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Idea Brunch with Brian Bellinger of Monimus Capital
Brian Bellinger shares his research process, his approach to biotech short-selling, and two interesting ideas
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Welcome to Sunday’s Idea Brunch, a weekly interview with underfollowed investors and emerging managers. We are very excited to launch our fifth issue with Brian Bellinger of Monimus Capital!
Brian is currently co-founder and CIO of Monimus Capital, an investment manager he launched in September 2020 after working at Raging Capital for eight years as an analyst and managing partner. During his tenure, Raging Capital grew its long/short hedge fund to nearly $1 billion in AUM and was well known for its eclectic long book and its short-selling acumen. Monimus Capital’s long/short portfolio has returned +31% net from inception through September 30, 2021.
Brian, we got dinner a few weeks ago and you mentioned that you have been passionate about the markets from a young age and always wanted to launch your own fund. Congrats, on your dream coming true! Why do you love investing and has running a small fund lived up to your expectations?
First of all, Edwin, thank you for the opportunity to participate in this interview.
I was introduced to investing at a young age by happenstance, through a stock-picking game in my 6th-grade math class. Like you, I grew up in a quiet suburb in Upstate New York and was far removed from Wall Street and finance in general. But as a child who was mathematically inclined and eager to learn, my first introduction to the stock market was enlightening. I found researching businesses to be a fascinating activity. During my teenage years, I did all of the things a normal teenager would do: reading the investing classics (Graham, Lynch, Greenblatt, etc.), going to the public library on the weekend to pour over the Value Line binders, and building mock portfolios. By the time I was in middle school, my long-term goal was to become a fund manager. The two things I’ve been most passionate about over the past 20 to 25 years of my life are investing and sports (baseball, in particular). I astutely reasoned at a relatively young age that I was more likely to become a fund manager than the GM of the New York Yankees, hence my desired career path.
A close friend and fellow fund manager once told me, “If you are intellectually curious, the stock market is the best game in the world.” And that’s absolutely true. Since childhood, I’ve had a natural affinity for identifying patterns or inconsistencies, solving puzzles, and sleuthing. The stock market is a perfect environment for exercising these skills. I come in to the office each day excited to tackle the challenges that the market presents.
As for running a fund, I have relished every moment of my time as a business owner and portfolio manager. I’m incredibly grateful to have come from humble beginnings and now have the opportunity to fulfill my childhood dream. I will say, though, that the process of launching the business was certainly not what I would have envisioned. My colleagues and I began managing capital on behalf of clients in September 2020 so the creation of the business, building out of our infrastructure, securing initial clients, and the first months managing a portfolio were all done on a fully remote basis amidst a global pandemic. That’s not how I pictured it as a daydreaming teenager! But the team has managed through with aplomb. We have since moved in to our offices in Woodbridge, NJ and we are off to a great start.
Bill Martin credited you for running Raging Capital’s biotech short book well. Given you don’t have a deep science or health background, how are you able to generate good biotech short ideas?
Monimus Capital’s approach to shorting in the biotech sector is driven by process and pattern recognition, with an emphasis placed on qualitative research. As Bill noted in his interview, at Raging Capital, I developed a systematic process that we utilized to assess biotech companies. Relying upon SEC filings, company documents, and other sources, we evaluate a set of risk factors for each company. When certain criteria are met, it is highly predictive of future failure. An example would be current and past associations of executives and directors. Was the CEO or CMO previously employed by a biotech company that obfuscated trial results? Is a director on the board of another company that has numerous red flags? Does management have a direct or indirect relationship with stock promoters? That is a small sampling of some of the qualitative factors we evaluate.
There are a couple hundred biotech companies that meet a predictive set of our criteria. From there, we filter out companies that do not meet certain thresholds for enterprise value, liquidity, and borrow availability/rate. Ultimately, our actionable subset of biotech shorts is narrowed down to 25 to 40 companies in total.
At Monimus, 15% to 25% of our short exposure is typically composed of this diverse group of biotech companies. We take a basket approach, with each individual position generally remaining small in size, in recognition of the inherent binary risks and above-average volatility demonstrated by what are predominantly small-cap biotech firms.
Over time, we expect our biotech short exposure to be a key source of returns. At Raging Capital, during a “raging” bull market in biotech stocks, our biotech short strategy generated significant absolute returns and was a durable source of short alpha for many years.
This is also a differentiating factor for the Monimus short book in general. It is relatively rare for generalist long/short funds to have biotech as a sizable percentage of their short exposure. We believe our systematic process that has been honed over many years gives us an edge relative to our peers.
You have a pretty diverse portfolio – ranging from microcap retailers to small cap stone distributors. How are you able to come up with off-the-beaten-path ideas in an industry with so much groupthink?
