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A Look at Klarman's Smaller Stock Holdings

Regular readers of my articles will know that I like to keep an eye on the smaller stock holdings of renowned value investor Seth Klarman (Trades, Portfolio).

Klarman is one of the most successful value investors of all time. As a result, when he makes a big trade, it is often well-covered by the financial media.

His smaller positions often attract much less attention, but they are no less critical to Klarman's portfolio. Indeed, the value investor won't open a position just for the sake of doing so. He only buys a stock after months of research, and if he can be sure that it offers an attractive risk/reward profile.

Small holdings

According to Baupost's fourth-quarter 2019 SEC filing, two new small holdings appeared in the fund's portfolio last quarter. These were Eldorado Resorts Inc. (NASDAQ:ERI) and McDermott International Inc. (OTCPK: MDRIQ).

Eldorado was a $23 million position at the end of 2019. That makes it the second smallest in Baupost's $9 billion equity portfolio. The McDermott investment was worth just $535,000 at the end of 2019, making it the smallest in the portfolio.

The first thing that's interesting about these positions is their size. They're so small that even if they rose in value ten-fold, they still wouldn't have much of an impact on Bapost's overall performance. The fund manages a total of $30 billion for clients around the world.

Therefore, it seems likely to me that Klarman is either in the process of building a more significant position, or he's initiated a starter position and plans to observe the businesses going forward. Whatever the case, it is clear he sees value here.

Eldorado Resorts Inc

Eldorado Resorts Inc. is a leading casino entertainment company that owns and operates twenty-eight properties across the country. It is in the process of merging with Caesars Entertainment (NASDAQ:CZR). The deal is expected to be completed in the first half of this year.

On the company's fourth-quarter earnings conference call, CEO Tom Reeg said Eldorado is "constantly finding new levers within Caesars to pull." He also went on to call the transaction a "home run for all of our stakeholders."

It remains to be seen if this will be the case, but what is clear is that the stock looks cheap on an EV/Ebitda basis. It is dealing at an EV/Ebitda ratio of 5.8 compared to the market average of 13.

Deal synergies were initially projected to be $500 million, but recent comments by Eldorado's management suggest that final cost savings could be in excess of this total.

There could also be hidden value in the transaction. To fund the deal, Eldorado is completing the sale and leaseback of several of its properties. This will unlock $3.2 billion of gross proceeds to strengthen the combined company's balance sheet.

McDermott International Inc.

McDermott International Inc. is a more interesting bet. After taking a closer look, it becomes clear why Klarman had such a small position. The $10 million market cap company filed for Chapter 11 Bankruptcy at the end of January.

Either Klarman is betting that the company will emerge from this situation stronger than it went in, or he was expecting that the business would avoid this situation.

As 13Fs only provide a snap-shot of a fund's holdings at one point in time, I don't know if he is still interested in buying shares of the company.

On this basis, it might be better to avoid the stock for the time being. Even if Klarman still owns the position, investing in bankrupt companies is a highly specialist field that is not always accessible to outsiders, and it's not for the faint-hearted.

Disclosure: The author owns no share mentioned.

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This article first appeared on GuruFocus.