Portfolio Update: Noteworthy Developments in AST SpaceMobile, Shentel and Altus Group

Commentary

The market’s robust first-half performance was largely driven by a small group of tech giants, with the “Magnificent Seven” accounting for nearly two-thirds of the market’s gains. Just three of those seven stocks drove almost half of the market’s return. More than 40% of U.S. stocks in the Russell 3000^® were down in the first half. The extreme outperformance of a handful of mega-caps is unusual, and stands in striking contrast to the dramatic underperformance of small-cap equities. With small-cap equities barely up in the first half of the year, large-cap stocks outperformed small-cap stocks by the largest margin in history.¹

On July 11, the June Consumer Price Index (CPI) report showed that inflation cooled more than expected, which has proven a turning point for small-cap stocks. Small-cap stocks proceeded to outperform large-cap stocks by the largest margin ever recorded in a 10-day period. While we suspect that this rotation has more to do with fund flows than fundamentals-driven investing, it is true that lower interest rates disproportionately benefit smaller companies, which are more reliant on floating-rate debt and external financing.

In our portfolio, our small-cap holdings and more rate-sensitive holdings have made up significant ground since the release of the impactful June CPI report. As of July 31, the Fund (HFCIX) returned 16.29% year-to-date compared to 6.62% for the Russell MidCap® Growth Index and 15.67% for the Russell 3000® Index. We believe that we are on the cusp of a less restrictive monetary policy that will prove beneficial to our holdings, and a wider range of companies and sectors overall.

During the quarter, we exited our position in SS&C Technologies Holdings, which was a 1% position as of March 31, 2024.

We did not add any new positions, but we have had some noteworthy developments at several portfolio companies, as discussed below.

AST SpaceMobile (5.6% of assets)

AST had a momentous second quarter with the announcement of a signed contract with AT&T (they had previously disclosed a memorandum of understanding with a contract under negotiation), a strategic partnership with Verizon that includes a $100 million commitment, and the addition of Chris Sambar, AT&T’s Head of Network, to the Board of Directors.

The emergence of Verizon as a partner was a significant positive surprise.  This effectively doubles the addressable market for AST in the U.S.—the most lucrative wireless market in the world—while advancing AST’s capital plan. Further, it is a major endorsement of AST’s technology, given Verizon had historically been a vocal skeptic of AST’s capabilities.

Meanwhile, Starlink—AST’s most formidable and well-funded direct-to-cell competitor—is coming under increased scrutiny from the FCC for interference its satellites may cause to wireless services in adjacent spectrum bands. It is not clear that these issues can be resolved using Starlink’s existing technology, posing a potential significant setback for the company.

In our view, these developments further solidify AST as the early leader in this emerging industry. Additionally, given the technological complexity, long lead times, and capital-intensive nature of building a space satellite network, we are increasingly thinking that there may be only one or two providers that manage to achieve global scale. If we are correct in this assessment, and AST is one of those networks, it should develop into a very high-quality, durable business franchise deserving a premium valuation.

Shenandoah Telecommunications (2.1% of assets)

Shenandoah Telecommunications (“Shentel”) has substantially repositioned its portfolio over the last several months, buying a complementary business in an adjacent market and selling a non-core asset to help fund that acquisition. These were large transactions for Shentel, each representing 30-40% of the company’s enterprise value.

•    In early April (announced in October), Shentel closed on a $385M acquisition of Horizon Telecom, an Ohio-based commercial and residential fiber business that is geographically adjacent to Shentel’s core western Virginia, Maryland, and West Virginia footprint. Like Shentel, Horizon provides rural residential broadband services, but it also has an attractive and fast growing commercial broadband fiber operation. There are obvious cost synergies from the combination of these two businesses, potential revenue benefits from commercial broadband learnings, and Horizon adds 86k homes to Shentel’s fiber build growth pipeline. While Horizon has clear strategic fit, Shentel paid a full price—12.9x post-synergy EBITDA.

•    In late March (announced early March) Shentel closed on the sale of its cellular tower business for $310M, or about 31x 2023 segment adjusted EBITDA—a full valuation for the asset. This was a high quality, but slow growth rural tower portfolio that was no longer core to the company after the sale of its T-Mobile wireless service franchise in 2021.

We have a mixed view of these transactions. While we were delighted to see the sale of the non-core tower assets at a rich valuation, we were disappointed with the purchase of such a richly valued fiber company. Based on our discussions with management, we had expected Shentel to be focused on acquiring distressed fiber overbuilders that overextended themselves the last few years during the period of cheap credit.

The premium priced acquisition of Horizon is especially disappointing in light of Shentel’s own stock trading at about 6x adjusted EBITDA at the time of the transaction. While it would have been impractical for the company to tender for hundreds of millions of dollars of thinly traded Shentel stock, we think a mid-sized share repurchase and continued patience waiting for distressed acquisition opportunities would have been preferable—a view that we have shared with management.

While we are disappointed with the price paid for Horizon, and the opportunity foregone, this was Shentel’s “big pivot” and we do not foresee any other large capital allocation decisions in the next several years. Further, management has a long track record of adept capital allocation, so perhaps this decision was an outlier.

Meanwhile, Shentel is executing well on its aggressive organic fiber build plan, and the stock remains very inexpensive. We think intrinsic value is building at a nice clip, so we will likely continue to be owners until such time that the business quality and growth profile are more fully reflected in the stock.

Altus Group (1.1% of assets)

In early July, Altus Group announced a transaction to sell its Property Tax services business for about $500M. This is a material transaction for Altus, with the business composing about 40% of overall segment level EBITDA. As we have written before, the Property Tax business is an attractive, but mature business with organic revenue and EBITDA growth likely to approximate 3 or 4% going forward.

Altus’s Property Tax business was a “cash cow,” useful for funding organic and inorganic investment in Altus’s higher growth, higher quality Analytics segment. With the Analytics business recently restructured, margins climbing, and several foundational acquisitions completed, Analytics is now in a much better position to stand on its own without the financial support of Property Tax.

We view this transaction as a clear positive, with the company receiving an attractive price (10x EBITDA, compared to the 8-10x we used in our sum of the parts valuation) and concentrating its exposure to its data and analytics franchises. We applaud management for making this decision. While Altus will be a smaller overall organization, it should also be more focused, with sharper execution and a streamlined story for investors.

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