That’s a fantastic question, Edwin. I will answer it by taking a step back to provide some context for our investment approach and then I’ll answer the question more directly.
There are many criteria that can lead to success in investing, but, in my opinion, a few are immutable if the goal is to outperform over the long term: knowing your core competencies, recognizing your deficiencies, and having a differentiated approach.
I describe our investment approach on the long side as “opportunistic value investing.” We are not only looking at stocks that are classically “cheap” with low P/E multiples and high free cash flow yields. We don’t invest in cigar butts. We have a process that is intended to identify growing businesses that are misunderstood, underappreciated, or overlooked. Within this opportunity set, we apply a value investing framework (seeking deep discounts to our estimate of intrinsic value) and we perform due diligence to uncover potential catalysts. As a rule, we are agnostic to market cap and factor (growth vs. value).
We know our core competencies: applying the above approach to companies operating within sectors where we have substantial institutional knowledge (consumer, technology, healthcare, and some industrials). We recognize our deficiencies: we do not claim to be macro investors and do not spend our time speculating on the direction of interest rates or global commodity prices so there are certain sectors that we tend to avoid (namely, energy and financials).
And we believe we have a differentiated approach that results in a portfolio that is idiosyncratic. There are plenty of other funds that own Alphabet (GOOGL) and IAC/InteractiveCorp. (IAC) – two of our largest positions since inception. There are not many funds that own the businesses that you made reference to: a micro-cap retailer, Tilly’s (TLYS), and a small-cap stone products distributor, Select Interior Concepts (SIC). You’ll note a similar dynamic with the two longs that I will highlight later on in this interview. There are a very select few that may own all of these companies concurrently. As a consequence, we have a long book that does not look (or act) like the indexes and it does not look like the long books of our peers.
On the short side, we also take a unique approach. About 60-70% of our short exposure is composed of catalyst-driven, single-idea shorts. While I believe we are skilled at individual short selection, the approach for that portion of the book is not particularly inimitable. About 30-40% of our short exposure is composed of diverse baskets of suspected frauds, stock promotes, and generally sketchy businesses. These baskets are inclusive of the biotech basket shorts I previously discussed. There are a few well-known short sellers that emphasize this basket-like approach on the short side. The number of long/short funds that have both a selection of catalyst-driven single-idea shorts AND a diverse basket of frauds and promotes is quite small.
Pull that all together and we have a long/short portfolio that should be generally uncorrelated with the market indices and highly differentiated relative to our peers. Through our first 12 months managing long/short capital, low correlation with the indices has persisted.
As to your question about the avoidance of groupthink, I believe that’s attributable in part to personal disposition and in part to my background. I am a skeptic and contrarian by nature – that has been critical to my development as a short seller, but likewise plays an important role in discovering and evaluating long ideas. I also have a non-traditional background relative to many fund managers. I am an accountant by training (no investment banking or private equity), I previously worked at a fund located in a renovated church in a tiny town in New Jersey (managed by Bill Martin, who has the epitome of a non-traditional background), and I now work out of quiet office park located next to a dying mall. While it is important to pay attention to consensus opinions, we are far removed from the groupthink that may be endemic in the hedge fund industry.
What are two or three interesting ideas on your radar now?
In our opinion, the opportunity set on the short side today is the broadest and most attractive it has been in the past 20+ years. The combination of new supply (via SPACs and a red-hot IPO market), the increased prominence of the retail investor, and distortions in the economy created by COVID have seeded a rich environment for short sellers. That being said, we have a policy of not disclosing individual short positions in a public setting. I would be happy to discuss individual ideas privately and my contact info can be found at the end of the interview.
While earlier this year we observed the opportunity set of long ideas to have narrowed quite dramatically, there has been substantial dispersion in recent months (even as market indices have trudged to new highs) and we are finding a number of attractive long opportunities. I will highlight a couple of current long positions that we find particularly compelling today.
Jakks Pacific (JAKK): The past decade has not been kind to shareholders of this manufacturer of toys and costumes, as the company struggled with uneven results, self-inflicted challenges, and an over-levered balance sheet. Enter John Kimble (not the Kindergarten Cop). Kimble joined as CFO in late 2019 after spending the previous 20 years in senior roles at Mattel and Disney’s consumer products divisions, and he may be the most overqualified CFO of a $100m market cap company we’ve ever met. He has spent the past two years cleaning up the balance sheet, right-sizing the cost structure, and working to improve the company’s contractual relationships with its licensing partners.
