Angry Tiger Audio Interview With Derek Pilecki

Ryan Ruppert:

Hello and welcome. You’re listening to Investing Ideas with the Angry Tiger Investment Club found at AngryTiger.com. I’m your host Ryan Ruppert.

My guest today is Derek Pilecki of Gator Capital Management. Derek founded Gator in 2008, and he currently manages a long/short equity strategy focused on the financial sector and a long‐only small‐cap equity portfolio. Today, we’re going to be focusing in on the small‐cap equity portfolio, which at the close of 2013 had delivered a return of over 380% since inception compared to just over 161% for the Russell 2000 index in the same period.Prior to founding Gator, Derek was a member of the Goldman Sachs Asset Management Growth Equity Team, where he was the co‐chair of the investment committee for the growth team and also a portfolio manager. Derek holds an MBA with honors in finance and accounting from the University of Chicago and a BA in economics from Duke University. You can find out more about Gator Capital Management at GatorCapital.com or by calling them at 813‐282‐7870.

Now, here’s Derek Pilecki. Welcome, Derek. How are you today?

Derek Pilecki:

I’m doing well. Thanks, Ryan.

Ryan Ruppert:

Thanks for joining me today, Derek. I invited you today because you are a highly successful money manager. The Gator small cap portfolio has performed exceptionally since its inception. To get us started, could you introduce our listeners to Gator Capital Management and tell us a little bit about your firm?

Derek Pilecki:

Sure. I launched Gator in 2008. And we manage a couple portfolios. I run a long/short equity strategy focused on the financial services sector. Then I run the Gator small‐cap portfolio, which is a concentrated small‐cap portfolio invested in about thirty stocks that I think have strong competitive advantages and shareholder friendly management. Try to own those over a period of years that allow the management teams to compound the good economics of the business.

I actually have a third portfolio that’s managed by a colleague of mine, Lee Kronzon. He runs a small/mid‐cap portfolio and has a similar investment philosophy.

We manage about $110 million as of June 30th, and we’re based in Tampa, Florida.

Ryan Ruppert:

Ok. What was the catalyst? Why did you form Gator Capital Management?

Derek Pilecki:

Prior to working at Gator or starting Gator, I worked at Goldman Sach Asset Management. I was part of the growth team. We managed about $30 billion in large‐cap, mid‐cap, small‐cap growth stocks. The team was based in Tampa. I was part of a big team covering financials, and I was looking to do something a little bit more entrepreneurial. I wanted to make the portfolio management decisions rather than just being an analyst. I had just gotten to a point in my late‐thirties where it was time to either take the entrepreneurial challenge on or to work for somebody the rest of my life. I just found it was good timing in 2008 to start Gator.

Ryan Ruppert:

Absolutely. And do you feel that you offer investors something unique at your firm compared to many of your competitors?

Derek Pilecki:

I do. I think there’s too many large firms who are very benchmark sensitive or benchmark aware. They manage large pools of assets, and they look at their business risk and say, “This is a decent business, but if I underperform the benchmark by a wide margin, I could lose a lot of assets and the business goes away.”

I think that’s the wrong way to manage money for a segment of people who are, especially people who invest in small‐cap stocks. I build my portfolios as if I was investing in them, and I do invest in my portfolios in a significant way. I invest in them to try to add value over the benchmark, so when I invest in companies, I’m looking at companies on an isolated basis and think that I’ll get decent returns from the companies standalone.

Then beating the benchmarks takes care of itself over time. I’m not worried about benchmark risk, so my portfolio tend to have very high active share. If you look at my returns, our returns are not closely correlated to the benchmark in the sense of it’s up 100 basis points or down 100 basis points. We beat them either by a substantial margin, and I would expect we will have years where we underperform by a substantial margin because we’re not building our portfolios to look like the benchmark in any sense.

And I think that’s better for investors because there’s no reason why an investor just should invest in a small‐cap index or a large‐cap index and try to mimic the market if you think you can add value over time and outperform the benchmarks.

Ryan Ruppert:

From what I’m hearing, you describe yourself more as an absolute return manager than a relative return. Do you have annual growth targets for your portfolio?

