BONHOEFFER FUND, LP Q3 2017

Dear Partner,

The Bonhoeffer Fund continues to raise funds and has now invested 80%+ of its capital in a
portfolio that represents select, growing securities purchased at prices below their intrinsic value. I
sincerely thank you for continuing to believe in my process and entrusting our team with your
hard-earned money. In this letter, and in future letters, I will select one security from the fund and
the approach that I apply to vet opportunities and do a deep-dive into how and why I chose a
specific position. The goal of this approach is to further your understanding of the Bonhoeffer
investment strategy and demonstrate my investment philosophy when applied to real-world
opportunities.

The Bonhoeffer Fund’s positions are pulled from all over the world, with just over half residing in
Asia. The rest are in Africa, South America, and Europe. The securities cover a variety of industries,
a few of which include payment processing, beverage, telecom, media, and real estate. Not much
can be said about the fund’s performance given the short track record, but I can highlight that these
19 securities have a weighted average free cash flow yield of 20% and a weighted average
EV/EBITDA of 3.0.

Many events occurred on the global stage over the past three months that influenced our investable
market and created opportunities for us to buy interesting and undervalued securities. For the
purposes of this letter, I would like to focus on Asia—and specifically the Koreas—since the largest
holding in the Bonhoeffer Fund is in this part of the world. The current threats from North Korea and
the ongoing diplomacy efforts, in conjunction with the Winter Olympics in South Korea, create some
interesting market forces and global perceptions. Many are approaching South Korean stocks with
trepidation because of the threat from the North. While this risk is real, in my opinion, the magnitude
and probability of a nuclear event occurring is overestimated by the market. We search for and
invest in these types of environments where dissonances in perception are present.

Over the first few letters, I will describe some key frameworks we utilize for security selection
including compound mispricings, miscategorized firms, and capital structure analysis.

Compound Mispricings

In this letter, I will do a deep-dive into compound mispricings and how the Bonhoeffer Fund
identifies and assesses these opportunities. The ability to do so is a lethal tool in any investor's

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armory; and much of the Bonhoeffer Fund’s holdings represent opportunities where a compound
mispricing is present.

A “compound mispricing” is a situation where both a firm and a security or derivative security is
mispriced. Early in my career, I was aware that compound mispricings generally existed, but I had
not seen them formally defined until I read David Abrams’s commentary on Nikkei puts in the 6th
edition of Graham and Dodd’s Security Analysis, which is a must-read for any investor. 1

We often look for compound mispricings in multifaceted corporate structures. Holding companies
and derivative securities such as long-term equity anticipation securities (LEAPs) fit the bill. Voting
and/or non-voting securities such as Korean or German preferred securities or Italian savings
shares are also good examples. When approaching these types of securities, the market oftentimes
misprices the underlying firm and/or securities in the firm’s capital structure. In complex capital
structures, there are many permutations available to unlock this hidden value. The following are a
few examples:

1) The underlying firm value may be mispriced due to the influence of bad press on public
perception, the effects often connected to short-term profitability, or a special situation
such as a spin-off or merger.
2) An excessive holding company discount which is a cut to prices directly related to the
amount of overhead incurred by the holding company. Other factors include: distribution
policy, the prospect of minority shareholders (versus management) realizing current and
future value generated by the firm, if there is a controlling shareholder, and the liquidity
of the holding company shares versus other firm shares.
3) Excessive voting/non-voting discounts. Voting/non-voting discounts are directly related
to whether they can make a difference (i.e., does someone already have a controlling
position), the differential amount of the dividend, and the liquidity of the non-voting
shares versus the voting shares.
4) Cheap leverage (e.g., low interest rate) embedded in derivative securities. This can
happen in a short squeeze when it costs a lot to borrow the underlying security.

To determine if each of these opportunities provides an opening to generate profit, benchmarks,

normal discounts, and interest rates must be estimated. As it relates to firm value, the difference in
multiples for comparable firms across countries adjusted for risk can be examined. Regarding
holding company discounts, typical worldwide averages are 10%–20%, but these discounts are
proportional to management/overhead expenses. A capitalization of these expenses in comparison
to the holding company’s Net Asset Value (NAV) provides a floor value for this discount, with the
qualitative factors mentioned above adding to this discount. For voting discounts, typical worldwide
averages are 5%–10% and proportional to the voting blocks held by others. If there is a controlling
shareholder, then it is worth less; if there is no controlling shareholder, then it is worth more. For

1
Graham, Benjamin, et al. “Additional Aspects of Security Analysis Discrepancies Between Price and Value .” Security Analysis:
Principles and Technique, McGraw-Hill, 2009, pp. 622-3.

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implied interest rates, Joel Greenblatt, in You Can Be a Stock Market Genius, refers to an interest
rate with the equivalent of a B credit rating as being reasonable.

