In this episode of The Acquirer’s Podcast Tobias chats with Steven Kiel. He runs Arquitos Capital and he’s got a lot of other interesting investments. He’s also a special situations investor. During the interview Steven provided some great insights into:
- Special Situations Investing – Transition Companies
- Balance Sheet To Income Statement Investing Graham Style
- Advice For Anyone That’s Considering Becoming An Activist – Don’t!!
- S1 And S3 Filings Provide A Great Source Of Investment Opportunities
- However Much You Think You Know About A Company In Reality It’s About 10%
- Applying A Buffett Partnership Style Investment Strategy
- Charlie Munger Was Primarily A Special Situation Investor
- Hedge Your Portfolio With Black Swan Style Protection
- Joel Greenblatt’s Asymmetric Situation Investing
You can find out more about Tobias’ podcast here – The Acquirers Podcast. You can also listen to the podcast on your favorite podcast platforms here:
Tobias Carlisle: All right, when you’re ready.
Steven Kiel: Leave all the stuff in.
Tobias Carlisle: Yeah, this is the stuff that people tune in for.
Steven Kiel: It’s good stuff, it’s good stuff.
Tobias Carlisle: All right, when you’re ready lets do it.
Steven Kiel: All right, man, let’s do it.
Tobias Carlisle: I’m Tobias Carlisle, this is the Acquirers Podcast. My special guest today is Steven Kiel, he runs Arquitos and he’s got a lot of other interesting investments, he’s a special situations investor, we’re going to talk to him right after this.
Tobias Carlisle: Hey Steve, how are you?
Steven Kiel: Hey man, doing great. Thanks Toby.
Tobias Carlisle: So, Arquitos, that’s your fund you’ve been running since 2012, it’s returned 16.9% after fees, and it says in the document that you sent through that you’re a special situations, so do you want to just talk a little bit about what you do at Arquitos?
Steven Kiel: Yeah. So, I mean special situations can mean a lot of different things. To me I’m looking for companies in transition, I’m looking to maximize company specific situations and minimize external things. So, it’s a variation of value investing and the way that I apply it based on my personality, but requires concentrated approach, a lot of aligned interests with the companies themselves, but ultimately I’m looking for companies that are in transition and that I can acquire at a reasonable price.
Tobias Carlisle: So, I saw you described it as having a strong balance sheet and then some pathway to free cash flow, so you’re looking for something that the business’ strength isn’t reflected yet in the financial statements, is that right?
Steven Kiel: Yeah. So, I do something called balance sheet to income statement investing, and it’s based on a quote by Peter Cundall, back in the day he said he buys on the balance sheet, sells on the income statement. Now, I don’t want to sell, but how do you acquire things at reasonable prices in this environment, applying a gram-style approach? And to do that you have to find things a little bit earlier I think than in the past, or you have to find things that there’s a little bit more uncertainty in the public reports, but you can follow some of the incentives in the company themselves. Whether it’s because of incentives to attract the strongest capital allocator, use insider ownership, alignment of interest, and that type of thing.
Steven Kiel: There might have been, back in the day, five years ago, there were things like tax loss, [inaudible 00:02:56] was more important as well, and other type of off balance sheet items or incentives based on that. So, I want to buy when the balance sheet is strong, when it’s reasonably priced, when there’s something specific going on at the company that might unlock that value over time. And then there’s a transition that would be made to, you know, reinvestment opportunities, predictable free cash flow generation over time, that’s where I want to continue to own and hold on to a company over time, hopefully for many, many years or decades.
Tobias Carlisle: So, that’s a pretty good statement of the theory. Can you give some examples of how you have applied that in the past?
Steven Kiel: Yeah. Well, with a larger company, even a Bank of America or some of the banks coming out of the crisis, where there was several years where they were trying to strengthen their balance sheets. And they had their repurchase and capital allocation decisions were controlled, either by the government or different regulations. And you’re looking from 2009, 10, 11, 12, especially with the TARP warrants with all the major banks, there was a great opportunity there to really get quite a bit of value by buying on the balance sheet, buying for balance sheet purposes. And then, most of those banks over the last few years have now made the transition of having predictable cash flow generation and predictable return of capital. And even today you can get really reasonable and attractive returns simply based on return capital alone.