Derek Pilecki:

The way I think about it is if I look at a stock and I think the stock can double in a three‐year time period, I think that’s an attractive absolute return. You don’t find those all the time, but the few times a year where I come across situations like that, most of those things end up in the portfolio. That’s my quick rule of thumb of our target return.

Ryan Ruppert:

Ok, obviously as you mentioned, there are going to be certain years where you underperform, which implies that there’s going to be higher risk in a portfolio like this. What type of investor is small‐cap investing in your type of portfolio really appropriate for, and are there individuals who shouldn’t be getting involved in something like this?

Derek Pilecki:

Absolutely. So the best type of investor for me is somebody who’s a seasoned investor who might have made a lot of money in their career, but they don’t have time to devote to stock investing. They want to have a portion of their portfolio where the manager is trying to put points up on the board. They understand that that’s a risky portion of their portfolio, and the person’s looking at an area in small caps where Wall Street’s disinvested from publishing research.

It’s really geared to somebody who has financial wherewithal to endure some volatility. Maybe they still have some cashflow from owning a business, and they’re constantly adding to their portfolio. They’re used to taking risks. I very much look at my client base, and it’s filled with entrepreneurs who have spent their whole life taking risks and understand the risks that I’m trying to take with their investing.

Ryan Ruppert:

Alright, I’d like to start with a broad question before we move too deep into your investment process. That is, how is small‐cap investing different from large‐cap investing?

Derek Pilecki:

I think there’s a lot less information flow in small caps. It’s mainly because there’s less people writing about small‐cap stocks. This goes back to the early 2000s when Eliot Spitzer had his settlement with Wall Street. He changed the way sell side analysts got compensated on Wall Street. They used to get paid a salary, and then they’d get performance bonuses based on the volume of the stocks their brokerage firm traded and the names they published on. They also got a portion of deal fees if they did offerings.

The Spitzer settlement outlawed analysts getting paid deal fees. It reduced the incentive for an analyst to work on IPOs and to work on small stocks that might do corporate financings. They’d rather focus on large stocks where there’s a lot of trading volume and their brokerage firm could trade the stock and get paid on that trading volume.

While the number sell side analysts might not have gone down or the number of research reports might not have gone down, there’s been a shift to research reports on larger companies. If you look at a big‐cap company like Apple, there might be scores of analysts covering Apple’s stock. Whereas if you look at a smaller‐cap company like one of the names whom I talked about, FTD, there’s only two analysts who cover FTD.

Just the fewer people who look at small‐cap stocks presents opportunity for investors who do their own research or do their own analysis. I think it’s not that the market is inefficient, it’s just less efficient than in large caps. I think it’s very difficult with all the people who are looking at Apple to really have a differentiated view that you can consistently outperform the market investing in companies the size of Apple or Microsoft or JP Morgan.

If you spend your time fishing in a smaller pond like small caps, it’s more likely you’ll come across names that are misvalued from what you think they should be valued just because people spend less time on them, and there’s not as much research written about those stocks.

Ryan Ruppert:

Ok, now on the companies themselves, obviously small‐cap companies often aren’t, certainly aren’t nearly as well established as many of the large‐cap names that we’re used to hearing about on CNBC every day. So are there certain ratios or figures that you pay less attention to with a small‐cap stock such as price earnings, or is that still very important and part of the equation when you’re looking at a small‐cap company?

Derek Pilecki:

I think those ratios remain the same. It’s valuation. I think you have to look at it several different ways. Maybe enterprise value EBITDA or you have to be aware of the number of turns of debt the company might have on it. The small‐cap stocks, even though they misvalued, they’re not as strong, durable businesses just by the fact that they’re probably less diversified than a big‐cap company. They’re probably dominated by one strong executive rather than a big company like Procter & Gamble where there’s a huge bench of seasoned executives. So business/the competitive advantage or the franchise can be less durable than large‐ cap companies. There’s more risk there, but the metrics you look at are the same.

Ryan Ruppert:

Does your approach to investing lean itself more towards growth or value? And by that I mean are you really looking for market inefficiencies or at least where the market is less efficient, as you’ve already mentioned, or are you looking more at companies that are well positioned to achieve real tremendous growth over the next few years?

