Manager’s Quarterly Commentary – David Barr – Q3 2015

Written by

We are business analysts. When we meet with fellow unitholders to talk about our investment process, we focus on our role as business analysts and how our private equity background complements this. The reason is simple. We don’t know what the price of any individual security is going to be in the short term. But we do know that over the long term the return we will get is the return on the underlying economics of the business.

Thoroughly understanding the underlying investments and the key value drivers of these companies allows us to concentrate our portfolio on our best ideas. It also helps us to navigate when short term volatility picks up in our holdings. This is relevant today as markets are choppy for one of our key holdings: Espial Group (TSX: ESP). The company has experienced panic selling at points over the past few weeks and our understanding of the business gives us the confidence to act rationally towards our investment during these periods. Anyone who bought ESP on a tip or a recommendation, without doing their own homework, is probably now looking at ways of allocating their capital loss on the investment for 2015.

Espial Group (TSX: ESP)

Last week, Espial announced their Q3 financial results. Revenue and cash flows were both at record highs. You would think this was great news. Au contraire. The press release mentioned that a customer, the “(North American cable) operator does not intend to deploy [Espial’s] software as previously contemplated”. The nature of the change was that this customer is pushing out one platform for future deployment and fast tracking an interim platform. Espial is still the vendor of choice on the interim platform and remains in a good position with the customer for the next generation platform. The financials speak for themselves, they received ~$3.5 million in license revenue from this customer in the quarter and will continue to gain revenue as it rolls out the interim solution.

Stock volatility arose as investors believed this news introduced uncertainty into the customer relationship. Some sell side analysts quite erroneously communicated that the company had “lost” the customer despite the company confirming they had not lost the customer on the conference call.

We took this opportunity to significantly increase our ownership of ESP. If you consider that the company has around $1.50 worth of current assets built into its share price (around $2.30 at the time of writing), factoring in the value of all existing and potential relationships, we believe it remains undervalued and a very attractive investment from a risk/reward perspective.

As business analysts we are always seeking to gain an insight or an advantage over other investors as to the key value drivers of our holdings over the long term. We won’t always be right, but our analysis give us the conviction needed to be aggressive when others are acting irrationally.

David Barr, CFA
November 2015
Standard Performance (as of September 30, 2015)PVF Holding Performance including Espial.