Enterprise Diversified (SYTE) ‘Is Worth Far More Than Book Value’: Arquitos Capital

New York-based hedge fund Arquitos Capital is bullish on Enterprise Diversified (OTCMKTS: SYTE), which is engaged in asset management, real estate, internet access, and home service businesses. In the fund’s Q4 investor letter, Steven Kiel, who manages Arquitos Capital, discussed Enterprise as well as two other companies. Let’s take a look at Kiel’s comments about Enterprise:

In 2017, Arquitos returned 80.8% before fees. Of that, almost half was generated by SYTE. We gave back some of those gains in 2018 but are still significantly ahead of our original cost basis. Clearly this position has an outsized effect on our portfolio. It currently makes up 29% of the fund. At the end of 2017, the stock traded at $14.88 and a multiple of book value of 2.2. As chairman, I won’t publicly provide my opinion of valuation on the company, but it is fair to say that I believe the company is worth far more than book value. Book value is understated for a variety of reasons, chief among them is that it does not take into account our relationships with a number of talented money managers.

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Those relationships contain fee shares with SYTE’s Willow Oak Asset Management subsidiary. As the funds grow, this provides exponential increases in revenue for SYTE with no corresponding expense. These fee shares provide positive leverage with no downside risk.

When you are partnered with talented managers, there is no better business than investment management. Our managers are driven, smart, and unique and have a long runway ahead of them. Plus, SYTE expects to team up with more fund managers through its Fund Management Services in 2019. There is a lot of potential with little risk for the company.

Let me give one illustration. The Bonhoeffer Fund is managed by Keith Smith, who is a SYTE director. Keith is a talented investor who runs a differentiated portfolio. He owns stakes of companies in South Korea, the Philippines, South Africa, Italy, and other countries.

Bonhoeffer was launched in July 2017 and currently has $14 million under management. SYTE has a 50% fee share with the Bonhoeffer Fund. It is not unreasonable to assume that by 2022 Bonhoeffer gets its assets under management up to $50 million. Let’s also assume, as a thought experiment, that the fund returns 30% that year. Too high you might say? 30% is the average yearly return that Keith made in his personal portfolio in the 11 years prior to launching the fund. (This includes a 146% gain in 2013 when

Arquitos only returned a lowly 59%). With Bonhoeffer’s fee structure and SYTE’s fee share, SYTE would earn approximately $1.5 million in 2022. Book value for SYTE’s Bonhoeffer interest is currently $0. The market cap of the entire company is currently $22 million. One relationship and one year has the ability to earn 7% of the entire value of the company.

SYTE also owns 100% of Willow Oak Select Fund and receives a fee share from Alluvial Fund in addition to its direct investment. Additionally, as part of the Fund Management Services agreement with Arquitos, SYTE receives a small fee share from Arquitos. This comes from the management company, not the fund. All of these relationships are extremely valuable to SYTE and are carried on the books at $0.

At the end of 2018, SYTE traded for $8.70 and a multiple of book value of 1.1. Book value grew in 2018 (through Q3, with Q4 not yet being reported). Quite frankly, given the details about the potential of SYTE’s asset management subsidiary above, does it really matter why the sentiment changed and the multiple of book decreased? Are there any legitimate doubts among SYTE investors that the long-term value of the company far exceeds its current valuation?

Enterprise Diversified (OTCMKTS: SYTE) has a market cap of $21.51 million. Shares of the company are down 3.15% year-to-date. While the stock has fallen 49.40% over the past six months.

SYTE’s wholly-owned asset management subsidiary is Willow Oak Asset Management which produced $330,112 in revenue for the quarter ending September 30, 2018. Through Mt Melrose, the company owns 195 properties in Lexington, Kentucky, consisting of single-family and multi-family properties, commercial properties, and vacant lots. The company operates its wholly-owned home services division through HVAC Value Fund in Arizona. Its wholly-owned internet operations subsidiary is Sitestar.net, which provides internet access, modem services, domain sales, and web hosting in the United State and Canada.

Disclosure: none