I always enjoy digging through the smaller holdings that appear in the portfolio of Seth Klarman (Trades, Portfolio)'s Baupost Group. I spend time trawling through these investments because one can often find the best value investments in the small-cap space of the market.
However, for a hedge fund with more than $30 billion of assets under management, these positions will never be a substantial holding. Neither will they make a considerable contribution to hedge fund performance. As such, they tend to fly under the radar.
This could present an opportunity for individual investors who have less money to work with and are looking for undervalued investments.
Klarman's value play
Noble Corp. (NE, Financial) appeared on Baupost's second-quarter 2021 13F report. According to the filing, the hedge fund acquired 105,000 shares in the offshore oil drilling company during the second quarter, giving it a 0.02% portfolio weight.
I should note that the 13F only provides information on the holdings in Baupost's equity portfolio. It does not detail cash or credit investments. Only around a third of the firm's assets under management are invested in equities. The remaining balance is invested in is credit, real estate, distressed assets, cash and other areas where Klarman sees value.
Baupost wasn't the only hedge fund buying a position in Noble during the second quarter. Howard Marks (Trades, Portfolio)' Oaktree Capital Management also initiated a position.
The reason why both hedge funds waited to acquire the position last quarter seems relatively simple. The company has only been a publicly-traded business for a couple of months. Before that, it was in Chapter 11. It filed for bankruptcy protection in early August 2020 as its inability to keep up with its high debt load forced the company to seek protection from its creditors.
During the space of the year, the company restructured and emerged from bankruptcy, supported by a new $675 million secured revolving credit facility. In November of last year, it also sold off several assets, including five of its cold-stacked floating drilling rigs.
As both Baupost and Oaktree are distressed debt investors, I think both firms' involvement with this business has more to do with their ownership of its debt.
Debt for equity
When it emerged from Chapter 11 bankruptcy in February (before returning to the public markets in June), shares in the company were issued to bondholders as part of the restructuring process. According to the company, "certain former bondholders and former equity holders of Noble UK were also issued warrants to purchase shares of the company."
It seems likely both Baupost and Oaktree bought the distressed company's debt, thinking it was worth more than the market was valuing it at, and were awarded shares when it exited bankruptcy protection. Suppose either of the funds continues to hold a position in the stock in the third quarter. In that case, this could be a strong indication that they believe the equity remains undervalued, despite the restructuring.
Of course, this is just speculation. Baupost and Oaktree could have bought the stock on the open market believing it was undervalued, though I think that is unlikely given their investing styles.
According to its second quarter results, Noble reported a book value of just under $1.4 billion at the end of June. That is compared to its current market capitalization of $1.3 billion.
Not only is the stock now trading at a discount to its book value, but it is also profitable. Earnings per share for the three months ending June 30 totaled $0.30. Based on these figures, it is entirely likely that both of these value-focused hedge funds could have bought the stock as a deep value recovery play, considering its recovery potential in a market where many of its competitors have also struggled through bankruptcy.
