Q1 2024 Review

And looking ahead to Q2

Disclaimer: Nothing on this blog is intended as financial or investing advice. Please do your own due diligence.

In keeping with my 2023 Year In Review post, I plan to provide quarterly updates moving forward. What you can expect from these updates are: 1) my biggest winners from the quarter past; 2) my biggest losers and what I got wrong; 3) my top ideas for the upcoming quarter; and 4) my current portfolio composition. What I won’t be including is overall portfolio performance, which is something I will save until the at-least the mid-year update (and perhaps not until the annual review) simply because I don’t think quarterly performance is a particularly worthwhile item to consider.

Largest Winners from Q1

GEO Group (31%)

I shared my thoughts on GEO earlier this year on X here. Though shares have appreciated a fair bit since I started my position last year, I continue to really like the setup. For one, there is still a fair bit of juice in this simply as a deleveraging story. Indeed, just this week the company announced a large refinancing process, which should materially lower the cost of debt and free up some capital down the road for shareholder returns. Then, of course, there is the real juice — viz. upside from the electronic monitoring segment in the event (I think highly likely) that Congress at some point in the near future provides additional funding for the ATD program. I lay out some (out of date, but illustrative) back of the napkin math in the linked tweet, but at bottom, the market is still giving very little credit, if any, to the fact that there is a high-margin software segment attached to this business that can add some serious upside to FCF from even a modest funding increase from the government. I have not sold any shares and also opened Jan 25 $12 strike calls in early February.

Liquidia (31%)

After returning 130% for me last year between the equity and some extra juice through call options, LQDA continued to be a very fruitful special situation into 2024. Despite the substantive legal risk having largely been resolved in December, the stock faced significant volatility in Q1 due to a variety of procedural legal hurdles that have understandably confused a lot of investors without much legal training. These procedural hurdles, in my view, are/were largely benign formalities and have created a pretty clear mispricing as the market appears to have underwritten far too much remaining legal risk. In effect, the market has turned these procedural hurdles into a series of catalysts for the stock to re-rate, despite the limited risk these hurdles actually pose. Given my view that the market was essentially pricing in risk that was largely imaginary, I viewed the stock as far too cheap at $12/share heading into the year, and I accordingly exercised the vast majority of my January 25 call options.

That decision appears to have been the correct one so far, as the stock has moved substantially higher with each passing “catalyst”, most recently with shares up ~5% in after hours on the last day of the quarter on news that Judge Andrews had lifted the injunction, despite the fact that such an outcome was already a near-certainty given the mandate to kill the at-issue patent from the week prior. Then, on Good Friday, UTHR’s motion to enjoin the FDA from approving Yutrepia for use in PH-ILD was denied.

With these hurdles out of the way, the path is now largely clear for LQDA to launch Yutrepia. I believe the stock is likely to trade towards $20/share in short order, or another 30% from here. Having said that, the event angle here is now largely played out, with this increasingly becoming a bet on Yutrepia itself, and specifically how much market share it will capture from Tyvaso and how insulated it is from further competitive threats. These are questions I am far less well-equipped to have edge in determining. Therefore, I will probably start trimming my position as we edge closer to $20/share. I have no intention, however, of fully exiting the position, and plan to hold a material portion for the longer-term as the upside here could still be enormous and I am big fan of this management team.

Spotify (~41%)

Despite my intimation in the 23 Year in Review that I would be promptly closing out this position, I fortuitously opted not to do; instead, I trimmed the position by about 30% at around $205/share. What’s the thought process? While this position is obviously a huge outlier in my portfolio (for many obvious reasons e.g. the size of the market cap, the steep valuation, the lack of a catalyst), I am really trying to make an effort as investor to “do less” and not “cut the flowers”. Yes, the valuation here is by no means attractive, but at the same time, I also see a business where the fundamentals are improving (e.g. top line growth coupled with cost structure improvements) and that has been able to miraculously capture a leading market share position despite facing stiff competition for well over a decade from the most dominant companies that have ever existed. History suggests that something like this might be worth holding on to despite the valuation. Though it may seem silly today, I would not be surprised to see a +$100B market cap on this company in the not too distant future (particularly if our institutions fail to get religion on fiscal and monetary policy). More practically, I hold these shares in a taxable account, and given a cost basis that is in the $80s, the tax drag from exiting would be fairly material.

Mereo Biopharma (~44%)

This is another one I don’t love owning and wouldn’t be a buyer of today, but I am now up around 300% on these shares in about 19 months, and it’s simply better for my psychology to continue holding rather than to grapple with the distress of having sold my position before the story unfolds, only to watch it multi-bag from here (which I think is far more likely than not). Again, doing-less.

