Idea Brunch with Chris McIntyre of McIntyre Partnerships
Compounding Capital with Concentrated Special Situations Investing
Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Chris McIntyre!
Chris is currently the chief investment officer of McIntyre Partnerships, a concentrated long/short value fund he founded in 2017. Before launching McIntyre, Chris worked as a managing director of MAK Capital and a senior analyst at Cobalt Capital. Since inception McIntyre has returned 20.2% gross annualized and 15.5% net of fees, compared to 9.1% for the Russell 2000 Value index. The fund invests in SMID cap stocks and targets the top five investments to be >70% of assets.
Chris, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch McIntyre Partnerships?
I’ve been working in investment management since graduating from the University of Virginia in 2007. I’m that kid that went off to college thinking he’d be a lawyer and ended up day trading oil futures in the back of the classroom. Growing up, I actually wanted to be a musician, but after years of practice, I realized that while I’m a good musician, I lack the natural aptitude to be a great one. In college, when some of my friends and I started to get interested in stocks, I noticed I had a faster learning curve with stocks than music because it meshed with some of my innate skills, such as math and probabilities. By nature, I have a contrarian bent and am calm under pressure. As my initial forays into stock trading went well, I felt maybe I was on to something. I still had to learn a lot of lessons – I doubled my personal account in a few months only to then see it go to zero in a few days not once but twice! – but I felt confident I could be a successful investor if I worked at it.
After graduation, I went to work on a trading desk at First New York Securities focused on risk and merger arbitrage. Those initial experiences focusing on market, rather than fundamental, inefficiencies still impact my investing today. While over time I’ve drifted towards more of a Buffett, fundamental value approach, I still look for attractive entry points caused by market inefficiencies and most of our investments have a special situations angle. Those initial years also pushed me to focus on concentrated investments. First New York could be a wild place – it was very much an “eat what you kill” mentality – but I repeatedly saw that the best traders knew when to massively size up their bets yet could sit tight when the opportunity wasn’t there. That style is very much reflected in the concentration at McIntyre Partnerships. I am willing to concentrate the book in only a small number of holdings at a given time, but I don’t just concentrate the book to say we are. You can’t just swing for the fences every at bat – you need to wait for that proverbial fat pitch.
After First New York, I went to work for several funds in analyst and sector head roles, before landing as a managing director at MAK, a value-focused equity and distressed credit fund where I lead investments in distressed debt, telecom, chemicals, and other sectors. During this period, my focus shifted much more towards fundamental research and it is when I really built out my knowledge of businesses and industries. Since college I had been tracking my personal returns and fund investments, and after a decade of work, I felt confident I knew what I was doing. I decided to go off on my own in 2017. Since then, we’ve had strong returns in a tough market for value investors, and I think we can improve upon them going forward.
You have a pretty diverse portfolio – ranging from an Irish financial services company to preferred stock in an automotive supplier. How are you able to come up with off-the-beaten-path ideas in an industry with so much groupthink?
My basic strategy is to look for quality compounders, but I try to find those where the market is missing the business’s strength and shares are at a discount. There’s a variety of reasons why a high-quality business might be cheap, but in a well-trafficked name, there’s typically a compelling reason why it’s cheap. However, that’s not necessarily the case in special situations and lower liquidity investments. Often instead of a compelling reason why it’s cheap, there’s a compelling reason why it’s overlooked. Think of a company in bankruptcy selling off assets or a large conglomerate spinning off a small division. There are special situations investors looking at these situations, but by and large, their mandates are to make an investment and move on once the special situation has ended. As such, their investment lens tends to focus on things like the near-term valuation of publicly traded comps rather than a deep analysis of a company’s ability to compound capital over long periods of time. I’m trying to focus on the things that they are overlooking.
A recent example of this was the fund’s investment in Rexnord (RXN). In February 2021, RXN announced a deal to sell ~70% of the company to Regal Beloit (RRX). RXN was a failed industrial rollup and the stock went nowhere for a decade, but the 30% left behind in the deal was actually a great company with significant market share, high operating margins, and a history of strong organic growth. However, the segment’s strength had been masked by issues in the business being sold to RRX. When the deal was announced, the stub company could be purchased for roughly 15x forward FCF while the business was growing sales at high-single digits organically with an opportunity for share repurchases and inorganic growth now that the problem child was gone. We purchased shares and held through the deal. After the split, the company changed its name to Zurn (ZWS) and shares now trade 30x forward FCF.
I picked this example because it highlights what I am trying to do. I still think ZWS is a great business that is likely to grow over time and I understand why people hold it now, but I only want to concentrate an investment when there is something extra compelling. As you’ve alluded to, this can make my portfolio look a little all over the map. I might buy a more trafficked GARP name because I especially like the business, or a might buy a lower quality spinoff because it’s exceptionally cheap, but the sweet spot is when they both align. That’s when I am willing to concentrate our capital and take very large positions.
