Forage Capital – 2Q20 Letter

July 20, 2020 David Kim
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Dear friends and investors,

For the quarter ending June 30, 2020 Forage Capital (“the Fund”) returned an estimated +33.9%, net of all fees and expenses compared to +20.5% for the S&P 500 Total Return Index.  At quarter-end, the portfolio was comprised of 15 companies and cash made up 15% of assets.

I am skeptical that the Fund’s past returns can be sustained and continue to believe that over longer time spans, annual returns closer to 10%-13% are probably more realistic.

I don’t have much to report this quarter.  In April, I sold our position in CACC.  I have little doubt that CACC will survive the COVID-induced demand shock (it has healthy profit margins and only a modest amount of recourse debt), but at 2.5x-3x book value the stock was pricing in not just survival but volume growth, which was already attenuating heading into 2020 and whose recovery I could not say with confidence was assured.  While it may be true that the more severe the COVID fallout, the more likely it is that capital abandons the industry and CACC realizes hefty returns (as was the case during the 2008-2009 financial crisis), subprime auto lending has no entry barriers and so capital tends to fill high-return voids rather quickly, punishing everyone’s reinvestment returns until the next crisis hits and the cycle repeats.

I replaced CACC with Liberty Latin America (LILAK), a cable and wireless company that operates in Latin America.  Questionable capital allocation, a calamitous hurricane, and a competitive pricing environment all conspired to blow up the lofty expectations that Malone followers had at the time Liberty Global issued LILAK as a tracking stock for its Latin American and Caribbean operations in 2015.  The stock has lost more than 80% of its value since then.  But at 4x maintenance free cash flow, I think the stock is far too cheap.  Usually when a stock trades at such depressed multiples, it either means the company is close to bankruptcy or its core business is in inexorable decline.  Neither is true of Liberty Latin America.  While its balance sheet is more levered than I’d like it to be, cable and wireless cash flows are pretty resilient and even in a stressed scenario, LLA should have no trouble covering its interest payments and debt maturities over the next 3 years.  Meanwhile, Liberty’s markets are consolidating at an intensifying pace – in the last 18 months, Liberty and Millicom have spent a combined $5bn acquiring assets – which over time should yield a market structure that supports firmer pricing and stable/expanding margins.

Also during the quarter, I pared back on Align Technology, HEICO, Microsoft, The Trade Desk, and Wix, though we continue to hold all those names.

[LILAK – Liberty Latin America] Once more unto the breach

Thanks for your continued support,

David Kim

IMPORTANT DISCLOSURES

This report is being furnished by Compound Insight LLC (“CI”) on a confidential basis to existing limited partners in Forage Capital, LP (the “Fund”) and does not constitute an offer, solicitation or recommendation to sell or an offer to buy any securities, investment products or investment advisory services. This report is being provided to existing limited partners for informational purposes only, and may not be disseminated, communicated or otherwise disclosed by the recipient to any third party without the prior written consent of CI. Any offer or solicitation of an investment in the Fund may be made only by delivery of the Fund’s confidential private offering memorandum to qualified investors.

An investment in the Fund involves a significant degree of risk, and there can be no assurance that its investment objectives will be achieved or that its investments will be profitable. Unless otherwise noted, the performance results of the Fund included in this report are presented on a net-of-fees basis and reflect the deduction of, among other things, underlying management and performance fees and expenses as well as brokerage and/or custodial fees and expenses. Performance results also include the reinvestment of dividends and other earnings. Certain of the performance information presented in this report are unaudited estimates based upon the information available to CI as of the date hereof, and are subject to subsequent revision as a result of the Fund’s audit. An investor’s actual performance and actual fees may differ from the performance information shown due to, among other factors, the timing of capital contributions and withdrawals.  Past performance is not necessarily an indication of future performance or profitability. An investment in the Fund is subject to a wide variety of risks and considerations as detailed in the confidential private offering memorandum of the Fund.

References to S&P 500 Total Return Index are for informational and general comparative purposes only. There are significant differences between this index and the investment program of the Fund. The Fund does not invest in all or necessarily any significant portion of the securities, industries, or strategies represented by this index. References to this index do not suggest that the Fund will, or is likely to achieve returns, volatility, or other results similar to it.

This report and the accompanying discussion include forward-looking statements. Forward-looking statements are not a promise or guaranty about future events.  All statements that are not historical facts are forward-looking statements, including any statements that relate to future market conditions, results, operations, strategies, or other future conditions or developments and any statements regarding objectives, opportunities, positioning, or prospects. Forward-looking statements are necessarily based upon speculation, expectations, estimates, and assumptions that are inherently unreliable and subject to significant business, economic, and competitive uncertainties and contingencies.

The information in this presentation is not intended to provide, and should not be relied upon for, accounting, legal, or tax advice or investment recommendations. Each recipient should consult its own tax, legal, accounting, financial, or other advisors about the issues discussed herein.