing you want to own is an early-stage biotech company that needs cash to fund its business. I think as I look back at our performance in the quarter, this was the one that I kind of hit ourselves over the head the most because I should have read the tea leaves a little better here.

In Q1 of 2019, Mersana announced termination of one of its development programs to focus on a second program that should aid its cash on its balance sheet. And just like the decline in Q4, because the world was ending, given the robust nature of the market in the first quarter, the stock is actually up 73% through February 25.

Adesto hurt us by $0.05 as well. There was no company-specific news as well that can be identified as the cause of the decline other than the fear of the trade war with China and what that would do to the technology supply chain. The entire semiconductor sector declined due to the China trade war plus excess inventory. The SOX index declined by 15%. You're just not going to have a stock that's up in the sector when everyone is selling and the index, in general, is down 15%. Like Mersana, this has clearly reversed itself in Q4. They reported last -- in Q1. They reported last week, and the stock is up 39% through February 25.

Airgain fits the same bill as Adesto. It was down last year because of fears of the China trade war, and the rest of the technology complex hurt us by a couple pennies. They reported earnings a couple of weeks ago. They were better than expected. The guide was better than expected, and the stock was up 24% through February 25. So back to my point about where we are currently, I can basically sit here today -- and if the quarter closed today, we would have erased all the gains from last -- all the losses from last quarter.

Next slide, please. Here is our weighted average performance of our public companies over the course of last year. If you told me that we would essentially have a market that was down 13%, would I accept a 10% gain in our public holdings? Clearly, the answer to that is yes, 100%.

Next slide, please. Here's our weighted public company performance for all of 2018. And again -- or I'm sorry, for the 2 years ended 2018. And again, if you told me that the market will be down 1.5% over the course of that period of time, would I have accepted a positive 43% for our portfolio? The answer to that would also be yes. We've had 4 doubles in our portfolio over the course of the last few years. Adesto, U.S.A. Truck, Turtle Beach, and TheStreet, we think we've done a fairly good job of managing the public markets portfolio over the course of the last few years.

Next slide, please. This is -- we think we've built a solid track record in our public market business. This is a snapshot of our public market sector versus the rest of the world. I think we built the case that common sense investing with a touch of activism can lead to great results. I think now we have a credible case to go out and seek more outside capital. I think when we started, we talked about our desire to manage outside capital. We've done so with a couple of SPVs. But I think the track record that we've built over the course of the last 2 years is going to give us a better case to make for a more robust capital, perhaps in a new activist fund that we're contemplating as we sit here today.

Next slide, please. This is a -- just a look at our NAV change. Of course, we are only using the portion of our balance sheet for the public market investing that we do. So the NAV growth and public market returns will look a little different. All in all though, fairly good success both in 2017 and 2018.

Next slide, please. We talked to you about our desire to turn our business into 100% public market investing. This is going to take time. We think we've made substantial achievement and had some success in this area over the course of the last 2 years. We've taken our cash in public securities as a percentage of our assets from 26% up to 40%. Now in Q4, we took a step back. We ended Q3 44% of our portfolio was in cash and liquid securities. And that number fell to 39.5%. But as you know, as I talk to all of you, the more you can have in cash and liquid securities, the more narrow that discount will be for our share price through our NAV as the market will have a better understanding of how to value our portfolio than just looking at our private holdings.

Next slide, please. I touched on this earlier. Again, a lot can change here in the next month, but our public market gross weighted average increase of $4.8 million or nearly 19% has equated to a $0.15 gain in our NAV year-to-date. This doesn't take into consideration what our private portfolio will be doing or, clearly, our expenses. But my point is, is that if the quarter was 5 months, we talk about a flat quarter. If 3 months, we have to talk about a $0.17 decline. Hopefully, this quarter, we'll be talking about a $0.15 or $0.16 or $0.17 gain. Who knows? We are managing your money not on a quarterly basis but from start to finish. And we think about investments over a long period of time. We're trying to build your capital. Unfortunately, the world stops, and we all keep score at the end of quarters, and we report on those quarters, but the idea is to grow the most money we can for you over a sustained period of time. We think we've done that.

We have built 2 new positions in public companies. We may or may not talk about them when we report Q1 because we are building those positions currently. And one other note, the Canadian dollar has increased in value versus the U.S. dollar. And as you know one of our holdings, D-Wave, a Canadian company, either benefits or gets hurt by the change in the dollar. Well, this change year-to-date has given us $0.01 per share increase in our NAV because of the Canadian dollar strength that we've seen year-to-date.