Derek Pilecki:

I think it’s a balance between the two. I’ve worked at both growth firms and value firms. I think it’s all part of the investing equation. So I think growth benefits the investor because it gives the management team a little bit of cushion to cover up errors. Growth just helps, is a nice tailwind for companies.

I also think that the market tends to not pay up for growth in some aspects. Certainly we can both point to aspects of the market where people are paying pretty stiff premiums for growth, but in general, I think if you can look out two or three years, and you have a growing company, it’s more likely that if you can take a little bit of longer time view, that you’re not really paying up a lot for some growth companies. So I like a cheap stock as much as anybody else, but growth is an important part of the equation.

Ryan Ruppert:

Ok, looking closer at your investment process, starting right from the top, how do you screen the market for opportunities?

Derek Pilecki:

There’s a couple things I do to keep aware of new ideas. I have a couple of screens that I do. And this is not how I get all my ideas, but it’s just a starting point. Every quarter, I screen for companies that have reduced their share count quarter over quarter. It generally comes up with a list of companies that are buying back shares. These tend to be companies that have good cashflow, and they’re using the money in a smart, shareholder‐friendly way to buy back shares.

So that just gives you a list of names. A lot of times, the names are the same quarter after quarter, but sometimes there will be new names that show up. Maybe you’ll take a look at the new name that shows up.

Another screen that I do on a quarterly basis is I look at companies that have a ROE above 20%. And I also like to look at companies that have high operating margins relative to their industry. So that just gives you companies, maybe they have some kind of franchise. It could be that they’re in the sweet part of their cycle. And if it’s a commodity business, they might have high margins for a few quarters while they’re at the right point in the cycle, but then there’s other companies that consistently have high margins. And maybe there’s some franchise there that’s durable that is investable. Those are a couple screens that I do.

And then I like to do reading about companies, and I listen for things when I read about companies. I pay attention to corporate events. I pay attention to CEO changes. Companies that are somehow going through some kind of strategic transformation that they have a spin‐off or they divestiture, that can be value enhancing. I just pay attention when I hear those little buzz words.

It’s to the point where I have Google searches set up for those buzz words like “CEO change” or “strategic alternatives” or “spin‐off.” I get emailed all the articles with companies that have those phrases in their press releases. So that’s just an idea, where some of the starting points I get for ideas.

Ryan Ruppert:

Ok, that makes sense. When you finally find a company that you’re interested in or at least that passes your initial screen there, what analysis do you conduct on that?

Derek Pilecki:

It’s reading their earnings releases and the earnings call transcripts. Viewing the company presentations. Reading through the securities filings. Building a financial model, and the financial model doesn’t have to be detailed. Usually I like to invest in companies where it’s pretty obvious that it’s a cheap stock. I do like to do a simple spreadsheet to model out the income statement.

And doing that, it helps to better understand the dynamics of the company. Looking at the income statement year over year, quarter over quarter, you get a feel for the seasonality a business. If you do the last eight quarters income statement, there might be a business that’s seasonal whether it’s around the Christmas season or around the back‐ to‐school season. You just better understand the business.

Then it’s looking at the holders list and seeing who the other holders are. See if there’s names that I’m familiar with, if I know anybody at the other firms. Sometimes that’s helpful just to compare notes with somebody that I know on the buy side.

Ryan Ruppert:

Alright, do you have a model or set criteria that you score each company against?

Derek Pilecki:

I don’t have a score card or anything. It’s if I think the stock’s too cheap based on the financial model or what I think a fair valuation is for the company. A lot of times, people talk about price to earnings, and they’re talking about this year or next year. And I mentioned earlier, if you can look out two or three years, there’s this concept of time arbitrage where sell side analysts publish the next two years’ earnings estimates, but maybe there’s going to be a step change two or three years out that will make the company look either very cheap or very expensive.

Ryan Ruppert:

Ok. Do you incorporate any qualitative information into your analysis?

Derek Pilecki:

Sure. Part of the reading of the annual report or the conference call transcript is to evaluate management and get an idea of their character.

