A Mutual Fund For Special Occasions: A Conversation With Value Fund Manager Tobias Carlisle, Part 1

Tobias Carlisle is the founder and managing partner of Carbon Beach Asset Managemnet and the author of "Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations."

Marketfy Maven Tim Melvin recently spoke with him about Carbon Beach's new fund, some extra-ordinary market positions, as well as Carlisle's stock screening website Acquirer's Multiple.

Below is part one of their interview edited for length and clarity.

Tim Melvin:  We’re on today with Tobias Carlisle. We’ve talked to Tobias several times over the years. He has done a lot of research and written some fabulous books on value investing. Tobias, you’ve got really some pretty big news today. You’re opening a new mutual fund. Is that correct? 

Tobias Carlisle: That’s right. The fund is called USA Mutuals Carbon Beach Deep Value. The ticker is DEEPX, so it is pretty easy to remember. The strategy is one that we’ve been employing in our firm for a while now. It is very simple. It is special situations on one hand and just sort of deeply undervalued, out of favored stocks on the other. We can consider the end of both of those sorts of those things as we go along and I am more than happy to talk about it with you as we go.

Melvin: This is going to be more of a qualitative manager driven fund as opposed to a fund quantitative approach, as you have often written about in the past. 

Carlisle: It’s not purely quantitative. The reason for that is that the special situations, I don’t think the computing power is there yet to just read natural language in filings and other news sources, because you need to be able to do that. The special situations are not fixed enough as a category. They are evolving all the time, so it necessary to have a human being reading the filings.

I hate to use the word synthetic because it sounds like I’m trying to make it sound more complicated that it actually is, but I’m going to use it anyway. So we can synthetically recreate some of these special situations by using options which is something that we like to do. So just to go back a little bit, special situations, as I’m sure you know are corporate event driven investments. The actual return depends on the board of a company deciding to do something like a merger, takeover, liquidate, spinoff or something like that. 

Melvin: Something along the lines of the Xerox deal we saw this week. 

Carlisle: Something along those lines. It’s not their usual business. It’s an unusual step for the company to do that is outside what they ordinarily do. If they are in the business of selling copiers, it’s spinning something off or something along those lines.

The attraction to it is that you have this known price sometime in the future and you can calculate a return from where it is currently trading to that price and you know over what period of time it is going to happen so you can annualize that figure.  When you combine that with deeply undervalued securities that provides your downside protection in the sense that it is already trading below what it is worth.

This is just something that is going to create that event to get you closer to what it’s worth. So the portfolio is a lot of these types of positions and a lot of things that you and I would agree that are really undervalued, but there is no immediate catalyst for that undervaluation to be fixed up. So we put them a smaller position and we watch them for the catalyst and when it emerges we increase the size of them. 

Melvin: Do you have any past special situations that you are involved in that you can run through to give everybody just a little bit better feel and understanding for the special situation side of the business?

Carlisle: Sure. I’ve got a few. The one we had on last year was Humana Inc HUM, which is a big health insurer that is being taken over by Aetna Inc AET. That was announced in June 2015. Humana has been a stock that I’ve held for a really long time just because it’s always been very cheap. They’ve been serial buyer backers of stock. They buy back stock all the time. I held it for 5 or 6 years. It was up pretty consistently, 15 to 20 percent a year over that period. Then when they announced they were getting taken over I sold them and I completely forgot about it until early last year when the tax inversions were blocked. 

Melvin: Yeah. Wasn’t it Pfizer Inc. PFE that they blocked? 

Carlisle: It was Pfizer Allergan. You’re right. So they were trying to get their hit off of services to get into a more favorable tax jurisdiction. The Treasury said no more. So all of these positions, initially there was a merger arbitrage, risk arbitrage that blew out really wide. So we went through all of the merger arbitrage positions, and we hadn’t been doing any up to that point. We just found the ones that weren’t tax inversions so there was no risk, that wasn’t the reason for doing them and there was no tax inversion involved.

One of the funny things is when the Department of Justice actually announced that it was going to block, the stock rallied quite a lot that day. Once you get rid of the uncertainty, the stock traded up on that. There was a period of time where Aetna and Humana were going to go to court to contest the decision with the DOJ and there was nothing that was going to happen between September and the court hearing in December. But there was a lot of volatility in the stock because there was still a lot of fear there. So we were selling put options to try to capture some of that volatility.

Now in January we are just waiting to hear. We’ve taken the position down a lot just because the gap is now 15 percent from where the acquisition price is and where the stock is trading. I think Humana was our biggest position last year. It paid us many times over, and we traded it lots of different ways, so I think it is the best example of a special situation and the way that we approach them.

Melvin: Now for the core value portion of the portfolio, I expect you are going to go with low enterprise multiple stocks? 

Carlisle: Yes. Our favorite approach is just something that is undervalued on a number of metrics. My favorite approach is always going to be the Acquirer’s Multiple which is basically operating earnings, EBIT operating earnings on enterprise value.  The reason I like that is that I like to approach them the way a private equity firm, a leveraged buyer firm would which is to find things that when you strip out the cash that they have what you are actually paying for. The little part of the business that you are paying for is generating really strong operating earnings, and in addition to that it does have some cash on its balance sheet, so it is not going away anytime soon.

Melvin: Often if you wait for a catalyst, I’ve found that you miss the move. 

Carlisle: Right. You pay for the catalyst. 

Melvin: Yeah, and sometimes you end up paying too much for the catalyst, whereas if you just have a diversified portfolio of these nice cheap stocks something good is going to happen most of the time and that usually ends up beating the market rather handily. 

Carlisle: Sometimes it is just an intervention. Sometimes it’s just too cheap and there are other values guides. You’re in there buying. I’m in there buying. Everybody else is in there. There are some deep value guys in there buying, and that is the thing that pushes it up. 

Melvin: So you’re going to blend between these 2 strategies. This is going to be available to retail investors, I assume through the different platforms. 

Carlisle: It is. The minimums are low. It is $2,000 for a cash account and its $100 for a retirement account. I’ve been looking for a way to share what we’re doing more broadly so we think previous to this stage we have been working with individuals and large institutions. As fun as that is, I get incoming requests all the time for smaller accounts and we just can’t administer them. 

Melvin: Your website is Acquirer's Multiple, and you are constantly screening for stocks that are trading at very low multiples of enterprise value to EBIT. What are you seeing out there now?

Carlisle: It’s a funny thing, one of my favorite positions is in the "all investable" which is the broader screen. So I give away the large cap one which is sort of a largest thousand. I give that away for free on the site. All you’ve got to do is register, but then there is an all investable. It’s a bigger universe and it tends to outperform just because it is finding these things that are really off the rung.

One of my favorite ones is the thing called Pendrell Corp PCO. It’s trading at about cash backing, a little discount to cash backing. It’s not doing much, but the thing that is attractive is it has net operating losses which are basically tax shields from future income. If it acquires something, then it can use those earnings from the acquisition to basically pay down the net operating losses and it does not have to pay tax for a period of years.

You can value those net operating losses. It’s trading at $6.63 at the moment. It could be worth more than that because smaller stock is $178 billion market capitalization. It hasn’t been going anywhere, but they’ve consolidated the shares ten for one. It was trading for 50 or 60 cents not that long ago.

To read more about Carbon Beach's DEEPX fund and what Tobias Carlisle thinks of some unique communiuty bank stocks, click here to read part two of this inteview.

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