During his recent interview with Tobias, Dan McMurtrie, Founder of the Long/Short hedge fund Tyro Partners and Bangladesh VC fund – Anchorless Bangladesh, discussed how turnarounds in big brand names provide significant investment opportunities. Here’s an excerpt from the interview:
Tobias Carlisle: Let’s talk about Tyro. Your Long/Short hedge fund first. So you cover four themes, consumer, healthcare, industrial, technology. Can you just take us through a very high level why do you focus on those themes and what’s interesting about each of them?
Dan McMurtrie: There’s a few angles you can take on that. I think one of them is there’s a lot of dispersion in all those sectors, so there’s trading opportunities. There’s also a lot of dispersion in financials, but we don’t have a specialty in that, and also you generally need a lot of leverage to get a high nominal return. We really want to focus. A lot of things you can spend research time on when you’re doing bottom-up fundamental research, and so our way to think about what we’re going to devote time to is by focusing on two things, big secular trends that we think are going to really drive how economics are occurring throughout a value chain, and then the value or supply chain itself.
Dan McMurtrie: We think increasingly industrials, technology, consumer and healthcare are blending together. There’s that very popular meme about every company needs to be a tech company now, and to some degree that’s true, and at other degrees, it’s not. But it does mean in certain times when technologies from one industry or the other are moving into the other industry, it’s going to change the competitive positioning of the market a lot and that is very important, particularly as you look at public versus private deals right now.
Dan McMurtrie: We spend a lot of time looking at private in addition to the public and so we just think there’s a lot of overlap there. We see common themes, we see common drivers and we think there’s a lot of synergies between covering those spaces. There are certain things within those sectors we don’t cover. We tend to cover specific sub-sectors, so we don’t do science-based biotech, for example, within healthcare, but a cashflow based healthcare business or a healthcare sector special situation we’ll participate in.
Dan McMurtrie: We also tend to not do as much SaaS. We’ve covered them, but I just have never been able to get comfortable with the valuation, so it’s never going to be a huge bet for us I don’t think.
Tobias Carlisle: Yeah, it’s hard to plug in those growth rates and I think that that’s been a differentiator over the last few years. Folks who’ve been able to accept those growth rates and employ them have done very well. When you’re looking in say, consumer, so could you just give us a flavor of how you think about consumer?
Dan McMurtrie: So in consumer and tech, well in the others too, but in consumer and tech specifically, we spent a lot of time really trying to understand specifically what motivates the customer purchasing decision? What does that company customer relationship really look like? A lot of the times it’s a little counter-intuitive or there’s some nuance that you miss if you’re just reading research reports. So we spend a lot of time going and talking to customers, talking to salespeople. We like to go to conferences that are not finance conferences. So if we can find an industry specific conference we’re going to go to that.
Dan McMurtrie: We really like turnarounds of strong brands. A big position for us in the last year was Papa John’s and we think that was an interesting situation because you had a massive footprint, a brand that was extremely popular sometimes for bad reasons, but had been run very poorly compared to comps, and we know a lot of people in the franchise business and it was a situation where the bar was much lower than the market really expected.
Dan McMurtrie: So we really like turnarounds. We really like strong brands where there’s something about the customer consumer relationship that is unique, and we really like repeat purchases more than a high ticket price items. There’s things like Peloton and companies like that, that I think are great businesses that people done very well in it. I’m not as comfortable underwriting those situations personally just because I think it’s such a small number of absolute customers and a competing product or a new story or something like that could potentially permanently impair the business.
Dan McMurtrie: I don’t think that’s as risky with a company that sells 25 different types of candy bars or something like that, it’s a little easier to underwrite, and so we tend to avoid some of these high ticket price item companies. We haven’t participated in things like restoration hardware or Peloton or any of the luxury names so much, just because that’s something that we don’t understand as well, but we tend to focus on things that we think 90% of the population is buying that we think is really popular. We also really like situations on long and short side where we think there’s a big perception gap between kind of New York, Connecticut, hedge fund people and the rest of the world.
Dan McMurtrie: So there’s a point in time where a lot of hedge funds were saying and the sell side was saying that everyone in the United States is going to be shopping in a whole foods and we just were looking at income and wealth and we’re like, that’s not possible, and so those are types of situations, and a lot of the times I think, on an average stock, on an average day, we do not think we have an edge. A lot of what we’re looking for is really doing our research first, completely independent of what we’re going to trade and then waiting for the market to make some sort of mistake.
Dan McMurtrie: So usually it’s some scary headline, then you peel it back and it’s really not anywhere near as bad as people think or you get an incremental piece of information that really increases the probability that your thesis is correct and the market doesn’t incrementally price kind of that probability change. So those are two things we really focus on, particularly in consumer because these are very emotional names and there’s a lot of retail money and there’s a lot of, people go from this is the greatest brand ever to this brand is dead and we’ll never come back in a month, if very frequently.