Steven Kiel: Now, that’s an example for a larger company. I owned Bank of America TARP warrants for many, many years, and actually owned it for about a five year period, the price didn’t move at all. And then after the election when Trump was elected, the next month it doubled, and then a few months later it doubled again. So, over five and a half years it looked like a tremendous investment, but for five years it could have been accused to be a value trap there.
Steven Kiel: But then all the way on the other side there’s great examples for smaller companies that we’ve owned as well that are a little bit more unique I think.
Tobias Carlisle: Well, let’s talk about those smaller companies. I actually participated in that TARP warrant, and I’ve found that later, so I got very lucky with that. But let’s talk about the smaller companies.
Steven Kiel: Yeah. There’s a company today that’s my largest position, and it’s called [MMA Capital 00:05:26]. And it’s made the transition over the last six or seven years, from this balance sheet type of approach, reasonable valuations, to now it’s transitioned into the income statement predictability. Other investors haven’t really realized it yet, and it’s also a very small company, it’s a $200 million company and it does have tax loss carried forward. So, you’re not able to own more than 5% of the company. So, this is good for small funds, it’s good for personal accounts for larger investors. But it’s a little bit of a complicated story, and so it’s not attracting. It’s too small for very large investors, but it’s a little too complicated for general retail investors. So, it’s good for our sweet spot with the smaller fund.
Steven Kiel: The background there was, there were a number of off balance sheet items, off balance sheet assets through the years. They were buying back about 10% of the company per year for four, five, six years in a row. A lot of insider ownership, alignment of interest. And again, we’re not paying any taxes on the assets that they were selling, so the balance sheet, the book value was growing every year. And they were transitioning into a different type of business, and their specialty asset manager, and now their primary business is much different than it was five years ago.
Tobias Carlisle: What’s the transition been?
Steven Kiel: Yeah. So, their primary business now is a solar lending fund. And they partnered up with ironically Bank of America several years ago. And they’ll likely throw off six dollars a share next year just from their returns from the solar lending fund. Trade’s at $32, book value’s 37 and change. And so it took several years to create that predictability, but now you’re there and we’re just waiting for last 12 month comparisons, and then it’ll start showing up on screens, and then because it trades below book value it also throws off so much of this return. Over the next year we’re going to have income statements, [inaudible 00:07:34] investors start buying into the company that we’re not interested in the company for all those years where it traded at 80% of book, but did not create a predictable cash generation.
Tobias Carlisle: So, in your last investment presentation, I think [Oleta 00:07:49], you had that as a 39% position in the portfolio, but I got the impression from the note that that had grown to that level, it’s nowhere near initiation at that level. So, how do you size something like that in the portfolio?
Steven Kiel: Yeah. So, generally when I buy into something I want to make it at 8-10% at cost, and it’s just grown over time. You never want to pull the flowers, so if something grows, if it becomes an outside piece of the portfolio, if it trades at a reasonable valuation, and MMA today might even be cheaper today than it was when I first bought into it five or six years ago, because the operations have improved so greatly. And it still trades at a discount, again book value’s 37 and change, and we’re a little bit below 32 today, and they continue to buyback shares below book, which is a creative obviously there.
Steven Kiel: So, it might be cheaper today than it ever has been, but it grew from 10% of the portfolio at cost up to anywhere between 35 and 40% today. And I’m happy to own it at that price because there’s still a pathway over the next five years for it to grow 30% a year from here. We’d love to own it from there, wouldn’t it be great to have a 40% position in the portfolio that grossed 30% a year for five years? I mean, we can sit back and relax for a bit.
Tobias Carlisle: So, I have followed another position in your fund pretty closely. I think anybody who’s been a deep value net guy, knows Sitestar which was, they have the machines that convert coins into cash, I think, right?
Steven Kiel: Coinstar, yeah.
Tobias Carlisle: Coinstar, did I say Sitestar, I’m sorry.
Steven Kiel: Yeah.
Tobias Carlisle: Am I confused? What is Sitestar?
