When you think of Stephen Mandel Jr. and his hedge fund firm, Lone Pine Capital, you generally think of savvy long and short bets on companies that are either benefiting from or hurt by the Internet’s evolution, among other strategies.
However, in its first-quarter letter to clients, the Greenwich, Connecticut, firm blames “two investment errors” involving distinctly non-Internet companies for hurting its quarterly and longer-term performance, admitting that they “resulted from an incorrect assessment of risk.”
The investment errors involved two pipeline companies, Dallas-based Energy Transfer Partners and Tulsa, Oklahoma’s Williams Cos., which have been trying to merge, and troubled Montreal-based drug maker Valeant Pharmaceuticals International.
“Nearly all of our long underperformance over the past nine months can be attributed to these errors,” says the letter, signed by Mandel and four others. “The combination of aggressive, highly-incented management, growth strategies predicated on acquisitions, significant balance-sheet leverage and a changed external environment proved to be a toxic stew in each case. Like Icarus, these companies flew too close to the sun and we miscalculated the consequences.”
In September the two pipeline companies agreed to merge in a deal valued at $37.7 billion. However, with energy prices still way down, it is not clear whether this deal will ever close.
Valeant’s stock price has collapsed amid questions about its accounting, one of its former business partners and its overall business strategy.
We earlier reported that Lone Pine’s long-short funds were down between 7 percent and 8 percent for the first quarter, while Lone Cascade, the firm’s long-only fund, lost 5 percent in the first quarter.
According to the firm’s first-quarter letter, dated April 14, Lone Cypress, the firm’s flagship long-short fund, finished the quarter down 8 percent; Lone Kauri was off 7.8 percent; and Lone Tamarack was down 7.1 percent.
Lone Cascade, the long-only fund, slipped 4.5 percent.
This compared with a gain of 1.3 percent for the Standard & Poor’s 500 stock index and a slight, 0.2 percent loss for the MSCI World Index.
Lone Pine also tells clients it lost money on the short side when a number of its holdings suddenly rebounded sharply.
The biggest source of losses on the short side came in the U.S. and to a lesser degree in emerging markets.
The bulk of Lone Pine’s losses on the long side came from U.S. stocks, although emerging-markets longs also accounted for about a quarter of the long-short fund’s decline.
As a result of the recent volatility in its returns, Lone Pine notes that it has “modified” how it manages its long-short balance sheet. It has adjusted its gross exposure to somewhere between 150 percent and 160 percent from a previous 170 percent to 190 percent.
The firm attributes the changes to quantitative strategies, which it points out “account for the majority of equity trading volume” and “create periodic short-term spikes in volatility and feed off of the risk-mitigation actions of fundamental long/short equity managers.”
The changes allow Lone Pine to more opportunistically take advantage of pricing anomalies created by quant-driven strategies, the firm says.
Otherwise, Lone Pine tells clients its biggest concentration remains on Internet franchises and in “leading business verticals enabled by the Internet.”
The firm once again reminds clients that these companies “are driving radical shifts in consumer and business behavior and spending patterns.”
Top bets here include Amazon.com, Electronic Arts, Equinix, Facebook, Alphabet, JD.com, Microsoft Corp., the Priceline Group and Tencent Holdings.
Lone Pine’s second-largest area of concentration is companies whose managements are boosting the operations of acquired businesses. Examples include Alimentation Couche-Tard, Altice, Charter Communications, Dollar Tree, Shire and TransDigm Group.
Another favorite strategy focuses on companies Lone Pine believes will significantly boost operating margins from supply-chain improvements, marketing enhancements or changes in business mix, or a combination of these factors. These companies include Constellation Brands, Lululemon Athletica, Nike, Safran and Ulta Beauty.
And finally, Lone Pine reiterates its strong interest in companies involved in new payment systems, including FleetCor Technologies, MasterCard, PayPal Holdings and Visa.
