Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Franco Chomnalez!
Franco is the co-founder of Sophon Capital Research, a new investment research and consulting firm focused on charting the microcap universe. Before launching Sophon in May 2024, Franco was an analyst at ARS Investment Partners/Papyrus Capital, a research associate at Citizens JMP, and an investment consultant for Tekne Capital. Sophon Capital is active on Substack and @SophonInvest on X.
Franco, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background, your passion for microcap investing, and why you decided to launch the Sophon Microcap Atlas?
After graduating with an undergrad degree from Yale, I started my professional journey as a strategy consultant at Bain & Company. There, I primarily worked on the retainer team supporting one of the largest activist hedge funds in the U.S. My interest in finance began early, trading stocks in my free time and discussing business with my parents, both of whom were investment bankers. Despite this, my initial career goal in high school and college was investigative journalism. I enjoy writing and conducting deep research. After Yale, I chose Bain for the practical benefits of career stability and skill-building while still holding onto my aspiration to one day be a writer.
My time at Bain was transformative. I focused extensively on primary research, speaking with a wide range of stakeholders, including former employees, customers, suppliers, and competitors, related to companies our investor clients were evaluating. The key lesson I took away is that after engaging with 50 or more people connected to a company, you can form a highly informed view of its investability. It truly was the type of work an investigative journalist would do, and I was hooked.
My education continued a few years later at Papyrus Capital, a long/short hedge fund managed by Nitin Sacheti, an incredibly gifted investor. Nitin is a huge proponent of “boots on the ground” research, going to lengths that few investors reach such as attending trade shows, industry conferences, and the like – not just a company’s Analyst Day. This, in essence, was a continuation of my experience at Bain and further solidified my conviction that primary research should be the cornerstone of a sound due diligence process.
In the microcap investing world, very few take the time to do this level of work. There is a wealth of actionable, non-public information that is simply overlooked. By approaching investments with the curiosity and rigor of an investigative journalist and reaching out to CEOs, ex-employees, and other insiders, you can uncover insights that others miss. Many small-cap executives are often surprised when contacted because no one has checked in for years. These conversations frequently yield far more meaningful information than any quantitative screen or SEC filing ever could.
This combination of deep research and direct engagement is what draws me most to the microcap space, and it is where I believe I can deliver the greatest value to my clients. I love primary research – I feel like I fulfill my initial goal of being an investigative journalist by doing it.
Sophon Capital Research was co-founded by me, Andrew He (a corp dev professional who worked at several high-growth technology companies), and Pascal Dangtran, a fellow hedge fund analyst. We initially did consulting for a family office, and found that writing thorough reports on our investments was helpful in giving us clarity on the investment thesis for a given company. We decided to start publishing our work on Substack, and it got a lot of attention from the get-go.
Today, we consult for two large family offices (one in South Korea and the other in New York), as well as a Los Angeles-based long/short equity hedge fund, mostly providing them with contract investment research. We had the idea of launching Sophon Microcap Atlas after deliberating with our Korean client on what their investment strategy should be going forward. We think that if you are managing a relatively small vehicle, the best place to invest today is in companies with a sub-$500M market cap. You get a trading advantage (this space is usually outside the mandate of hedge funds, or too small in size to move the needle) and an information advantage (which we gain through a heavy primary research effort). Warren Buffett claimed that if he were to manage just $1M today, he could achieve 50+% returns. That’s because in the microcap world, there are some incredible asymmetric trades that you won’t find in the larger end of the microcap spectrum.
Sophon Microcap Atlas is the product of extensive research across the entire microcap space. We are not limiting ourselves to a screener or “piggy-backing” on another investor’s idea. We want to look at everything. We think we will have a more informed perspective for our clients, and that we will become better investors by completing this project.
Could you please share your typical research process when evaluating a microcap stock? How do you source new ideas, and what does your due diligence entail (e.g., speaking with management or visiting operations)?
We try to look at as many companies as possible – roughly one or two a day. I’m not exaggerating when I say we go through a list of microcaps on major global exchanges, looking at companies “from A to Z.”
Usually, we realize after an hour or two that we can pass on a company due to a lack of fit, interest, or investability. We generally do not use screens to filter out names – we think there are great businesses out there that investors are unaware of due to screening poorly. We take notes on everything we look at to build institutional memory – this is what gave birth to our research platform, Sophon Microcap Atlas.