For those not familiar with the story, I outlined it in the 23 Year in Review. Essentially, I got involved when shares were below $1/share and shortly after Rubric capital went activist on the company and secured four board seats. In their activist letters, Rubric conservatively valued the company at ~$4/share. Mereo is a pre-revenue biotech, but the risk is spread between several candidates, most importantly two later stage programs — setrusumab and alvelestat. There’s not much to report on with setrusumab, with Mereo’s partner Ultragenyx continuing to move the Phase 3 trial process along. I think this is a significantly derisked program based on what we have seen so far.

The more interesting (and frustrating) development has been with respect to alvelestat. Here, the company is looking for a partner in advance of commencing Phase 3 trials. That’s all fine and well…except for the fact that the company has been saying the same thing literally since I first purchased my shares and yet still no partnership has been formed. This has me admittedly concerned, as drawn out processes like this can often be evidence that the underlying value is not quite as advertised. Meanwhile, in January, Sanofi paid ~$1.7B for Inhibrx’s AATD candidate. This news sent Mereo shares flying above $4 given alvelestat is also for the treatment of AATD and further along in its development. There are two contrasting ways to view Mereo’s inability to partner and/or monetize alvelestat yet given this development: either 1) management’s narrative, which is that the INBRX deal caused the company to reappraise the value of the drug and seek even more favorable terms for a deal; or 2) the market’s narrative (shares have since come back to around $3), which is that alvelestat must be less than advertised if the company still hasn’t been able to secure value for this program despite the bullish backdrop. Time will tell, but I am comforted by Rubric’s presence (and the array of other prominent shareholders on the register) and I suspect Rubric will not hesitate to shake things up once their standstill agreement expires after the AGM in May if they are unsatisfied. Moreover, we are not paying much, if anything, for alvelestat at these levels.

Cipher Pharmaceuticals (~51%)

I have written extensively on this name here, so I will spare you any further thoughts now except to say that I added throughout the quarter for as high as $8/share, haven’t sold any shares, and have no plans to do so.

NUVB (131%**)

Some of you will recall this was the first stock I wrote up here, which I presented as a win-win binary — viz. either a strategic review/liquidation or a rerate on positive drug development. I closed out the idea for subscribers in late February after a ~45% return, noting that the discount to liquidation value had essentially closed. At that time, I noted I intended on keeping a portion of my shares, given the risk reward, though murkier, still seemed attractive. Well, in the final week of the quarter, the company announced a reverse merger, which sent shares flying over 100% (I think this was clearly an overshoot and the stock has pulled back a fair bit since, but it is still at $3.50 vs. $2 when I closed to the idea). Unfortunately, I missed much of this gain as the merger was not something I felt competent to underwrite (this would have been well over a 200% return for me had I held). That said, I am not losing sleep over that decision as my position was relatively small heading into the announcement, and I do think there is wisdom in exiting a position once your thesis breaks, even if you lose money doing so. On average, that sort of discipline I think is likely to pay off in the long run, even if you take some stingers from time to time.

Biggest Losers from Q1

Spirit Airlines (~60% in the quarter; ~40% overall; closed)

There has been plenty of commentary on this situation, so I will keep my venting short. This loss absolutely stung, resulting in ~3.5% loss of my NAV. Having said that, and with several months having now passed to allow me to reflect further removed from the pain, this is the kind of bet I would make time and time again. Look, it sucks to lose money on a binary bet like this, but the average cost of my shares was ~$10, putting me in a position to nearly triple my money had the deal gone through on the announced terms, which I continue to think the odds strongly favored. Indeed, I have poured through Judge Young’s decision several times over now, and as someone who was a practicing commercial litigator as recently as last year and who has spent far more of his life reading jurisprudence than 10ks, I am unable to come to any conclusion other than this being one of the more egregious judicial opinions I have ever encountered both as a matter of legal reasoning and of public policy. Taken literally, the opinion supports a most draconian reach for antitrust law and creates a deeply cumbersome terrain for M&A parties to navigate.

With that said, I did make one costly, and inexcusable mistake with respect to how I played this, which was that I was far too aggressive in expressing the bet through call options. The risk/reward on the Jan $20 strikes was incredibly enticing, offering as much as 5x depending on when they were purchased, and I simply couldn’t resist. The problem, which I knew but chose to overlook, was that there are just far too many things that can spoil the party when you play arbs through options; not only are they a zero if the deal breaks, but you need to worry about timing (the trial was delayed twice), price cuts, etc. It turns out I ended up getting the timing right despite the delays, but of course I was wrong on the outcome and got zeroed. To rub salt in my wounds, the equity actually fell much less than I had anticipated when the deal broke, and I was actually able to exit my shares for ~$7, which would have limited my overall loss to a more palatable ~30%. Which is of course yet another reason to avoid options in these situations— there’s always a chance the market overprices the equity on the downside; options are never as forgiving.