To provide a sense for the level of improvement, in Q1-Q3 2019, JAKK generated $15.6m of EBITDA on $446m of revenue, a 3.5% EBITDA margin; in Q1-Q3 2021, JAKK generated $44.2m of EBITDA on $433m of revenue, a 10.2% EBITDA margin. Gross margins improved >500 bps vs. 2019 and SG&A declined by >200 bps as a percentage of sales vs. 2019. Without multiple transitory factors, the improvement in performance would be even greater. In 2019, JAKK was a beneficiary of toy sales around the Frozen 2 blockbuster (a boon for the toy industry), while those sales have largely run off in 2021. In the most recent quarter, JAKK had ~$40m of sales that pushed to Q4 due to well-known supply chain delays.
Net leverage at the end of 2019 was nearly 7x (~$130m net debt vs. ~$19m 2019 EBITDA). Today, giving the company credit for seasonal cash flows in Q4, JAKK should end 2021 with net leverage below 1x (estimated $30m net debt vs. estimated $45m 2021 EBITDA). Balance sheet improvements have, in part, been driven by debt restructuring initiatives that resulted in substantial dilution to equity holders – but that’s a benefit to current shareholders. With some smaller peers suffering from current supply chain challenges, JAKK’s balance sheet is positioned to be offensive if the right M&A opportunity arises.
As we model out 2022, we expect continued growth in revenues and EBITDA off of 2021 levels (the sparse Street consensus calls for revenue flat and EBITDA declines). JAKK also has broad licenses for Encanto, including exclusivity on dolls (typically split with Hasbro on most licenses). Encanto is expected to be the next Disney animated blockbuster, with box office estimates calling for it to be the #1 grossing movie this holiday season. While it will not be as big as Frozen, the movie could provide further tailwinds for JAKK’s business in 2022.
With shares at $10.50, JAKK has a market cap of ~$105m and an enterprise value of ~$160m (including estimated Q4 cash flow and preferred stock). We currently model $50m of 2022 EBITDA and 2022 pre-tax earnings of ~$3.00 per share (accumulated NOLs will shield taxes for many years), both of which could prove conservative. On our 2022 estimates, JAKK is currently trading at 3.2x EV/EBITDA and less than 5x tax-effected EPS. Industry peers trade at 9-11x forward EBITDA and 16-20x EPS. With a cleaned-up balance sheet, expanding profitability, and a pathway to sustainable growth, a 6x EV/EBITDA multiple and 10x earnings multiple is far from a stretch. That would imply a share price of ~$20 (+90%), with upside to $40 (+280%) if JAKK were to trade at the low end of larger peers.
Zynga (ZNGA): Despite positive secular tailwinds, sentiment has soured for mobile gaming companies due to exposure to Apple’s new ATT framework. ZNGA’s shares were punished following its Q2 2021 earnings release in August, as the company was one of the first to call out user acquisition headwinds related to IDFA. With shares having declined 30% over the past 3 months, we believe ZNGA has an attractive setup with several ways to win.
First, while IDFA could cause choppiness in bookings and EBITDA for the next couple of quarters, we think that ZNGA is ultimately a net beneficiary of Apple’s actions. Businesses with scale advantages (namely, more first-party data and greater resources) will be long-term winners under the ATT framework, while sub-scale competitors will increasingly be squeezed out. We expect this dynamic to be particularly acute in mobile gaming. ZNGA’s broad suite of mobile games (~40m DAUs and ~200m MAUs globally) paired with the recent acquisition of a mobile programmatic ad platform (Chartboost) position the company to gain share. ZNGA has also proven to be an adept acquirer in recent years and we expect smaller developers pressured by IDFA to fuel a healthy M&A pipeline for the company.
Second, there is substantial upside to ZNGA’s earnings power from potential changes to Apple and Google app store policies. We estimate that app store fees (AAPL/GOOG’s 30% take rate on in-app purchases) offset 20-25% of ZNGA’s total revenues. A reduction in take rates and/or a shift toward direct payments would be highly accretive to ZNGA’s earnings. For example, we estimate that if one-third of in-app purchases were shifted to direct payments, ZNGA would see a 25% lift in earnings power. Take rate reductions of 10% or more would lead to even greater earnings accretion. While the timing of such changes is difficult to predict, Apple’s ongoing lawsuit with Epic Games and recent (minor) actions taken by Google indicate they are likely inevitable. We believe this optionality should be reflected in ZNGA shares (although it is not at the moment).
And third, while we think Zynga as a standalone can compound earnings at a very attractive rate through organic growth and bolt-on acquisitions, it would be a desirable asset for a company like Activision (owners of King Digital) or a number of other potential strategic acquirers. As one of only a handful of independent mobile gaming companies of significant scale, we see ZNGA either increasingly flexing its might as it rolls up smaller peers or they will ultimately be taken out at an attractive multiple by a strategic.
