David Nierenberg (Trades, Portfolio), of Nierenberg Investment Management, runs a small portfolio of just eight stocks.
Managing a concentrated portfolio allows him to make significant bets on the securities that he has identified. These securities, mainly equities, are undervalued and come from stocks and sectors that get little attention. One of those areas, for example, is micro-cap equities.
Nierenberg is also prepared to be a catalyst when he wants to see more progress at the companies in which he is invested. He uses friendly activism when necessary.
Who is Nierenberg?
The guru left Yale Law School in 1978 with a juris doctor degree. Previously, he graduated with a history degree from Yale College in 1975.
According to InsiderMonkey, Nierenberg had a seven-year stint at Bain & Company Inc., where his positions included partner of managing strategy, acquisition and cost reduction projects for CEO clients. Nierenberg was also a general partner at Trinity Ventures for about 10 years before forming Nierenberg Investment Management Company in 1995, setting up the D3 Family of Funds.
Based on information on his Bloomberg profile page, he has been on the boards of well over a dozen companies and serves with several non-profit organizations, including the Washington State Investment Board, which manages more than $124 billion worth of assets.
His personal profile at Rosetta Stone, where he is a board member, says he is a retired member of the Massachusetts Bar and has extensive experience in capital allocation, strategic planning, cost reduction, executive compensation and turnarounds.
What is Nierenberg Investment Management?
The investment advisory firm is based in Camas, Washington. According to the Form ADV Part 2A, it has an offshore subsidiary based in the Bahamas and is general partner to:
- The D3 Family Fund, L.P.
- The D3 Family Bulldog Fund, L.P.
- The D3 Family Canadian Fund, L.P.
- The DIII Offshore Fund, L.P.
The firm serves mainly clients who are private investment funds and, in turn, these are generally high-net-worth individuals and institutional investors.
As of March 1, Nierenberg had $116,546,783 of discretionary assets under management, according to the firm’s Form ADV.
Strategy
Nierenberg and company say, in the Form ADV Part 2A, their goal is to invest in companies that are both undervalued and not widely followed by analysts, institutional investors or others in the investment community.
They do that by trying to develop what they call an “informational advantage,” which allows them to find “pockets of informational inefficiency” in public markets.
This pulls them into subsectors such as micro-cap stocks, turnarounds, busted initial public offerings, industry or regional panics, corporate spin outs and spinoffs, well-managed cyclical growth companies and closed-end mutual funds.
Because they intensively research each stock they are considering, they limit themselves to a candidate list of eight to 14 names, in industries they already understand.
In addition, they like to be among the largest owners in the companies in which they invest. This allows them to communicate with, and influence, management or the board of directors. In some cases, they will take a seat on the board to advance change or shareholder interests.
The companies in which they invest share several common attributes, which they believe will reduce the risk of loss and maximize the potential for long-term gain:
- Bargain priced.
- A catalyst to unlock hidden value (sometimes Nierenberg sees his firm as the catalyst).
- Management committed to, and capable of, creating shareholder value.
- Strong competitive and customer position.
- Manageable debt, or no debt at all.
- Able to increase, significantly, its earnings per share.
Nierenberg says they are not interested in companies that are simply cheap; by focusing on the guidelines above they get cheap, quality businesses with good management.
The firm holds companies until: their fundamentals deteriorate, they become fairly valued or are edged out by better investment opportunities. The average holding period is five to seven years.
The firm says its investments are expected to be mainly equities because that provides the best opportunities for long-term capital appreciation. As of Jan. 4, though, equities made up just $69 million of the firm's $116.5 million worth of assets under management.
It also occasionally uses some short selling and leverage to gain edges.
Looking at the top eight equities in the Nierenberg portfolio, they are either rated a lowly one star or not rated at all. So the guru has been investing according to the principles he has set out; the list has a definite cigar-butt hue.
The biggest holding in the top eight is laser-maker Electro Scientific Industries Inc. (ESIO, Financial). Nierenberg joined the company's board in 2010. After struggling for six years, the share price began rising in 2016.
This 15-year chart of Electro Scientific's share price suggests Nierenberg may see the share price double from where it was when he became a board member (marked by the red square):
While the share price has climbed impressively, the stock still does not get much lift in the GuruFocus ratings, with a 7 for financial strength and a dismal 2 for profitability and growth.
Another of Nierenberg's holdings worth watching is Houston Wire & Cable Co. (HWCC, Financial). On Jan. 4, Nierenberg sent a letter to the company's chairman, letting him know the D3 Funds' position had grown to nearly 9%, likely making it the largest shareholder.
He began as a friendly activist, by noting D3's increasing ownership, and adding, “Please take this news as it is intended: a sign of enthusiasm for the company's prospects, management, and governance.”
And, after discussion of favorable trends, proposed Houston Wire take the following four steps to seize growth opportunities:
- Drive profitable revenue growth: Nierenberg believes the company should grow its specialty fastener business, which is not cyclical, and move ahead with digital commerce, which he sees as the “next evolutionary” sales and marketing growth channel.
- Continue to increase insider ownership: earlier in 2017 Nierenberg complained about low levels of purchased ownership by the CEO and board; they appear to have heeded that request in the fourth quarter.
- Consider further evolutionary changes in board membership: suggestions include someone with e-commerce credentials, a veteran of the fastener industry and someone with knowledge of electric vehicles.
- Use free cash flow to cut the debt in half: Nierenberg says a cut in debt would provide greater freedom for capital allocation, including share repurchases, dividends and future acquisitions.
Nierenberg is a value investor who tries to find a competitive advantage in “pockets of informational inefficiency.” He is looking at securities characterized by undervaluation and beyond the horizon of most other market players. His D3 Funds may act as a catalyst for unlocking value, with solid positions and friendly activism.
Holdings
As this GuruFocus chart shows, technology and energy make up almost 75% of Nierenberg’s eight-stock portfolio:
These are his top equity holdings as of the end of the third quarter of 2017:
- Electro Scientific Industries Inc. (ESIO, Financial): 18.58%
- Flotek Industries Inc. (FTK, Financial): 17.12%
- Rosetta Stone Inc. (RST, Financial): 14.71%
- Radisys Corp. (RSYS, Financial): 13.65%
- Malibu Boats Inc. Class A (MBUU, Financial): 10.75%
- Houston Wire & Cable Corp. (HWCC, Financial): 8.73%
- C&J Energy Services Inc. (CJ): 8.55%
- Geospace Technologies Corp. (GEOS, Financial): 7%
Nierenberg’s holdings in undervalued tech stocks is consistent with knowledge this sector has provided much of the gain experienced by investors over the past decade. He is also betting the beaten-down energy industry makes a major comeback in the next few years.
Performance
Online searches pull up no information about Nierenberg’s performance, which is not a surprise for a relatively small hedge fund.
However, GuruFocus does provide this chart of his equity holdings:
Conclusion
While outsiders are unable to assess how well Nierenberg has done with informational advantages, his stock picks provide value investors with at least two names worth exploring.
Those two were Electro Scientific and Houston Wire & Cable; but they are just two of the stocks worth further investigation by keen value investors. Keen because of the need for due diligence, and because it may take up to seven years before Nierenberg succeeds or fails.
For value investors, there is also benefit in thinking about the “informational advantage” and its flip side, “pockets of informational inefficiency,” Nierenberg pursues. Can I find a stock or sector that has been overlooked by the crowd, an opportunity that the mainstream has missed?
Disclosure: I do not own shares in any of the stocks listed, nor do I expect to buy any in the next 72 hours.