Tidewater Midstream (-18% overall; closed)

I shared my thoughts and the lessons from this loss here.

Calumet (~-18% in the quarter)

This is a top 5 position for me in terms of sizing, so it was a drag on quarterly performance, but I still love thesis and added throughout the quarter, including parroting the CEO by adding some Jan 25 $20 LEAPs (I know, I know, more options).

Sportmans’ Warehouse (~-28% in the quarter)

SPWH, which I have written up here, took a continued pounding this quarter, despite there being essentially no material news from the company. I think this is a just a product of what is now firmly a microcap garnering no interest after shares have declined nearly 70% in a year; however, the more cynical view here is that this is a busted retailer with a fair bit of leverage undergoing more than merely transitory margin degradation. We will have some insight one way or another when the company reports Q4/FY23 results tomorrow. I will, of course, be sharing my thoughts after the call.

Altogether, my cost basis on SPWH is $3.65/share, as I averaged down pretty heavily during the quarter.

Favorite Positions heading into Q2.

My top 5 ideas heading into Q2 are, in order: Moberg Pharma (MOB.ST), Cronos Group (CRON), Calumet (CLMT), Roivant Sciences (ROIV), and Tidewater (TDW). I am also very bullish on a little Canadian microcap which I intend to discuss during this Twitter/X Spaces on April 8, and which I will be aiming to publish a write-up on shortly thereafter. There has been a ton chatter online about Moberg and frankly the story is not very complicated, so I’ll spare you my comments. Likewise, CLMT has been a value investor favorite for years, and there are plenty of good write-ups online. Meanwhile, I have already written up Cronos Group and discussed Tidewater at length in the 23 review. So I will use this space to share some brief thoughts outlining the Roivant situation.

Roivant

I think ROIV is, in some respects, like the CRON of biotech, in that the market cap is essentially equal to the value of its net cash and 57% stake in Immunovant (IMVT), and you get the rest of the business for free (and the numerous high-upside call options attached to it). Specifically, in addition to the valuable optionality that comes with the enormous cash pile and the upside from a likely near-term monetization of IMVT at a premium, shareholders get: one commercialized product (Vtama) with approval for significant expansion likely to come this year; eight ongoing phase 2 and 3 trials, including five registrational trials in large markets; and an interest in the potential proceeds that subsidiaries/investees Arbutus Bio and Genevant could receive from their ongoing litigation against Moderna and Pfizer concerning the LNP technology used in the COVID-19 mRNA vaccines. You want asymmetric exposure to catalysts?…look no further.

The market has not been giving ROIV any credit for this optionality. Why? Certainly there are a combination of factors at play, including the overhang created by a large number of legacy shareholders looking for an exit. Perhaps more simply, however, is that this investment requires both comfort with a lot of uncertainty (not to be confused with risk, of course) and the patience to wait for these things to play out over an indeterminate period of time — characteristics altogether absent from the vast majority of capital today. In my view, this myopia is creating an incredible opportunity for those with a longer-term view to purchase shares of a business with incredible upside and very, very little corresponding risk. In short, this situation offers the kind of asymmetry that I really see as the essence of great investing.

And voila — as I write this only two days into Q2, the catalysts are already beginning to unfold, with two positive developments having just been announced. First, one of the company’s candidates from its subsidiary Priovant (75% ownership), brepocitinib, showed positive results from its Phase 2 study for use in non-infectious uveitis (NIU), which is a leading cause of blindness, and in fact demonstrated the best treatment failure rates among active NIU studies. This indication alone is a huge opportunity with only one currently approved therapy, not to mention the fact that brepocitinib is already in P3 trials for dermatomyositis, which itself is a huge opportunity. Indeed, there is a real chance of brep becoming a multibillion dollar franchise and, of course, this is just one of several candidates in the pipeline that have such potential. I’ll leave you to do the math on how much our upside could be if just a couple of these hit.

Second, and perhaps more importantly, the company simultaneously announced a massive $1.5B share repurchase program today, including purchasing the entire $648m stake held by legacy holder Sumitomo at a massively accretive price of $9.10/share. Obviously, this is a great use of cash by management to simultaneously repurchase ~9% of shares outstanding at not only a discount to the present share price, but an enormous discount to intrinsic value, whilst also providing an exit for one of its legacy shareholders, thereby clearing up a technical overhang that has long been plaguing the stock. This should also give the market further confidence that these guys serious about capital allocation and value creation. Interestingly, management’s comfort in distributing this large sum of cash may suggest that they expect further liquidity to be on the way soon (the most obvious source of which would be selling the IMVT stake).

