As money con­tin­ues to gush into ETFs and tar­iffs weigh heav­ily on multi­na­tion­als, smaller com­pa­nies re­main a refuge for old-style value in­vestors like Nick Gal­luc­cio.

as money con­tin­ues to gush into etFs and tar­iffs weigh heav­ily on multi­na­tion­als, smaller com­pa­nies re­main a refuge for old-style value in­vestors like nick gal­luc­cio.

Forbes - - CONTENTS - By Matt Schifrin

If ever there was a fit­ting setting for a by­gone busi­ness, it is the sprawl­ing two-story brick head­quar­ters of the money man­age­ment firm for­merly known as Ga­belli As­set Man­age­ment, in Rye, New York. Si­t­u­ated about a mile from Play­land, an amuse­ment park whose past-its-prime at­trac­tions have more value as his­toric land­marks than as vi­able en­ter­tain­ment, Gamco In­vestors, as it’s now known on Wall Street, is a place where old-fash­ioned bot­tom-up fun­da­men­tal anal­y­sis still reigns supreme. Prob­lem is, demand for the kind of stock pick­ing that made Mario Ga­belli a leg­end is at an all-time low. Gamco’s as­sets peaked in 2014 at $49 bil­lion.

Yet tucked into a bright and mod­ern five-room of­fice suite on the main floor of Gamco’s 60,000-square­foot head­quar­ters, just past a for­bid­ding Tu­dor-style

pan­eled lobby, is an af­fil­i­ate whose time may be now. Un­der the di­rec­tion of Ni­cholas Gal­luc­cio, $3.3 bil­lion (as­sets) Te­ton Ad­vi­sors is laser-fo­cused on find­ing bar­gains among small com­pa­nies. Gal­luc­cio’s in-the-weeds ap­proach to stock pick­ing, com­bined with a near per­fect storm of fa­vor­able macro fac­tors for in­vest­ing in small caps, could bode well for Te­ton and Gamco.

“All the trade jaw­bon­ing has re­ally rocked large-cap global com­pa­nies this year,” says Gal­luc­cio, 68. He points out that only 20% of the rev­enues of Rus­sell 2000 small-cap in­dex com­pa­nies comes from over­seas ver­sus 40% for the larger caps in the Rus­sell 1000.

Gal­luc­cio wastes no time get­ting into the nitty-gritty of in­di­vid­ual stocks. His fa­vorites these days are what he calls “old tech”: for­got­ten tech­nol­ogy firms with good mar­ket po­si­tions and re­cur­ring rev­enue streams. Com­pa­nies like En­te­gris. Founded in 1966 not far from Mas­sachusetts’ Route 128 cor­ri­dor, it makes clean­room fil­tra­tion sys­tems for semi­con­duc­tor com­pa­nies, as well as spe­cialty chem­i­cals that its chip-man­u­fac­turer cus­tomers use to make wafers. “These aren’t app com­pa­nies,” he says. “These are in­dus­tri­als, the build­ing blocks of the in­ter­net.” Gal­luc­cio adds that En­te­gris has a 90% cus­tomer-re­ten­tion rate and mod­est debt. He has owned the stock since 2008, when it sold for $3 and had a mar­ket cap of $400 mil­lion. To­day it trades for $35 a share.

While Gal­luc­cio prefers to talk about his in­di­vid­ual un­der­val­ued picks, he’s ready to make the case for the small-cap sec­tor in an era of FAANG dom­i­nance. In the past decade, more than $1 tril­lion has flowed out of ac­tively man­aged funds and mostly into large-cap in­dex ETFs, he notes. But small caps are one of the true re­main­ing ar­eas of wide­spread in­ef­fi­cien­cies, where ac­tive man­age­ment can add value. “If you look at an­a­lyst cov­er­age, 45% of small caps have no re­search at all,” he says. More­over, Gal­luc­cio ar­gues, po­lit­i­cal tail­winds, in­clud­ing lower cor­po­rate taxes, a re­laxed reg­u­la­tory en­vi­ron­ment and over­due fis­cal stim­u­lus, as well as the ac­cel­er­at­ing econ­omy, mean that small, do­mes­ti­cally fo­cused com­pa­nies are the most lev­ered to cur­rent conditions.

The best rea­son to pay at­ten­tion to Nick Gal­luc­cio is his $77 mil­lion Small Cap Se­lect Value strat­egy and its re­sults. Over the past three-year pe­riod, his mu­tual fund ranked in the top 5% among 613 in the small-blend cat­e­gory, ac­cord­ing to Morn­ingstar. It’s been in the top 15% for the past five years. In 2016, when small-cap stocks led the mar­ket, Gal­luc­cio’s no-load fund had a to­tal re­turn, af­ter ex­penses, of 31% ver­sus 21% for the Rus­sell 2000. Last year its 15.9% re­turn out­paced its bench­mark by more than three per­cent­age points.

