Greenhaven Street Capital Q3 2024 Investor Letter

Pricey Fellow Buyers,

The Fund^[1] returned roughly +15% web throughout the third quarter, bringing year-to-date returns to roughly +12% web. Returns will range by fund and funding class so please examine your particular person statements.

SELF-HELP

The final two letters have featured the Charlie Munger quote suggesting that “[t]he large cash is just not within the shopping for or promoting, however within the ready.” There’s lots of knowledge in that quick quote – compounding takes time, as does constructing a permanent enterprise.

Collectively, as a partnership, we’re excellent at ready. Unscientifically, I put us nicely into the highest decile of “waiters” on this world. The flexibility to attend is a superpower. We are able to wait, we do wait, and we’ll wait, however even Munger would agree that ready is just not the one supply of alternative. Lately, we now have been discovering alternatives that I broadly place right into a bucket I name “self-help.” With a lot of our portfolio requiring us to attend, self-help feels fairly good.

The primary sort of self-help alternative is a enterprise pursuing a transition that will yield a considerably higher enterprise. Sable Offshore (SOC), mentioned within the appendix of this letter, is an instance of a enterprise serving to itself. If they’re profitable, I imagine the corporate may be price multiples of in the present day’s share value. Sable’s “self-help” course of, if it occurs, will happen over the course of months, not many years, and must be much less correlated to the general market because the catalysts are firm particular.

The opposite sort of self-help scenario we now have been is balance-sheet-related. In smaller firms, there are occasions when the stability sheet is a matter; for instance, an excessive amount of debt and/or not sufficient progress capital. In these conditions, our capital will help remedy the issue, together with by being a catalyst to assist drive a “re-rating” of the shares. As a bonus, such purchases / infusions of capital usually happen at a reduction to the market share value.

For instance, earlier this yr, we invested further capital into PAR as they raised cash by means of a PIPE (Non-public Funding in Public Fairness). The providing enabled PAR to fund their acquisition of restaurant know-how supplier TASK, which gave PAR a world product providing and each McDonald’s (MCD) and Starbucks (SBUX) as clients. The “catch,” if there was one within the case of PAR, was that the shares we bought within the PIPE needed to be registered and thus couldn’t be offered for about 90 days. Given our propensity for ready, the illiquidity was acceptable. We helped an organization that we firmly imagine in considerably develop their addressable market AND acquired an 8% low cost to the market value on the time. Partially due to the acquisition we helped fund, PAR’s share value has elevated greater than 30% since our funding and the discounted shares we purchased within the PIPE (which at the moment are tradeable) are up greater than 40%.

LIFECORE

After the third quarter ended, we participated in one other PIPE of an organization we already owned, Lifecore Biomedical, Inc. (LFCR). On this case, we invested to not assist fund an acquisition however to as an alternative strengthen the corporate’s stability sheet. Our purchases had been at a >10% low cost to the market value, which, I imagine, is quickly depressed. The extra capital removes near-term liquidity points which, we imagine, ought to assist the share value within the quick time period.

Lifecore is a contract improvement and manufacturing enterprise (CDMO) that does the fill/end for sterile injectables offered by drug firms. In layman’s phrases, when any person injects themself with a single dose of Ozempic, that dose was formulated and packaged by a third-party CDMO utilizing Novo Nordisk’s recipe. This tends to be enterprise because the fill/end is a small portion of the general prices and switching CDMOs requires FDA approvals, so churn tends to be low.

Along with being “self-help,” I imagine that our Lifecore funding has been well timed. The Lifecore CDMO enterprise had been buried within an packaged items conglomerate that offered salsa, packaged salad, made guacamole, and imported olive oil, along with manufacturing medication. There was no industrial logic to the mix, the CDMO was not higher off due to the lettuce. Previously yr, Lifecore completed its divestitures of its different holdings and is lastly a “pure-play” CDMO enterprise.

The divestiture of the agriculture enterprise led to re-statements of audited financials. The restatements, for my part, weren’t materials to the corporate’s monetary situation (six figures in magnitude), however had the impression of the corporate being “darkish” and never reporting present financials or internet hosting earnings calls. After greater than a yr, that “darkish” chapter ended this summer time, making the corporate analyzable utilizing dependable monetary statements (low bar I understand).

Lifecore has a brand new CEO, who has circled three earlier CDMOs, in addition to a brand new CFO who was the CFO for one more CDMO that was acquired. That is to say that they’ve related trade expertise and relationships. Following the latest capital injection, I imagine the most important dangers to the enterprise are execution dangers. From right here, the marching orders are clear – promote new enterprise and enhance margins.

Lifecore simply went reside with important new manufacturing capability, an enterprise that took nearly 4 years to get on-line. With now nearly doubled capability, Lifecore now operates at lower than 35% utilization, which means that it could possibly nearly triple income with just about no further capital required.