Look through the proxy statement and look how much they pay themselves. How much stock they own of the company? So nothing in those numbers is‐ Somebody gets paid 500,000 versus 800,000. It’s hard to quantify that, the difference between those two, but qualitatively you can see, if this small‐cap company CEO gets paid 500,000 versus another guy gets paid 2.5 million, you know there’s a difference in culture between those two. The guy that’s getting paid less is probably trying to make money from his equity holdings rather than current cash compensation.

So it’s just a valuation of the character of management. Do you want to be partners with these people? There’s very much a qualitative assessment of that.

Ryan Ruppert:

Ok. Before this interview, you identified two securities that we could use to understand your investment philosophy. I’d like to start with FTD. Can you tell me how you identified FTD as an investment opportunity?

Derek Pilecki:

Sure. FTD recently announced a transaction with Liberty Media where they’re going to issue shares in exchange for the Provide Commerce subsidiary of Liberty. I think that’s an interesting transaction. You could classify it as a corporate event. So obviously Liberty is controlled by John Malone, who is a money maker and has created a lot of value over time for himself and for shareholders. And as part of this transaction, he’s going to retain a stake in the combined company of FTD and Provide Commerce, and he’s also going to take four seats on the board of directors. So I think that’s interesting.

The announcement of that transaction was the starting point for doing the analysis. So then it’s talking about, or thinking through FTD’s business. Obviously FTD has the network of floral shops where you can go into a floral shop locally, and they’ll transmit the order to a florist shop near where the recipient lives. They’ll actually deliver the order, and FTD gets paid a transaction fee. That network has a valuable competitive advantage.

Then there’s been a shift in the floral industry of overnight delivery. So that’s where Provide Commerce comes in. They have a great website where they’re generating orders. If they can deliver the orders overnight, they’ll do it through their own network, but if they need same‐day delivery, they’ll use one of the, either FTD or TeleFlora to transmit orders to florist shops. The combination of the profilers subsidiary of Commerce and FTD will be, it will have some nice, interesting synergies.

On top of that, you’d have the Malone stake. You have supervision. You have a significant equity holder who is providing supervision over the FTD management. So you know that nothing is going to be out of bounds. FTD’s management won’t pay themselves too much, or they won’t make a wild acquisition because you have the Malone board members stopping, effectively vetoing any bad deals.

So that was the next step is to understand the two businesses. How will they integrate? Do the synergy numbers make sense? Look at the valuation. One thing that I like about this deal is that the company will have a little bit of debt, so FTD is issuing both cash and shares to Malone. So they’re raising some debt. FTD will be cashflow positive, and they’ll use the cash to pay down debt. So it’s not overly levered, but it’s going to be a nice little leverage transaction. So the first couple years, they’ll pay down debt. Then I expect them to use excess cash to buy back shares going forward.

Ryan Ruppert:

Ok, FTD is in the floral industry, which, as you know, is a very competitive industry right now. Can you comment on how FTD is positions competitively and also why you think that it’s well placed to deliver superior shareholder value?

Derek Pilecki:

Yes, it’s interesting. The floral business, the number of floral shops is declining year over year. It has been for several years. There’s a shift in the business to the online floral business. So a big competitor is 1‐800‐ FLOWERS. They’re going to own ProFlowers.

There’s some efficiencies to sending flowers overnight. You can do it from a single or a limited set of warehouses. You don’t have delivery trucks. You’re using the UPS or the FedEx networks to deliver the flowers. You can ship the flowers from‐ If you’re buying flowers from Latin America, and you have them shipped to Miami. Then ProFlowers ships them across the country from Miami, that’s a lot easier than having flowers delivered throughout the US and then have local delivery trucks take them out.

There’s a shift going on there. It’s interesting the dynamics within that shift. Provide had not been using FTD to do same‐day delivery to florist shops or any transmit same‐day delivery for orders to florist shops. They had been using TeleFlora. They’ll switch that over to FTD, so it will strengthen FTD’s network. I think it will make FTD a little bit stronger with the merger. It’s going to strengthen their competitive advantage to have that volume on their network. It will make it more likely that florist shops will want to maintain their FTD affiliation.

In general, I think the flower business is, it’s a low‐single‐digit growth market. They take price. There’s generally low‐volume growth. I think it’s a decent business, and it’s going to stay that way for a number of years.

