Q&A: Maglan Capital’s CIO Talks Distressed Investing, Is Bullish On FairPoint Communications

Jun 10 2015 | 3:30pm ET

Does that include taking an activist role in your positions?

Bankruptcy folks tend to have a natural activist tendency, so when it makes sense, yes. We’re not afraid of tackling complex legal matters, and we usually understand the bankruptcy process better than most. Most of the companies we engage with come with a story and hurdles that have to be surmounted before a turnaround can work, so if we can be helpful & effective behind the scenes, we like to do so. If we have to draw more visible attention to ways in which shareholder value can be created, we’ll do that too as we have in the cases of FairPoint Communications and Madalena Energy.

Do quantitative factors play in role in your investment process?

Yes, but only to an extent. We will incorporate quantitative metrics in our decision making, especially when it comes to timing entry into, or exit from, a position. But we’re fundamentally drawn to deep value situations. We don’t typically trade tactically around a core position; most of what we own, we bought until we’re pretty full on it.

Let the cake bake, so to speak?

Yes. It’s sometimes the hardest thing about what we do. Patience is an extraordinarily valuable commodity, especially in a mark-to-market business. Part of that process admittedly entails managing our own expectations, since once we’ve decided to go into something, there is a tendency to expect it to start working almost right away.

Let’s talk about the current portfolio. What’s top of your mind at the moment?

Our biggest position is FairPoint Communications (FRP), a small telecom company that operates in primarily rural areas. The company went through some serious integration issues a few years ago following its acquisition of Verizon’s assets in Northern New England, and we first started getting engaged via debt while the company was in Chapter 11.

The stock came out of bankruptcy at ~$20, and promptly collapsed in 2011. We ended up accumulating a lot of stock in the mid-single digit range, because we just didn’t believe the company was going back into bankruptcy. Management was doing too many good things, increasing cash flow and so on. But the market didn’t appreciate it. Recently, the company had to deal with a labor strike (now resolved) which allowed it slash its pension and OPEB liability by ~$700 million. Throughout, we were confident the issues facing the company were transient and unrelated to the underlying business model. We’ve been right so far – the stock is now back near $20 per share – and the firm is ready to be sold. We think a deal worth doing will come within the next 12 months or so, and for a substantially higher valuation. Given that most M&A in FairPoint’s industry takes place around 6-7x EBITDA, we’re looking at $30 per share.

FairPoint is also a good example of the activism I mentioned earlier. We’re one of the largest shareholders in the company, and went activist in order to push for board representation. It was a good process, because it raised awareness of the company and added some corporate savvy to the board that has come in handy.

Are your plays always company specific or do you also trade broader trends?

Sometimes both. It all depends on the opportunity. Take our investment in Madalena Energy, a small oil and gas company headquartered in Canada but whose assets and operations are primarily in Argentina.

Our initial foray into Argentina was via sovereign debt, and later in state-owned energy company YPF. After exiting those investments, we looked further downstream and found Madalena about 18 months ago. We watched it for a while, and by the second half of 2014, when the energy markets were falling apart, we decided to go into the name heavily.

Madalena is good example of a contrarian bet all around. First, it’s Argentina, which is an issue all by itself. But then there is the commodity exposure, the small-cap element, and the currency. We have to deal with all these risks. 

But at same time, the company is very asset rich. With oil collapsing, those assets are not being fairly valued at all. This is a true case of the baby being thrown out with the bathwater. The stock market totally underappreciates this company’s advantages, such as a locked price of $77 per barrel set by the government and adjusted monthly. Plus, the energy space in Argentina is complicated – it used to be net exporter, now it is a net importer – so there are massive incentives for companies to increase production.

Argentina has the third-largest shale deposits in the world, and Madalena has assets in the sweet spot of the Vaca Muerta formation. We own 14% of the equity, and have made changes to the board to focus on its Argentine shale and conventional plays, and to monetize its noncore assets in Canada and Argentina. While the balance sheet and assets are great, the company was spread too thin amongst too many plays and needed to narrow its focus on its most prized assets.

It’s a very representative deal for us in terms of what we look for when sourcing investment opportunities. It’s suffered a momentary lapse or shift in its underlying business (oil), but it isn’t facing a broad, endless secular decline. The situation has put companies like Madalena under extreme pressure to tighten up and increase efficiency, both of which will be very valuable when the inevitable recovery occurs. In our experience, the upswings from situations like Madalena can be dramatic and long.

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