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Seth Klarman's Small Caps: Worth a Look?

- By Rupert Hargreaves

According to Baupost's -- the hedge fund of the highly respected value investor Seth Klarman (Trades, Portfolio) -- fourth-quarter 13F Securities and Exchange Commission filing, the fund's largest position at the end of 2018 was 21st Century Fox. At the end of the year, this holding accounted for 22% of the firm's $11.1 billion equity portfolio, worth around $2.5 billion.


In total, Baupost's top equity five positions at the end of 2018 accounted for 50.2% of assets under management in the equity portfolio.

Whenever the financial press covers Klarman's investing moves, they always concentrate on these positions, as they are the largest and most liquid. However, while they do make up the bulk of the portfolio, at the end of 2018, Baupost's stock portfolio contained more than 30 individual positions, so there's much more to consider outside the top 10.

One of the smallest positions in the portfolio at the end of 2018 was Paratek Pharmaceuticals (PRTK). Baupost owned 2.4 million shares of this tiny pharmaceutical company, which has a market capitalization of $202 million. At first glance, it is not immediately clear why Klarman likes this business. It is loss-making and expected to remain so for the next two years. While revenue is expected to more than double by 2020, Wall Street analysts believe the company will lose as much as $119 million that year.

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With losses growing, management believes the company has only enough financial resources to keep it in business until 2021. As per its full-year 2018 results release:


"Based upon Paratek's current operating plan, the Company anticipates that its existing cash, cash equivalents and marketable securities of $292.8 million as of December 31, 2018, estimated NUZYRA product sales, and SEYSARA royalty-backed loan with HCRP will fund company operating expenses, capital expenditures, and debt service beyond the first quarter of 2021."



Another small-cap stock that featured in Klarman's portfolio at the end of 2018 was AMC Entertainment Holdings Inc (AMC). At the end of the year, Baupost's position in this business was worth around $18 million. At the time of writing, the company has a market capitalization of $1.5 billion and an enterprise value of $6.6 billion.

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This appears to be a recovery play. The company ended 2018 with net debt of $5.2 billion and a net gearing ratio of 368%. It has struggled to report a profit for the past two years. Analysts have the company reporting a net profit of $17 million in 2019 and $40 million in 2020. The stock also supports a dividend yield of 5.3% at the time of writing. It trades at a price to book value of 1.1 and an EV-Ebitda ratio of 8.3 -- so it looks cheap, but that debt could be a problem.

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Sentinel Energy Services Inc. (STNLU) also featured in Baupost's portfolio at the end of the last year. The investment firm owned 1.6 million shares in the company, worth $16.5 million shares, compared to the company's market capitalization of $440 million at the time of writing. Sentinel was formed with the purpose of acquiring a similar business and had planned to buy Strike Capital (a private equity-owned pipeline service and maintenance business), but the deal fell through earlier this month.

The final company described here is Trilogy Metals Inc. (TMQ). At the end of 2018, Klarman owned $22.5 million of this $328 million market-cap business.

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Formerly NovaCopper, Trilogy is a Canada-based base metals exploration company with its primary asset being the Upper Kobuk Mineral Projects. The business is currently in the process of performing initial testing on these prospects, and it doesn't look as if it is going to be profitable anytime soon. A full schedule of drilling is planned for 2019 to assess project feasibility.

Disclosure: The author owns no share mentioned.

This article first appeared on GuruFocus.