An important aspect of investing in compound mispricings is growing value. If you are investing in
growing firms, then the securities will have a tailwind. If you are investing in declining value firms,
then it is difficult to determine what the real discount is because part of it is due to the expected
decline in the firm value in the future. An important caveat in investing in derivative products such
as LEAPs is the expiration date. The date must be forward enough to capture the change in value
of the underlying security; so this is typically greater than two years.

Some of the key catalysts to reduce the discounts include: better governance (which reduces
holding company (holdco) and vote/no-vote discounts), growth (which reduces firm value discount),
and corporate events such as spin-off, new management, death of a control member (which
reduces firm, holdco and vote/no-vote discounts). Some of the key value traps associated with
compound mispricings include: declining firm value, corporate maleficence, and inflated real estate
appraisals.

In my experience, I have found success applying the below tools to uncover the mispricings
(IDEEAS):

● Identify other investors investing in the company.

● Determine where the controlling shareholder has the largest interest within the holding
company.
● Estimate “look through” earnings, cash flow, and book value multiples.
● Estimate economic holding company discount based upon capitalized expenses.
● Adjust appraised value cap rates, if real estate appraisal cap rates are too low.
● Select a combination of compound asset/security discounts and “look through” earnings,
cash flow, and book value multiples to assess cheapness.

Applying one or many of these filters multiple times highlights the advantageous opportunity. To
show how the Bonhoeffer Fund uses the above tools in analyzing a compound mispricing, see the
case study later in this report.

One of our largest holdings, NICE Information & Telecommunication (NICE I&T) is an example of
country and industry miscategorization. NICE I&T is a South Korean payment processing firm that
not only demonstrates some of the implications of geography that I alluded to earlier, but also is a
nice (ha, “nice”) example of what the Bonhoeffer Fund looks for in investable opportunities. NICE
I&T is part of a group of financial processing and service firms called NICE Holdings in South
Korea. Its specific function is an electronic payment processing value-added network (VAN) and
payment gateway, and it currently is the leading domestic VAN with a 16% market share and the
fourth largest payment gateway in the country. VANs generate revenue based on fixed fees per
transaction. And with the trend of the cashless economy and increased credit/debit card usage,
revenues are expected to continue to grow.

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NICE I&T is trading at 3.1x EV/EBITDA, which is a significant discount to both domestic competitors
(with an average EV/EBITDA of 13.2x) and international comparables (with an average EV/EBITDA
of 23.6x). Within the publicly traded firms of the NICE Holding companies, NICE I&T has the largest
discount from other domestic and international comparable firms. In addition, the firm’s
management/holding company owns a large stake at 42% of the shares and has modest yearly
compensation, which indicates an alignment of interest. Moreover, the pricing of this security
accounts for country risk, currency risk, and structural difference of the industry in Korea. I would
classify this opportunity as a country mischaracterization and a prime example of a great investable
opportunity for the Bonhoeffer Fund.

South Korea is an exciting place to invest at the moment, but, to properly manage risk, we are
judicious about the opportunities pursued and have limited our exposure to 35% of the portfolio. Our
other positions, across nine different countries, embody nine compound mispricings, 12 country
mischaracterizations, and five industry mischaracterizations. This strategic distribution of geography
and investment opportunity safeguards the South Korea strategy and balances our portfolio. As is
seen in the above breakdown of the Bonhoeffer Fund positions, we have some unusual
characteristics that aim to provide diversification in US or international portfolios. Based on the
location of the holdings, I expect more volatility than a large-cap US portfolio; but I also expect to
see higher returns as the market tends to re-rate these undervalued stocks.

Compound mispricings are often found in complex companies which makes them more difficult to
analyze but all the more rewarding to leverage in our investment strategy. It is my hope that this
letter provides a small vignette of what we do at the Bonhoeffer Fund and highlights the amount of
thought and due diligence we are putting into investing your money. As always, if you would like to
discuss any of this in deeper detail, then please do not hesitate to reach out. In future letters, I will
similarly dig into miscategorized firms and capital structure analysis to give you a feel for the
Bonhoeffer Fund investment strategy. Until then, thank you again for your time and confidence in
our work. Have a wonderful holiday season, and we will be in touch in 2018.

Warm Regards,
Keith D. Smith, CFA

November 10, 2017

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BCM CASE STUDY

Compound Mispricings Case Study: Asia Standard International (HKG:0129)

As discussed earlier, a compound mispricing is when a value-based investor benefits from the
double leverage of two mispriced securities—the underlying firm and its securities or derivatives.
This situation is not common but advantageous for the investor because understanding the
phenomenon of compound leverage within a single security increases the odds of a successful
investable outcome. Compounded discounts are multiplicative, not additive, which can lead to
complex situations to assess. Many times, I use discounted benchmarks pulled from market data or
look at indicators such as capitalized overhead expense for holding companies. Another appraisal
tool is a “look through” of earnings or cash flow using normal holding discounts. There are also
qualitative factors which can reduce these discounts such as better corporate governance, firm
growth, increasing liquidity in shares, value-enhancing events, and new management.