Steven Kiel: Yeah. Sitestar is a small public company I took over in 2015. And background was it was an internet service provider actually, so when you think about what’s more simple than maybe a coin operated machine or something like that, well it’s dial-up internet. And so, we had that and had some real estate as well, Jeff Moore and myself and Jeremy Gold helped to take it over in 2015, 2014, 15. And a small public company, it was SEC filing company, and when we took control in December 2015 we had some ideas, primarily in the asset management area, which we’ve executed through the years. We have a couple other businesses associated with it as well that are kind of none-core at this point.
Steven Kiel: We learned a good lesson not to be diversified quite frankly, we did change the name to Enterprise Diversified, which I think was a mistake, because we were really trying to focus on the asset management area where we found a lot of success and teamed up with a lot of great people, including Dave Waters, and Jeff Gann, and Andrew [Queued 00:10:42], and Keith Smith and others like that. So, that’s the part of the business we’re really trying to grow, we think there’s a ton of potential there.
Tobias Carlisle: So, you guys got control of that business. Can you talk us through that process and what the process of getting control was like, and what it’s been like running it?
Steven Kiel: Yeah. When I first found the company my fund was fairly small, and so you could have a position in a sub to million dollar company for example, especially when it traded at about a quarter of book value. And thought there was some additional value off balance sheet, I mean it was historical prices on some real estate and things like that.
Steven Kiel: So, Jeff Moore actually was the person who originally found it. And yeah, I was going to own it just as a passive investment, and owned it for a few years and then Jeff and I we would regularly meet with the CEO, chairman at the time, and were obviously unimpressed with some of the decisions he was making. And then turned out there was some self-dealing and things of that nature. So, we ended up getting on the board, and we ran a proxy context and eventually just instigated him to step down as the CEO, and we took over.
Steven Kiel: Ironically now we’re about four years in and stock price is about the same. I can’t say it’s been… it went up and it’s gone back down again here, so it’s been a bit of a challenge. But the things we’ve done, especially, again, in the Asset Management area behind the scenes, it has tremendously more value than what’s reflected so far. And it really would be very, very difficult to replicate the relationships, [inaudible 00:12:26] relationships, that we’ve built with some other really talented portfolio managers.
Tobias Carlisle: We’ll come to Willow Oak in a moment. But just, how much cost and how time consuming is it to get control of that board, and what was that like?
Steven Kiel: Yeah. You know I think, I don’t remember who said this, but I think, actually I think it was Blackstone or something like that, where basically he said if you’re going to put in the work, you might as well do it for a larger company as opposed to a smaller company, because it’s the same amount of work, and it paid off to be much quicker. And so, I obviously didn’t know that at the time, or maybe didn’t take that to heart.
Steven Kiel: So, there is a tremendous amount of work in 2014, 15, time period, and early 2016. Not only to take control of the business, a lot of legal ramblings and things like that. But then also, once we did take control to [inaudible 00:13:30] size, the internet operations, turned it into a really regular predictable [inaudible 00:13:36] actually generating entity, and sold off some of that real estate and then entered a few other business lines as well. So, it was a lot of work at that point.
Steven Kiel: I now am chairman, I was CEO at the time, I’m not chairman of the company. We’ve got a great team, it takes time to build that team out too. It probably took us two years to really get the people in place at the senior level that we needed to do. And if we would have had more resources, if it would have been a larger company, I think that would have been easier.
Steven Kiel: So, my advice, if anybody wants to go activist, is first of all don’t, it’s probably not worth it in the short-term, though it will be worth it in the long-term. And second, if you’re going to do it, do it with a larger company. If you’re a small fund, it’s difficult to do with a small company because the expenses are still going to be substantial, and you have to make that transition yourself, and it’s difficult to build out a really talented team, it takes time to do that, if you don’t have the resources especially. So, it’s better to have more infrastructure in place I think.
Tobias Carlisle: So, the Asset Management business, Willow Oak, that’s wholly created by you? By you guys?
