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Maran Capital: “Crossroads Systems (CRSS) is not an Easy Company to Compartmentalize”

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Maran Capital Management, an investment management firm, published its second quarter 2021 investor letter – a copy of which can be downloaded here. A quarterly median account return of +24.9% net of fees was recorded by the fund for the second quarter of 2021, bringing year-to-date returns to +53.1%, net. Over the past five years, the partnership has compounded at the annualized rate of +26.2%, net, based on the fund’s standard fee structure. You can view the fund’s top 5 holdings to have an idea about their top bets for 2021.

In the Q2 2021 investor letter of Maran Capital Management, the fund mentioned Crossroads Systems, Inc. (NYSE: CRSS), and discussed its stance on the firm. Crossroads Systems, Inc. is a Dallas, Texas-based holding company, that currently has a $155.2 million market capitalization. CRSS delivered a 166.67% return since the beginning of the year, extending its 12-month returns to 225.00%. The stock closed at $26.00 per share on July 29, 2021.

Here is what Maran Capital Management has to say about Crossroads Systems, Inc. in its Q2 2021 investor letter:

"Crossroads Systems is not an easy company to compartmentalize. Its name provides no hints about what it does. It is small, obscure, and illiquid.

CRSS in its current form began as a cash and NOL shell, which then combined with Capital Plus Financial, a B-Corp and community development financial institution (CDFI) seeking to bring financial services and affordable homeownership opportunities to underserved communities, primarily in Texas. It shares some characteristics with a community bank, but it doesn’t have a bank charter. CRSS’s core business is to purchase homes, rehab them, sell them, and then provide a mortgage to the buyer. Is it a real estate “flipper” or a mortgage lender?

That CRSS is far off the beaten path and difficult to characterize didn’t deter me from studying it. And careful analysis reveals that this is a gem of a business. CRSS has remarkably high returns on assets (multiples of that of the average community bank), and, as we will see, a savvy, nimble, and entrepreneurial management team intent on taking advantage of opportunities, even if slightly outside of some pre-ordained notion of its core business.

Several years ago, I had the opportunity to listen to a talk by Chauncey Billups. Billups is a Colorado basketball legend, having played at George Washington High School and CU Boulder before going on to play for the Denver Nuggets and several other pro teams during his career. His motto, as imparted by his high school coach, was, “If you stay ready, you don’t have to get ready.” He told the story of two young athletes who each were not drafted into the pros after their college careers. Fast forward six months, and they were called back by a team to try out for a spot that had opened. One player had continued to work out and stay in shape. The other had backed off from his workouts. It is no surprise which player the team placed on its roster: the one who was prepared, who had stayed ready.

Turning back to our domain, we want to invest alongside management teams who stay ready. Who are in proverbial shape, prepared, nimble, and ready to take advantage of opportunities. We want to partner with operators and capital allocators who are so good that they tilt the odds in our favor. I believe we have done this with CRSS. The right management team can absolutely be a source of free options in investments.

In this instance, as a CDFI, Capital Plus Financial was among the most well-positioned companies to help get Paycheck Protection Program (PPP) funds into the hands of those who needed them most. In the first round of PPP funding, banks were criticized for lending money to well-heeled clients who weren’t actually experiencing hardships. In an effort to ensure that PPP funds got into the hands of those who really needed them, the government turned to CDFIs in subsequent funding rounds. Capital Plus Financial, though not previously in the business of small-business loans, was ready – it saw the opportunity and acted quickly to capitalize on it.

CRSS was ultimately the second-largest PPP lender in 2021 (by loans issued), placing over $7bn of loans with almost 500,000 borrowers in just a few months.

As CRSS noted in its 2Q results press release:

“In the last several months, Capital Plus has transformed from a regional single-family mortgage-based lending institution into one of the country's largest providers of small business loans," said Eric A. Donnelly, Chief Executive Officer of Crossroads Systems. "When the SBA announced its reopening of the [PPP] program in January, we immediately identified strong synergies between the program's focus on small businesses and Capital Plus' core mission as a CDFI. Together with our loan service providers, we established early incumbency as the go-to institution for small business owners, independent contractors, and sole proprietors. Financially, our success in the program has put us into the best position we have ever been in, netting us more than $150 million in operating income for the quarter. At a record cash position, we are well-capitalized to support the future growth initiatives that will drive our double-bottom line.”

Due to its success in rapidly scaling its business when the opportunity presented itself, CRSS started the second quarter-trading at under $10 per share and ended the quarter in the position to announce a special dividend of $40 per share, which is set to be paid out next week.

The fun may not be over. The large special dividend has created a special situation set-up. As for my analysis of the current opportunity and how I am positioning the fund around the dividend and for the trading of the remaining business, I’d rather not shout my strategy from the rooftops (but I’m happy to discuss it in more detail with any interested LPs).

My good friend Rimmy Malhotra of Nicoya Capital introduced me to CRSS at a VALUEx Vail conference several years ago. Thanks, Rimmy!"

Photo by DocuSign on Unsplash

Based on our calculations, Crossroads Systems, Inc. (NYSE: CRSS) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. Crossroads Systems, Inc. (NYSE: CRSS) delivered a -39.18% return in the past 3 months.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

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Disclosure: None. This article is originally published at Insider Monkey.