In this case study, I will focus on a compound mispricing in a company called Asia Standard
International (HKSE: 0129), a real estate holding company with assets in Hong Kong and mainland
China.

Asia Standard holds three types of properties: 1) four hotels (three in Hong Kong and one in
Canada) via Asia Standard Hotels that amount to 23% of the company’s NAV, 2) three
office/mixed-use buildings (all in Hong Kong) that amount to 36% of NAV, 3) four residential real
estate buildings (two in Hong Kong and two in China) that amount to 36% of NAV.

Presently, the real estate business in this part of the world (and across much of the developed
world) is booming due, in part, to the population migration from rural to urban. Many are moving into
cities chasing jobs, industry, and a lifestyle where they can live, work, and play all within a radius
that is walkable or accessible via public transportation. Both corporations and real estate companies
are noticing this trend, so corporate headquarters are moving into downtown and real estate
companies are profiting by building and redeveloping properties to fit this trend and their new
customer base. Currently, “walkability” is at a premium, and real estate developers on the forefront
of this trend are realizing high profit margins. A majority of the profits are made in real estate
development where land and buildings are erected or improved to maximize use of the space. Asia
Standard has a combination of mature properties which generate cash flows to fund the
development and improvement activities. This allows Asia Standard to not be dependent upon the
capital markets for investments in real estate.

Asia Standard has a typical corporate structure of real estate companies in Hong Kong,
family-controlled holding companies holding underlying real estate and services firms. This structure
can marginalize the minority shareholders and all but negate the value of their voting rights. This
can also lead to large holding-company discounts (as is the case for Asia Standard) that can
decline as management demonstrates good corporate governance.

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For Asia Standard International, the net asset value of the firm is dominated by Hong Kong and
mainland China real estate (more than 95% of NAV); therefore, paying close attention to its
economics is key. Asia Standard has a combination of mature properties—which generate cash
flows to fund its development—and improvement activities. This affords Asia Standard
independence from the capital markets for investments in real estate. Over the past five years, Asia
Standard has achieved above-average book value growth with a book value and dividend growth
rate of 15% per year. This growth was driven by Hong Kong and China real estate development and
improvement.

A related company, Asia Orient, owns a majority stake in Asia Standard (95% of NAV) and the
controlling family owns 25% of Asia Orient and 50% of Asia Standard. Additionally, Dalton
Investments, a well-known US value investor, also has substantial holdings, with 12% of Asia
Standard and 19% of Asia Orient.

Over the past eight years, the company generated cash flows that delivered on the balance sheet,
in addition to funding projects that contributed to the growth of the company. In short, the
management transformed the company from a net debt position in 2009, to a net cash position
today.

To illustrate the power of compound mispricings in this scenario, observe the “look through” funds
from operations (FFO), real estate, and NAV multiples of Asia Standard International and Asia
Orient. As of September 2017, Asia Standard common stock trades for 3.6x P/FFO and 0.24x
EV/NAV; this is undervalued when compared to other real estate holding companies.

When evaluating Asia Standard, we must consider an additional holding company discount for the
“look through” analysis. One way to consider these expenses is to capitalize holding company
expenses. In this case, if we capitalized Asia Standard’s G&A (general and administrative)
expenses at 10%, then we imply a discount to NAV of 1.0%. We conservatively use a 20% holding
company discount (to account for other factors contributing to the discount) in our calculations of
NAV above.

If we perform the same calculations for Asia Orient, then the commons trade for 4.2x P/FFO and
0.30x EV/NAV.

BCM Case Study Conclusion

Considering these parameters, in my view, the optimal position to hold shares in Asia Standard is at
the Asia Standard International level, not only because it is the most undervalued position, but also
because the controlling family holds a majority of its shares at this level.

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Disclaimer

This letter does not contain all the information that is material to a prospective investor in the
Bonhoeffer Fund, L.P. (the “Fund”).

Not an Offer – The information set forth in this letter is being made available to generally
describe the philosophies of the Fund. The letter does not constitute an offer, solicitation or
recommendation to sell or an offer to buy any securities, investment products or investment
advisory services. Such an offer may only be made to accredited investors by means of delivery
of a confidential private placement memorandum, or other similar materials that contain a
description of material terms relating to such investment. The information published and the
opinions expressed herein are provided for informational purposes only.

No advice – Nothing contained herein constitutes financial, legal, tax, or other advice. The Fund
makes no representation that the information and opinions expressed herein are accurate,
complete or current. The information contained herein is current as of the date hereof, but may
become outdated or change.

Risks – An investment in the Fund is speculative due to a variety of risks and considerations as
detailed in the Confidential Private Placement Memorandum of the Fund, and this letter is
qualified in its entirety by the more complete information contained therein and in the related
subscription materials.

No Recommendation – The mention of or reference to specific companies, strategies or

instruments in this letter should not be interpreted as a recommendation or opinion that you
should make any purchase or sale, or participate in any transaction.

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