Silver Ring Value Partners, an investment management firm, published its first quarter 2021 investor letter – a copy of which can be downloaded here. The partnership has compounded capital at an annualized rate of over 17% per year net of fees since inception. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Silver Ring Value Partners, in their Q1 2021 investor letter, mentioned Discovery, Inc. (NASDAQ: DISCK), and shared their insights on the company. Discovery, Inc. is a New York, New York-based mass media company that currently has a $17 billion market capitalization. Since the beginning of the year, DISCK delivered a 19.82% return, extending its 12-month gains to 62.09%. As of May 03, 2021, the stock closed at $31.38 per share.
Here is what Silver Ring Value Partners has to say about Discovery, Inc. in their Q1 2021 investor letter:
“After years of languishing at what my analysis suggested was an extremely low price relative to business value, Discovery’s stock sky-rocketed in 2021. With the company launching its direct to consumer (DTC) Discovery+ service, market sentiment completely shifted. Whereas before people would yawn when I brought up the company and would cut off all discussion by doubting the business’s terminal value, now it started to be perceived as a growth company.
My view on Discovery+ was, and is, that it does increase the company’s value. The reason is that in a linear cable TV world, there were very few ways to monetize the company’s vast library of content. This potential energy was converted into kinetic energy with the launch of the DTC offering which heavily leans on the library for its content. However, the amount of value creation was, and still is, highly uncertain as these are very early days of the rollout of this service. I stuck to my process, and began reducing the position prior to Q1 results, at ~ 90% of my Base Case value. After the company reported its results, my value estimate went up, by roughly 10%. The new evidence about the uptake of the DTC service by consumers was encouraging, but given that we are still early in the adoption curve it is hard to draw strong conclusions at this point in time. The market however reacted extremely positively, taking the stock first to, and then somewhat past my increased Base Case value.
I remained disciplined, and continued reducing the position between 95% and 105% of my value, selling my last shares in the low $60s. On average, I exited the position at $51, or somewhere between 90% and 95% of my Base Case value. I never try to capture the last dollar, as at that point the investment typically lacks sufficient margin of safety. While the wait was long, the rewards were meaningful given that we purchased the shares between $15 and $25. This demonstrates that for a business that is appreciating in value and whose stock is trading at a large discount to value, you can be early and still achieve an attractive annualized rate of return. In short, long-term investing pays off.
The above was all that I was going to write to you about Discovery. And then, to quote the classic line from The Godfather Part III, “Just as I thought I was out, they pull me back in!” Then the Archegos episode happened.
If you have avoided all financial news in the last month, Archegos is the family office of an exhedge fund (ex) billionaire. This man apparently had a very strong appetite for leverage, as by some reports the portfolio that he was running was levered 5:1. Furthermore, he was running a very concentrated portfolio, and Discovery was one of his few holdings.
Warren Buffett once said: “Whenever a really bright person goes broke who has a lot of money, it is always because of leverage.” Most people seem to ignore the warning as they think that they can get the benefit of financial leverage while skirting the risks. I am not one of them. Silver Ring Value Partners employs no portfolio leverage and does not use margin debt. I strongly believe that a good and safe rate of return is far preferable to a possibly higher rate of return that bears the risk of losing a lot of our money.
After Archegos became financially over-extended, one of its holdings declined in price. That led to margin calls and forced selling of its securities at depressed prices. The vicious cycle unfolded rapidly, with distressed selling leading to more margin calls, and the latter leading to even more distressed selling.
Discovery’s price for its C-shares (DISCK) collapsed from a recent high of $66 to an intra-day low of $31 on Friday 3/26. If this is not a direct challenge to the Efficient Market Theory, I am not sure what is. Mind you, this is a highly liquid stock which in the span of less than a week lost more than half of its market value on no fundamental news. Fundamentals, however, were the last thing on anyone’s mind. All market participants were trying to figure out was when/if the next block of Discovery’s stock would come to market and at what price.
As I assessed the opportunity over the weekend, my first inclination was to just buy the stock. It was now below 65% of my Base Case value and I was happy to own again at those levels. However, upon further inspection, the options were far more irrationally priced than the equity. With everyone panicking and wanting short-term insurance against further price declines, implied volatility in the options went through the roof. The annualized rate of return on the April 16th $35-strike put options
was over 200%. Put differently, with the stock trading slightly above $35, I could sell put options (insurance) for about 2 weeks and receive a premium of over $3/share. If the stock were to fall below $35, my effective purchase price would now be around $32. If the stock stayed above $35, I would keep the premium free and clear.I sold the April 16th $35 put options in the amount that if the stock were put to me would make for a 10% position. I set aside the cash to purchase the shares should such an event occur, thus not employing any leverage. I then used the premium received from the sale to buy the $42.50 May 21st call options. This is well past the expected date of the company’s Q2 earnings call, which should add incremental information about its value and perhaps allow sufficient time for the market to refocus on the fundamentals. Ultimately, if the stock price remains near current levels and my value estimate stays the same or rises, I expect the partnership to acquire a position in the company’s stock.”
Our calculations show that Discovery, Inc. (NASDAQ: DISCK) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the fourth quarter of 2020, Discovery, Inc. was in 31 hedge fund portfolios, compared to 36 funds in the third quarter. DISCK delivered a -7.98% return in the past 3 months.
The top 10 stocks among hedge funds returned 231.2% between 2015 and 2020, and outperformed the S&P 500 Index ETFs by more than 126 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Here you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.
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Disclosure: None. This article is originally published at Insider Monkey.
