Idea Brunch with Mike Hacke of Steel City Capital

Mike Hacke on starting a fund, short-selling, value traps, and his best ideas

Welcome to Sunday’s Idea Brunch, a weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Mike Hacke!

Mike is the founder and head of Steel City Capital, a long/short equity fund he founded in 2018. Before launching Steel City Capital, Mike was a senior manager at Macquarie Group and an associate vice president in the equity research team at Barclays. Since its May 2018 inception Steel City Cap has returned 8.7% annualized net of fees, with an average net long exposure of 59%.

Mike, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Steel City Capital?

I always like to start my story by telling people what attracted me to investing in the first place. My (late) grandfather, who never completed college, was a manufacturers’ representative in the candy business. He stood between candy manufacturers and retailers, and took a small cut of each completed sale. He liked to tell me that he “sold lollipops for a fraction of a penny.” I think most people reading this realize that being a low-margin distributor isn’t necessarily a pathway to financial independence.

But it’s what he did with those slivers-of-a-penny that ultimately brought me to the world of investing. I’ll never forget him sitting me down one day to show me an article from the Philadelphia Inquirer that he saved. The article was about a young Mexican investor that was just granted a government monopoly to set up a telephone network in Mexico. The investor was Carlos Slim, and the company was Telmex. So whenever my grandfather had some extra money sitting around, he invested it in Telmex, right aside Slim. Let’s just say my grandfather did quite well for himself.

Growing up, he made an effort to pass his interest in investing along to me, which ultimately led me to pursue a career in the industry. In early 2010, I managed to earn a job in the Credit Risk Management department at Morgan Stanley. I spent time doing credit analysis on companies across a wide spectrum of industries. From there, I joined the MLP research team at Barclays working for a gentleman named Rick Gross and one of his junior analysts, Christine Cho. It was a fascinating time to cover energy infrastructure. I started in early 2013, launched coverage on a number of companies that went public, and then watched quite a few of them implode when oil prices rolled over in late 2014. After Barclays, I worked closely with the management team of Macquarie Infrastructure Corporation (NYSE: MIC) on investor relations and financial planning and analysis.

I launched Steel City Capital to fulfill a life dream of mine which was to manage outside capital. There were plenty of people that advised against the move (and for a variety of reasons), but nothing was going to dissuade me from giving it a go. I was motivated in part by a “regret minimization” framework and a hunger to learn. I’m almost four years in, and I can honestly say it’s one of the best decisions I’ve ever made.

How did you transition into a role managing money when none of your previous roles were on the “buy-side?”

Let me start by saying that it wasn’t an easy transition. Early on, the hardest part was managing the emotional burden of knowing the decisions I was making would directly impact the value of someone else’s hard-earned money. This was punctuated by the fact that most early investors were of the “friends and family” variety. Who wants to look at a friend and tell them you torched some of their money? This is part of the reason I try to write letters that detail the thesis behind the Partnership’s largest investments. I want everyone to know exactly why we own something.

That said, I’ve created an investment approach that I think leverages the skills I’ve gathered and the experiences I’ve had over the years. For example, the common thread that ran through my experiences as a credit analyst and MLP analyst is a focus on cash flow. In the world of credit, you need to know if a company can generate sufficient cash to meet its obligations in full and on time. And in the world of MLPs – particularly when they were pitched as total return vehicles – you needed to understand where a company would source the cash it needed to both invest in projects and pay distributions to shareholders. More than a few were exceptionally reliant on external funding (some might call this a Ponzi scheme…) and this ended badly for them when oil prices rolled over.

Another thing I learned was to think about the “downside” or “stress” case of an investment. This figured prominently in my work as a credit analyst, particularly because the 2008/2009 downturn was so fresh in everyone’s memories. At Morgan Stanley, we’d spend a lot of time looking at how an obligor would fare in the event of a double-digit decline in revenue. So that’s something that’s also part of my analytical toolkit.

And lastly, my time working on the “inside” of a public company really opened my eyes to how little public investors actually know about the day-to-day operations of a company. Even with the best public disclosure in the world, there’s probably something you will never know that could result in an unpleasant surprise. So that experience made me very value-sensitive in my investment selection. Classic value investors would refer to it as a “margin of safety.” For me, buying “cheap” is an important factor to protect against those unpleasant surprises.

How do you go about finding the hidden gems of the market and how do you ensure you don’t end up in “value traps?”

Idea generation is the hardest part of the job. I have an investor whose mind works like a Rube Goldberg machine. She’s always asking me, “did you think about how X affects Y? …and how Y affects Z? and how Z affects A?” My mind doesn’t work like that, and my responses are more often than not, “No, no, and no.” That’s not to say I can’t connect the dots on things – for example, the Partnership is short WD-40 Company (NASDAQ: WDFC), which is slow-growing, cyclically exposed, and whose margins will continue to be squeezed by higher oil prices. But some people are just really good at thinking outside of the box and identifying things way before they happen.

For me, I spend a lot of time doing what I call “Idea Generation by Surfing Around.” I’ll pull up a list of tickers (sometimes screened on certain metrics, sometimes in certain industries, sometimes by market cap, etc.) and read some of their filings, look at their presentations, and read articles about them. The process is quite frustrating because I often feel like I’m not doing anything productive, but I’ve also found quite a few gems this way. I try to stay off Twitter. While the “FinTwit” community is interesting and engaging, I’ve been burnt by a couple of ideas that, in retrospect, represented some pretty bad cases of groupthink.

The value trap question is a good one. The short answer is that I’m always looking for some sort of catalyst to help price and value converge. Buying a stock on the basis of a cheap multiple typically doesn’t cut it — there’s a difference between “cheap” and “cheap for a reason.” So I’m always looking for things like new contracts, M&A, revamped capital allocation, an activist rattling the cages, and so on.

Unlike many fund managers you have a very active short book. What do you typically look for in your shorts and has your short book diminished your overall returns?

I wouldn’t necessarily say my short book is “more active” than others, but instead I talk about some of my short positions more prominently. I do this for the reason I articulated above — I think it’s very important my Partners understand my rationale behind taking a particular position. I also think that any successful investor needs to be comfortable standing apart from the crowd, and whether the position is long or short, writing about it is a good opportunity to discuss where I differ.

2021 was a satisfactory year for the Partnership’s short book, generating a positive return in what was a strong year for the market. 2020 was a completely different story. I was caught “offsides” with a number of positions. There were multiple reasons: incorrect theses, position-sizing, and some “thumb-sucking” on my part. I learned some important lessons and amended my approach to shorting as a result.

What are two or three interesting ideas on your radar now?

The Partnership’s largest position is Anterix (NASDAQ: ATEX — $1.03 billion), which is the largest owner of 900 MHz spectrum in the United States. The company went through a multi-year process with the FCC to have this spectrum band reconfigured to support broadband communications, specifically for electric utilities. For their part, utilities are interested in the spectrum to meet their ever-growing data needs and because of their desire to create more resilient private networks. Sales of comparable spectrum and initial contracts executed by ATEX point to a stock that is worth 2-3x where it trades today. I really like it in today’s environment because 1) I have a high degree of confidence in my assessment of intrinsic value and 2) the path the value realization should be largely independent of what’s going on in the world.

On the short side, I recently re-established a small position in Snap-On (NYSE: SNA — $11.1 billion).