Letter to Artko Capital partners Q1 2022

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Dear partner,

For the first calendar quarter of 2022, an average stake in Artko Capital LP decreased 11.4%, net of fees. At the same time, investments in the most comparable stock indices – Russell 2000, Russell Microcap and the S&P 500 – fell 7.5%, 7.6% and 4.6% respectively. Our detailed results and associated footnotes are available in the table at the end of this letter. Our results this quarter came from Currency Exchange International as well as modest contributions from US Ecology warrants, while the rest of the portfolio declined along with the broader markets.

2Q21

3Q21

4Q21

1Q22

1 year

3 years

5 years

Creation 01/07/2015

Annualized creation

Artko LP Net

0.5%

-6.1%

-3.4%

-11.4%

-19.2%

7.1%

4.9%

69.3%

8.1%

Russell 2000 Index

4.3%

-4.4%

2.1%

-7.5%

-5.8%

11.7%

9.7%

80.6%

9.2%

Russell MicroCap Index

4.1%

-5.0%

-2.7%

-7.6%

-11.0%

13.0%

9.9%

72.9%

8.5%

S&P 500 Index

8.6%

0.6%

11.0%

-4.6%

15.6%

18.9%

15.9%

150.0%

14.5%

On recent sales

In our last letters to you, we wrote that our main concern remained the Federal Reserve’s willful ignorance of its belief in a unicorn-like concept of “transient inflation” and that three hikes of 25 bp would solve the problem, in particular:

“…we strongly believe that while signaling three to four rate hikes, the Federal Reserve, which has painted itself into a corner, will likely be forced to make seven or eight hikes, including some mid-meeting surprises. That risks creating more market shocks and leading to more psychologically painful adjustments in the more speculative segments of the market, where higher quality small caps will also not be immune, despite strong fundamentals. in short, our expectations for the price performance of our portfolio are volatility in 2022, where despite our best efforts to invest in high-quality growth businesses, there is a chance that “our baby” will be thrown out with the water bath. in the short term…”

Sometimes we hate being right. The market has understood that small incremental increases are unlikely, and it is clear that increases will be measured in hundreds of basis points, not small multiples of 25. We believe the real new risk today is that a clearly embarrassed Fed is trying to act TOO harshly, which it has openly admitted it would, and needlessly “overdoing it” and causing a recession. That seems to be the common view in the market today, which is why small cap indices are down nearly 20% year-to-date. Despite a portfolio with strong balance sheets at over 10% of net cash as a percentage of market capitalization and substantial revenue and earnings growth with little recession-related risk, to date the median valuation of our portfolio is close to 4.0x EBITDA and, as we predicted, “our baby” is being thrown out with the bathwater. After listening to 1st 2022 quarterly earnings reports and subsequent conversations, we remain confident that our portfolio companies will continue to grow in the turbulent and uncertain months ahead due to strong backlogs, commodities and secular tailwinds far exceeding short-term economic uncertainties. Thus, we believe the current market performance is much more like “taper tantrum” and uncertainty-based Grexit/Brexit-style declines than late 2008/March 2020 based declines on decimated fundamentals. In other words, we consider it to be market growth difficulties adapting to a more normalized economy where the cost of capital is above zero and where fundamental-based marginal investors are once again taking part in speculative investors. of recent years. In general, this is the least worry we’ve had in a negative market performance scenario and we consider not having enough capital to invest in the tremendous opportunities available in the microcaps space today is our biggest problem.

Enhanced Portfolio Additions

1847 Goedeker Inc $2.25 02/06/2026 Warrants (GOED WS)

We acquired an 8% position in 1847 Goedeker Inc (GOED) warrants at an average cost of $0.62 starting in late December 2021 and we are continuously adding more throughout 2022 to drive our price down medium. We are very excited about this investment and believe the market has presented us with a fantastic multibagger opportunity.