Ryan Ruppert:

Ok, you’ve mentioned a lot of good news about FTD. Certainly, the market has taken notice of that. Why is FTD still undervalued today despite all of this good news?

Derek Pilecki:

I think it’s normal for stocks to have good news like this, and the market underreacts. The stock is up maybe 12% from the deal price, and I think it should be up more. If you look at earnings estimates for next year. Consensus is around 245. So FTD is valued at 13.5 times next year’s earnings. They’ll get a little bit more synergy in 2016 I think, so the growth rate in 2016 will still be good. I think it’s a pretty inexpensive stock, and I think it’s just normal.

There’s a little bit of noise with the transaction, and the guidance isn’t crystal clear, like we’re going to earn 250 in 2015, and 285 in 2016. So it takes a little bit of time for the market to digest good news. So I think as the market gets more clarity on what the numbers will be. Also, there’s only two analysts who write on FTD or publish on FTD. So It’s not well known. It will be a billion dollar market cap, and a third of that will be owned by Liberty. So the flow of the stock is not enormous, but for small‐ cap managers, it will be perfectly fine to get positions in FTD.

Ryan Ruppert:

Absolutely. So one of the other things that’s extremely important to any money manager, actually, is sell discipline. When you’re looking at FTD today, what kind of increase in valuation or company events would trigger an event where you’d want to sell your shares?

Derek Pilecki:

One thing that I try to do that’s different from other managers is I try not to set price targets because good things can happen to companies that you don’t expect. If you sell at very disciplined price targets, sometimes you don’t get the benefits of those knock‐on effects. So I try not to limit my upside by thinking it’s overvalued here. I try to use my sell discipline more of, are things going an unexpected way for me?

Things that would cause me to sell FTD would be if there was some change in consumer habit that all the sudden sending flowers became a lot less popular. That would be something that I would want to reevaluate. Obviously if this deal doesn’t get consummated, I will reevaluate. If there’s something about the management that changes unexpectedly. Say they made a bad acquisition, which I already said I don’t expect to happen, I will reevaluate.

When I run my portfolios, I don’t do a lot of trimming and adding around positions. So I guess the thing that I like to do is not add to names that are underperforming. So Say FTD starts underperforming the market or the rest of my portfolio and it looks cheap, I probably won’t add to it because I’ll think of that as a mistake. There’s something about my analysis that I missed. And so I’m guarding against throwing bad money after good money. So that’s a risk management technique that I have. I just try not to dump more money into the names that aren’t working.

Ryan Ruppert:

Ok, you’ve mentioned quite a few possible risks, but are there any other challenges or risks that investors that are thinking about FTD should be aware about?

Derek Pilecki:

I think it’s normal things about the economy, margin expectations, like execution of the merger is not going to be simple. There’s going to be some integration risk with ProCommerce and FTD, along with the ProCommerce business or the Provide Commerce business, there’s some other brands that are not in the flower business, so like Shari’s Berries is part of the transaction. There’s a couple other, that type of‐ Gifts.com, Personal Creation. There’s other websites that might be a distraction for management. So there’s, I would say, integration risks with Provide and then just normal economic risk. It’s very consumer‐facing, so consumer confidence will be important for FTD.

Ryan Ruppert:

Ok and when you were analyzing it, how exactly did you model FTD?

Derek Pilecki:

I built an income statement to model out what I think revenues could be and where I thought margins go to. I used the company’s estimates of improvement and synergies.

One interesting wrinkle is this past [Valentine’s Day 00:29:08] was a terrible season for flowers because of the weather in the Northeast was so bad. So just making estimates, are we going to bounce back to what it was like in 2013, and what do the numbers look like then? And so just trying to come up with where I thought margins could get to and what that translates into in income and then earnings per share.

Ryan Ruppert:

Ok, alright, so before I move on to EnLink, is there anything else that you’d like to mention about FTD?

Derek Pilecki:

No. I think FTD is an interesting transaction that not a lot of people are looking at. You get to invest alongside one of the great value creators of all time in John Malone. So I think it’s an interesting situation for people to take a look at.

