Investing in small caps with courage and conviction

0:09courage and conviction investing two things we need now more than ever welcome back to the show it's always great to have you. Irina, it's great to be back. Thanks for having me. Sorry, it's been a while. I forget how long it's been, but it's good to reconnect with you. Absolutely. We've had many requests from many fervent fans, the exact kind of fans we all love to have. Requesting your presence back on the show, a time that we're in now, it has been sometime since we last spoke. Certainly some change was happening even then. A lot of unknowns, the unknowns remain. For those who have forgotten or want a reminder or never knew in the first place, you have an investing group on Seeking Alpha, Second Wind Capital.

0:59Second Wind, also something we are all deserving of, I think. Talk to us. Where is your head at these days? Update us in this current moment for you? Sure. Yeah, I'm in a, I'm in a, I wouldn't say a Billy Joel, New York state of mind, because we did watch, my wife and I watched that HBO documentary, it was quite good. That was my first concert I ever went to, Billy Joel. Yeah, he was quite a talent. Interesting personal life, how they portrayed it with his wives and whatnot, but just an unbelievable talent. I don't know. It seemed like all his wives wanted to make it work, but anyway, I'm going way off the tangent.

1:42No, let's get into it. Yeah. I'm in a, I'm in a, I'm in a philosophical place. I just turned 45 on the 15th. My best friend from childhood's mother is in hospice after a two and a half year fight with cancer. She was supposed to live six months and she lasted this long. So I've been thinking a lot about that. I was really, I'm really close with him. And I used to go over her house all the time. Just such a nice lady. So into her family, such an advocate for her family. I hadn't seen her much later in recent times, but we had such good times together. Anyway, that's kind of on my mind and uh life has been busy we had a lot of summer baseball this year my my son's play um so we were traveling all over we had a tournament in maine up by colby uh we were in uh the state tournament with my middle guy and just a lot of baseball then we had a two two day break and then we were in football and that's full swing my daughter does soccer so it's been busy i'm literally trying to catch my breath in terms of markets which probably we're here to talk about um it's been humbling um it's been a grind this year took a big big drawdown or not a 20 maybe drawdown uh in april i didn't know what was happening with the tariffs the 20 correction the smp i think was one of the fastest in history uh Uh, so that was, that was interesting.

3:26Um, and then markets kind of roared back. Um, there was some really good tactical trading setups on the earnings front because valuations had gotten so depressed. Baby got thrown out with the bathwater, uh, came roaring back. My biggest position Cineverse, which we can talk a lot about, uh, a little bit later in the program if you'd like, moved from, we owned it in size in the low twos, it hit 740 in July, which was nice. Unfortunately, only sold 20 % of it. And that's gotten cut in half, I think, unnecessarily kind of silly that it has. And I'd like to get to get to more detail about that later but um you know it's just it's just been a it's just been tough if you're not in ai and you're not in if you think about the massive capex cycle in ai and i talked about this in our i haven't been writing too much of the free site but what is a hundred million dollars a billion dollars a quarter with the hyperscalers so if you were if you're simply downstream of that it was just this It's this huge gold rush arms race.

4:41And anything directly correlated to that has done exceptionally well because you have that CapEx spend to someone else's revenues that are showing incredible revenue growth, multiple expansion. And it seems like the market's so dominated by the flows, the momentum, mag seven, quantum, whiz bang tech all this crazy stuff and in the small little universe that i play in the sandbox i play in that's not what i do i'm playing in micro caps and small caps mostly sub 500 million market caps and i don't get to to play in that because that's not that's not what i do and so So you kind of watch in this euphoria, this 1929-esque great Gatsby party.

5:33I'm just grinding every day trying to understand the mispricings, I think, in some of the names that I own and I've owned for a long time. Whereas some of these companies, something good happens. You get the tailwind of the revenue price. So you get an expansion of multiple to revenue and then you have all that money comes in and chases it and it just takes it higher. So I honestly don't know what to make of it, but it's we're doing fine. It's still generating decent returns, but it's been a tricky year and it's kind of a lot of ups and downs. So indubitably, that's my when did answer your second.