Shares are barely up on this news to $10.90 (about 4.5% on the day), with the reaction likely muted due to an ugly day in the broader market, and still down well below the 52-week high of ~$13.20. This is a complete gift in my opinion (in fact, I just bought a pile of shares in the middle of writing this). With continued buybacks and more value crystallizing with each passing read-out, I think this should easily be a $20 stock over time.

Portfolio Composition Heading into Q2 (in order of position size) (noting average cost basis and quarterly changes)

• Tidewater (TDW) - $33/share, unchanged;

• Cipher Pharmaceutical (CPH.TO) - $4.80/share, added more throughout the quarter;

• Cronos Group (CRON) - $1.97/share, new position initiated in March;

• Mereo (MREO) - $0.91/share, unchanged;

• Calumet (CLMT) - $16.10/share, added more at ~$14/share;

• Liquidia (LQDA) - $6.89/share, options exercised;

• Geo Group (GEO) - $8.51/share, unchanged;

• Roivant Sciences (ROIV) - $10.64/share, added throughout;

• Sportmans Warehouse - $3.65/share, added throughout;

• Vistry Group (VTY.L) - £9.60/share, new position initiated in January;

• IWG Group (IWG.L) - £165.6/share, unchanged;

• Natural Resource Partners (NRP) - $57.58/share, unchanged;

• Spotify (SPOT) - $86/share, reduced by 30% at ~$205/share;

• Moberg Pharma (MOB.ST) - 19SEK, new position initiated in March;

• Burford Capital (BUR) - $12.25/share, unchanged;

• Organigram (OGI) - $2.36/share, initiated new position initiated in March;

• American Coastal Insurance (ACIC) - $7.71/share, added at $11.85;

• Ocean Wilson’s (OCN.L) - £10.07/share, unchanged;

• Montero Mining (MON.V) - $0.15/share, unchanged;

• Icad (ICAD) - $1.85/share, reduced by 50% for at ~$1.55/share;

• Alibaba (BABA) - Jan 25 $75 LEAPS (Why do I do this to myself?)

Positions Exited:

• Unit Corp (UNTC) +82%. I closed this position in early January after concluding there was likely not much value left following the massive December dividend payout;

• Spirit Airlines (see above);

• Odyssey Marine Exploration (OMEX) - call options only + 25%. I fortunately made a small profit on these options after the stock ran up in late December and I sold a material portion for a 100% gain. Much of that gain was offset by the options I continued to hold into March after the tribunal stunningly announced that it would need more time to issue the award (because apparently 2 years to write a decision isn’t enough).

• Cassius Mining (CMX.AX) - 70%. Another litigation play that ended in misery this quarter with the tribunal appallingly selecting Ghana as the seat, despite the very reasonable apprehension of conflict that suggests. Hard to believe such an outcome was the product of good faith. Fortunately, this was less than a 1% position for me, so the outcome is palatable.

• Nuvation Bio (see above);

• OmniAb + 40%. This is, in my view, a quality business that likely does very well in the long term. But my initial thesis was based around the spin-off dynamics, which played out to an extent, but not with the upside I was hoping for. I am trying (slowly) to reduce the amount of positions I have to 15-max (this is proving difficult, as I continue stumbling across what I believe to be great opportunities), but this was an obvious candidate to exit given I lack a differentiated view of the business and it was not a large enough position to move the needle.

• Solvay (SOLB.BR) + 28%. This was a set-up I played merely as a quick-trade on a spin-off of this company from its sexier counterpart Syensqo. I purchased shares prior to the spin, quickly sold off the Syensqo portion, and held the Solvay shares from a post-spin price of ~€20 up to just shy of €26. In my opinion, Solvay looks to still be materially undervalued at €25/share, but it’s not one of my best ideas, and as, I said, I am trying to reduce the number of positions I have, so I exited and applied the capital elsewhere.

• Instil Bio (TIL) - 1%. Explained here.

• Opera (OPRA) +24%. I paid a visit to this old friend (2023’s biggest winner) for a quick trade after it reported stellar earnings, which the market was delayed by about a day in reacting to. At the current ~$15/share, I still think OPRA is quite undervalued, but perhaps not sufficiently to be interesting as a fundamentals play. If the market takes shares back to around $13, I’ll definitely consider taking this for yet another spin.

Closing Notes

As noted, I’ll likely be sharing a new idea next week, which is a quality, rapidly growing Canadian micro-cap undergoing an inflection. Before then, you’ll be hearing my thoughts on SPWH earnings some time this week.

As always, questions, comments, and feedback welcome.

Cheers,