Alluvial Capital Management, an investment management firm, published its second-quarter 2021 investor letter – a copy of which can be downloaded here. A return of 7.0% was delivered by the fund for the Q2 of 2021. Returns for the quarter, year-to-date, and since inception periods comfortably exceed all relevant benchmarks. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
In the Q2 2021 investor letter of Alluvial Capital Management, the fund mentioned Crossroads Systems, Inc. (NYSE: CRSS) and discussed its stance on the firm. Crossroads Systems, Inc. is a Dallas, Texas-based holding company with a $143.3 million market capitalization. CRSS delivered a 146.15% return since the beginning of the year, while its 12-month returns are up by 201.89%. The stock closed at $24.00 per share on September 10, 2021.
Here is what Alluvial Capital Management has to say about Crossroads Systems, Inc. in its Q2 2021 investor letter:
“We took advantage of another fast-moving opportunity this quarter in Crossroads Systems. Given the fund’s large investment in P10 Holdings, I am obviously a fan of Robert Alpert and Clark Webb at 210 Capital. Crossroads Systems is another 210-controlled entity. Prior to this year, Crossroads’ sole line of business was an alternative housing lending business in Texas. Solid, profitable, and growing, but perhaps not the most exciting. But with the expansion of the Paycheck Protection Program, Crossroads saw a major opportunity to earn fee revenue by partnering with a financial technology firm to provide PPP loans to small business operators and sole proprietors. When the dust settled, Crossroads Systems subsidiary Capital First Financial had provided billions through >470,000 individual loans and received an astonishing windfall from the associated fees. In the space of a few months, Crossroads used up its net operating losses completely and earned more than $50 per share, net of tax. The company will likely earn another ~$3 per share from net interest income before these loans are forgiven.
We were able to acquire shares of Crossroads Systems at prices ranging from $40 to $50, prices which I believed provided an acceptable discount to fair value and a high likelihood of an attractive return once the company revealed its bumper profits to the market. Last month, the company reported results for the quarter ended April 30, which included net loan fees for 200,000 of the total PPP loans. Some investors were disappointed by the margins Crossroads earned after processing costs and the fee split with the fintech loan originator, but the report confirmed the windfall profit. While the magnitude of the company’s one-time earnings bonanza was now known to investors, an important question remained. What would the company choose to do with all the excess cash? After all, the PPP program was over and done, and existing operations could not absorb this much incremental capital.
Last week, Crossroads Systems announced it would pay out most of its earnings as a $40 per share special dividend, retaining $20 per share in liquidity to support the growth of existing operations. The market reacted positively, sending shares to $60. Whether or not Crossroads Systems has a continuing place in our portfolio depends on where shares settle following the dividend payout, and on the strategy the company pursues going forward. I have a lot of confidence in the company’s team. Members of the 210 Capital complex continually find creative ways to make money. If Crossroads Systems trades at or below pro forma book value following the dividend payout, the risk/reward tradeoff may be too good to pass up.
A pet peeve of mine is small companies that hold onto cash far, far beyond their conceivable needs. Sure, businesses should keep adequate cash to fund operations through ups and downs, and a “rainy day” cash stash is never a bad idea. But when companies hoard cash sufficient to cover years upon years of losses in the most adverse scenarios, shareholders are being deprived. It usually comes down to incentives. If management does not own a meaningful percentage of the company, what does it benefit them to return excess cash to shareholders? Sure, the principalagent issues at hand can be ameliorated with well-designed compensation structures, but most small companies have nothing like that. So more and more, I avoid small companies with large non-operating cash holdings in the absence of a specific strategic rationale. I simply don’t trust management to use the cash well or return it in a timely fashion.”
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Based on our calculations, Crossroads Systems, Inc. (NYSE: CRSS) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. Crossroads Systems, Inc. (NYSE: CRSS) delivered a -52.00% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