6:19When did answer? I love a pun. Uh, so let me ask you in the name of learning lessons, maybe highlight some of the losses or the mispricings or the confusion that you've had this year predicated on some specific names. And then also very important, especially in tough times, but always to highlight the wins and also value that side of things also. So would be happy for you to get into specific wins and losses that you've had and, and lessons that you've taken from that. Yeah, so beginning of January, I did a ton of work, or a lot of work, a ton maybe is too exaggerated, but a lot of work on the company Green Plains, a big ethanol producer in Omaha.

7:09They have nine ethanol plants. They had 800 million gallons of capacity. and what i thought the market was missing was their their 40 the 45 z so it's in their nebraska campus of this uh which is carbon capture and it's a very uh generous program through the through the ira i believe and it was through 2027 and then there was uncertainty with president trump coming into office? Would it get extended? Would it get changed? And so there was a lot of uncertainty there, but this was a huge value unlock and management was very clear about this. They spelled it out nicely. Unfortunately, with any commodity business and ethanol is a really tough business because you have different incentives.

8:02So the incentives for a lot of the producers are to grow corn crush ethanol and they have their byproducts to the come from it um but it's it's a it's about kind of maximizing because it's a very fragmented industry although it is it is a little bit more concentrated but it is fragmented at the margins um so anyway i i didn't do enough work or i didn't appreciate enough how high inventories were so they were say 23 million barrels should have been 20 million barrels which is not that big a difference but it matters when you're in the shoulder periods because ethanol demands driven by driving because it's 10 or a little bit higher in some states of uh demand so we came into the shoulder period and demand doesn't pick up until until the spring and then because it's a lot cooler you can run the plants more efficiently.

9:02So you have much, you have higher output and basically crush margins got just straight crush. I'm not talking about the byproducts. So crush margins got dinged. I was in Mount Snow with my good friend. I hadn't skied since college, nice getaway for two days. green plains reported they put up a negative even a quarter uh and stock got crushed and so this was a top name i had some good money allocated to it not crazy amounts allocated to it but but it was well-sized stock goes on to bottom out in the threes okay so i took this massive drawdown but because in addition to running family money and run the service i also have two family office accounts and we had a great q4 we started up the relationship in q4 last year we had a great q4 got a nice payout and say we have pretty good allocation to this and luckily i found the right guy very sophisticated he's got the right temperament understands the game and we own a lot of shares we took a massive drawdown we're talking a three million dollar drawdown and but i said to myself i've done a lot of work on this business the 45z should work we were in touch with the cfo the cfo of green plants is fantastic phil just a very professional guy knows the company inside and out very responsive and i talked a lot of different management teams I just think he's a good guy and just a true professional.

10:54And we would talk through the different scenarios and just kind of scratching our heads when we have our calls with him. And anyway, long story short. So the next quarter was was not as wasn't great, but the conference call was fantastic. And Cora was an activist fund came on the board and they outlined all these great changes. So all these smart streamlining of SG &A, they had a nice marketing agreement that they took to get more scale to get their ethanol price price into better places. They signed some good co-product agreements. They got the mezzanine debt, which was kind of hanging over their head with BlackRock.

11:39They got that extended. And everything looked like the 45Z was going to happen with a big, beautiful bill. So we aggressively added in the threes and fours. And then as the, as the year progressed, the big, beautiful bill gets passed. It was, it was more favorable than initially thought. So that really helped crush margins got better. They were able to hedge and something that we owned in size, they say nine took the draw down to the low threes. And then maybe we don't in the low sevens. And then we basically scaled out the nines to the 11s just because we think it's probably fair valued here.

12:24Maybe there's some upside, but we like to buy things that we think are materially mispriced. So we swung from down 3 million to, I don't know, maybe up a couple million. But that's how high intensity this stuff is. but that I think that's a good example of of what this year has been like so that's one example should I go into another or yeah yeah yeah whatever you feel like is most valuable for listeners yeah I mean so it it's just like this game is hard right if you're just again notwithstanding April if you didn't panic sell at the April lows and you didn't just completely lose your mind what was happening and you held on and you were in tech or momentum and stuff where all the flows are um notwithstanding that that kind of scary drawdown it's been a straight line up right just a straight line back it's it's difficult to kind of stare into the abyss with some of these bets where you have really high conviction.

