Idea Brunch #2 with Ryan Rahinsky of Blue Outlier Capital

Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Ryan Rahinsky!

Ryan is currently the chief investment officer of Blue Outlier Capital, a Tampa-based value-focused fund that uses long-term options in special situations to structure asymmetric risk to reward. Before launching Blue Outlier Capital in January 2023, Ryan traded his own capital, worked as a consulting associate at BDO, served as a non-commissioned officer in the U.S. Navy, and earned an MBA from UNC Chapel Hill in 2021. Ryan was previously featured on Idea Brunch in January 2023.

Ryan, thanks for doing Sunday’s Idea Brunch again! Can you please remind readers a little more about your background and tell us about your experience launching Blue Outlier?

Thank you for having me again. I come from a small town in Tennessee, from which I joined the Navy at 19. I served in a since decommissioned helicopter squadron for four years, including one year in South Korea, and balanced serving and deployments with going to school.

When I got out of the Navy, I finished my degree and went to live in Tel Aviv for seven months working with BDO Israel on their U.S.–Israel Desk. It was a tremendous experience and introduction to international business, and even better, introduced me to my wife. From there I got an opportunity to consult for BDO USA out of Washington D.C., before attending UNC for my MBA.

I’m one of the kids who was always obsessed with entrepreneurship and the stock market, making my first trade at the age of 12 with money earned from my younger ventures. Over my life, I’ve studied markets and great investors and dove deeper into a self-developed strategy investing my capital as I was gaining first-hand experience and a formal education.

My unique upbringing and career path have led me to have what I call a Sam Walton-style strategy, meaning I took pieces of my strategy from many different world-class investors that I thought had it right. I'm a value investor who believes that markets are reflexive and inefficient, while looking for asymmetric opportunities that maximize risk to reward, sometimes by taking advantage of option model inefficiencies through the use of long-term options.

At UNC I decided to launch a proof-of-concept account to demonstrate the strategy, and the results were promising and generated some interest. From January 2020 through the end of 2022, I turned an initial $34K into over $1MM in gross earnings and decided to launch Blue Outlier Capital in January of 2023 to start investing on behalf of my partners.

You’ve had an incredibly strong first year! What has contributed most to your success? And what have been some unexpected learnings or challenges?

Thank you, although it was a strong year for us it was in many ways one of the most frustrating and difficult. The lack of breadth, breakdown of correlations, and markets oftentimes moving counter to what I would have expected based on the data, made this an overall frustrating year. Despite this, we were able to generate just over 50% net for our partners, despite being net short tech and the magnificent seven where so much of this year’s market performance was.

I think our success despite the challenging environment speaks to how we structure our investments. In many of our investments, we use inefficiencies in option pricing models to create long-term asymmetrical opportunities when they present a better risk to reward than owning or shorting the shares outright. I discussed a few of these inefficiencies in our last interview so I won’t go into detail again here, but utilizing this strategy can lead to long-term investments with better risk to reward. Structuring a portfolio full of diverse and uncorrelated asymmetrical risk-to-reward opportunities should continue to lead to outperformance over the long term.

The biggest challenge for me this year was determining the market’s response to volatile interest rates and making sense of the lack of breadth. I expected the high-valuation quality names to be most impacted by the comparative value available in fixed income with higher interest rates. Many of these quality companies’ multiples were previously justified as being bond-like when yields were low, and I expected multiple compression as interest rates rose. Many saw fundamentals deteriorate significantly this year, and yet continue to command multiples up to twice their long-term average. Despite this, most of these companies never saw substantial downside and are ending the year at or close to highs. Much of the downside was in the smaller capitalization companies with lower relative valuations. I attribute this primarily to a safety trade as recession fears from the volatile year and higher interest rates pushed investors into companies that can better handle the economic volatility and any possible recession. Maybe this will mean revert as recession fears abate, but the dispersion between higher valuation quality names and the rest of the market surprised me this year and was very challenging as a value manager with many small and mid-cap portfolio companies.

There are a lot of emerging manager long/short equity funds. What are some of the ways Blue Outlier differentiates itself from the crowd?

There are a lot of managers, and like any industry, competition ultimately benefits the customer. I created Blue Outlier to be a long-term partnership, and I wanted to be fair to our partners. We go against industry standards by not charging management fees or any operational fund expenses, outside of trading and brokerage expenses, to limited partners, and only charging an annual performance fee. All fund administration, accounting, and audit expenses are taken by the general partner. This keeps incentives aligned long-term and ensures the limited partner pays nothing outside of performance or trading-related fees.

Outside of our expense differences, I believe our strategy is unique, and fills a special place in a balanced portfolio that other strategies can’t fill. The outperformance we’ve shown in both up and down markets over the last four years showcases our asymmetrical strategy, and I believe we serve in a special niche between deep fundamental value investing, and exploiting structural inefficiencies in options markets that not many managers take advantage of.

Last January you pitched Consol Energy (NYSE: CEIX) as your top idea. Since then, the stock has gone up ~80% from ~$58/share to ~$105/share. What went right with Consol Energy and where do you think the stock goes from here?

I went on a site visit to Consol (NYSE: CEIX — $3.24 billion) this year and had an opportunity to go into the mine to see operations, as well as visit their strategically critical marine terminal in Baltimore. Consol’s Pennsylvania Mining Complex (PAMC) is the best coal mine in the world, led by the best management in the business, with a CEO who’s worked his way up over a nearly 45-year career starting as a miner. He’s a true industry expert on everything from the machinery to the geology, and has held almost every position in the company throughout his career, and that’s a depth of knowledge that can’t be replicated by peers.

Consol has been operating the PAMC since 1984 and will likely have around 50 more years of production at the mine. They’re one of the few mines with such long-term reserves, and they have much fewer geological issues than peers due to the flat geology that they’re blessed with. These factors, as well as their best-in-class operations, logistics infrastructure, and marine terminal, lead them to be one of the lowest-cost exporters for their quality of coal in the world.

Coals have many different qualities, but the high-quality coal that Consol exports is relatively rare globally and much sought after, particularly for industrial uses such as cement production.

They’ve successfully pivoted their business, with only 25% of their revenue coming from legacy domestic power generation customers, down from 65% in 2017. They continue to pivot to industrial and crossover metallurgical coal opportunities that are growing sustainably and command higher prices, with these industries accounting for 42% of revenue, up from 15% in 2017. Demand for these coal qualities is expected to continue to outpace supply, keeping coal prices higher for longer and structurally underpinning Consol’s profitability.

Imperative to their export strategy, they’re one of the few coal companies that owns 100% of their marine terminal, and that has excess terminal capacity. They raised their marine terminal capacity from 15MMt to 20MMt year-on-year, and I think there’s more upside possible in the future as they continue to pivot more to export markets and hit new throughput records, and as their new metallurgical coal mine operates at full production for the first time this year.

Finally, Consol has never been in a better place financially and has been largely derisked. This year they achieved a net cash position for the first time in their history, and have pivoted to deploying their FCF, 77% in the most recent quarter with a stated target of 75%, into incredibly accretive share repurchases. In 2023, they repurchased over 4.1MM shares through the end of October, over 12% of the total share count. They have large investors like David Einhorn and Mohnish Pabrai who are proponents of buybacks and holding the last publicly available golden shares, and I believe that the company is committed to buybacks and driving their own rerating as they naturally squeeze out the uncommitted holders over time. I believe that Consol is still a great long-term opportunity as an underappreciated compounding machine.

What are a couple of other interesting ideas on your radar now?

I’ve got two beaten-down, cheap, off-the-beaten-path ideas I’m excited to share!