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Dear Tarpon Investors,
It’s easy to be a defeatist.
In spite of recent performance that probably brings my sanity into question, I still believe - and think you should still believe - in valuation as an objective truth.
Even here, in the energy sector…a corner of the market that lately has suffered from a strain of investor sentiment that borders on nihilism.
But that is also the opportunity.
Because in investing, free cash flow is ground truth. And in energy, the next few years will almost certainly look much different than what we just went through.
Next month, I’ll share some more specific thoughts on Tarpon.
In the meantime, though - once again, I am asking for continued patience. To resist the urge to throw in the towel. Because if you can make the mental shift of expanding your time horizon from months to years, the volatility that feels like such a problem today can reveal itself as a big opportunity tomorrow. If you can summon the courage - and if you can afford the time - to hang on. More on that in a moment.
It is a painful truth to acknowledge that I have probably tested the trust many of you put in me by subjecting Tarpon to so much drama the last few years.
And I am overdue in my attempts to rebuild that trust.
We own a portfolio skewed heavily towards energy due to my expectations for significantly positive – and widely unanticipated - changes to owners’ earnings per share at each of our companies.
The current free cash flow yield of the S&P 500 is approximately 4%. We are still waiting on capex budgets from some of our companies, but it appears that in 2020, Tarpon will have a free cash flow yield of 3x-5x that of the broader market – at $60 oil prices.
It’s usually quite a challenge to find companies that (a) have free cash flow yields of 10%, which (b) can can also generate growth in free cash flow of at least 10% per year.
Yet we’re swimming in ‘em.
And if we own shares in companies with 10% organic growth and 10% free cash flow growth, the math says we’ll generate an annual 20% unlevered return.
But hold that thought, for now.
This letter is the first of two coming to you in the next month or so.
And it’s the next one that will contain more on free cash flow and our positions in the Tarpon Folio.
This rest of letter is about The Plan.
The Plan For Tarpon
Among my mistakes during this particularly frustrating oil market cycle is my attempt to extract from you all a degree of patience that you may no longer possess.
And in spite of my own strong belief that it is absolutely in our interest to continue to stick with this current thesis in Tarpon, I also understand the doubts and concerns you may have about continuing that approach ad infinitum.
Which means it's time to propose a plan to mitigate the risk that this thesis takes even longer to play out.
This summer, it's going to be time to make a decision.
The current small cap energy strategy that Tarpon has essentially become will be spun-off as a re-named model portfolio here at IIM, focused exclusively on the energy sector.
At the time of that spin-off, Tarpon will then formally return to its roots as a small cap U.S. value portfolio, focused on long-term growth across a number of different industries.
And at that point this summer, the options for current Tarpon investors will be to either:
a. Continue to invest in energy companies via that spin-off strategy; or
b. Resume a more diversified, long-term growth strategy in the back-to-basics Tarpon.
So if oil were soda, and Tarpon right now was New Coke, then Coke Classic is coming back.
That said, it doesn't have to be an immediate, all-or-nothing switchover on a distinct date, either. We can do it as quickly or gradually as you'd prefer. And if you’d like guidance on the move in general or timing more specifically, we’ll work together on that, too.
The point is that by this summer, Tarpon will be diversified. Again. And this current energy-centric strategy will become named something else here at IIM. Like the Sisyphus Perpetual Frustration Strategy - if that domain name is still available, obvs.
Between now and the date at which we formally announce the ‘back to basics’ Tarpon is ready, I will also add two new duties:
1. Analyzing new prospective companies outside the energy sector; and
2. Beginning to recruit other portfolio managers with expertise in specific sectors who want to run their own Spoke Funds here at IIM.
Over time, IIM will become a "hub" for a number of sector-focused Spoke Funds. Each portfolio will be fully transparent, each manager will have a significant stake in the same portfolio as his or her investors, and each strategy will include a few new features for investors, too.
I will continue to manage the current energy-centric strategy, the income-focused Gecko Folio, and the ‘back-to-basics’ Tarpon. Down the road, once we have a full roster of sector specialists onboard with their own Spoke Funds, Tarpon will eventually become a "best ideas" portfolio here at IIM - meaning it will contain the most researched, highest conviction ideas among our future cadre of IIM Spoke Fund managers.
Retz will continue to manage her three international Spoke Funds - Frigate, Treasure Harbor and the small cap Yellowtail, too.
And Maria here in the shop will also continue to help us both manage the fast-growing Private Account business that has taken off here over the last few years - in which we create and manage large portfolios containing a mix of our five proprietary Spoke Funds, alongside more diversified, lower cost, specialized ETFs.
We very much like the idea of bringing you all more analytical expertise in specialized strategies, with the same transparency and alignment of interests that we’ve always had...while giving you more control and flexibility, too.
I am especially fond of doing all of that in a manner consistent with the long-term, value investing philosophy that likely brought you here to begin with.
And I am very curious what you all think about that plan, too.
So, at your convenience, please let me know.
You can either hit reply to this email, or post some thoughts on the Investor Boards.
Thank you. Back to you in a few more weeks with that next note on Tarpon.
- Cale
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Cale's Notes: 