13:41Maybe you get the timing a little bit off. The balance sheet's a little levered. It wasn't that levered. It's levered. But if you understand the cash flows of 45Z, which is about 150 million just in Nebraska in 2020, it's coming online in Q4. it's like wow this doesn't this doesn't really make any sense how did the equity get down to a 200 million valuation and with any commodity market things normalize eventually that's the nature of how this works but you get these these crazy drawdowns where you you can almost question your sanity because it doesn't even make any sense so that that's that's the nature of small caps and that's why it's the highs can be really high but the lows can be really low too and it seems like we live in a world where people just want bernie madoff returns and get me one percent one and a half percent with no drawdowns no volatility you could probably if you could actually do that you could probably run trillions i mean i'm kind of exaggerating but whereas as the, the, you have to, you have to have real conviction in your names and your work and talking to management teams to, to even get up in the morning and try to play this, the small cap game.

15:08And that's why there can be big returns and it's, it can be highly rewarding, but it's also, it's also pretty tricky. Um, and it's, so it's very humbling and it's, it keeps you grounded because what you did last year, the past five years, no one cares that that was last year. This is this year. It's kind of like sports when teams are winning that the, the, you can't get a ticket. The merch is sold out. Everyone wants to, to, to be on the bandwagon. When things aren't going that well, things go a little bit south. It's, it's crickets. Sometimes I shouldn't say that. I have some really loyal members that have been with me a long time and they've been fantastic and they get it and they have that perspective, but it can, it can feel, it can feel really lonely at times, but that's kind of the game.

16:09But just, just to give you an example on Cineverse we're in touch with management. We own a lot of stock. And as I said, we were in this thing. I think our last podcast, we talked about Centiversary. There may have even been a snippet about it. And we highlighted it in the twos. And again, it hit 740 in July. So that was a great return. We only sold 20 % of it because we think it's worth a lot more. What happened was they had this Terrifier 3 movie. It was a big hit. But the real investment thesis there is they have a great business model and that they acquire. So their niche is horror. So they own Bloody and Disgusting, which is a podcast and a website that talks about horror movies.

16:59And if you understand how horror movies work, and here's a key nuance, I don't think the market doesn't get. Generally speaking, horror does so well. If you look at the box office the past couple of years, even this year, it does exceptionally well because people that get excited about going to concerts live concerts or sporting events or a music event yes they enjoy what they're going to to see that they they value the uh the art whatever form that is in but it's a it's a it's a camaraderie it's a night out it's an experience. And so generally speaking, people that love horror movies and watch horror movies, I don't think you're watching horror at home by yourself on Netflix.

17:49It just doesn't. That's not how it's experienced. You go with a group of friends because you like to get scared together. You're really into this niche thing. And it does really well at the box office, one of the few areas outside of the big Hollywood blockbusters. But it doesn't cost a lot of money to produce these films so they have a formula where they acquire or they produce the the ip and then including their marketing because they own um 17 fast channels they own um they have screen box and they have 1.4 million subscribers total um and then they have this c360 this this this uh ad network they have this they have a captive audience where people that want to hear about the next um jordan peele movie the next movie in horror they come and and go to to to some of their sites and they read about it and they you know check it out so what happened is they did so well and they had three movies coming out um one and one of them in which was not really a horror film but they acquired it so the whole model is you you you acquire the ip and then you spend some money on marketing and then you you run your rail so to speak and the pipes of your marketing has to to go to market under five million dollars and the way it works is you get about half the revenue in the box office and then you have ancillary revenue streams um down uh with streaming and selling merch and selling dvds or renting on you license it to some of the big streamers so what happened was they made some really good money on terrifier three it was the biggest unrated hit at 54 million they had another uh encore quarter because some of the downstream revenue associated with that.

19:53And then the next quarter was a shoulder quarter. It was a little bit soft. Expenses were a little bit elevated. When I talked to management, they had the SOX and the public traded costs associated with that. And then there was also the marketing expenses because they bought Toxic Avenger, the full right. So it flows to the P &L a little bit differently. and basically um they bought the movie that cost 20 million dollars to make it that the the company that made it had had some massive hits um i think kong and congress is i i'm not remembering the hits but anyway it sounds like they took a tax loss and they gave it to center versus they would they did right by the actors to take this to the movie theaters uh peter Dinklage was great.

