From the February 2013 issue of Investment Advisor • Subscribe!

Southern Charm in the Small-Cap Space

Reducing volatility in a notoriously volatile space has Mark Travis of Intrepid Capital outperforming (significantly) in small caps

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Photography by <a href="http://kettermanphotography.com/">Ryan Ketterman</a> Photography by Ryan Ketterman

“I like to joke that I have a small brain that turns at high RPMs.”

Don’t let the easy-going, good ol’ boy charm fool you. Yes, when not in the office, you’ll find Mark Travis competitive skeet shooting or surfing waves off the Northeast-Florida coast. The Jacksonville-based money manager went to the University of Georgia, and loves SEC football and Tim Tebow (can this guy get anymore cliché?).

However, raise the topic of investment management, particularly the small-cap space, and the “aw shucks” attitude quickly fades. His command of the sector makes him deadly serious. He has to be, after all; to outperform in notoriously volatile small caps takes some doing. The fact that he focuses on fixed income tempers that volatility somewhat—but only somewhat.

Intrepid Capital Fund (ICMBX) has a one-year total return of 10.95%, a three-year total return of 9.79% and a five-year total return of 8.54% (as of Dec. 31, 2012), ranking it in the top percentile of its Morningstar category. The Intrepid Small Cap Fund (ICMAX), which he co-manages with Jayme Wiggins, has a five-year total return of 12.45% (as of Dec. 31, 2012).

“We run four ‘40 Act no-load mutual funds and a long/short partnership here,” he explained when asked about the firm’s philosophy and process. “We try to find the most undervalued equity and pair them off with very overvalued equity. That’s largely been the retained earnings of this firm since we started.”

By started he means 1994. Today, the firm has $1.4 billion in assets and 17 employees; half of them devoted to securities analysis and trading, and the other half to the firm’s RIA and private client business.

“I feel the investment advisor’s pain,” he said. “The first decade of our existence we dealt with private clients, so I know the emotional roller coasters their clients go through.”

Travis said he understands that clients don’t care what happened between point A and point B. He knows they’re prone to buying high and selling low, and tries to have a deliberate, disciplined process that’s low in volatility to “wake up every day with a little bit more money.”

“The process is not sexy; it’s really a lot of reading,” he noted. “It’s going through the 10Ks and the 10Qs and trying to ascertain what the free cash flow is to the enterprise and what that valuation would be. Our estimate of value is more conservative than our peers. In deriving the valuation using the discounted cash flow calculation, we use a double-digit return for what you hope to earn coupled with a low assumption for growth rate. Therefore we tend to capitalize cash flows at a higher number and end up with a lower valuation. We think that should be double-digit; we think you need to be rewarded for taking less liquidity and smaller-business risk.”

Ask him where he’s currently finding alpha, and he wastes no time naming names, highlighting the energy sector.

“Particularly since the spring when natural gas prices hit $2 per McF (an abbreviation for a thousand cubic feet of natural gas),” Travis began, “I think the economics of it, at this point, don’t make sense below $4 per McF for other companies. So one company is Bill Barrett Corp., an energy company whose core business is natural gas and oil exploration, which is trading in the high teens; we think we can get into the mid-30s.”

Intrepid Small Cap FundAnother name he’s recently revisited is Patterson UTI, a company with “around 230 rigs. The beauty of their business is that the rigs are mobile. So as some of these producers decide, ‘Hey, this is not economical at today’s gas prices,’ they can move that rig and begin drilling for oil instead.”

Travis also likes the consulting space, and recently bought a company called FTI Consulting. It’s had a hand in the PR for everything from the BP oil spill to forensic accounting for the Lehman Brothers bankruptcy. 

“They have attractive cash flow margins,” he added. “The shares are currently in the low 30s, but we’ve come up with a value in the low 40s.”

As for the small-cap outlook in general for the next 12 to 18 months, Travis is (not surprisingly) optimistic, but cautious.

“As hard as it is to believe, you’ve had a pretty nice three-year run in equity prices in general,” he said. “You’ve got margins that are at a peak and likely to get worse. We consider ourselves to be defensive portfolio managers by nature. When we buy businesses, we’re thinking, ‘What happens if …?’ Most particularly, what happens if we go into another recession, or if Israel bombs Iran?”

For that reason, he’s cash-heavy and generally finds prices to be fairly high. “We’re still able to find a place to put money to work. It’s just not an overly abundant list of new ideas.”

When asked about what he does better than other managers, Travis took an almost paternalistic attitude toward the firm.

“One, it’s my baby. Two, it’s my net worth. And three, it’s being a native of this part of Florida,” he said. “I have a lot of—for lack of a better term—widowed mothers of lifelong friends of mine who are longtime clients and believe in our approach. And I have all their money.”

Believing a large part of the industry flows through some type of consulting and ends up in a quasi-indexed product, Travis operates the firm “like a private equity buyer in the capital markets looking for an absolute rate of return.”

“If we can’t find something that trades at low enough valuation for us to acquire in equity or debt, we’ll sit in cash until those prices appear,” he explained.

Like almost everyone else, his corporate philosophy is to participate in up markets but preserve capital in down markets.

“One of my favorite Warren Buffett lines is ‘You don’t get to see who’s swimming naked until the tide goes out,’” he said. “The tide went out quick and hard four years ago. We woke up and our best performing fund, the Intrepid Small Cap Fund, was down 7% in 2008 and the Intrepid Capital Fund was down 16% when most of the index-centric products were down 35% to 50%.”

“It’s one thing for me as a professional to lose my money,” he emphatically stated. “It’s a whole other one for me to lose someone else’s money; money that they’ve earned and saved and paid taxes on. Nothing gets my blood pressure up quicker, harder and faster than doing something stupid with someone else’s money.”

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