Regarding sector diversification in the portfolio, much of that stems from following special situations, as the focus is market dislocations rather than specific sectors. Since I started there, I have been a generalist investor my entire career. At first, I felt it often put me at a disadvantage. I’d show up thinking something was cheap only to find out all the sector specialists were aware it was cheap, and there was often a good and terrifying reason why. However, after 15 years of doing this, I think having knowledge across many industries is a distinct advantage. There are often underlying themes and risks, such as the growth of software or the consumer shift towards health and wellness, that require multi-sector knowledge to understand. I think this is doubly true in special situations, as there is often limited analyst coverage and historical financials to help guide you. When I come across a new idea, it is rare for me to not at least be somewhat familiar with the industry and I can more quickly identify potential risks. I consider myself someone who is broadly studying and following many businesses and industries, yet only choosing to own an investment in size when there is a compelling reason.
One of your major holdings is Chemours (NYSE: CC), a specialty chemicals company that you have written about extensively. Why do you like Chemours? And do you have any opinion on the legal liabilities Chemours and similar companies (e.g., DuPont, 3M, Bayer, and Johnson & Johnson) face?
Chemours (CC) is the company I know best and it has been a significant holding for the fund over the last few years. I have previously written about it in letters and online. The quick pitch is the stock currently trades at roughly 6x my estimate of $5 in 2022 FCF/sh. As CC’s end markets are currently below mid-cycle and leverage is conservative, I believe this is too cheap for a company of this quality entering a cyclical upturn. I believe CC should trade at least 10x mid-cycle, which implies roughly a double from its current price. CC has two main business lines in TiO2 and refrigerants, and a smaller yet growing portfolio of specialty chemicals. TiO2 is a pigment used primarily in paints, coatings, and plastics. It’s a building block of modern society – one of those chemicals you never think about but is ubiquitous around us. Given its widely dispersed end markets, it is a GDP growth industry that can be cyclical in the short term but over time is dull and predictable. However, while the industry is low growth and cyclical, the company’s TiO2 business has one of the largest moats I have ever analyzed. The company uses a proprietary process to make TiO2 which has made CC the permanent low-cost producer. To put this moat in perspective, over the last 30 years, CC has consistently been around 20% of global TiO2 production but generated over 50% of the industry’s profits. This low-cost position enables CC to generate substantial profits through the cycle, whereas many cyclical chemical producers burn cash at troughs. In refrigerants, CC’s primary business is Opteon, a patent-protected specialty chemical currently used primarily in automotive air conditioning. To the downside, I estimate CC should earn roughly $3/sh. in a typical trough environment. In 2020, CC earned EPS of ~$2; the difference was caused by a previous operating issue that has since been resolved. To the upside, I believe CC should earn over $5/sh. this year, which compares to Street estimates of $4.50. At present, TiO2 pricing is strong, up 15% y/y, and I believe CC is likely to beat guidance. CC is rationally levered at 2x EBITDA minus CapEx. The company plans to return the majority of FCF to shareholders via dividends and buybacks and is on pace to retire 5% of shares outstanding in H1 2022.
Beyond cyclical concerns, CC’s biggest risks are its outstanding legal liabilities. Stocks with legal liabilities are a favorite hunting ground of mine. In general, investors tend to place these stocks in the “too hard” bucket, as estimating legal liabilities requires a lot of work and must be analyzed case by case. These stocks often trade at large discounts and can be compelling investments if the legal fears are unfounded. For the sake of simplicity, I’m going to divide legal liabilities into two groups: personal injury litigation and everything else. In my opinion, personal injury litigation is by far the hardest legal liability to estimate, and the highest risk situations are when litigation reaches jury trials in the USA. In US personal injury litigation, juries can award both compensatory damages for emotional suffering and punitive damages, which are arbitrary concepts that can result in staggering sums. You can debate the facts of a case all you want, but the reality is that once it goes a jury, if they come back with a big number, it’s a problem. Most of the legal liabilities that have materially impacted companies were personal injury litigation, such as asbestos and Roundup. Beyond personal injury, again I’m oversimplifying, but everything else tends to be regulatory actions with multiple stakeholders that are tied to actual costs. For instance, the EPA might make you install a water filtration system that costs $20MM, but they don’t arbitrarily assign $500MM penalties on top. Regarding CC, the company at present primarily faces regulatory actions, particularly environmental remediation around existing plants. There are no material personal injury litigations pending. CC, along with its former parents in DuPont and Corteva, have set up a trust to share legal liabilities up to $4B, which I believe more than covers any potential costs.
What are some other interesting ideas on your radar now?
Garrett Motion (NASDAQ: GTX / Preferreds: GTXAP) is currently the fund’s largest holding and I believe it is an exceptional risk/reward for investors who can participate in lower liquidity situations.