With that, I will turn the call over to Daniel, and then I'll come back for concluding comments. And then we'll open it up for Q&A. Daniel?

Thank you, Kevin. Please turn to Slide 15. As talked about earlier, we added 1 new position during the fourth quarter that we're ready to announce publicly. It's called Intermolecular. Intermolecular symbol is IMI. It provides semiconductor companies with materials, development resources using its expertise, accelerated learning and experimentation platform and information and analytics infrastructure. We've known of IMI since its founding, it was a venture-backed company, and have tracked its development over the years. We recently became re-interested in it because of the hiring of a new CEO, Chris Kramer. Chris was formerly at Entegris and was a customer of IMI. He had unique knowledge of both the specialized capabilities of the company and the problems with its prior business model. He and his team turned around the company, reset its business model and signed new customers, including some of the leading semiconductor manufacturing companies in the world. The company has a pristine balance sheet with $30 million in cash and no debt. And its services generate 60% to 70% gross margins. We took advantage of distribution shares by one of the venture capital investors to establish our initial position and have been adding to it throughout the rest of the quarter and into the first quarter of 2019.

Please turn to Slide 16. As we said in prior calls and letters, we continue to believe our private portfolio contains companies that can generate material, meaningful returns on invested capital. As of December 3 -- as of the end of the year, our most mature private portfolio companies: D-Wave, AgBiome, Nanosys and ORIG3N, were valued at approximately $30 million in aggregate or over half the total value of our private portfolio and more than what the market actually has valued our private portfolio at the end of the year. There are other private companies within our portfolio. However, these companies are in the early stages of developments. And the time lines and potential exit values for these companies are highly uncertain.

As a reminder, following the sale of our shares of HZO to unnamed investors for an aggregate price of $7 million in the third quarter of 2018, we continue to look for opportunities to monetize our private portfolio investments in transactions that we believe are in the best interests of our shareholders. Towards this goal, we were able to sell our convertible note in Genome Profiling to an unnamed investor in January 2019 for the principal amount of the note of $230,000 plus unpaid accrued interest. While not as material as our sale of shares of HZO, it is a continued step in our efforts to monetize our private holdings so we have additional capital to pursue work in our public investment strategy.

Please turn to Slide 17. As we have discussed in our prior calls, we have greatly reduced our operating expenses, which will make it far easier to grow NAV than in years past. For the fourth quarter of 2018, our operating expenses were essentially flat versus the same quarter in 2017. I note that these figures do not include sublease income, which was the same in the fourth quarter of both years.

Please turn to Slide 18 and 19. As we discussed on all of our past quarter calls, we currently anticipate the reductions in our operating expenses as a percentage of the net assets. We base on growth in our net assets rather than further reductions in our expenses. This slide shows that we continue to make progress on that front with estimated operating expenses as a percentage of net assets, including and excluding our year-end bonus accruals from each year -- if there were any, although there wasn't any this year -- from those of last year due primarily to an increase in our net assets. Last quarter, we also mentioned that we may make investments in our business by adding to our investment staff, which would increase our operating expenses. We will only pursue such a hire if we believe that the investment will help us grow 180's net asset value.

Kevin already mentioned this that given the performance during the quarter, management recommended, and our compensation committee agreed, that the investment team would not receive a bonus for 2018. Our compensation committee did determine that 2018 met the persistent performance goals from the deferred bonus from 2017. So half of the deferred amount was paid to management. The remaining half will only be paid if such performance is persistent through 2019. We remain committed in treating every dollar of shareholder money with the utmost care and consideration. It is much easier for us to grow NAV when the expense hurdle rate is where it is today.

I will now turn the call back over to Kevin.

Thanks, Daniel. Q4 2018 was brutal. We suffered along with it, albeit not as bad, and the year 2018 was challenging. Although I would say, as we sit here today, we certainly have survived. Being up last year, albeit a small amount, is an achievement that not a lot of funds can say they had positive returns.

If you look at our scorecard on Page 20. We grew our NAV, our cash and public portfolio securities went up and our expenses went down. And we also managed more third-party capital than we did in 2017. So our stock price declined, not happy about that, as you know. And our discount to NAV actually widened, not happy about that either, as you all know. But in terms of managing the business, sort of controlling what we can control, we think that, as I said, not only did we survive 2018, but I think the world can point to our performance as one of the elite performers in all of 2018, certainly, Lipper would.