Tobias Carlisle: Consumers or investors?
Dan McMurtrie: Both. Consumers tend to be, I think that’s probably the high ticket price item thing is a little scary to me is I think in certain consumer categories you see big shifts in terms of what people are buying. In others, the street will freak out. But then if you actually think about it and you look at some of these businesses, a nightmare quarter is 6% lower sales, which might actually be 3% lower volume with some discounting. And so if you think about what is, is that franchise really impaired permanently? Is this a dead business?
Dan McMurtrie: I think that’s a little bit of a jump from kind of a 3% volume decline and yet the street makes this assumptions very, very frequently. And so when you have a setup like that on kind of the sentiment side where people are really freaked out over something that is not a material volume shift where there’s a clear short term issue and particularly if there’s a management team in place or a new management team in place that has a very tangible plan and course of action that they’re actually going through and executing tangibly, we really like to get long those situations and we like to short kind of the opposite.
Dan McMurtrie: We like to short most situations where people start to assume everyone’s going to have this product and things like that, and you have to be careful because there are Netflix’s and things like that where that’s a really dangerous bet but that comes back to really understanding what that customer purchasing relationship is and kind of where is the sentiment of people in the industry and people buying the product versus where the street is. And so a lot of the times our big long and short positions are something where we think there’s been a marginal shift up or down in the business but the street has completely over-exaggerated that, and usually that’s amplified by a positioning issue. I don’t think that most stock price moves are really entirely fundamentally driven, particularly on like a one day, one week basis, and so our approach across the board is to really try to understand certain businesses, the pizza business, something like that.
Dan McMurtrie: It’s not… Pizza hasn’t changed and I don’t know how long. I mean, Domino’s has rolled out an app and done a great job with fortressing and all of that. But I don’t know of a really a new pizza other than adding incremental pieces of chicken onto different pizzas in a long time. So when we see Papa John’s go from, I don’t even know where to 40 and then it rallies all the way to 60 on an M&A rumor, at 40 it’s a pretty obvious buy if you’re not getting scared about the situation, and at 60 when they’re assuming it’s going to get bought out, you could run whatever M&A math you want. There’s no way that thing was going to get bought there for over 60, 65 bucks. So you really didn’t have any upside after it was a clear sell, and then it went right back to 40 and meanwhile with that stock, management had laid out a plan and a timeline.
Dan McMurtrie: It was very clear what needed to happen, and the street kind of every month had a new narrative for how this Papa John’s turn around was working or not working, and when they first announced it, they needed to come out and they needed three months till they had their franchisee meeting. And so you can’t turn around a franchise based business unless you get the franchisees to buy in.
Dan McMurtrie: And so in the course of the part of the plan where we have to get with our people and get everybody on board, the streets sort of generated, I don’t know how many narratives and so we’re just following the business and so it’s kind of like 80% of our time is following the business, and then we check in on what the street’s doing, and I have no idea what the streets talking about half the time when some of these names, because I’m like, I’ve been talking to people at the company and the industry franchisees and they have no idea what the street is talking about and sometimes the street’s right, but we really like those situations where we think there’s some big dramatic psychological game happening in terms of how people are trading an aim and associate that’s amplified by a lot of positioning and sort of agency risk on money managers parts that’s causing those pricings to be wider. And that’s kind of how we cross kind of the fundamental view with the, when we actually trade.
Tobias Carlisle: Yeah. I think you pointed out that the last great innovation in pizza might’ve been sticking some garlic salt onto the marinara sauce.
Dan McMurtrie: Yes. So this is a true point, and it’s still online. When Domino’s, right now everybody loves Domino’s, but people forget that for a long time that was not the case and it was not a good performing company. And one of the first things if not the very first thing-
Tobias Carlisle: The box and the pizza tasted roughly the same.
Dan McMurtrie: … Yes. So one of the first things that happened when new management came in is they issued a press release, they did some calls on things and the press release, which is still online on kind of an old version of the Domino’s website, basically says, “Our pizza sucks and we’re going to reinvent our recipe and all of this.” And what they did is the classic trick that every amateur and professional chef know. A lot of people in my family are chefs, my uncle runs restaurants, things like that, and you add garlic salt. So they put garlic salt on the crust and they made a couple slight tweaks and then they started going to college campuses and offering aggressive discounts because they’re like, college students will buy $5 pizzas and they just ran, and I was a beneficiary of those $5 pizzas. As anyone’s with a video feed will see. And then I think six years later Papa John’s just made that exact same press release, which it was so funny to me. I was looking up side by side and they’re even worded very similar. It’s this-
Tobias Carlisle: Well, it worked.
Dan McMurtrie: … We’re slightly change the sauce and we’re going to put garlic salt on it.
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