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Pricey Mates and Purchasers:
Welcome and thanks for studying. For the 3Q23 quarter (ended September 30, 2023), cumulative internet returns have been 8%. YTD returns by quarter finish have been 20%. Since inception in November 2015 by quarter finish 3Q23, LCA has returned a cumulative 190% internet of charges, or 14% CAGR. As a backdrop to returns, since inception by 3Q23 we comfortably exceed two broadly used consultant indices for passive small firm investing, the iShares Micro-Cap ETF (IWC) and Russell 2000 Index (RTY), and at current, the S&P.
Previous efficiency is not any assure of future outcomes. Particular person account returns could fluctuate.
Lengthy Solid continues to draw purchasers aligned with its long run, small firm centric and research- intensive focus. I welcome the continued curiosity from people and establishments as I patiently develop the enterprise, and have capability so as to add extra accounts.
PORTFOLIO UPDATE
MTRX was the highest performer within the quarter, adopted by MAMA, QHRC and RSSS. Detractors have been CCRD, RELL, DAIO and PDEX. Throughout the quarter we added to MTRX and considerably exited smaller holdings in AIM, SNES and SANW to “harvest” their losses for tax functions, leaving us with a extra concentrated portfolio, with fewer shares and extra cash. My purpose is to maintain our losses small and our positive factors giant, and in these instances a minimum of, I did. Given geopolitical tensions, I’m leaning in the direction of holding extra cash than common whereas persevering with to scour for brand spanking new concepts. In relation to investing, I attempt to by no means be in a rush.
Our 2Q letter included a quick write up round our prime five-positions. Little or no has modified substantively round our thesis for proudly owning these, so I believed I might add slightly little bit of element on three of our smaller holdings. If I might level to similarities to all three firms, I might say, they’re all small, buyer centric, attempting new issues, and run by good humble managers who’re iterating in the direction of higher options. I take into account them “excessive IQ” firms, an idea I’ll contact ultimately of this letter.
PDEX is a small contract producer within the medical gadget area. The core product is a battery powered handheld driver utilized by surgeons to screw implants or plates into bone (suppose knees, spines, facial reconstruction, et al) with a exact quantity of torque to keep away from stripping. The corporate has its personal engineering workforce to develop its personal merchandise and works with branded gadget producers to develop theirs (I consider Stryker is the biggest single consumer).
I don’t usually consider contract manufacturing as a beautiful trade however there are few elements about this firm that make it an uncommon, compelling and enticing long-term funding. I elaborate on three of those attributes under.
The Board: Chairman Nick Swenson and Board member Ray Cabillot collectively personal about 40% of the corporate. They’re considerate traders who run their very own hedge funds (AO Companions and Farnam Road Companions, respectively) and so they handle the capital allocation technique at PDEX. The proof noticed within the development in e book worth per share, which I consider have their “fingerprints” suggests a give attention to worth creation.
New manufacturing facility: The corporate doubled the dimensions of its manufacturing area by buying a brand new facility 4 miles from the present headquarters in Irvine, CA. The construct out and validation of the area took for much longer than anticipated, partially impacted by COVID, and partially as a result of this can be a tiny firm that doesn’t have quite a lot of expertise doubling the dimensions of its manufacturing area. The enlargement is now full. Clearly, the area doesn’t promise extra revenues nevertheless it doubles the dimensions of the chance.
Backlog: Together with doubling the dimensions of its manufacturing footprint, the corporate doubled the dimensions of its backlog to $41M by a big order from a number one buyer. The inference is that FY24 could possibly be a excessive development yr.
SOTK is one other firm increasing its footprint and backlog. I final wrote about this in 4Q21. The Milton, NY primarily based firm traditionally made specialty nozzles for depositing particular and measured quantities of liquified supplies. During the last decade it has transitioned from simply manufacturing nozzles for OEM’s to now designing, manufacturing and promoting the items themselves. Two of their current improvements are a roll to roll steady system for material coating and a steady glass coating system that’s extra exact and environment friendly than current options in the marketplace.
The corporate owns the commercial park from which it operates and over the previous few years as tenant leases have lapsed, it has taken over extra of its area for manufacturing. With year-end backlog at file highs, extra capability and straightforward comparisons, vital development in ’24 appears seemingly.