Slide 21 is the sum of the parts. We do this for you every quarter. Basically, we start with our share price. We then say what is the value of our publicly traded portfolio companies, $0.80 a share, add-back of cash. Take other noninvestment asset per share, and we end up that our total nonprivate portfolio's net asset per share of $1.03, meaning the world is paying us $0.72 per share for our private portfolio. And given that we've marked our private portfolio at a $1.61, even though we show, overall, a stock that trades at 2/3 of its NAV, if you actually look at what the market is paying for us, for our private portfolio, you'll see that it's really $0.44 on the dollar. Recall last year that we returned capital in the form of the HZO, not only at NAV but at a premium to NAV. So we certainly think the market has misinterpreted the value of our private portfolio. It is up to us to monetize it over time.

Lastly, on Slide 22, our goals or our vision for 180. We want 180 to be known as a prominent and dominant leader in our world of public company constructive activism. We think we've had a number of successes who are ready to speak up: Turtle Beach; certainly, TheStreet. We hope to have another one lined up that we'll be able to hopefully share with you sooner rather than later. We will always continue to strive for excellence in investment management performance. If you cannot pick stocks, you don't deserve other people's money to manage. And our job is excellence in investment performance. We think we've proven that we can do this. I'm pretty proud of the track record that we've developed. We need to continue along on the same path.

We want to be known as game changers and helping businesses generate positive shareholder returns. Activism means a lot of things to a lot of people. We call our activism collegial or constructive. I would ask the management and the board of TheStreet to set -- to ask them, was 180 constructive in helping turn a $0.80 stock into a $2.20 stock in basically 15 months? We are aligned with you. I said it earlier, management owns nearly 1 million shares. The window has been closed for us since we reported the quarter. For us to be successful, we must increase the price of our stock. We've said that from day one. That is how we keep score at the end of the day. And I certainly know when I go home at night, I know that the TURN stock price will greatly affect my net worth and net worth of the management team and the board. So we are clearly aligned with shareholders on that front. With that, we will open it up for questions.

I've already decided that the first couple of words for my next shareholder letter, if things continue the way they have gone, and 2019 is going to be never mind. Meaning never mind all that we've said in our last quarterly report when we reported Q4. With that, Daniel, why don't we open it up for questions?

Sounds good. (Operator Instructions)

It's Bryant Riley. Congrats. I mean being in the frontline of the small caps, I've certainly seen the difficulties in that market. You guys did a good job. Can you help us understand AgBiome and D-Wave? How big are those companies? What is the -- how do you value them? Are there -- is it a private share sales? Just given that it's such a big piece of the portfolio value, can you just provide a little clarity there?

Yes, I'll let -- first off, Brian, thank you very much for your comments. I'll let Daniel comment on D-Wave and AgBiome, and maybe I'll have something to add.

Yes. Thanks, Bryant, a great question. And so taking a step back, every quarter, we go through a robust valuation process. The values are prepared by management with the supporting information and are actually set, at the end of the day, by our Valuation Committee, which is made up of all of our independent directors. Most of the time, you have situations where companies, and especially with a company like a D-Wave or an AgBiome, where they're really just building their businesses. They are starting to generate revenues. They're starting to figure out their longer-term business models. But oftentimes, they also do raise capital in those endeavors and as they're building. And so we often will use a most recent round of financing as a base on which we will then work to derive value or if there was a material secondary transaction that occurred. And that gives us an indication to what the value of those shares we hold may be. And we use option pricing models, which has become standard in the industry, as part of deriving value when you have complicated capital structures. But there's -- for a company like an AgBiome or a D-Wave, both of those companies actually had either a financing event or a secondary transaction within -- meaningful secondary transaction within a year of the valuation date. And so those are the primary implicit value as of at least this current date.

I would say, Bryant, they're our 2 biggest positions by a country mile. They matter the most. I think most of our investors, when they think of us, they always ask about D-Wave because it's an artificial intelligence quantum computing company that has oodles and oodles of IP and brilliant engineers and they basically develop answers to questions that haven't even been asked anymore -- or that haven't even been asked. And so the amount of technology and brain power that's there is substantial. We think -- this company has been around for a long time. It's a mature company in terms of its notoriety and the amount of financing they've done. They need to monetize themselves over the course of the next 2 years, and we hope they will. It's a very important company up in Canada. It's Canada's prize jewel as it relates to technology. AgBiome, so while I think that investors always ask us about D-Wave, we think that our best private business that we own is AgBiome. It's in the seed world. It's run by an unbelievable collection of a brilliant CEO and his management team. We think they're doing the right thing. They're setting up holding companies for their businesses. Each round of financing they have been done has garnered more and more demand and, therefore, a higher price. There's actually business there as well. They got big -- both companies have big valuations though, in the hundreds and hundreds of millions of dollars as opposed to in the $20 million or $30 million or $50 million, so these are really big businesses.

