My favorite line of the day came from private equity investor, Justin Ishbia: “We don’t promise outcomes, we promise a process.”
That captures something essential about investing. We all want strong long-term returns. A sound process, practiced faithfully through good times and bad, gives us the best chance of achieving them.
It is more difficult than it sounds.
A process is easy to embrace when it produces immediate results. The real test comes when following it makes you look wrong. When a stock you buy falls further. When the market rewards what you passed on and punishes what you own. When your analysis points to an opportunity so attractive that you hesitate to say the numbers out loud.
This last scenario is particularly relevant to my presentation.
I pitched QXO, an investment characteristic of our approach: an honest, probabilistic assessment of a business’s fundamentals and resulting value, compared with the expectations embedded in its stock price. We consider a range of outcomes, what could go wrong, and whether the prospective reward adequately compensates us for the risks. We are willing to tolerate short-term downside when we believe the long-term gains justify it.
QXO has tested that willingness. The stock fell more than 60% from its recent high to its recent low. We actively purchased shares after the decline, and those purchases weighed on short-term performance.
By the time I presented in Chicago, our estimate of intrinsic value was approximately four times the stock price. Our analysis implied a compound annual return of roughly 50%.
I recognize how that sounds. When I’ve heard investors pitch stocks with those kinds of prospective returns, I’ve historically scoffed. It’s easy to pencil optimistic assumptions into a spreadsheet. It’s more difficult to deliver on them.
But I also had to remain true to our process. An unusually attractive conclusion deserves additional scrutiny. It does not deserve automatic rejection because it sounds too good. If our assumptions are reasonable, our probabilities honest, and our assessment of the risks sound, we should be willing to follow the analysis wherever it leads.
Those estimates may prove wrong. Our responsibility is to keep testing them against the evidence, including evidence that challenges what we believe.
I was recently asked if it’s more difficult to remain optimistic after a stock declines a lot. As with everything in investing, the answer is it depends.
In the case of QXO, it’s not more difficult. In fact, I’m energized when I find opportunities to make a lot of money from a market misunderstanding. The reason the stock is down: weak macro and being early in the technology transformation plan. But these reasons don’t reflect negatively on the long-term fundamentals of the business. When fundamentals continue to support our long-term estimate of value, it’s easy to have conviction.
Mostly, stock prices move with fundamentals, though to a much greater degree. When fundamentals disappoint, that’s when we need to reassess our enthusiasm. In these circumstances, we do a thorough review of our assumptions and analysis, and exit when appropriate.
As of this writing, QXO has bounced approximately 30% from when we presented after pre-announcing results that were better than expected.
The QXO situation reminded me of a commentary Bill Miller wrote in January 2010. Discussing inexpensive, widely followed companies, he drew on Edgar Allan Poe’s The Purloined Letter: “Like Poe’s Purloined Letter, these values have been hidden in plain sight.” You can read a copy of that letter here.
In Poe’s story, an exhaustive search for the missing letter fails because the searchers don’t look in the most obvious place. It’s sitting right on the desk.
Investment opportunities can be similarly visible. In today’s market environment, there aren’t broadly mispriced asset classes waiting to be discovered. Some of the most attractive returns are lying in plain sight, in corners of the public equity markets where a combination of passive and short-term investing creates inefficiencies.
In a market where attention is often measured in hours, days, months, or quarters, the willingness to look several years ahead—and endure the intervening uncertainty—can be a meaningful advantage. An investor concerned primarily with the next quarter may have little interest in an attractive outcome several years away, especially if the stock could fall before getting there.
Precigen offers another current test of that discipline.
Following the unexpected accelerated FDA approval of Inovio’s competing treatment for recurrent respiratory papillomatosis, Precigen shares fell approximately 48% quarter-to-date through November 6. The decline has detracted roughly 440 basis points from our portfolio’s return.
We believe the market is overreacting to the news. PAPZIMEOS reported a 51% complete response rate at one year, versus 27% for Inovio’s treatment in its FDA-defined efficacy population. PAPZIMEOS has a significant head start getting to market with hundreds of patients treated, while Inovio has yet to hire a sales force. On top of all that, Inovio’s device delivers painful shocks. We continue to believe in the superiority of Precigen’s product, though we’ve always assumed competitive products would enter.
PAPZIMEOS’s commercial performance continues to exceed our expectations. Third-quarter PAPZIMEOS revenue reached $72.9 million, up 37% sequentially, and Precigen generated $11.9 million in positive operating cash flow.
We estimate the value of their RRP (recurrent respiratory papillomatosis) business alone is worth approximately $11 per share, compared with the current stock price in the mid $4’s. We also see additional value in the broader pipeline. Excluding investments to advance the pipeline, PGEN trades at 6.8x 2027 earnings with a 16% free cash flow yield. We take the competitive risk seriously, but we believe the selloff has widened the gap between price and value.
Drawdowns are painful, though they are an inherent part of investing. When we face these situations, we strive to do an honest reassessment of the impact of any changes on the underlying fundamentals of the business. We view erosion of our intrinsic value estimate as a significant risk indicator.
In the cases of PGEN and QXO, our intrinsic value estimates have held steady. As such, we view price weakness as an opportunity.
We cannot promise when the market will recognize the values we see, or that every investment will work. We can commit to doing the work, being honest about uncertainty, and making decisions based on prospective returns rather than the discomfort of recent price moves.
That is the process we believe gives us the best chance of finding—and realizing—attractive values hiding in plain sight.
FOR INSTITUTIONAL USE ONLY
The views expressed in this commentary reflect those of Patient Capital Management as of the date of the commentary. Any views are subject to change at any time based on market or other conditions, and Patient Capital Management disclaims any responsibility to update such views. These views are not intended to be a forecast of future events, a guarantee of future results or investment advice. Because investment decisions are based on numerous factors, these views may not be relied upon as an indication of trading intent on behalf of any portfolio. Any data cited herein is from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. The information presented should not be considered a recommendation to purchase or sell any security and should not be relied upon as investment advice. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned. References to specific securities are for illustrative purposes only and are not intended as a, solicitation, or recommendation of any particular security or investment strategy. Any specific securities referenced herein, have been selected by the author on an objective basis to illustrate the views expressed in the commentary. Such references do not include all material information about such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities.
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