Assuming no benefit from app store changes, we model EBITDA of $900m by 2023. Applying a multiple at the midpoint of ZNGA’s historical trading range, we get to a share price of $12.50 (+70%), with upside beyond $15.00 (+100%) if structural changes are made to app store fees or with outperformance of acquisitions and new game launches. A share price in the $12 to $15 range would also align with precedent transaction multiples in the mobile gaming space. With sentiment already terrible, a valuation multiple at the bottom of its historical range, and a put in the form of platform scarcity value, we believe ZNGA offers a highly asymmetric setup over the next 12-24 months.
Brian, what are some of the first things you do when researching a company? What does that first hour of research look like? Is there anything you do that most people don’t?
For Monimus, the first hour (or few hours) of research depends on the source and background of the original idea. There are many hundreds of companies where we have an established level of institutional knowledge, having previously held a long or short position at some point in the past decade (at Monimus or a previous firm) or previously researching the company as a prospective investment or as part of a peer group analysis. Leveraging our significant institutional knowledge accounts for a sizable percentage of our idea pipeline. The first hours here involve quickly getting back up to speed: reading recent earnings call transcripts and investor presentations, reviewing key sections of the 10-K/10-Q/proxy, scanning sell-side research to get a sense for sentiment, updating alternative data files (if available) to assess current trends, and refreshing our valuation analysis. After that, we build a list of questions that we need to answer and begin to craft a narrative for the bull case and the bear case. At that point, we make a decision as to whether we want to proceed with additional work or move on.
If we are researching a company from scratch and we lack background familiarity – let’s say a recent IPO – the approach requires some more upfront legwork to understand how the business functions. We will read the prospectus or 10-K cover to cover, taking note of any primary sources highlighted in those documents (a great way to find trade publications and obscure data sources). In addition to the resources cited before, we will dig through the company’s website, LinkedIn pages, product reviews, etc. to enhance our understanding. And we will quickly review the competitive set to get a general sense for the company’s market positioning relative to peers. From there, the approach is the same as before – list of questions, bull/bear case narratives, and decision to proceed or not.
A critical aspect of our investment approach is being able to say “no” and avoiding time spent on research that will have little to no marginal benefit to our investment process. That includes putting companies in the “too hard” pile when the ROI on the time required to prove out a thesis is unlikely to be attractive, even if the investment case is compelling on the surface. An extreme case would be Seth Klarman hiring a dedicated analyst who spent years solely focused Enron debt and trade claims. We don’t have such resources today (maybe someday!). Over time, I think we’ve become very adept at discarding most ideas quickly and focusing our research efforts on the select opportunities that could become material positions in our portfolio.
While there are a number of our research processes that I believe are unique, I will very respectfully decline to elaborate. Identifying and maintaining an edge is paramount in this business. One tip that I would have (and I’m not sure how prevalent this is): only read black-lined versions of 10-K’s and 10-Q’s, if they are available. Utilizing these versions elucidates new disclosures and (sometimes more importantly) disclosures that were removed. Finding seemingly nominal changes to wording can occasionally be fortuitous.
What would you like Monimus Capital to look like 10 years from now?
Our primary objective as thoughtful stewards of capital is to build wealth for our clients. Accordingly, ten years from now, we will have achieved our goal if we have generated exceptional returns for those who have entrusted us with their capital. Our initial base of clients has a long-term orientation, an appreciation for our investment approach, and an open dialogue with me and my colleagues. Over the next decade, we intend to identify a select group of similar clients as we build our capital base. While this is a business, our aim is not to be asset gatherers, but instead to be intently focused on maximizing returns.
From an investing perspective, we will improve our craft year after year. I would observe that many firms, with asset growth and the passage of time, witness style drift and/or become complacent. I am vigilant to avoid both. As a student of markets for the past 20+ years, I believe it’s clear that most superlative investors have demonstrated a willingness to adapt and evolve their investing approach over time, yet do not betray the core of their investment philosophy. I do expect that Monimus will likewise evolve its approach, but we also know our core competencies and are cognizant of our limitations. And I challenge my colleagues (and myself) to emphasize a mentality of continuous improvement – assessing how we can enhance our investment process and learning lessons when we inevitably err. If we are successful in these pursuits over the next decade, I expect that we will meet our primary objective for our clients.
Brian, thank you for the great interview! What is the best way for readers to follow or connect with you?
I can be contacted by email at firstname.lastname@example.org. I would be happy to dive into greater detail on anything we’ve discussed and always enjoy sharing ideas and perspectives. Edwin, thanks again for having me as a guest.
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