Got it. Okay. So I'm sorry, I've missed that. So the market -- the rough valuation, so your percentage ownership of AgBiome is roughly what percent?

Go ahead, Daniel.

Yes, we don't disclose exactly what our value -- our range -- or the exact amount is because the other investors get unhappy when we do that. But in ranges, what we said is, AgBiome in somewhere between 5% and 7.5%. D-Wave is somewhere between 2.5% and 5%.

So Bryant, we always get asked, why don't you just monetize them? Or why don't you to make them go public? Or why don't you make themselves sell themselves? In those -- in these cases, we aren't controlling the shareholders. And so there's only a certain amount of push that we can give in that they'll listen. We're just not controlling the shareholders. That doesn't mean that the companies aren't doing the right things and that there's other shareholders that have greater interest that aren't aligned with us, because they are in both cases, but it's -- these are not controlling positions.

Got it. All right. Well, you guys truly -- I mean I think you've done a great job. You deserve more outside capital. And I know you took on a lot of positions, and you've done a lot of to move the needle. So congratulations, and I appreciate it as a shareholder.

It's very nice for you to say it, Bryant, thank you very much.

Thanks, Bryant.

I think maybe it's up to me, Daniel. This is [Al Shams] here in Atlanta, Georgia. So I reiterate Bryant's comments, a good work in a very tough time. Looking at Intermolecular, interestingly enough, I've got a position in that thing myself, so kind of -- actually, a coincidence. But I've noticed that a gentleman by the name of Neil Subin sold about 250,000 (sic) [205,000] shares recently. And then another gentlemen, Miller Lloyd (sic) [Lloyd Miller], I think he passed away about a year or so ago, I think his estate has a lot of stock. Could you comment relative to those 2 transactions?

Yes. So Neil and Lloyd Miller -- Neil Subin is managing the foundation of Lloyd Miller, I believe. And therefore, when it says Neil Subin ownership, it really is the foundation or the holdings for Lloyd Miller when he passed. A couple of comments there. Many times, when you go through a market meltdown, and then you're staring at your screen and you're wondering why on God's earth is this going down this much, what am I missing? We all would say, what am I missing? What am I missing? We -- Daniel and I, right, we'd be yelling at each other. In Q4 and then, quite frankly, sometimes we look back, I think we really didn't miss anything other than there was a market meltdown and there was forced liquidation. So we always hear forced liquidations, forced liquidations. Well, they actually do occur. And they actually are real. And in Q4, I highlighted for you the Lipper and the hedge fund data. But we also knew that there were a number of LPs that were literally selling positions at the end of the year regardless of price. And Intermolecular's fourth biggest holding did just that. We were aware of that, that one of their LPs, one of the companies that it owned Intermolecular when it was private, they came public, they retained their position, the fund closed, and they a distributed all that stock to its LPs at the end of Q4. And we knew that was coming, and we -- and that's why we were there with the basket at $0.94 a share at the end of the year. I don't know any more about what Neil Subin is doing other than he sold stock the other day. I don't know what that means, if there is more stock for sale or not. We like to keep our ears peeled to the -- to all trading desks to make sure that if events like Q4 happen where 1 LP sells 4 million shares in 1 day, if somebody else is going to do the same thing, well, we love this business, we think it's worth $2 over time. We think the CEO is doing a fantastic job. We think there's ample cash on the balance sheet. We want to be ready. And so if that stock is for sale then we're on the buy side. If it's not for sale, then it's not. But if it trades, you could expect us to be part of that trade.

[Operator Instructions] We see no more questions. Thank you.

Okay. Well, thanks, everyone, for listening. Of course, if there's any comments or questions that you have, feel free to reach us in the office or by email. I'm glad 2018 is over. It was a brutal quarter and a tough year. But as I said earlier, we -- not only do we think we survived, but we think we actually can put our performance against most other funds and be very proud. So we'll continue to work hard for the benefit of all of our shareholders, and we look forward to reporting to you Q1 in just a couple months. So thanks very much, and have a great day.

Thank you. You can all disconnect now.