Gal­luc­cio’s path to port­fo­lio man­age­ment is hardly typical. A Con­necti­cut na­tive who taught gui­tar dur­ing col­lege and earned a mas­ter’s in English lit­er­a­ture from Columbia Uni­ver­sity, he de­vel­oped an in­ter­est in busi­ness while ex­pos­ing lo­cal cor­rup­tion as a re­porter at the Spring­field Daily News in Mas­sachusetts. Af­ter earn­ing an M.B.A. from Columbia in 1978, he went to work as a re­porter for Forbes. That year, he wrote the mag­a­zine’s first cover story on an emerg­ing phe­nom­e­non in fi­nance—lever­aged buy­outs. His story, “Do You Sin­cerely Want to Be Rich?,” shed light on a new firm, Kohlberg Kravis Roberts & Co., which then had just $30 mil­lion in cap­i­tal. Seek­ing riches him­self, Gal­luc­cio jumped to Lehman Broth­ers in 1980 as an an­a­lyst cov­er­ing semi­con­duc­tors. His re­search there got the at­ten­tion of Robert Day, founder of Los An­ge­les’ Trust Com­pany of the West, whom he had pro­filed at Forbes. Day re­cruited Gal­luc­cio to cover small-cap stocks. He worked side by side with leg­endary in­vestor Buzz Zaino in New York dur­ing the 1980s and 1990s, with Gal­luc­cio’s fund beat­ing his bench­mark by an av­er­age of 300 ba­sis points an­nu­ally over his 25 years there.

Then, around 2004, Gal­luc­cio be­gan hav­ing break­fasts on Satur­days at the Putnam Diner in Green­wich, Con­necti­cut, with Mario Ga­belli, who had been Zaino’s class­mate at Ford­ham Uni­ver­sity. In 2007 Ga­belli asked Gal­luc­cio to quit TCW and run one of his un­der­per­form­ing sub­sidiaries, Te­ton Ad­vi­sors Inc. Gamco spun off Te­ton, with Ga­belli him­self re­tain­ing 51% own­er­ship and man­ag­ing its mi­cro-cap fund, Mighty Mites. CEO Gal­luc--

cio would own 20% and fo­cus on small caps. Like Gamco, Te­ton is pub­licly traded. Its thinly traded Pink Sheets shares re­cently traded at $50, up from $2.75 when Gamco spun it off in 2009.

Gal­luc­cio screens for com­pa­nies with mar­ket caps be­tween $300 mil­lion and $3 bil­lion in four cat­e­gories: turn­arounds, un­der­val­ued growth, un­der­val­ued as­sets and emerg­ing growth. Like most other value in­vestors, he in­sists on meet­ing with CFOs and CEOs.

In this un­der­fol­lowed area of the mar­ket, gain­ing an in­for­ma­tion edge is ev­ery­thing. To this end Gal­luc­cio’s small team main­tains a pro­pri­etary data­base on com­pa­nies it has re­searched over the past 20 years. They knew, in Oc­to­ber 2016, to pounce on Elec­tro Sci­en­tific In­dus­tries, a Port­land, Ore­gon, man­u­fac­turer of flex­i­ble printed cir­cuit boards used in smart­phones: Michael Burger, a skilled turn­around artist they had backed as CEO of an­other small cap, Cas­cade Mi­crotech, had just joined the com­pany. “He took costs out [of Elec­tro] and cre­ated enor­mous— lean—lean man­age­ment, you know, across the or­ga­ni­za­tion. Then the or­ders started pick­ing up. The op­er­at­ing lever­age was huge,” says Gal­luc­cio. “The stock went from 5 to 20, like, im­me­di­ately. That’s what hap­pens in small-cap land.”

For a com­pany to be­come one of the 80 or so hold­ings in Gal­luc­cio’s port­fo­lio, he must see a cat­a­lyst on the hori­zon. Takeovers are com­mon, es­pe­cially by pri­vate eq­uity firms flush with cap­i­tal. “Many of the valu­a­tion met­rics that we em­ploy in our analy- sis are the same ones used by pri­vate eq­uity,” he says, adding that 29 of his port­fo­lio com­pa­nies have been taken over since 2012. “There has been ma­jor con­sol­i­da­tion in the tech sup­ply chain. These com­pa­nies have a lot of cash, no debt, they buy back stock and pay good div­i­dends.”

In Gal­luc­cio’s un­der­val­ued-as­sets cat­e­gory, re­gional banks are a fer­tile area for new buys. His big­gest hold­ing is Legacy Texas Fi­nan­cial, a $9 bil­lion (as­sets) bank that was tar­nished (un­fairly, he be­lieves) when en­ergy prices dipped in 2017. Te­ton bought in at $18. The stock trades for $40 to­day. An­other un­der­val­ued-as­set play is Hous­ton oil­field­ser­vices firm Pat­ter­son-UTI, which Gal­luc­cio says sells at about half the re­place­ment value of its rigs. Other picks in­clude Hart­ford’s United Fi­nan­cial Ban­corp, an East Coast re­gional with $7 bil­lion in as­sets sell­ing at 1.4 times book value, and New Jersey’s Ori­tani Fi­nan­cial, which pays a 6% div­i­dend. “There’s go­ing to be more con­sol­i­da­tion in banks,” says Gal­luc­cio. “There are too many.”

Gal­luc­cio’s big­gest challenge these days is in­ject­ing some of his own stock-pick­ing DNA into Kee­ley As­set Man­age­ment, an un­der­per­form­ing Chicagob­ased firm Te­ton bought last year af­ter Kee­ley’s CEO un­ex­pect­edly died from a blood clot. “We now have col­lab­o­ra­tive re­search meet­ings with them weekly. It’s in­ject­ing new life into the think­ing,” says Gal­luc­cio. “Af­ter a decade of growth out­per­form­ing, value is com­ing back.”

te­ton ad­vi­sors’ old-school stock picker ex­traor­di­naire, ni­cholas Gal­luc­cio, in front of a vin­tage hand­made 48-star flag quilt in his con­fer­ence room.

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