In terms of due diligence, we try to speak to management. We use LinkedIn to find ex-employees (1+ years out of the company), usually in sales or strategy positions – bypassing the typical expert networks like Tegus which are a little bit outside of our budget.
We also look at 13Fs. If we see an investment firm holding a position in a name we’re interested in, we make an effort to connect with them to fully understand their thesis and perspective.
Finally, we try to talk to industry participants. These include employees at competing companies, to researchers at trade publications. We want an unbiased perspective on the company.
You’ve suggested in the past that around 95% of sub-$500M companies won’t perform well over time, and that your job is to find the 5% that do. What qualities signal to you that a microcap is a good long-term investment rather than a value trap?
We have our own framework – the Sophon Score - with different criteria that assess everything from market opportunity to revenue quality to the business model. The most important indicator that a company is a good long-term investment is its returns on invested capital, its durability, and the length of the reinvestment runway. Oftentimes, we pay up for companies with high ROIC and extensive reinvestment opportunities – most statistically cheap companies are indeed value traps. Durability of ROIC is tied to the strength of a company’s moats – we want companies that have access to what the business theorist Hamilton Helmer called a “cornered resource” – some asset or advantage that cannot be accessed or replicated by competitors. Valuation and quantitative work are part of our process, but most of our time is spent qualitatively analyzing a business’s competitive advantage.
Can you tell us about any unique aspects of your research process? What are your tips for Sunday’s Idea Brunch readers get better at evaluating small companies?
We are very scrappy when conducting primary research – we’ll reach out to ex-employees and other stakeholders on LinkedIn, offering to donate $50 to the charity of their choice in exchange for a bit of their time answering our questions. A large percentage of the people we reach out to take us up on this offer. We probably spend less than 10% what the typical hedge fund spends on their primary research effort using platforms like Tegus, while going to a similar level of depth.
We are big fans of a new expert network called Trata, founded by Eric Cho – formerly a hedge fund analyst at Cobia Capital. Trata connects us to investors at other buyside firms, with whom we can debate or discuss a specific name. It’s a great service – we try to use it as much as possible. People who work at hedge funds undoubtedly tend to be very sharp, and we enjoy hearing the perspective of others regarding a company, since we often are exposed to a different perspective and thought process.
On the Yet Another Value Podcast, you highlighted Thunderbird Entertainment (TSXV: TBRD) as a microcap that “fits Sophon’s investment criteria.” Can you walk us through that investment case to illustrate your process?
At Sophon, we try to build positions in companies that are either i.) great businesses trading at a fair price, or ii.) fair businesses trading at a great price (the latter oftentimes is a catalyst-driven special situation of some sort). Usually, things fall into one of those two buckets. We think Thunderbird (TSXV: TBRD — CAD$72.6 million) is a rare case of a great business trading at a great price.
We pride ourselves as rigorous bottoms-up investors who are still aware of market opportunity and thematic tailwinds that can benefit a business.
Thunderbird is incredibly cheap – it trades at around 2x NTM EBITDA despite having topline growth north of 20% and historically healthy margins in the range of 15-30%. So statistically, it’s quite cheap.
Secondly, it’s an incredibly solid business. We talked to over two dozen industry participants in entertainment, from talent agents to producers to employees at streaming platforms. The feedback we got was consistent: that Thunderbird has a great brand and reputation, which is evidenced by the recurring work they do with major networks and streamers, who entrust them with millions of dollars to produce world-class content. This is an incredibly sizable moat – something competitors can’t replicate.
After talking to other investors, we believe Thunderbird is largely misunderstood. This is not the typical Hollywood studio, which is a really bad business model, with uncertain outcomes/returns and heavy, frontloaded expenses in production and marketing. Thunderbird pre-sells all of its own shows – this business has negative working capital dynamics, which is rare for a studio – and for service work they have all expenses (besides labor, which they receive a large rebate on through Canadian tax credits) cash flowed by their clients. They are also not commodity players – they have what Hamilton Helmer refers to as “process power,” which is the ability of produce more efficiently than their competitors. They have a real competitive advantage in our opinion.
So Thunderbird is a classic investment that fits our criteria because the business model, in our mind, is excellent. But there’s also the thematic tailwinds that we look at apart from our bottoms-up process. We think there is a narrative among investors that content spend among streaming platforms will plateau. We, on the other hand, think there’s going to be an acceleration in content spend as households rationalize their spending and cut subscriptions. Content is the main differentiator, and streamers will invest in it to reduce churn and hold on to their subs. Thunderbird is a great “pick and shovel” way to play that theme.