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Raging Capital: A Lesson In Small-Cap Activism

Sometimes activism isn’t clear cut. It comes in all shapes and sizes. And can even come from a church. Bill Martin founded Raging Capital Management back in 2006 and runs the firm out of what looks like an old church in Princeton, New Jersey.

Raging Capital headquarters

Raging Capital headquarters

Before founding Raging Capital, Bill founded the institutional investor research platform, insiderscore.com, in 2004. Bill is also an avid private market investor, funding privately held companies and advising private equity firm Princeton Ventures Management.

But don’t let Bill’s startup mentality or wonky headquarters fool you.

The $500+ million AUM firm has been crushing it, with a compounded annual return of between 22% and 24% since inception (depending on the fund) - outstripping the S&P 500 CAGR by over 14 percentage points.

Bill has managed this running a hefty short book, along with a long book that’s becoming increasingly skewed toward activism and activist targets. All told, Raging Capital’s philosophy goes something like this - invest in deep value stocks with a catalyst and growth companies before they’re known, all while running a “off the beaten path” short book.  

Bill is getting his entrepreneur fix by investing in small- and micro-cap information technology companies, taking an activist approach. That’s the beauty of small-cap activism, you have the potential to make a meaningful difference, akin to truly doing God’s work.

Raging Capital is the underrated activist

Raging Capital has been involved with some home runs in the small-cap activist investing space. The likes of Sigma Devices (NASDAQ: SIGM) and Resource America (NASDAQ: REXI) have worked out well since Raging Capital’s involvement, but one of its biggest, and hardest fought battles was with Vitesse Semiconductor (NASDAQ: VTSS) - the now $366 million market cap fabless American semiconductor maker.

From the day Raging Capital went active until the day it was sold to Microsemi (NASDAQ: MSCC), shares of Vitesse were up 108%. Over that same period, the S&P 500 was up 60%. A 29.4% CAGR for Raging Capital in Vitesse over its 13D period - versus an S&P 500 CAGR of 17.9% over the same period.

Raging Capital first got serious about Vitesse in 3Q 2011 when it filed a 13G, revealing a 3% stake. Things got interesting in mid-2012 when Raging Capital officially went active on the company with an 8.5% stake. Then in early 2013 it took its stake closer to 20%.

When the company was sold in April of this year, Raging Capital owned over 20% of the company and from start to finish (from its very first investment in Vitesse) the fund made a CAGR of 35%+ on its money.

Vitesse is the epitome of small-cap activist target - a beaten down company where an activist can come in and have a material say in how the company is ran and its future direction. Being able to have a truly meaningful say is where that alpha and additional value is generated and created.

Vitesse took nearly a decade to crawl out of the depths of the tech bubble, where it ultimately lost over 95% of its market value. With a pivot away from storage networks toward wireless networking technology, Vitesse essentially saved itself. It started locking in contracts for long-cycled semiconductor chips with major network players like Cisco (NASDAQ: CSCO).

But, without much attention from Wall Street, a battered history and hefty debt load, you still had a company trading for 25 cents a share in 2010. And, well, Bill is a sucker for a turnaround story backed by valuable technology. Hence, Bill and Raging Capital did the legwork, realized that the runoff value of Vitesse’s contracts were worth more than the trading value of company and made their move.

What’s most interesting about Raging Capital’s involvement at Vitesse, like many small-cap activist campaigns, is that it wasn’t straight equity. Raging Capital also bought a fifth of Vitesse’s outstanding bonds at a discount to par value.

As the activist story goes, Raging Capital started with getting one nominee on the Vitesse board and ultimately had four representatives on the seven-person board. With boots on the ground Raging Capital could really get its arms around the company, ultimately helping ease the debt burden.

Vitesse had large debt maturities set for 2014 and the answer was to raise capital via the equity markets. A sometimes frowned up practice that dilutes current shareholders, yet, in this case, it helped significantly deleverage the balance sheet. What was encouraging at the time was that throughout the three capital raises from 2012 to 2014, Raging Capital participated each.

Ultimately, its technology did prove valuable and with that its customer base grew. With Raging Capital’s help, Vitesse took advantage of the consolidation in the semiconductor space and formed a strategic alternatives board in early 2015, getting the company sold at a 35% premium in April.

The big key here is that through these three years, Raging Capital’s Bill Martin likely grew a lot and learned a lot. Specifically, how to find leverageable, underappreciated, technology and create a runway (i.e. balance sheet finesse) to ensure the market has time to fully appreciate the opportunity. Meanwhile, there are ways to protect the downside, either through debt ownership or inherent runoff value.  

Where else Raging Capital is finding value

Raging Capital’s top holding on the long side, after the Vitesse sale, will be Range Resources (NYSE: RRC). This is all part of Raging Capita’s big bet on natural gas.

The capital allocation management is the real story with Range Resources - not to mention its natural gas acreage; Marcellus Shale anyone? Being able to match capital expenditures with cash flow is something that many commodity companies are struggling with, but Range Resources’ ability to do so should allow them to boost production by 20% this year. Bill has called his natural gas bets the invisible hand, where the supply-demand natural gas imbalance will sort itself out sooner rather than later.

Seemingly, Raging Capital runs a portfolio that’s skewed toward energy, with about 40% of their long-only portfolio invested in names like Range Resources, but that 40% is a bit misleading - Raging Capital has a couple hefty call positions on Pioneer Natural Resources (NYSE: PXD), Chesapeake Energy (NYSE: CHK) and even Range Resources.  

Their real bread-and-butter is in the information tech space, hence Vitesse.

Raging Capital’s latest activist bet

In July, Raging Capital went public with its latest activist campaign, taking on the $100 million market cap clean-tech semiconductor maker, Intermolecular (NASDAQ: IMI). Raging Capital owns 22.9%. Intermolecular is Now off 80% from its all-time high in 2013

At the end of the day, some of Raging Capital’s 14 percentage point alpha (versus the S&P 500), and closer to 22 percentage point alpha versus the Hedge Fund Research hedge fund index, can be attributed to small cap activism. An area that more investors should pay attention to, rather than falling all over themselves for Bill Ackman’s latest foray into an increasingly crowded area of large-cap activism. Don't forget - sign up for our free daily newsletter to stay in the activist investing know.