20:41Kevin Bacon, Elijah Wood were in it. And but it didn't really hit the horror niche. And it they didn't, it was a little bit tricky how to market it. There were one or two little mishaps. Long story short, it didn't do well at the box office. But including the downstream revenue with the streaming, they'll still probably break even. So this is the type of risk that you want to be taking that i don't fault management at all they they bought some decent ip with name brand actors at a very low price they used that network and for whatever reason they couldn't position it right or it was over labor day it was beautiful and it just didn't land but again they're going to break even on this stock has gotten hammered now they have two two um two movies coming out um silent night deadly night in december which is was banned in a theater in 84 that's right down the middle if you're thinking baseball it's a fastball right down the middle that should hit their their their genre their audience they know how to market to that audience there should be some pent-up demand for this given that it was censored in the 80s.

22:01And they're smart. They produced it, so they own the global rights and they sold the international rights to recover two thirds of the cost. So these guys are literally playing money ball, right? Think of the Billy Bean, the famous book, I'm blanking. The Oakland Days. Yeah, Michael Lewis, the great author, he wrote Liars poker so uh they have that and then they have a um return to silent hill in january which is it's a it's horror but it's it's a big video game franchise that did a billion dollars in sales 20-year anniversary again same formula same playbook right down the middle but everyone's it's what have you done for me lately oh this movie didn't do well i thought they were going maybe make some money and maybe they broke even stock gets cut in half and then you have a lot of other optionality in that they own uh center search which is they claim is the best ai search tool for movies they they built it with google and they're talking to big television oems for smart TVs about trialing it about hopefully landing a licensing deal.

23:15They have a match point, which is a really compelling technology, how to distribute all because they, because they, they stood up these fast channels. They stood up these streaming channels. They believe they built a better mouth shop there. They've talked to all the Hollywood studios, big companies. They think they're close. They have to land a deal, but if they land one of these deals they mentioned the conference call maybe five million this would this would this be a sas software deal it's a whole different multiple if you can land one of these and then you have once you have proof of concept you probably land another deal if they land one of these deals the stock probably doubles on that alone and again they've stood up all these different channels they have the the uh 360 the mark the ad piece, there's some compelling aspects of that that they talked about in the conference call.

24:09I've talked to management. They're really smart. They're disciplined. Balance sheet's clean. There's no debt. They have about$8 million in cash. You can tap the different financing markets for movies, but again, they're sticking to their playbook. This is a big position. In July, we're up massively. and we like i said we sold 20 then you take this big draw now we we have aggressively added so i've never been bigger in terms of dollars invested because i added aggressively some in the fives and then a lot in the the mid threes so you know i'm in it i'm in it to win it and that's that's the game and that's what i'm trying to do but it it does get a little bit annoying how much hot money evidently was in this name and that they were just looking at this as an event okay the august movie didn't do well i'll revisit this in december and so the money rushes in the money rushes out you take these big uh unrealized marks on the pnl uh but again it just it just doesn't make any sense if i because i think i understand the business i think i understand the nuance it's just so mispriced from an optionality standpoint of what can go right with multiple ways to win how am i able to buy this company at a valuation of um what 75 million bucks well again with no debt it's not like they have onerous debt where they have to worry about they can make the payments and they roll the debt that's not that's not the that's not the case here but those are the swings you want to play in this game you want to play small caps and micro caps and high conviction investing it's like i said it's a lot the highs are really high the lowest can be really low but you have to have a north star and have some conviction and in your work and your research and when you think you have an edge right that's the whole thing you think you have an edge because you've done what you think is real work and you've talked to management and you've thought about the ecosystem and you thought about what they're trying to do and what can go right and what can go wrong.

26:28Not to mention resilience, which is, I always tell my daughter, probably a top quality to have to get through this life, which, you know, we've all been humbled, certainly a humble time for everyone, a confusing time for everyone. I'm curious, there's talk of small caps in general, mid caps in general, when it comes to cutting rates, which we just saw from the Fed. Thoughts on that strategy or pseudo conviction when it comes to small mid caps? Gosh, I wish I knew, Irina. I mean, again, I don't do macro. I don't try to time markets. You could argue the market was overvalued 2 ,000 points ago on the S &P.