A close to time period alternative, in the direction of which there’s some visibility, is clients going “from the lab to the manufacturing” i.e. they used SOTK gear “within the lab” and now want bigger larger priced items to supply at scale. I consider one can observe an instance of this in course of. Here’s a video from a start- up utilizing SOTK gear within the lab (the brand is roofed in tape) and here’s a photo from an article about that firm in Quick Firm with a bigger piece of SOTK gear within the background (their gear sprays on the supplies to kind a catalyst that appears like a big bike tire restore patch).
The long run alternative, which for my part might yield multiples larger return, might happen if SOTK’s spray deposition can exchange some portion for the big marketplace for larger price batch course of vacuum deposition. I consider that the corporate is pursuing R&D and / or license offers pursing this chance. Within the meantime, with out regard for any unknowable future, you’ve a worthwhile firm funding its personal development, working with a wholesome steadiness sheet and patiently growing options round a core skillset. These are the sorts of issues that favorably tilt the percentages in the direction of long run worth creation.
Lastly, on RSSS, which I lately wrote about within the 4Q22 letter, it’s value a brief replace right here, to share a video of my interview with its CEO at September’s Microcap Management Summit.
IN CONCLUSION: ON “CORPORATE IQ”
The varied geo-political tensions put my head in a darkish place. Warfare is wasteful and pushed by ardour and beliefs. It stifles development and the results are tragic. I gave up my perception in God after studying “Considering Quick and Sluggish” (a “System 2” answer to a “System 1” drawback) and threw my lot in with Humanity (discuss a Job-ian expertise) so I’ve hope and religion that we are able to do higher, regardless of all a lot proof on the contrary. Isn’t that what religion and perception are all about?
Thankfully, our invested capital is much less impacted by the information than my spirit. It’s nonetheless affected by the downdraft impacting the small cap markets, to which I pin rising charges as the last word offender. Credit score drives all the things and since smaller firms are likely to have extra vulnerabilities than bigger firms – they’re much less diversified, extra reliant on fewer clients and restricted financing choices – they get discounted earlier in a cycle. When charges peak, they need to do higher sooner. In brief, I feel it’s an opportune time to supply new concepts.
As I take into account what I’m in search of in an funding, I’m drawn to a obscure notion of “company IQ”. The thought took place once I noticed a “excessive IQ” supervisor who was a horrible CEO changed by an “common Joe” who I feel is a terrific CEO. I’m positive everybody can level to examples that exhibit how intelligence and administration are very completely different skillsets.
The attributes that outline company IQ are diverse and I’m positive it’s not value my time to attempt to nail down each single one. It’s not about intelligence of the administration however whether or not or not the corporate presents in a means that’s aligned with the issue they purpose to unravel for his or her buyer. Firms that I take into account “excessive IQ” are run by managers who have a tendency over time to be taught from their errors (all of us make them) and apply an iterative and incremental course of to enchancment. They take the lengthy view. They’re open and conscious of criticism. They don’t function for the satisfaction of their very own or their CEO’s ego however for the aim of fixing an issue for patrons at a margin that generates returns for shareholders. They follow humility. I do attempt to run my very own enterprise alongside these rules as properly.
No matter company traits one may take into account “excessive IQ”, the opposite side value realizing – and in my thoughts, the extra necessary one – is that within the technique of norm scoring, you will see that that half the businesses in a inhabitants might be under common on that rating. Holding this in thoughts is means of setting a base charge. As a long-term investor, if I can merely eradicate the probability that I’m investing in a under common IQ firm, then I’ve made my job a bit simpler.
I stay dedicated to constructing a sturdy and sustainable enterprise primarily based on a repeatable funding course of and clever capital allocation. I respect your entrusting me together with your capital and the duty related to being its steward. In case you have any feedback or questions, please don’t hesitate to name.
Sincerely
Avi
Editor’s Notice: The abstract bullets for this text have been chosen by Looking for Alpha editors.
Editor’s Notice: This text covers a number of microcap shares. Please concentrate on the dangers related to these shares.