MDC Partners

A docile animal in captivity

Published on:
March 16, 2019
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Noam Ganel is the voice behind Pen & Paper, a value-oriented stock research publication. He  serves as  Vice President in Capital Markets at Silvergate Bank and holds the Chartered Analyst Credential (CFA).

Bored, without anything better to do, I looked which investment funds own the stock of Seritage Growth Properties (SRG on Nyse). The list in Seritage is the all-star dream team of value investing. Owners of Seritage common stock include Warren Buffett (owns 2 million shares), Bruce Berkowitz (owns 3.2 million shares), Mario Gabelli (owns 114 thousand shares) and Victor Cunnigham of Third Avenue Management (owns 291 thousand.)

Yet I had never heard of Seritage's largest investor, a mutual fund provider by the name of  Hotchkins & Wiley. Founded in 1985 in Los Angeles, California, Hotchkins describes itself as "boutique asset management firm with an orientation for long-only value investing." It manages $27 billion and it offers mutual fund products, from large capitalization stocks to small capitalization stocks.

One of its funds, the Small Cap Value Fund, looks for companies with market capitalization from $100 million to $4 billion. Since its inception, the annual return of the fund, net of fees, was 11%. That means that a dollar invested in the fund in 1985 would now be worth 31 dollars. Not bad, I reckoned.

I looked at the companies owned by Hotchkins, hoping to copy from them a few stock ideas. Their largest poisiton is in First Hawaiian Inc (FHB on Nasdaq) which seemed to trade at a reasonable price to value. I could not understand what lured the fund managers to own the stock. The second largest holding was Seritage Growth Properties, a stock which I already bought a few months ago. Enstar Group, their third largest holding, is an insurance company that trades at a fair price. A marketing firm by the name of MDC Partners (MDCA on Nasdaq) was the one company that caught my attention.

MDC Partners      

Described as "the first advertising hedge fund" by Adweek a few years ago, MDC buys established marketing companies and lets the original owners decide how to best run their business. MDC defines itself as "a partner company, not a parent company." 

According to its website, MDC’s business model "fuels the entrepreneurial nature of agency parents and provides collaboration and continued support to ensure that each partner achieves their greater ambitions." You would expect such marketing language from an ad company. But the operational results are quite good, too.  

In numbers: over the past three years, revenue grew by 4% compounded annually, from $1.3 billion in 2015 to $1.5 billion in 2017. I estimated that the 2018 revenue (which will be publicly disclosed in one week) will remain stagnant at $1.5 billion.

The company's normalized after-tax free cash flow increased by 24%, from $32 million in 2015 to $61 million in 2017. I estimate that the company’s normalized after-tax cash flow will be $50 million, or about 70 cents per share in 2018. With a current price tag of $2.30 and an earnings multiple of less than 5 times, the stock of MDC seemed attractive to me.

Yet the stock market feels differently. Over the past year the stock price slashed by over 70% from $8.45 as of February 2018. After MDC reported on a loss in the first quarter of 2018, the stock dropped by 40% in less than a week and throughout 2018, without significant improvement to report to shareholders, the stock tumbled.  

The (strange) reason why I bought shares in MDC Partners

Readers of this blog know that I refrain from social media and hardly know of our popular culture icons. This makes me the last person to understand how digital marketing works, let alone which marketing company has a brighter future than its peers. So to be clear: owning shares in the marketing industry is beyond my circle of competence.

Yet perhaps it is not beyond the abilities of a discrete hedge fund, FrontFour. Managed by Stephen Loukas, David Lorber and Zachary George, FrontFour owns over 5% of the common shares of MDC Partners. 

According to its 13D filing glossary, the company, through its various funds, bought - over the past year - 3,009,500 shares for $13.73 million, which are now worth $10.08 million. This is a market loss of $3.65 million, or 26% loss on paper.

FrontFour decided to do something about the loss in value and is now calling for a significant change to the board of directors. Its energy and enthusiasm are the reason I decided to buy a few shares in MDCA. Loukas, as an individual, bought 3,500 MDCA shares at a price of $4.2, and I bought a few weeks ago the same amount of stock at slighly lower price of roughly $3.

Epilogue

"The choice of a common stock is a single act," lamented Graham and Todd in their seminal work Security Analysis. "Its ownership is a continuing process. Certainly there is just as much reason to exercise care and judgement in being a stockholder and in becoming a stockholder. It is a notorious fact, however, that the typical American stockholder is the most docile and apathetic animal in captivity."

They continued: 

"In good part his docility and seeming apathy are results of certain traditional but unsound viewpoints that he seems to absorb by inheritance or by contagion. These cherished notions include the following: (1) The management knows more about the business than the stockholders do and therefore its judgment on all matters of policy is to be accepted. (2) The management has no interest in or responsibility for the prices at which the company's securities sell. And (3) If a stockholder disapproves of any major policy of the management, his proper move is to sell his stock."

Kudos to FourFront for proving otherwise and for also eliminating my boredom.