Ryan Ruppert:

That’s compelling. I’d like to move on to EnLink now then because you’ve identified the shares ENLC as the opportunity, which is the general partner unit at EnLink. So before we go too deep into the business, I want to ask you, because investors can also gain exposure to EnLink through its MLP, which trades under the ticker ENLK. Can you explain to me why you opt for the general partner shares rather than the MLP? What advantages and disadvantages are inherent in that decision?

Derek Pilecki:

Sure, I tend to like the general partners as a rule of thumb. So there’s approximately 120 MLPs that are existing in the public markets. Almost all of them have a general partner. Most of those general partners are privately held, but there’s about fifteen general partners that are publicly traded. In my small‐cap portfolio, I own five of those general partners.

I like the general partner business. I think it’s possibly one of the best business models on the planet. You grow as the underlying MLP grows. It’s not just if the MLP grows, earnings per share or distributions per share, but if they issue more shares, it’s technically bigger. So the general partner benefits from those additional shares outstanding. The underlying MLP could do a merger that was barely accretive, but if it doubled the number of shares outstanding, the general partners’ cashflows are going to double.

So I like the general partner business because even if they don’t issue new shares, the general partner tends to grow at a leveraged rate compared to the underlying MLP. Then you get the inorganic growth at the general partner level if they issue new shares and an offering or in an acquisition. So I generally very favor general partner stakes because of that leverage growth off the underlying MLP.

Now it also makes it more risky because if the underlying MLP declines in its cashflows, the general partner will decline at a leverage rate on the downside, too. So in 2008, when there was some thought that pipeline buy‐ins could decline, or just general economic activity was going to go down, the general partners went down disproportionately compared to the underlying MLP. So it’s just a higher‐risk way of investing, but I think the underlying MLPs generally are stable, slightly growing businesses.

Ryan Ruppert:

Ok, for those who aren’t familiar, can you explain the general partner business? How exactly they benefit and how it’s different from the MLP?

Derek Pilecki:

Sure, the general partner is in control of the MLP. So the MLP doesn’t have a vote, a shareholder vote. You’ve given the general partner authority to make management decisions for the MLP. So the general partner will share in the distributable cash flow that the MLP pays out.

And so it comes in splits, so it might be 0% for the first dollar of distribution that the MLP pays out to its unit holders. And then maybe from $1 to $1.20, the general partner will get 10% of the split. Then maybe from $1.20 to $1.50, the general partner will get 25% of the split. And then above $1.50, the general partner might get as high as 50% of the split of the increase in distribution.

And so having that dollar minimum before there’s any split gives the LP almost a senior position in the distribution of the cashflows, but then as the underlying MLP grows, they’re sharing more and more of the distributable cashflow with the general partner.

Ryan Ruppert:

Alright, that makes sense. Looking specifically at EnLink to provide us with some context, can you tell me about EnLink’s business?

Derek Pilecki:

Sure, EnLink was recently renamed. It started its life as Crosstex Energy, and it became public in about 2004. It has some distribution pipelines in Louisiana and East Texas. And it was a decent growing business. And they got a little over their skis heading into the financial crisis. They didn’t quite have all their financing sewn up, and so they had some issues during the 2008 time frame, and they needed some outside capital.

So Blackstone GSO came in, provided financing, and stabilized the business. And they were growing nicely. They’d gotten back not quite to their former highs, but the business was growing nicely and recovering. Taking advantage of the new basins in Texas, the opportunities to grow their pipeline business.

Then last fall, they did an interesting transaction with Devon Energy where Devon was going to do an IPO of its midstream assets, but instead, they decided to do a transaction with Crosstex where they basically put their midstream assets half into the general partner and half into the limited partner. Then Devon took a significant stake in both entities.

And so if you look at a stock chart last October, Crosstex went from the low 20’s to the mid 30’s as a part of that transaction. So now, the opportunity going forward is you have Devon in there as a parent sponsor of EnLink. Now the transaction’s closed, and there’s going to be a couple drop downs from the general partner into the limited partner.

A drop down is when a general partner owns an asset that could be owned by the limited partner, they’ll create an independent valuation committee and come up with a price, to sell that asset down into the limited partner. The general partner gets cash for that asset or shares in the limited partner, and then they benefit because the distributable cashflow from the limited partner will rise. And so the limited partner, normally, will get a asset the general partner already understands. And they’ll get a decent price for making that acquisition, and they get to grow.

