The themes, sectors and stocks Tribeca tips for a turnaround

Winding back the clock to last March, there was a strong view that markets would be awash with buybacks and other capital management initiatives from Australian listed companies seeking to shore up COVID-smashed balance sheets.

“The recapitalisation opportunity wasn’t as big as we initially expected because economies rebounded faster, and we didn’t have the liquidity crunch that we might have,” said Tribeca Investment Partners’  David Aylward during a recent interview.

“But there has been a constant flow of deals and plenty of M&A that has enabled us to play those transactions, both in terms of being targets and looking for bumps in terms but also in terms of the financing.”

In the following Fund Manager Q&A, Aylward – portfolio manager of the Tribeca Recapitalisation Strategy created early in the COVID crisis – details how his team finds beaten-down companies poised for a turnaround. 

The discussion includes an explanation of the “theoretical ex-rights price,” how to spot a TERP discount, and how Tribeca exploits the “red-hot” IPO market by finding the rarest opportunities.

Aylward also outlines some sectors and themes he believes hold great promise over the next couple of years, reveals two watch-listed stocks he’s keeping an eagle eye on, and names a pre-IPO fintech his team is firmly backing.

(VIEW LINK)

What spurred the launch of this fund?

As it has played out, the recapitalisation opportunity wasn’t as big as we initially expected because economies rebounded faster, and we didn’t have the liquidity crunch that we might have. But nevertheless, there has been a constant flow of deals and plenty of M&A that has enabled us to play those transactions, both in terms of being targets and looking for bumps in terms but also in terms of the financing.

In what have been fairly strong markets, we’ve seen a very hot IPO market. So, the fund’s core proposition remains as we initially intended. The mandate has broadened a little, but it’s ultimately capitalising company balance sheets to allow them to either survive or grow. As things have played out, we've found enough opportunity to reliably extract some return in most months – and in a very non-directional way – so we don't carry much market exposure.

The opportunity set is still there, and of course, there will be other little crises along the way, too. There’s some valuation stress out there now and it won’t take too much to destabilise that at some point over the next nine months. We want to be ready for those opportunities.

Speaking of IPOs, how do you weigh up the opportunities there?

For us, the opportunity needs to really stand out and look very “rare,” especially given there is so much IPO activity now. I don’t want to have too much market exposure from day to day, and certainly pre-IPO companies but to some extent IPOs as well require us to carry them for the medium term in a way that’s very hard to hedge out. Ultimately, the process is the same as for all our research. We have to understand:

• the industry,
• management and their objectives,
• the financials around the business
• how the growth targets are going to be funded and
• what role we see ourselves having in that.

That’s pretty typical of what we do across all environments. But in pre-IPOs, we require a higher rate of return because we don’t have the liquidity you’d normally like to have; we’re a bit more beholden to market conditions because of that. We have to be comfortable with the underlying instrument that we're buying and confident our position is reasonably well protected should things pan out differently on the way through.

As deals flow in the IPO market, we’re starting to see some tensions. Some of the deals have been done at quite full multiples, which is putting some pressure on those that are looking a bit “punchy” at the moment.

What sectors do you regard as the COVID winners from here on, over the short term? Has this changed since the onset of the Omicron variant?

We don’t tend to think about specific sectors, keeping quite a broad remit in terms of the types of companies we look at. But some of the travel and leisure related names have had a few bites of the cherry and they could play out again, some still presenting as interesting opportunities. We were also recently involved in quite a successful IPO in that space, SiteMinder, which benefited from being priced in a “pre-reopening” market and then came on as we were reopening. And I think there will be more opportunities in that space.

And in retail, there may be some relative value in “high street” retail as opposed to online retail if Omicron pans out to be more benign. There seems to be almost a “ping pong” effect between online spending and high street spending. But in previous reopening phases, we’ve seen that people are quite keen to get out of the house and go to the shop, so there could be opportunities in that space.

