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Hazelton Capital Partners 3Q17: Micron Technology, EZCorp, Softbank

Hazelton Capital Partners 3Q17 Letter, October 20, 2017

  • Gained 7.4% in 3Q17 and gained 16.2% YTD; S&P 500 gained 4.5% during the quarter and up 14.2% YTD
  • Top 5 holdings include Micron Technology, Western Digital, USA Technologies, Manitowoc, and EZCorp

Micron Technology (MU)

  • Witnessed strength in both its DRAM and NAND segments, leading to an EPS of $4.86 for 2017 and the market is expecting over $6.50 for 2018
  • Closing out the quarter just under $40/share, currently trading at P/E of 8.2x and 6.2x for 2018 – true indication that market does not believe that the current DRAM and NAND average selling price is sustainable
  • Today, with 3 major players in DRAM and 5 in NAND, pricing is primarily driven by production capacity and not to achieve market share, as industry players have become more “rational”
  • Cyclicality will continue to play a role but as demand for digital memory and storage expands from an increasingly connected data ecosystem, including the cloud, data storage, mobile devices and now the burgeoning IoT (internet of things), it is expected that the duration of the cycle will be longer with a muted peak to trough pricing, leading to a stronger and more sustainable average selling price
  • At the same time that the average selling price of both DRAM and NAND is forecasted to decline over the next year, industry players will be able to leverage recent production advancements to lower production costs, allowing for continued healthy margin

EZCorp (EZPW)

  • Historically, pawn shops have the reputation of being a sleazy business that preys on the disadvantaged by charging high fees to either receive cash or a loan for one’s personal property
    • Pawning personal property is a short-term loan; a pawn customer exchanges a personal item for cash equal to between 40-70% of the appraised value of the property
    • In order to get the item back, individual needs to repay the original loan plus interest, in which rates and fees can hit monthly levels in excess of 25%
    • Individuals who use pawn shops do so because they do not have access to traditional bank loans due to the size of the loan (average pawn loan is less than $150) and/or because they lack a banking relationship
  • Recent FDIC survey found that ~27% of American households were either under or unbanked – that equates to nearly 67 million American adults
    • For these working-class Americans in need of short-term money, pawn shops provide immediate access to cash to cover living expenses
  • Majority of the roughly 13,000 pawn shops in the US are family run, customer friendly businesses that have been designed to resemble a retail store. Instead of eliminating pawn shops, federal and state governments have chosen to regulate them, recognizing that they provide a much needed financial service
  • Increased regulation acts as a competitive edge for EZPW as it is able to spread this growing fixed operational cost across its 517 stores, while smaller operators are negatively impacted
    • Creates an environment ripe for consolidation
  • In the process of deploying a POS system that will not only help streamline store operations but will allow for real-time benefits in managing inventory, and pawn loan pricing
  • Mixture of declining gold prices (jewelry is the number one pawned item and revenues are highly correlated to the price of gold), bad management decisions, and a non-attentive board created a headwind for EZPW and its share price
  • New management team took over in 2014 and began exiting all of its non-core businesses to focus solely on pawn operations
  • Got the opportunity to rebuild its position on 6/27/17, when EZPW announced a $125 million convertible debt offering – market reacted negatively to the news, driving the company’s share price down over 25%
  • Believes there to be a meaningful discount between company’s share price and its intrinsic value
    • Contraction in margins is directly related to the restructuring of the company’s core pawn business
    • Starting in 2018, most of the write-downs, impairment and restructuring charges will have been taken, leading to increased profits and FCF
    • Improved FCF could be used for future acquisitions or debt reduction, allowing company to be debt free within the next 4-5 years
    • Believes there to be a conservative 65% upside to its base case outlook

Softbank (SFTBY) – Closed: 78% Gain

  • Closed out Softbank position over the summer
  • Thesis did not change as we still believe there to be a discount between the sum of the parts and its share price
  • However, trajectory to achieve that valuation is now less certain as Masayoshi Son launched a $100 billion fund to invest in artificial intelligence, connected devices, “integration of computers and humans,” and other technology companies
  • Son’s Vision Fund gives him access to a pool of capital that is equal to the 5 largest global PE funds put together. Concern is not with Son’s ability to allocate capital but that Son will be incentivized to invest the money quickly, at a time when market valuations are not cheap
  • With interest rates at historic lows for the past 10 years, investors have grown impatient for investment yield as an abundance of capital has been flowing into both public and private equities
  • Environment of too much money chasing too few assets is seen by many as a reason for the longevity of the recent market rally and motivation of why a private company like Uber is now worth approximately $69 billion
    • If Uber were a public company, it would be ranked the 75th largest company in the US and 2nd largest transportation company ahead of FedEx
    • When one buys shares of FedEx with a market cap of $60 billion, one invests in a company that employs 400,000 full and part-time employees that own and operates nearly 600 planes and over 66,000 vehicles and truck trailers
    • For just $9 billion more, one can invest in Uber which does not own or maintain a fleet of cars and whose drivers are independent contractors. For someone who is bearish, it is impossible to justify paying $69 billion for a company with a ride hailing app whose business model has yet to be profitable that is disrupting an industry that has historically been unprofitable (in the short-run, the only clear winner will be the consumer)
  • Masayoshi Son has not hidden the fact that he has strong desires to be in the ride-hailing space, as Softbank is already the largest shareholder in the foreign companies and is anxious to establish a foothold in North America
  • Son’s vision for the future is that AI and robotics will inexorably change our world and his goal is to own the companies that will play a significant role in that outlook. With a 300-year plan to build Softbank into world’s most valuable company, even Son could easily justify paying a market premium for an acquisition
  • Hazelton’s plan has always been to lighten its Softbank position in the low to mid $40/share range. Above $40/share, discount between assets and its share price is less substantial
    • Will continue to review Softbank and its valuation and welcome the opportunity to reinvest in Masayoshi Son

Image Source: The Japan Times

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