Our investment in GOED, a high-growth home appliance e-commerce company, is very reminiscent of our investment in HireQuest (HQI), where a large, successful private company merged with a significantly smaller and underperforming public competitor. In the case of HQI, it merged with a competing command center with a market capitalization of $20 million and it took the market a while to realize that the new company is a cash flow generating machine. available (FCF) led by an industry veteran and it was not. plus the company represented by its historical numbers. GOED is no different as it was a small $50 million revenue and near-bankrupt company that merged with much larger competitor Appliance Connection in 2021. The combined company is expected to generate nearly $650 million in revenue. and nearly $65m/$55m EBITDA/EBIT in 2022, with revenue growth of more than 20%, despite an incredibly challenging economic environment. This was again reaffirmed in the company’s latest earnings call in May. Despite all of this, at the end of the quarter, the company, at a share price of around $1.40, had a market cap/enterprise value of 150mm/$170 or 2.3x/3, 0x EBITDA/EBIT, an absurdly low price implying bankruptcy or an imminent collapse in consumption. Given that Bank of America just approved a $140 million loan deal to the company, the size of its total market capitalization at the time, and unlike furniture, most appliance purchases don’t cannot be put off (try going without a fridge for a few weeks), we find the above scenarios highly unlikely.

So what makes GOED (or Appliance Connection) so special? On the one hand, we believe that the home appliance e-commerce industry, with a share of about 20% of the total home appliance pie, is still far behind the furniture industry with a penetration of more than 40 % and these secular tailwinds are expected to drive industry growth of 20%. -30% per year in the intermediate future as it continues to take brick and mortar retail market share. This is consistent with the 20% revenue growth guided by management during its late March 2022 earnings call and reaffirmed in May 2022. The industry is currently quite stratified with large bricks and mortar: Home Depot, Lowes and Best Buy controls around 70% of the share, while the rest is characterized by legacy “mom & pop” competitors where Appliance Connection CEO and Founder Albert Fouerti sees the most opportunities to take market share . The company’s main differentiators are services such as delivery and installation where larger competitors, where appliances are a small part of their business, are not excellent, and selection, where most places have 10-20 bestsellers available compared to the 365 low to high end items carried by GOED.

We are thinking of post-merger investor turnover; a capital structure, where a company with a stock price of $1.70 and 106 million shares outstanding, has 98 million warrants at a strike price of $2.25; and general economic fears pushed the stock price to unrealistic valuation levels of low single-digit earnings multiples. The company’s peers are trading at high single-digit/low double-digit multiples with lower growth opportunities. We believe this valuation gap is unsustainable and with our near-term price target of over $5.00 per share, warrants are the best opportunity to play this particular situation. With the newly approved loan, confidence in the outlook, and management’s willingness to continue to repurchase shares and clean up the capital structure, we believe it’s not a matter of “if” but of “when.” the market will wake up to one of the best small cap investment opportunities in the world.

Partnership Updates

We welcomed a new partner to the partnership this quarter, bringing our total to 45 at the end of March. We completed our audit successfully for the sixth consecutive year, the results of which you should have received last month. Despite the current economic challenges, we are excited about the continued growth in the number of partners and are grateful for your business.

Opening of the next fund

Our next partnership openings will be June 1, 2022. Please contact for updated offering materials and presentations at [email protected] or 415.531.2699.

Peter Rover, Portfolio Manager, Artko Capital LP


Appendix A: Performance Statistics Table

Artko Raw LP

Artko LP Net

Russell 2000 Index

Russell

Micro Cap Index

S&P 500 Index

YTD

-11.1%

-11.4%

-7.5%

-7.6%

-4.6%

1 year

-18.1%

-19.2%

-5.8%

-11.0%

15.7%

3 years

10.5%

7.0%

11.8%

13.0%

18.9%

5 years

7.9%

4.8%

9.7%

9.9%

16.0%

Creation 01/07/2015

114.1%

69.3%

80.6%

72.9%

150.0%

Annualized creation

11.9%

8.1%

9.2%

8.5%

14.5%

Monthly average

1.2%

0.9%

0.9%

0.9%

1.2%

Deviation St monthly

6.8%

6.5%

5.7%

6.3%

4.2%

Correlation with Net

1.00

0.71

0.69

0.62


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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.

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