27:17Look, if you look at the S &P versus the Russell, the Russell's basically gone nowhere. And depending on what timeframe, I mean, you can cherry pick it and say, okay, it's a little bit better depending on what vantage point you look at. But it's basically gone nowhere. The factors and the momentum, there's not that I follow that so closely, but I do have friends that run quant money. And it's just so out of favor just because it feels like to me because of the market structure. People want that liquidity that you can buy and sell a billion dollars of NVIDIA or Apple or Tesla or Meta. Or if it's a really compelling AI company, these things trade massive volume and you get the momentum behind you.

28:13It's very powerful. so the fed cutting a quarter is is good but it sounded like based on the few pieces i read that paul was kind of more of a cautionary cut i know he's getting a ton of pressure from pennsylvania avenue to cut more but i i think the fed on balance that again this isn't this isn't my swim lane but i i think paul's doing the best he can it's a very difficult job a lot of pressure and it's very important the fed stays independent it's so important for the bond market um so i just i just don't know because because of the lag effects of tariffs and the cross currents from that i i don't really know if we're going to really get into a big cutting cycle um and then on the flip side you could argue well if they need a cut more aggressively that's because the job market's really poor because the, because, because confidence is down or various different factors.

29:15So it, I wish I could say skies are blue. It's going to be unicorns and rainbows and everything's going to be amazing. I just don't know. I'm not, I'm not really kind of feeling that, but I hope that happens, but I'm not betting on that to happen. And this is the small canvas that I paint on. So I'm kind of constrained to that universe. And I'm trying to play that game with the opportunity set that I have available. Anything to say about the tariffs affecting small caps or some of your names in particular? Anything of note there? I don't really believe I'm particularly tariff impacted, the names that I'm invested in.

30:12I certainly try to, I haven't really done much. In the past, coming in 2020, 2021, I haven't, even maybe 2022, had a lot of exposure to the consumer, consumer discretionary kind of retail names. I don't really own many of those names anymore. I will say, though, this is the debate you always have in the back of your mind, the investing versus trading. To my group, I never got it on the free site, but I wrote a piece in December 2020 about how I love Build-A-Bear and how it was mispriced. It was$2.90. I think it hit$70 recently. Now, that's five years later. But a name that I did get on the site was Potbelly at$2.

30:59and that got bought for 17 and it's you wonder how i mean there was so many dislocations back then but so i was doing a lot more in retail but the good business bottles that emerge where you again baby gets completely thrown out with the bath water you get these these these huge overreactions and and kind of mispricings and um that's what i kind of try to take advantage of but I'm a little bit hesitant to try to, I don't have the courage to buy some of these companies that are, I just don't know what the ultimate impact is going to be on the tariffs. And if they're going to be able to pass them through and how elastic their pricing power is.

31:49It feels like to me, again, this is not what I do per se. I'm not a macro timer. But it just anecdotally, it feels like the economy is kind of weak. Seems like the job market, again, depending where you are, if you're in data centers, you're in electrical engineering, you're in semiconductors or certain niche fields, business has probably never been better. But it just seems like, just anecdotally, again, take it with a grain of salt, because I'm not trying to proclaim that I know, I don't. it just seems like the job market's tricky you hear about kids that are that have done well in school and uh there aren't as many rungs in the bottom of the ladder to climb onto because ai seems to be displacing uh people and so if if you did a really good job in school and worked hard and you're trying to get into the job market and those opportunities aren't available um it's it's tough and housing is so expensive.

32:59So there are a lot, just it's so expensive mortgage. It's not just mortgage rates, but I feel sympathetic, empathetic for the Gen Z generation saying we did everything right. We went to school, we worked hard, we got an education. We want to start a family. We're optimistic, but our are maybe our jobs aren't not as secure as we'd hope to have college debt the job it's very expensive for to try to buy a house and to to get it to get into the to the game so to speak um and i just kind of seeing that anecdotally in some of the reports again i don't have compelling empirical evidence to proclaimatively make these declarative statements that I'm not.

