The long only portfolio increased by +5.1% during the quarter, bringing our YTD returns to +20.5%. We own several industrial and cyclical positions that will generally outperform should the U.S. achieve a soft landing. While our investment in each of these names is based on their own merits, I am comfortable with our broader portfolio construction given what I view to be the most likely economic outcome.

Note: All returns are net of management and performance fees. Past performance is not indicative of future results. Returns for the Merion Road Small Cap Fund for the period prior to fund launch (01/13/22) reflect a basket of SMAs.

During the quarter I bought two REIT’s which will benefit from lower interest rates but are more immune to economic gyrations; from a risk-management perspective, these provide nice diversification should my broader assessment be off. The first was Four Corners (FCPT), a well-run triple net lease REIT that we owned a few years ago. Additionally, I purchased the newly spun-off Curbline Properties (CURB) when the standalone company was available for trading in the issued market.

CURB is the recent “good co” spin-off from the shopping center SITE centers. It consists of a portfolio of convenience real estate in suburban markets with a geographic concentration in high growth areas like the Southeast and Southwest. Over 50% of leases serve restaurants with the balance taken by businesses like medical offices, beer & wine retailers, and fitness centers. Unlike office or malls, these properties are not being obviated by scary trends like work from home or online shopping. 96% of properties are currently leased and leasing rates have been strong with average new spreads of +28% and renewal spreads of +8%. The portfolio requires relatively low capital investments given their standardized site plans.

Since 2022 CURB has purchased almost 1.0mm of gross leasable area (GLA) for nearly $700mm imputing an average price of $710/GLA. This 1.0m in GLA represents 37% of the entire portfolio today. CURB was spun with over $600mm of cash and no debt, giving it plenty of firepower to continue rolling up the industry. Management believes that this is an active submarket with most buyers being private entities, positioning CURB to be the preeminent public acquiror.

I think it is fair to assume that valuation levels today should be higher than properties acquired over the past couple years, given the improved economic outlook and where we are at in the interest rate cycle. Yet, when CURB became available for trading in the issued market, it was valued at ~$20/sh which implied just $554/GLA. Given the differential between where the public market was valuing the company and the prices they paid for the same assets, along with an attractive free cash flow yield, I decided to build our position.

The Small Cap Fund returned +5.4% for the quarter and is up +11.2% YTD. This compares to the Russell 2000, our primary benchmark, up +9.2% and +11.0% for the respective periods. As a reminder, I use the Russell since it is the most widely followed small cap index. But it is not a perfect benchmark for the fund. For instance, the average market cap for the Russell is $3.6bn while our positions are typically in the $100-$300mm range. Furthermore, several of our holdings are too small to even be included in the index. This is part of the reason why the fund has exhibited relatively low correlation to either the Russell or the broader market.

During the quarter, I increased our market exposure and we ended the period with a beta adjusted net exposure of 43%. This is inline with our long-term average. I am generally looking to increase this figure given attractive valuation multiples within our investment universe on an absolute basis and relative to alternatives (i.e. large cap valuation multiples, bond yields).

United Bank (“UBAB”) appreciated modestly despite mixed Q2 results. During the quarter the Treasury announced proposed disposition guidelines for institutions that received ECIP capital. As a reminder, UBAB received $124mm in perpetual preferred equity through the ECIP program that costs no more than 2.0% p.a. and have little to no voting rights. Within the proposed disposition guidelines is a framework for ECIP participates to buy back the security at a price equal to the present value of future interest payments. Based on prevailing rates, the Treasury estimated that this would result in a purchase price between 7% and 28% of the principal amount. This is obviously great news, but is not new.

An alternative disposition venue would be for a “mission-aligned nonprofit affiliate” to buy the ECIP capital. UBAB already has a subsidiary nonprofit established, not that it matters as there is no mention of how long the nonprofit must have been operating. Should the nonprofit purchase the ECIP preferred equity, the Treasury states that the price will be set at just 0.5% of the principal amount. Functionally, this means that UBAB could repurchase $124mm of preferred equity for $0.6mm (and not say $25mm). These are still just proposed guidelines, and any repurchase cannot occur for another several years; nonetheless, this could further bolster the longer-term return of our investment.

Sincerely,

Aaron Sallen

General Disclaimer

This material does not constitute an offer or the solicitation of an offer to purchase an interest in Merion Road Small Cap Fund, LP (the “Fund“), which such offer will only be made via a confidential private placement memorandum (the “Memorandum“). An investment in the Fund is speculative and is subject to a risk of loss, including a risk of loss of principal. There is no secondary market for interests in the Fund and none is expected to develop. No assurance can be given that the Fund will achieve its objective or that an investor will receive a return of all or part of its investment. All statements herein are qualified in their entirety by reference to the Memorandum, and to the extent that this document contradicts the Memorandum, the Memorandum shall govern in all respects.

This material is confidential and may not be distributed or reproduced in whole or in part without the express written consent of Merion Road Capital Management, LLC (the “Investment Manager“). The information and opinions contained in this document are for background purposes only and do not purport to be full or complete. Unless otherwise stated, the information in this document is not personalized investment advice or an investment recommendation on the part of the Investment Manager.

The performance data discussed herein do not represent the performance of the Fund, but rather, represent the unaudited performance of a basket of separately managed accounts managed by the Investment Manager pursuant to the same strategy expected to be implemented for the Fund. Results generated in the Fund once outside capital is admitted could be materially different than those results shown. The results shown reflect the deduction of: (i) an annual asset management fee of 1.5%, charged quarterly; (ii) a performance allocation of 15%, taken annually, subject to a “high water mark;” and (iii) transaction fees and other expenses actually incurred. The management fee and performance allocation were applied retroactively and do not reflect actual fees charged. None of the results shown reflect the deduction of certain organizational and operating expenses common to investment funds, which would serve to decrease profits or otherwise increase losses. Results were achieved using the investment strategies described in the Memorandum.

Results are compared to the performance of the Russell 2000 Index, the Russell Micro-cap Index, and the Barclay HF Index (collectively, the “Comparative Indexes“) for informational purposes only. The Fund’s investment program does not mirror any of the Comparative Indexes and the volatility of the Fund’s investment program may be materially different from the volatility of the Comparative Indexes. The securities included in the Comparative Indexes are not necessarily included in the Fund’s investment program and criteria for inclusion in the Comparative Indexes are different than criteria for investment by the Fund. The performance of the Comparative Indexes reflects the reinvestment of dividends, as appropriate.

This material contains certain forward-looking statements and projections regarding market trends, investment strategy, and the future asset allocation of the Fund, including indicative guidelines regarding position limits, exposures, position sizing, diversification, and other indications regarding the Fund’s strategy. These projections and guidelines are included for illustrative purposes only, are inherently predictive, speculative, and involve risk and uncertainty because they relate to events and depend on circumstances that will occur in the future. The guidelines included herein do not reflect strict rules or limitations on the Fund’s investment program and the Fund may deviate from the guidelines described herein. There are a number of factors that could cause actual events and developments to differ materially from those expressed or implied by these forward-looking statements, projections, and guidelines, and no assurances can be given that the forward-looking statements in this document will be realized or followed, as described. These forward-looking statements will not necessarily be updated in the future.

PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.

Original Post

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

Share.
Exit mobile version