Lifecore hit an “air pocket” this yr as their largest buyer, Alcon, is “de-stocking”/decreasing stock ranges, which impedes progress for 2024; nonetheless, there are a number of years left on their contract, which has required minimums that enhance over time. Rising contractual minimums and investments in gross sales and advertising and marketing present components for the corporate’s sustained double-digit income progress. Administration’s medium-term progress steerage is “at the least 12%,” which shouldn’t be a heavy raise as this CMDO enterprise traditionally has grown organically at 12% per yr, and the broader sterile injectable market is equally projected to develop at 12% per yr.

Whereas Lifecore doesn’t presently manufacture Ozempic, Wegovy, or any of the GLP-1 medication – necessary drivers of the trade’s progress – they’re geared up to take action. Administration has hinted at GLP-1 conversations, which if got here to fruition might take most, if not all, of the prevailing spare capability. On condition that Eli Lilly and Novo Nordisk are severely capacity- constrained on volumes, that are anticipated to proceed exploding, trade capability ought to proceed to be absorbed by GLP-1s benefiting Lifecore even when they don’t sigh immediately. In a latest interview (hyperlink) the Eli Lilly CEO indicated that there are 41 international locations the place their GLP medication are accepted however haven’t launched due to manufacturing capability constraints. They can’t make GLP-1s quick sufficient.

Whereas useful, we don’t want a GLP-1 contract for this funding to work. Lifecore is promoting capability into an trade that’s constrained. Their new CEO ran enterprise improvement when he was at Mylan (market cap $9.5B earlier than merger) and Lifecore traditionally grew at >10% with successfully no gross sales drive. Contractual minimums alone will enhance revenues even with zero new clients. A future world the place Lifecore is rising is eminently believable.

Extra necessary to the funding thesis than the anticipated income progress is the potential to enhance margins. Lifecore’s EBITDA margins are presently 15%, whereas a number of trade friends are 30%. Margins ought to enhance as volumes enhance/capability is utilized, however, even with out progress, there’s alternative on the associated fee aspect.

Since changing into CEO, Paul Josephs has overseen a spherical of layoffs and focused price financial savings, along with some non-recurring bills rolling off, all of which is able to enhance margins going ahead. Administration has said that they imagine such fundamental blocking and tackling efforts can get margins to at the least 25% over the medium time period. If administration is profitable on this 66% margin progress (15% to 25%) whereas rising revenues at 12%+ per yr, merely holding multiples regular would see us greater than double our cash over that timeframe. If we see margins attain the trade common of 30% with the identical 12% progress, you will have line of sight to a triple.

The potential third engine to drive returns is a number of growth. The shares we bought had been buying and selling at <15X what I believe is an already depressed EV/EBITDA, whereas two latest acquisitions within the area have been made at >25X (Catalent (CTLT) at 31X and Biovectra at 27X). We don’t want a number of growth for the funding to work, however it’s believable and will get us into 5-bagger territory. Lifecore will maintain its first investor day on November 21^st and can start to actively “get the story out” from there, which, together with progress, can be key to any a number of growth.

Whereas our lately bought Lifecore shares have had a +25% “pop” with the stability sheet issues decreased, this “self-help” funding will nonetheless require ready. The CDMO enterprise is enticing, partly due to very low buyer churn. Sadly one of many main causes that churn is low, is that it takes two years to onboard new enterprise due to regulatory necessities and approvals. Within the very close to time period, progress can be flat to down. With earlier signings and Alcon returning to their contractual minimums, progress ought to return, however in the present day’s investments in gross sales and advertising and marketing will take two-plus years to indicate up. Margin enchancment can occur extra rapidly and, if there’s line of sight to income progress, a number of growth can occur as nicely, however I believe Munger can be proper but once more in that the large cash (if it comes) can be within the ready with Lifecore.

TOP 5 HOLDINGS

Greenhaven Street’s present high 5 investments are all firms that I’ve written about extensively in earlier letters. I’ll evaluation them within the context of what has been completed within the time that we now have owned them, whereas we “waited.”

PAR Expertise (PAR) – We now have owned restaurant know-how supplier PAR for about 5 years and commenced shopping for when the share value was within the $20s. Main accomplishments over the previous 5 years embody:

• Enhancing the POS (point-of-sale) code base to enhance stability, which laid the muse for progress. Executing 5 acquisitions that expanded the addressable market, product strains, and supplied scale.
• Successful Burger King and Wendy’s as clients. These Tier 1 wins have led to the most important RFP pipeline within the firm’s historical past.
• Divestiture of presidency enterprise to grow to be extra of a “pure play” enterprise software program firm.
• Rising the ARR/Share from $1.04 to $5.30 (as of June 30, 2024) with line of sight to >$8.
• Inflecting to profitability (whereas not but reported, I believe it occurred in Q3 of this yr).