Steven Kiel: Yeah. We started than in 2016, and the initial purpose was to seed Alluvial Fund, which is a fund we started with Dave Waters. David runs and managed accounts for several years. He ran the blog, continues to run the blog, otcadventures.com. And Dave and I go back many years, we share stock ideas, he’s probably fairly well known in the value investing, and especially small micro-cap communities.
Steven Kiel: And so, he had been successful with the managed accounts, he had wanted to start a fund, and we approached him and thought it might be worthwhile to really be string strategic partners to do that. So, we launched the fund, we seeded it, we raised money at the public company, we created the Asset Management subsidiary Willow Oak Asset Management, and that was the genesis of it.
Steven Kiel: From there, we ended up launching a fund with Keith Smith called Bonhoeffer Fund, and Keith is on our board. He’s fairly well known in the [inaudible 00:15:58] Berkshire and Fairfax, been at many of these events, Fairfax events and things like that. He’s a great guy and we’re excited to launch it with him. And then, most recently, we’re launching a fund actually in January 1st with Jeff Gann and Andrew [Queuen 00:16:15] at [inaudible 00:16:16].
Tobias Carlisle: And so, the focus of all of those, the connection between all of them, they’re all value guys, but beyond that are you looking for any particular style, or you’re just looking for focus of value investors generally?
Steven Kiel: Yeah. At this point, because Willow Oak is still small and growing, and it is kind of all part of our network and my network, And so I didn’t just meet these guys one day, we’ve had relationships for many, many years. And I always was impressed with them and impressed with what they’re doing. Each one of them had a very great long-term personal track record that we thought could translate into a fund.
Steven Kiel: So, that’s where that came from; each of them wanted to start a fund, and we were there, Willow Oak was there, to assist with that and to provide some best practices and operational support and things like that. So, in the future, I don’t know. We’re niche value, we’ve got each of the funds has a slightly different approach, but all with the same foundation. I think it might be a little charitable to call them emerging funds at this point, it might be frontier funds.
Steven Kiel: But you know, the runway is long, and if any of you follow the Peter Kaufman Five Aces thing, there are a number of things there that, having integrity, having a niche approach, and things like that. But the fifth one is having a long runway, and I think each of those funds has a long runway, and when you think of the fees that they could earn, the fee shares that Willow Oak can earn, the return that we can give to the investors in the funds themselves five or ten years from now, just from being a performance and compounding and things like that alone, we’ll all be very happy.
Tobias Carlisle: And so, Willow Oak provides a back office function and some assistance with raising capital?
Steven Kiel: Yeah. So, the back office is the biggest thing, especially for just the operational infrastructure, that if you’re starting a one man fund, which I did in 2012 when I started Arquitos, there are a bunch of best practices that you just have to learn along the way, and there are expenses associated with that, there’s showing that you’re not just a one man band. And there are a number, especially as the investor base grows, there are just a number of distractions potentially that need to be done; interacting with the auditors, and the administrators, and legal, and just keeping track of everything, and compliance. And so, Willow Oak was designed to provide some of that, to reduce the monetary risk for the startup. We have paid for the launch of the funds themselves, and the idea is to solve a problem.
Steven Kiel: And then certainly there are people who, investors, who discover one or more of the funds, and some allocators they want to spread money around amongst several different funds, they like the philosophy of each one, and so we definitely have overlap of investors as well. And we have an opportunity to have some joint marketing. We do a thing at the [Bercher Averley 00:19:37] Meeting every year, where you can see on our YouTube page, panel discussion and others like that. So, it’s been great to learn from each other and to be able to have formal resources there.
Tobias Carlisle: And how do you divide your time now between Enterprise Diversified and Arquitos?
Steven Kiel: Yeah. Most of my time is with Arquitos, now that we’ve been able to build out the team at Enterprise Diversified. So, my job is really more as a strategic person, a cheerleader, and the network that I’ve got to build with the investors themselves, then with the different portfolio managers, and other that’s been valuable. And then our operations staff kind of handles all the day to day. So, I’m not as involved in the day to day very much any more, we’ve got a great team at Enterprise Diversified and Willow Oak to do that. But I’m kind of here to do, to talk to you and do these events and help to promote the business, and help to explain the business too and show how excited we are about it.