So that provides a little bit of tailwind for EnLink going forward. Then also, it’s important to have this relationship with Devon because Devon’s a dynamic oil and gas company. They’re drilling in new basins in Texas. There will be need for infrastructure, midstream infrastructure assets to support those operations. It will provide some nice organic growth opportunities for EnLink to continue to grow.

Ryan Ruppert:

So you’ve mentioned that EnLink is the result of the merger between Crosstex and Devon’s midstream capabilities. Did you find that and invest in EnLink because of that event, or was there something else that drew your attention to it?

Derek Pilecki:

I had already owned Crosstex prior to that happened. That was a nice bonus last fall, but I think the continuing transaction, continuing entity will have some nice growth rates going forward. So that’s why I wanted to talk about it today. The general partner, the ENLC, general partner provides a nice leveraged growth vehicle on the underlying growth of ENLK.

Ryan Ruppert:

Ok, Gator’s mandate is to achieve high growth. And obviously pipelines being it, pipelines and gas transportation is EnLink’s main business. That’s typically not what investors would consider a high growth industry. They’re certainly profitable but not necessarily high growth. Can you tell me why you think that investors stand to achieve the exceptional growth from EnLink?

Derek Pilecki:

Yes, I think it’s going back to the general partner structure that enables the high growth. If there’s a inorganic acquisition at the MLP, that will provide some nice growth. Then all the cashflow that goes to the general partner is available to reinvest in the business or pay out to shareholders. So the way the math works, even though the underlying pipeline’s only growing a certain amount, it translates into an attractive return for the general partner.

Ryan Ruppert:

Ok, so what this essentially is is a play on the leverage that you have in the general partner position?

Derek Pilecki:

Right.

Ryan Ruppert:

Ok so obviously again, the market has this information. Why do you think that EnLink is undervalued today?

Derek Pilecki:

So I think EnLink, I think it’s fairly valued. I just think the market is underestimating the growth potential of the business. And there’s been a couple of other mergers in the space amongst general partners, and so it’s coming down to there’s going to be a limited number of general partners available.

So if you look at the energy transfer business, they’ve been acquiring general partners. There was some deal talk earlier this summer about Targa Resources’ general partner being in play. Then the Kinder Morgan transaction from a few weeks ago. I think they’re going to, once they do their consolidation of their general partner MLP, I think they’ll be in the market to roll up more businesses. I think it’s possible that EnLink might be in a consolidating field. It’s one of the few plays out there that could be available for consolidation.

Ryan Ruppert:

So you think that EnLink’s underlying business actually stands to see some margin growth as well and certainly some more revenue growth or at least stable revenues?

Derek Pilecki:

Right. That’s correct.

Ryan Ruppert:

Ok, alright, is there anything else from the financial model in EnLink that you think is worth mentioning or thinking about as an investor?

Derek Pilecki:

I think you have to get comfortable with the leverage. If you looked at a financial model, you have to get comfortable. What would the business look like if EnLink’s revenue, earnings, or cashflow went down? Get comfortable with the leverage that’s inherent in the model. To guard against that, we do have Devon as a significant interested owner of EnLink, of both of the EnLink entities. And so I would argue that EnLink is better positioned than it’s been in its history as far as a financing standpoint with that big parent involved.

Ryan Ruppert:

Ok and what fundamental challenges and risks does EnLink face today that we haven’t already mentioned?

Derek Pilecki:

Well I think one big risk is the amount of oil wells and gas wells that are producing energy that certainly commodity price risk is significant. Its not so much in their business and how they price their contracts, but more if volumes decline because prices go down, I think that could be‐ Will people stop drilling if the price of oil drops to $75 or $80? I think that’s a macro risk that I worry about with EnLink.

Ryan Ruppert:

Ok, so I want to make this absolutely clear for our listeners. It’s not direct exposure to oil where a $1 or $2 fluctuation, a small fluctuation in the price is going to have a major impact on ENLC. What’s going to happen is if there’s a large fluctuation, specifically a large decrease in the price of oil, you’ll see lower supply of oil being shipped and drilled, which will have negative repercussions for the company. That’s correct, right?