It is a vertical market software program firm with accelerating progress and inflecting to profitability. The markets are larger, the merchandise are higher, the shoppers are bigger, and group is deeper. The long run is way brighter than after we invested 5 years in the past.

KKR (KKR) – We now have additionally owned asset supervisor KKR for about 5 years. Over the past 5 years, KKR has grown AUM from $206B to $601B and perpetual capital from $19B to $250B whereas additionally increasing its concentrate on merchandise for insurance coverage firms with the acquisition of International Atlantic. Over the previous few years, KKR’s funding in distribution to high-net-worth people has dramatically grown their investor base. Given the progress, it’s not stunning that shares are up 5X over the past 5 years. At their most up-to-date investor day, KKR administration laid out a path (for many who wait) to quadrupling earnings over the subsequent ten years.

Cellebrite (CLBT) – We now have owned Cellebrite for about three years. The corporate stays the go-to software program answer for legislation enforcement to entry and analyze cellular phone knowledge for legal circumstances. Product enhancements have improved and broadened the worth proposition, and the corporate has raised costs and offered extra “seats” as they’ve delivered extra worth to their clients. We started shopping for shares in October 2021 and averaged down from there. Within the interval we now have owned the shares, ARR (annual recurring income) has grown from $187M to $345M whereas remaining worthwhile. The corporate took out the SPAC warrants.

I do assume it’s price articulating a medium-term risk for Cellebrite. The corporate’s merchandise are used to extract proof from digital gadgets, analyze the information, and be certain that search warrants are complied with. The demand for Cellebrite’s instruments to research encrypted knowledge from superior cell telephones and different gadgets is prone to persist at excessive ranges for a very long time. Can you actually think about an investigation the place the topics cellular phone is just not checked out for geolocation knowledge, calls, emails, texts, photographs, or net shopping historical past?

In case you imagine, as I do, that distribution can be vital for vertically targeted AI merchandise, Cellebrite is completely positioned. The corporate has merchandise and relationships in nearly each main legislation enforcement company. AI is the buzzword of buzzwords, however Cellebrite clients have in depth case backlogs and human capital shortages which can be ripe for added instruments. Cellebrite is already touching the information and has required guard rails in place to make sure authorized compliance with constraints like search warrants. If in case you have performed with the latest AI instruments like Perplexity Professional or NotebookLM, which might parse monumental quantities of information, it’s not onerous to examine use circumstances for legislation enforcement scuffling with exploding quantities of information. Cellebrite has a big alternative in entrance of them to promote more and more extra highly effective instruments into legislation enforcement. If their merchandise can remedy extra circumstances and supply labor efficiencies, clients pays. Cellebrite is nicely positioned to develop and promote the subsequent technology of AI analytics instruments. If well-built the productiveness good points will enable them to boost costs, increase costs once more, after which increase them once more whereas nonetheless delivering nice worth to their clients.

Burford (BUR) – We now have owned litigation financer Burford for lower than two years, however the progress was not lengthy in ready. Substantial developments of their authorized case towards Argentina have occurred, with the potential proceeds being multiples of BUR’s present share value. The Argentina case is way from their solely useful asset and Burford additionally holds one other $5B of circumstances of their portfolio that might be price considerably extra.

Hagerty (HGTY) – We now have owned traditional/collector automotive insurance coverage firm Hagerty for about three years. Throughout that point, revenues have roughly doubled and profitability has flipped from a adverse to a constructive, all with out substantial contribution from their strategic partnership with State Farm. Over that very same interval, the corporate launched an internet market and in-person public sale enterprise for traditional/collector automobiles, each of that are doubtless within the high 5 for the trade. Mixed with a latest acquisition that vastly expands the post-Eighties automotive insurance coverage alternative, Hagerty is well- positioned for increased progress over the subsequent 5 years.

SHORT SIDE

We stay quick the flying taxi firm that has the trifecta of regulatory threat, know-how threat, and enterprise mannequin threat – and you would arguably throw in a wholesome dose of execution threat however nonetheless has a market cap of greater than $4.5 billion. We’re additionally quick two firms going through important litigation with the potential for treble damages (i.e., 3x the precise quantity) for his or her actions and potential liabilities far in extra of their market capitalizations. We’re additionally quick two main indices.

OUTLOOK

Our Partnership is nicely set-up for self-help investments. By means of our Companions Fund², we now have in depth relationships with different managers and are the beneficiary of lots of “seems” at alternatives. With an funding committee of 1, we will act rapidly. We’re sufficiently big to make a distinction to smaller firms and sufficiently small that our investments could make a distinction in our returns.

With a concentrated portfolio of idiosyncratic firms, our returns have and can proceed to return in chunks. As we “wait,” progress is being made. I believe we maintain a number of multi-baggers and imagine that the desk is about for one more “chunk” of returns.

Sincerely,

Scott

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