Alluvial Capital Management, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A return of 7.0% was delivered by the fund for the Q2 of 2021. Returns for the quarter, year-to-date, and since inception periods comfortably exceed all relevant benchmarks. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
In the Q2 2021 investor letter of Alluvial Capital Management, the fund mentioned Garrett Motion Inc. (NASDAQ: GTX) and discussed its stance on the firm. Garrett Motion Inc. is a Switzerland-based automobile technology provider with a $478.2 million market capitalization. GTX delivered a 66.82% return since the beginning of the year, while its 12-month returns are up by 130.22%. The stock closed at $7.41 per share on September 10, 2021.
Here is what Alluvial Capital Management has to say about Garrett Motion Inc. in its Q2 2021 investor letter:
“We owe a large portion of this quarter’s gains to a new investment in Garrett Motion Inc. We participated in the company’s post-bankruptcy recapitalization through our purchase of Garrett Motion preferred shares.
Garrett Motion is a manufacturer of automotive turbochargers that was spun off from Honeywell in 2018. Honeywell gave Garrett Motion a parting gift of hundreds of millions in asbestos-related liabilities, which ultimately proved unmanageable and led to the company’s bankruptcy in late 2020. The resolution of the bankruptcy process allowed Garrett to shed many of its liabilities and to recapitalize the company with new debt and preferred stock. Shareholders were granted the right to subscribe for new Series A convertible preferred stock.
The rights offering bore all the classic signs of an attractive “special situation” investment. I believed the offering price of the preferred shares, $5.25, was significantly below their market value based on any reasonable estimate of Garrett Motion’s post-emergence performance. What really got me excited about these preferreds was the behavior of the large hedge funds backstopping the rights offering. These funds had the right to acquire all the preferred shares not purchased by holders of Garrett Motion common stock, and the subscription process was designed to be quite difficult for smaller, less sophisticated shareholders. Vague, confusing paperwork; attorney attestations; proof of financial status—clearly, these backstopping funds didn’t want anyone else to get their hands on these preferreds. And if these large, sophisticated funds with their deep involvement in the bankruptcy proceedings thought these preferreds were so great, well…that was not enough for me to say “I’m all in!”, but it did suggest taking a much closer look.
We subscribed for a healthy number of Garrett Motion preferreds, and our investment has been a good one to date. The preferreds trade nearly 50% over our subscription price. Nice to see, but I think the best is yet to come. Following the bankruptcy, Garrett Motion is a small company with a confusing capital structure (term debt, Series A preferreds, Series B preferreds, common stock), no analyst coverage, and no guidance from management. On top of that, Garrett’s business model faces long-term challenges as the internal combustion engine gives way to electric. It’s no wonder the market values Garrett at distressed levels. But Garrett will generate hundreds upon hundreds of millions in free cash flow each year for the next several years, which will allow the company to deleverage and simplify its balance sheet, invest in next-generation products, and reward shareholders. I fully expect the preferreds we hold to be valued at 2-3x the current price in just a few years’ time.”
Based on our calculations, Garrett Motion Inc. (NASDAQ: GTX) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. GTX was in 17 hedge fund portfolios at the end of the first half of 2021, compared to 2 funds in the previous quarter. Garrett Motion Inc. (NASDAQ: GTX) delivered a -8.88% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