Derek Pilecki:

Right. Correct. Also, if people stop drilling, there’s less projects and less opportunities for bringing on new projects. So it just slows down the whole value creation in this segment. So ideally, oil would stay at this level or rise slightly to keep those projects coming online.

Ryan Ruppert:

Ok and is there anything else interesting about EnLink that we haven’t covered today that you think investors should hear about?

Derek Pilecki:

I think that’s a good overview of EnLink.

Ryan Ruppert:

Alright, I’d like to conclude this interview where we began: looking at the big picture on small caps. We’ve heard about two very interesting opportunities today. But the cyclical nature of the market often punishes investors who buy good companies at the wrong time. And small caps are even more vulnerable to market volatility than the rest of the market, certainly the larger caps.

So taking a broader market view, is this a good time to be buying equities now, especially considering that the S&P just hit 2000 for the first time or exceeded it today?

Derek Pilecki:

I think one interesting thing with the market this year is how much small caps have underperformed the large caps. It will be an interesting time at the end of this year. Will small caps catch up to their large cap peers and close that performance gap, or are the small caps’ underperformance, is that telling us that the market is about to roll over?

I tend to think that small caps will play catch up. I think that the economy’s solid and getting stronger. I think with employment gains and new household formation that people are getting more confident in their spending. I also think of it as if you have a five‐year time horizon, you should be more focused on small caps than large caps because, although over the next year, large caps might outperform, I think over any five‐ or ten‐year time period, small caps will outperform large caps. So I think it’s an interesting place to look for new investment ideas. And you never know when you can find a name that’s just misvalued because it’s off everybody’s radar.

Ryan Ruppert:

Ok, thank you very much. Are there any macro factors that would give you a little bit of pause and make you question your belief that the market is going to continue rising?

Derek Pilecki:

I think it will be interesting as the Fed starts to raise interest rates in 2015 what [knock on 00:46:06] effects that will have. Will they raise rates too quickly, and it will scare people, or will they do it in a deliberate fashion where it’s 25 basis points every other meeting? So people can adjust and businesses can readjust to the interest rate increases. So I think that’s something to watch for. If they start jacking up rates faster than people can absorb them, I think they’re might be some businesses that have a tough time. So the macro event that I’m looking forward to the most is at what pace does the Fed raise interest rates?

Ryan Ruppert:

Alright, Thanks for taking the time to speak with me today. Before I let you go, I’d like to ask you if you have any parting advice that you’d offer to investors who are looking at small‐caps or just investing in general?

Derek Pilecki:

I think looking at stocks in general is just do your own work and make your own opinion. And you can get ideas from other people, but don’t pull the trigger until you’ve done your own reading. And spend that hour to two hours reading through earnings reports and earnings conference call transcripts. The amount of information that’s available on the web to individual investors these days is great. And so take advantage of that, and do your own work.

Ryan Ruppert:

Thanks again for joining me today. I really appreciated your thoughtful insights on small‐cap investing. Take care. Have a great day.

Derek Pilecki:

Thanks for having me, Ryan.

Ryan Ruppert:

That concludes our interview with Derek Pilecki. If you’d like to find out more about Derek and his team at Gator Capital Management, visit them at GatorCapital.com or call them at 813‐282‐7870. Derek clearly demonstrated that investors should research opportunities in small‐cap equities as these often go overlooked by major banks and investors. FTD and ENLC appear to be tremendous opportunities, and as an investor, they are certainly worth consideration and additional research.

Before I let you go, I need to conclude with some important disclaimers. None of the information discussed today is meant to constitute a buy or sell recommendation for any securities, nor is it an investment advice. We shared the past performance of Gator Capital small‐cap equity portfolio for demonstration purposes only. Past performance is not indicative of future results. Always do your own investment research and be sure to include multiple sources of information.

Derek Pilecki disclosed that he has long FTD and ENLC. This interview was taped on August 26th, 2014. Derek Pilecki’s positions may have changed since this interview was taped. We believe that all of the information presented in this interview is accurate, but we cannot guarantee it. This interview is subject to all of Angry Tiger’s terms of use found at AngryTiger.com/terms.