The Small-Cap Opportunistic Value Strategy that we employ in Royce Small-Cap-Opportunity Fund uses an opportunistic approach to invest in companies that Portfolio Managers Brendan Hartman, Jim Harvey, Jim Stoeffel, and Assistant Portfolio Manager Kavitha Venkatraman slot into four themes: Turnarounds, Unrecognized Asset Values, Undervalued Growth, and Interrupted Earnings. They discuss four key holdings in the portfolio—two Turnarounds, one Unrecognized Asset Value, and one Undervalued Growth company.

Mativ Holdings was formed in July 2022 through the merger of Neenah and Schweitzer-Maduit International. It falls under the Turnaround theme in the Fund’s portfolio. Mativ is a market leader in technical and fiber-based materials used in various industrial applications. It operates via two reportable segments: Filtration & Advanced Materials, which focuses primarily on filtration media and components, advanced films, coating and converting solutions, and extruded mesh products, and Sustainable & Adhesive Solutions, which provides tapes, labels, liners, and specialty paper, as well as packaging and healthcare solutions. Mativ is led by CEO Julie Schertell, who was the CEO of Neenah prior to the merger.

As a result of the merger, Mativ began operating with a high debt load and a significant amount of restructuring, integration, and cost cutting challenges. Early on the company announced a restructuring plan to streamline its organization and focus on high growth end markets. It targeted $40 million in overhead savings by the end of 2026. Mativ achieved more than $30 million in merger synergies in 2023, exceeding its $25 million target. Management expects to realize $20 million in savings in 2024, with an additional $20 million by the end of 2026. These efforts were designed to increase operating leverage, particularly when demand improves as we move farther away from the Covid period, with its customers entering a prolonged period of inventory destocking. In November 2023 Mativ divested its Engineered Papers business, using the $632 million in proceeds to pay down debt, significantly improving its balance sheet: total net debt decreased by $605 million year over year.

Mativ Holdings (NYSE: MATV)
12/31/23-9/20/24

Past performance is no guarantee of future results.

Mativ now appears to be at an inflection point, with signs of improving demand, significant cost-saving initiatives underway, and a strengthened balance sheet. The focus on higher-growth segments and its ability to execute on synergies and restructuring efforts both suggest potential for improved financial performance in the coming years. In addition, restructuring efforts appear to be bearing fruit under CEO Schertell’s leadership. We expect Mativ’s shares to continue to rerate over time as the company improves its operations and continues to reduce its debt.

Spun out of IBM in 2021, Kyndryl Holdings provides IT infrastructure services and helps run mission-critical systems for its customers and is another Turnaround candidate. The company has more than 4,000 customers, more than 80,000 employees, operates in more than 60 countries, and generates around $16 billion in annual revenue, making it the largest IT infrastructure services provider in the world. At the time it was spun out, 40% of its revenue was priced at 0% gross profit as IBM viewed this part of its business as a loss leader. Kyndryl’s CEO Martin Schroeter, a lifetime IBM executive, was tasked with renegotiating unprofitable contracts, cross-selling new higher value services, and implementing other transformational measures. To date, 50% of these contracts have been repriced and approximately two-thirds will be repriced later this year. As these contracts reprice, overall margins will improve.

Kyndryl Holdings (NYSE: KD)
12/31/23-9/20/24

Past performance is no guarantee of future results.

Kyndryl sees significant growth opportunities from offering new capabilities aligned with secular trends and customer challenges. It has built partnerships with key cloud and tech players, including Microsoft, Amazon Web Services, Google, Oracle, and Germany’s SAP. The two biggest pieces of Kyndryl’s business are cloud services, where it delivers integrated, multi-cloud management solutions, and Enterprise Solutions, which provides secure mainframe services for customers’ core infrastructure. Kyndryl remains relatively underfollowed, covered by around five analysts. It also does not screen well for investors as revenues will remain in decline until more legacy contracts are renegotiated and top line growth resumes, which is expected to happen in fiscal 2025. As this is all ongoing, however, margins are expanding and leading to improved profitability.

Initially a Turnaround that has since moved into the portfolio’s Unrecognized Asset Values category, Artisan Partners is an investment manager that offers products focused primarily on global equities and fixed income. When we first invested in Artisan in late 2022, its assets under management had fallen 24% from a peak of $175 billion to $132 billion—but its share price had fallen by 42% over the same period. We felt that Artisan’s valuation had become too cheap and failed to reflect the company’s long history of alpha generation through full market cycles. Historically, investing in Artisan’s shares during market drawdowns has generated highly attractive returns when the market recovered, driven by Artisan’s alpha generation and asset inflows as market sentiment improved. We believed this would be the case again coming out of the 2022 bear market. Artisan also has a long and successful track record of investing in and/or seeding new products, particularly during periods of market dislocation. This proven approach has helped Artisan both to diversify into new asset classes and geographies and to build expanded scale. During the 2022 market trough, Artisan was expanding its credit and emerging markets offerings, a move that explains its shift from a Turnaround to an Unrecognized Asset Value in our Fund. We liked this contrarian approach and invested in Artisan when its valuation was very low compared to its long-term history.

Artisan Partners (NYSE: APAM)
12/31/23-9/20/24

Past performance is no guarantee of future results.

Our thesis has been playing out, with both assets under management and valuation multiples recovering from the trough, as reflected in Artisan’s share price appreciation over the past two years. However, we continue to be shareholders because the recovery is not yet complete. More important, Artisan continues to execute well on its long-term value creation strategy, which we believe will result in a much higher share price as the market cycle peaks.

In the Fund’s Undervalued Growth category, nLight is a vertically integrated manufacturer of high-performance lasers serving the aerospace & defense (“A&D”), industrial, and microfabrication markets. The company designs and manufactures semiconductor and fiber lasers for various applications, including laser sensing, directed energy, cutting, welding, additive manufacturing, and microfabrication processes. nLight enjoys a strong position in the growing A&D market, which is the primary growth driver of the business. The company is also seeing significant opportunities in directed energy and laser sensing for missile guidance, proximity detection, and countermeasures. These technologies, while still in the early stages, are expected to be a key component in defending against drone warfare, and the company is seeing increasing demand for sophisticated, cost-effective defense solutions driven by recent geopolitical unrest.

nLight (Nasdaq: LASR)
12/31/23-9/20/24

Past performance is no guarantee of future results.

nLight also has an Industrial and Microfabrication segment where it sells to non-defense commercial customers. One reason its shares have remained range bound is that this segment has not yet exhibited its expected growth potential due to global demand softness. nLight has a strong balance sheet with $121.3 million in cash and no debt. We are excited about the firm’s prospects as we expect sequential growth and significant improvement in the second half of 2024 and continued robust growth in the years ahead.

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