As one of the world’s most respected value investors, the last place you would expect to find Seth Klarman (Trades, Portfolio) investing is in the unicorn space. But that is precisely where he is now looking for value, according to excerpts of his most recent letter to investors as published in the Wall Street Journal.
Buying fallen unicorns
According to the Wall Street Journal, Klarman is now looking for opportunities in busted unicorns, private companies with billion-dollar-plus valuations. This market is highly illiquid and also highly speculative. While Klarman is used to investing in highly illiquid assets, the speculative nature of the business is not what he is known for.
According to the letter, however, Klarman and his team are only looking to buy into the companies where “we are comfortable making and the cash flow projections that underpin our financial models.” In other words, Klarman is bringing disciplined value investing into the tech space. Where other investors might be afraid to tread due to falling growth expectations or just a lack of positive sentiment surrounding a particular company, Baupost should be able to step in and take a position at a favorable valuation.
The idea of investing in this market is part of Klarman’s drive to venture into investing in “the new firms that are seeking to displace the older incumbents.” This is an interesting conversation. I have nowhere near as much experience in investing as Klarman, so I do not want to criticize, but I think it is fascinating the way his strategy has now seemingly adapted to take on growth.
Turning his back on value?
Historically, Klarman has always been a value investor. He has hunted under rocks of all shapes and sizes to find the best hidden gems at the right prices.
Gradually, as these hidden value stocks have disappeared, Klarman has ventured out into businesses that are more speculative. A great example is Cheniere Energy (LNG, Financial). With more than $24 billion in net debt and no profit expected until 2019, all of Cheniere’s value is contained within the company’s future cash flows. This has not stopped Klarman from devoting nearly 12%, or $1 billion, of his equity portfolio to the business. There is no question that this position is more speculative than traditional value plays.
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Investing in busted unicorns for the promise of cash flows at some point in the future is similar to Klarman’s Cheniere trade. What is odd is there is so much that could go wrong in this scenario. Unlike traditional value investing, where the risk of downside is minimal but there is potential for multi-bagger returns on the upside, a leveraged play on future cash flows like Cheniere or investment in a fallen unicorn based on its future potential has a much higher rate of risk. And by risk I mean the chance of permanent loss of capital.
It is interesting that Klarman is looking at fallen unicorns not just because of their speculative nature, but also because they are technically growth investments. If Klarman has switched from value to growth at a reasonable price, is this a sign of the times? Can one of the best value investors of all time see no more value in pursuing such a strategy? It is impossible to answer this question, but it does provide some food for thought.
Too much data?
Another point to consider is whether or not Klarman believes value investing in its traditional sense in the public markets is now dead. Technological advances over the past decade mean that today, anyone can use a simple stock screener to find the market’s undervalued stocks. As a result, the best opportunities are taken quickly. The only option is to invest in sophisticated, illiquid instruments as this is one area that might still yield value.
As noted above, I do not claim to know what Klarman is up to, but it is interesting to see how his style is developing with market changes. Hopefully, we will get some more insight into his fallen unicorn strategy and what he plans to buy in the months ahead.
Disclosure: The author owns no stocks mentioned.