What allowances have you made in your approach for other potential COVID variants?

We're operating on the broad basis that there will be some permanent changes in the way people work and shop and live out of all this, but they won't change everything. Our core view is that vaccines are very successful, they will continue to be amended and, progressively, the world will come out of this. Our central thesis is that by mid to late next year, things will hit a version of “normalcy” – and that’s been our view for around 18 months.

Clearly, we must be ready to reassess that view, but at this stage, Omicron doesn’t look to be shifting things a whole lot.

What is TERP and why is it important for picking COVID turnarounds?

If you talk about the discount that you're getting, or not getting, to the theoretical ex-rights price, it’s about considering all the new shares in any given company that exist after any secondary market transaction. You consider what the business looks like after the transaction. That’s important in framing those secondary market transactions, particularly recapitalisations. In a classic recapitalisation story, when companies are looking for money, often the timing isn’t at the discretion of management.

You're usually executing those transactions when there are some reasonably significant uncertainties around. So, you tend to end up with discounts to TERP, which is something we can really exploit in a fund like this, particularly if we can trade out the other side of the transaction quite quickly and lock in that discount on its own.

There’s usually a narrative around why any particular raising is going to either save the company, get them through a crisis, or enable growth or M&A or something similar. You look at all of that, your forecast for the company and whether there’s any discount you can get to that TERP number. You then establish your expected internal rate return on the back of that.

How does the discount to TERP look now, on average, across the ASX versus in 2008 and 2009?

Around April and May of last year, you were seeing deals at discounts to TERP of around 8% to 12%. That has come in a fair way since then, to around the 3% to 8% level – though this is very much a "back of the envelope” calculation.

In the GFC, we probably had a more extended period where the discount-to-TERP was at around 10% to 15%. On average, the discounts are probably not as attractive now as they were then. But as a starting point, you want a good discount on TERP, because if nothing else, it gives you a safety buffer. From our point of view, we want those discounts to be as big as possible because listed companies – and quite rightly – want them to be as small as possible because – otherwise it means more dilution to existing shareholders. But it's a marketplace and it depends on the circumstances and the perceived risks around the actual transaction.

What's one stock, maybe one that you don't already hold that, that you're watching very closely and why?

From an M&A point of view, we’re circling the battery metals space, where we’re looking to be involved from either the target side or the acquirer side of the deals. It's a space we find interesting regardless but if you're going to put a big circle around the miners - in terms of the off-taker and the shareholders – you get this web of BHP Group (ASX: BHP), Fortescue Metals (ASX: FMG), Independence Group (ASX: IGO), Western Areas (ASX: WSA), Mincor Resources (ASX: MCR). 

Ultimately, I think that is all going to play out very interestingly from an M&A point of view. To that end, stocks like Western Areas and Mincor look very interesting to us.

Among pre-IPO companies, what are some of the biggest opportunities you see for next year in terms of themes and is there a specific IPO that you're most excited about?

In terms of the thematic, the world is going to have lower emissions, less waste, and hopefully less disadvantage. And the corporate sector, led by technological developments, will need to have a big role to play in that.

All the companies we look at fall within the broad sectors of energy, food technology / agricultural technology, and how they’re all going to be financed. It's really all linked to that broad thematic.

Certainly, by the end of next year, you're going to see even more big opportunities in the pre-IPO space in places like AgTech and also in construction technology – in areas like smart buildings.

And in terms of an IPO that we're excited about, we’ve rolled BeforePay, a financial technology firm that’s in short-term lending, through from the pre-IPO space. It has been growing very quickly.

There will be an element of controversy and various views around how it should be valued but we think it's been put together well. We believe it has a genuine purpose in terms of helping people with their cash flow. There's certainly a market for that, a view that is backed up in the way BeforePay (ASX: B4P) is growing. And importantly, if you look at what's happening to valuations across the Growth segment of companies, that will play into this IPO. There's no doubt about that.

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