Raging Capital Reveals New Long Position (CAVM) and Discusses 3 Short Positions (VRX, LC, PMTS) in Q2 Letter to Investors

Hedge funds’ quarterly 13F filings are quite useful for retail investors seeking to invest like wealthy and successful money managers, but their quarterly letters to investors are even more informative and useful. Raging Capital Management LLC, an investment firm launched by William C. Martin in April 2006 with capital from friends and family, recently sent a quarterly letter to investors discussing the firm’s performance and its biggest contributors to that performance.

New Jersey-based Raging Capital Management, mostly known for its activist investment strategy, invests in both emerging growth stocks and deep-value investments. The activist asset manager generated a net-of-fees return of 5.1% in the second quarter of 2016, bringing tits return for the first half of the year to an impressive 14.0%. Mr. Martin’s investment firm delivered a compound annual growth rate of 21.2% since inception through the end of the second quarter, approximately three-times the 7.1% return generated by the S&P 500 Index over the same time span.

“Current policies are failing to jumpstart growth, yet they are serving to sustain and inflate asset valuations. This is leading to an odd and difficult juxtaposition for investors,” Raging Capital said in its second quarter letter to investors. As Mr. Martin and his team have excelled at both long- and short-side investing, the following article will discuss one of the asset manager’s new long positions, as well as three of the firm’s shorts, as revealed in the aforementioned letter.

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Raging Capital Management Likes Cavium Inc. (NASDAQ:CAVM)

Cavium Inc. (NASDAQ:CAVM) is a provider of semiconductor processors which Raging Capital believes is “trading (at) a bargain valuation.” The semiconductor maker has lost 25% of its market value since the beginning of 2016, as “investors have punished CAVM due to short-term worries about the exact timing of the ramp up of its latest network processor and the slow initial uptake of the ARM-server market.” Furthermore, Mr. Martin and his team reckon that the network processor business offers “a solid foundation of value”, while Cavium’s products in the pipeline provide opportunities for “home-run upside potential.”

In mid-July, Cavium agreed to acquire storage connectivity chip maker QLogic Corporation (NASDAQ:QLGC) in a cash-and-stock deal valued at approximately $1.36 billion. Wall Street analysts were struggling to see the strategic rationale behind the deal, viewing the acquisition as growth and margin dilutive. Under the terms of the agreement, QLogic shareholders are set to receive $11.00 in cash and 0.098 shares of Cavium per QLogic share. QLogic is known for its Fibre Channel (FC) adapters used in cloud-storage technology. Ken Fisher’s Fisher Asset Management acquired a new stake of 98,928 shares of Cavium Inc. (NASDAQ:CAVM) during the June quarter.

Activist Raging Capital Shorts Valeant Pharmaceuticals Intl Inc. (NYSE:VRX)

Raging Capital’s set of long positions does not seem to be as captivating as the firm’s short plays. The activist asset manager’s short book was up by an exciting 14.3% in the first half of 2016, contributing approximately 10.80% of the fund’s overall returns for the period. Raging Capital Management’s short position in Valeant Pharmaceuticals Intl Inc. (NYSE:VRX), established in May at an undisclosed price, added roughly 2.20% of returns attribution to the fund’s performance in the first half of the year. While some investors and analysts believe the embattled Canadian drugmaker may have left its worst days behind it, Mr. Martin and his team believe Valeant will have a hard time cutting down its $30-billion-plus debt load, so “bankruptcy could ultimately become a more likely outcome.”

Fresh media reports say that the once-hedge fund darling may be able to sell its constipation treatment Relistor for $400 million-to-$500 million, with multiple companies being interested in acquiring the drug. Mr. Martin explains some of the reasoning behind his short position in Valeant, saying that “VRX’s bad balance sheet is compounded by the risks associated with past price-gouging misdeeds as well as the fact that (nearly) $1 billion of high-margin revenues are at risk from generic competition in the coming year.” The Canadian drugmaker has seen the value of its stock plummet by 78% since the start of 2016. Emmanuel Ferreira’s Convector Capital owns 192,000 shares of Valeant Pharmaceuticals Intl Inc. (NYSE:VRX as of the end of the second quarter.

The second page of this article will lay out Raging Capital’s thoughts on two other prominent short positions.

Raging Capital Discusses LendingClub Corp (NYSE:LC) Short

LendingClub Corp (NYSE:LC), the San Francisco-based peer-to-peer lender, has seen its market capitalization plunge by 57% since the beginning of the year. In May, the shares of the online lending marketplace operator tumbled after the company announced that its former CEO, Renaud Laplanche, was forced to resign due to an internal company review that revealed irregularities in the sale of $22 million in near-prime loans to a single investor. The online lender also found that the former CEO and his family members used LendingClub’s platform to take out dozens of loans in late-2009 to help the company’s loan volume reach analysts’ expectations. In the fresh quarterly letter to investors, Mr. Martin said: “It appears LC was playing games to hit its numbers and possibly to make up for a shortfall in high-FICO score loan obligations.” The individual ethical issue associated with the company’s irregularities in the sale of the $22 million in loans “was not part of our original short thesis,” but it represents “a symptom of the broader issues LC faces.” The lack of differentiation in a highly-competitive market with increasingly picky investors was one of the reasons behind the LendingClub short. Vy Capital, started by Alexander Tamas, has 4.50 million shares of LendingClub Corp (NYSE:LC) among its holdings at the end of the second quarter.

Raging Capital Comments on CPI Card Group Inc. (NASDAQ:PMTS) Short

Chip card maker CPI Card Group Inc. (NASDAQ:PMTS) was the largest short contributor to Raging Capital’s performance during the second quarter, as the company significantly lowered its full-year guidance in mid-May due to larger than anticipated un-issued card inventories at large issuers, as well as evidence of slower than anticipated conversions for small- to mid-sized issuers. The shares of the provider of comprehensive Financial Payment Card solutions in North America are down by 57% year-to-date. Mr.  Martin and his team said the following about their short position in CPI Card Group in the quarterly letter to investors:

“PMTS benefited in 2014 and 2015 from a one-time surge in MV-enabled credit and debit card manufacturing in order to meet compliance deadlines. Amid this boom, PMTS’ private equity backer did what can be expected: After first failing to sell the company, they chose to lever up the balance sheet to pay themselves a large dividend before pushing out an IPO (at any price) in October 2015.

Now that the rush to meet deadlines is past, PMTS’ business has normalized and many card issuers have even found themselves with excess inventories. As a result, volumes for PMTS are drying up and margins are collapsing. PMTS missed Q I, and we believe its new guidance, particularly in the second half of 2016, is as disingenuous as its prior guidance. Further, the company’s misleading and self-interested dividend policy (designed, in our opinion, to prop up the stock) only enhances the possibility that PMTS ultimately goes to zero. Thus, even though its equity has been more than cut in half, we have added to our short position.”

Disclosure: None