33:53It's just more kind of what I've observed. You have the courage to make them, but not the conviction behind it necessarily. Yeah. Well, I appreciate you straying a bit from your lane for our benefit. If I may ask you one more question in that realm, any thoughts, and you don't have to necessarily have an opinion, but any thoughts on Trump's announcement about changing the pace of earnings announcements that it would just be a couple of times a year? How do I answer that? With courage and conviction, for God's sakes. I mean, it's, I don't know what to make out of Washington. On the one hand, you could argue there's some really good policy, pro-business, pro-growth, get the red tape out of the way, common sense approaches.

34:58is let's let's try to address the deficit let's try to bring innovation back let's use whatever tactics or things that we can control to get these big and powerful companies to make those investments in the United States. So that is potentially positive. But then again, on the flip side, how do you think through the small businesses that don't have the reserves, don't have the billions in cash sitting idly? And how have they been impacted by the tariffs? Has their business been displaced? Are they getting displaced by the big and powerful kind of winner take all economies? Because that's what it kind of feels like to me.

36:02And I get it from a stock perspective and I get it why a management team wants to merge and they want to combine resources. and there's economies of scale and you're taking out SG &A, you have product diversification, you have revenue diversification. I get all those things. But at the flip side, you just have to try to make sure you're balancing those animal spirits of how do you get people to take risk and smart risk and how are they able to access capital to start a business, to hire people, to try to live that American dream. And, you know, so on the one hand, you're an investor and you're in the stock market.

36:54I think things have been great. If you've been lucky enough to save and you were healthy and your kids are healthy and you're blessed in that way, you probably have done well with real estate. You probably have done well investing. saying you're the baby boom generation is doing exceptionally well um i i just don't know from a policy perspective there are other things that scare me some of the i don't want to mention the names of some of the people in these agencies and places i have no idea how they were they're sitting where they're sitting and it seems to be doing some really i hope not irreparable damage to those institutions and those sectors because we're moving so fast and trying to break things without perhaps thinking about those downstream effects.

37:47And is this really the best policy? Is this really in the best interest of the country? So I don't know. In terms of your specific question, I think it's a bad idea. I think the market likes the quarterly earnings. I think they like that transparency to make better decisions. On the one hand, yeah, it'd be nice if the public companies invested like private equity, where they have a five-year time horizon. The capital is through long-duration investors that are genuinely interested in making a portfolio different investments that they think will do well in a various strategy and the management teams have that luxury and latitude to think more farsightedly and make smarter decisions but unfortunately or fortunately depending on your perspective because there are a lot of benefits too of being public if you're a publicly traded company you are beholden to the market and And I think on balance, it's probably better to keep the quarterly earnings.

39:01But who knows? I have no control over what they're going to do in Washington. And again, sometimes I just scratch my head that I'm living on Mars some days. I don't think you're alone in that. Any further updates that you would want to share with listeners? Again, more philosophically, markets are great. It's a great tool for wealth creation. It's a, it's a, it's a, there are periods in my life where I've had incredible intellectual curiosity and it ebbs and flows. And, but at the same time, it's not your whole life, no matter how good things are, how bad things are, um, if you can balance life and your family or your friends, or, you know, not just the markets up today, my accounts up today, you know, I feel so good.

39:48And it's like, you know, that that that's important and it's good. It can be intellectually interesting. But, you know, there's a lot more to life than just money and kind of winning the rat race, so to speak. So, yeah, I hope the country kind of heals and we get from less polarized and in our echo chambers. And, you know, what I'm seeing, it's it's just it's just kind of sad to see it. You know, investing is great and you have some good times, you have some uptimes. But, you know, at the end of the day, that's not really what matters. It's really about family and trying to be a good person. And let us all say amen.

40:29Yeah. Your investing group to get back to that matter is Second Wind Capital. This is the kind of thought process, courage, conviction, consciousness, awareness that you will find behind the investing strategy. Courage and conviction investing thoroughly always enjoy talking to you. Thoroughly always appreciate your insights and your willingness to share them. Thanks again for coming on. Don't wait so long before coming back, please. Thanks so much, Reena. My pleasure. Thanks for having me. Just a reminder, anything you hear on this podcast should not be considered investment advice. This is for entertainment purposes only, and you should seek advice from a licensed professional before investing.

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