Interview: Ryan Morris (Meson Capital Partners) Part 1

Member: Ryan Morris
Title: Portfolio Manager
Firm: Meson Capital Partners
Focus: Deep Value
Location: Los Angeles, CA
Undergrad: Cornell University
Post Grad: Cornell University
Notable Stock Expertise: FMD, PNCL, INFU, ATPG, ZAGG

SumZero: What is the Ryan Morris investment philosophy?

Ryan Morris: My background is in physics and engineering, so my nature is that I need to have a really bottom-up, fundamental understanding of how a system works. With investing, that means trying to understand the root cause of excess returns which is where there is a competitive void due to non-economic factor – for example most funds are by mandate not allowed to own bankrupt companies – or misperception.

If perception was always the same as reality then the market would be perfectly efficient and risk and return would be correlated. Most of the time perception is a pretty good approximation to reality, but not always and it is those times when perception and reality are as divergent as possible that I try to focus on. In these cases, almost by definition risk and reward will not be proportional so there’s the opportunity for high risk, low return payoffs (like CDOs in 2006) or low risk, high return as well. You can never completely eliminate risk, but if you get overpaid for taking each risk and manage it with a portfolio, you should be able to generate excess returns over time.

I have a bit of an odd personality that I like the really extreme cases where there is likely to be some significant misunderstanding such as when you see a stock down 90% and everyone rushing to the exits. I tend to get more energy and focus when a messy situation presents itself I also look for things like hidden assets or balance sheets where GAAP paints a misleading picture such as with non-recourse debt.

There are all kinds of reasons that something can be misunderstood. It is really fundamentally to what Ben Graham talks about when he calls the market a voting machine in the short term. When the average market participant “votes” to set the price, it’s usually based on the superficial view that you’d get by spending 30 seconds hearing the story. I like things where the 1 hour complicated explanation of a stock is dramatically different than the 30 second explanation. Ideally all the risks that sound bad (company losing money, losing market share, etc.) in the 30 second story will turn out to be invalid or at least much less serious than they sound once you really dig in and do the research.

I have evolved in a more activist direction over the last year and a half because the big risk factor that you can’t control just with research is that of the stewards between you and the assets of the company you own. If you have a great asset but a board of directors and CEO who don’t know how or don’t want the value of those assets to accrue to shareholders, then you have a problem as an investor. So I have been increasing my ability to use this tool when necessary to change the risk/reward profile of an investment. For smaller companies, which I really exclusively look at for competitive reasons, it is particularly important because the range of management quality is so wide. I got into this tack first by having some bad experiences with my positions and reacting and now people I know tend to contact me and ask for help. So if any readers out there have a cheap company that will stay cheap because the directors aren’t acting in the shareholder’s best interests, let me know and maybe I can help!

SumZero: Which investors do you admire/follow?

Ryan Morris: Warren Buffett is the big one of course. He’s been my hero since I bought my first stock at age 12. While his size means I don’t borrow his current investment ideas, his principles of how business is done best from an ethical, fairness and owner-orientation is just so engrained in me. I really admire Joel Greenblatt and David Tepper as pure investors and Jeff Ubben and Bill Ackman for how they’ve built their funds over time to have such a huge impact on so many companies.

SumZero: What do you read to stay sharp?

Ryan Morris: I find that reading blogs and community forums like SumZero, Value Investors Club and DDIC are one of the most efficient uses of time for broad-based reading. These act as sort of human-powered, nonlinear stock screens and I’ve found a lot of my best ideas from inspiration from these. Often I will get my best ideas from an old write up where the stock has plummeted since being posted, for example. Sometimes if I read about a stock and dig into it to understand its value chain and competition I’ll find a cheaper competitor or perhaps a supplier that is a more interesting investment. I tend to just read the newspaper on my phone during all those little 5 minute waiting times during the day that add up.

SumZero: What are the characteristics of an ideal investment?

Ryan Morris: Ideally there would be no competition to buy it – either because of structural factors or emotion and misunderstanding on the part of the other market participants. I emotionally don’t seem to be able to stomach chasing stocks that have gone up, but I tend to get excited when a stock is down and falling since it’s possible that is a clue for irrational thinking. Ideally it would be at least a reasonably good business that I can’t find any competition or substitution headwinds such as competition from cheap foreign labor or technology obsolescence.

The returns you make are a combination of capturing the temporary mispricing in the market and the change in intrinsic value of a business. I’m looking to hold something for 1-3 years to mostly capture that mispricing as my source of return, as a small and energetic investor it would be suboptimal to buy to hold for 10 years I think. So my focus is more on just avoiding headwinds to the intrinsic value of a business than on trying to grab onto big tailwinds. In part it’s a humility issue, I think most people are probably being overconfident if they really think they know what the world is going to look like in 10 years for a particular business and base their purchase decision according to that. As I get more experienced and have a larger capital base, I will be ready to have that problem, but I’d rather avoid as many unpredictable elements as I can in an investment.

SumZero: Price notwithstanding, what companies today come close to that ideal?

Ryan Morris: InfuSystem Holdings Inc (Nasdaq: INFU) is an interesting example of what I mean by no competition because of “structural factors” above. When I made it a large position in November, it was only about a $25M market cap and the shareholders were mostly hedge funds managing $100M+ and it was a sub 1% position for them.

The assets are great, but the performance has lagged due to the CEO and board of directors (who have granted themselves roughly 18% of the shares over the last 4 years while the stock has declined 75%). It made no economic sense for any of these holders to try to do something about this, as being an activist takes a significant dedication of time and effort so it wouldn’t make sense to triple a 1% position. Because I could make it a much larger position to my fund, it was proportionally worth it to “bang the brick wall down with my head” and do something about the situation. I’ve been so lucky to work with some great and supportive partners for this investment.
Pinnacle Airlines (Nasdaq: PNCL) has a similar structural issue where the board owns basically no stock and the other holders are large. In general, there is a nearly total competitive void in microcap companies that need a change of direction at the board level, which is another reason why I have been increasing my involvement in that and why I think there is a significant source of excess return there.

Pinnacle is also very misunderstood as a business – the analysts say they are going bankrupt and equity normally goes to zero in a bankruptcy. First of all they aren’t an airline, they don’t pay for fuel or sell seats, they are more of an operating vendor. The reality of the situation is that the balance sheet is misleading and they have a rare “fake” liability due to revenue recognition accounting from a bankruptcy claim they sold for cash in 2007. They have about $12/share in tangible equity in brand new aircraft but it only looks like $4 because of this line item that has absolutely zero real liability associated with it. Also the leases they have on the old, impaired aircraft are not their responsibility but are tied to an operating contract, so those will not present a liability should the contract run out as happened in Mesa Airline’s bankruptcy for example.

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