Tobias Carlisle: So, what’s the plan with Enterprise Diversified, is it to turn it into an Asset Management company, or will it be a more diversified, as the name suggests?
Steven Kiel: Yeah. We’re going to have to drop the diversified portion there. Originally the idea back in 2015 and 16 was to invest in a few different types of business, and different types of industries, but the idea was for us to be funding partners and to invest in the operators themselves. But unfortunately at that size, the operators that we invested in it just wasn’t going to, in hindsight, it hasn’t worked, and it’s unlikely to work at this size as part of a public company. There’s a reason why most of those companies are and should be private.
Steven Kiel: But where we’re most excited about and found the most potential in, was in the Asset Management area there, and so that’s where the focus is at this point. We have several other lines of business, we have the old dial-up internet business, we have some real estate, we have things like that which are really none-core parts of the business at this point. What we’re trying to do is continue to grow our investor base in the funds that we’re associated with, and to continue to create formal relationships with new portfolio managers.
Tobias Carlisle: You’ve had some criticism on Twitter from the Woodmont folks, Tice Brown, do you want to address that?
Steven Kiel: Yeah. So, this is one of the issues with the real estate, this was a part of the none-core business there. We had sold off a portion of the real estate to Woodmont, and as part of that sale there is a confidentiality clause in the agreement, which unfortunately Woodmont has violated, but we will not be violating that. So, we filed a lawsuit listing several items associated with it, it’s an unfortunate situation there, but the only things we’ll be able to mention is through AK filings and things of that.
Steven Kiel: But, I think the important thing there is, again, our focus is on the Asset Management business, and some of the other lines of business are such a minor part at this point. When we first took over the business the book value for example of Enterprise Diversified was the way to value the company, and it’s really not the case any more. The same way I’ve approached through Arquitos fighting companies that are in transition, that transition for book value kind of analysis, to income statement predictability. That’s where we’re at with Enterprise Diversified as well, where we are in the midst of that transition, and the Asset Management area is really where most of that is. And if you share different relationships with those managers, and so our book value for the none-core businesses used to be such a big part of the business, and they’re really not any more.
Tobias Carlisle: Well, let’s go back to Arquitos, how are you finding your ideas there? You say you don’t screen, so what’s the process for generating ideas?
Steven Kiel: So, I always believed in primary sources, so my background is as a recovering lawyer, join the club, you’re a member as well.
Tobias Carlisle: Yeah.
Steven Kiel: We’re not alone. And so, we’re not averse to glancing through… you might need to cut that.
Tobias Carlisle: Steve’s logo just fell off the wall.
Steven Kiel: We’ll go back to the question there. Hopefully it’s not an omen.
Tobias Carlisle: It’s not portentous.
Steven Kiel: Yeah, how the market’s doing today. No, so my background was as a recovering attorney, and so we are not averse to reading through several hundred page documents, it’s not just the 10-Ks, but it also might be an employment agreement, and things like that, that are essentially SEC filings.
Steven Kiel: And so, that’s where I go, I go to the primary sources, I have a number of SEC alerts set up. When you think about an S-1 filing or an S-3 filing, I love those, we get five, seven, 10 of those a day, obviously don’t read through each one of them but I at least glance through and set aside some of the more interesting ones. And so, that’s a great place to look, looking through employment agreements, I’m looking through different key terms, such as contingent value rights, rights offerings, tender offers, and occasionally I’ll come across something interesting and you follow that lead.
Tobias Carlisle: What was your area of practice as a lawyer?
Steven Kiel: So I did a lot of government investigations and some things like that, some MNA, more on the HSR side, second requests and things like that. And I actually am still a lawyer in the army reserves, about 20 years in, a defense attorney is a little bit different than the private practice.
Steven Kiel: But, when I was practicing, this was 2007, eight, nine period, there were a number of companies where you really see behind the scenes. When you’re doing some sort of government investigation, you’re reading emails and different background information on the leadership of public companies oftentimes, and it gave me an appreciation for how little the public actually knows about what goes on behind the scenes.
Steven Kiel: And when you think about this idea of alignment of interest; I mean we all want alignment of interest with the investments, [inaudible 00:26:48] passive investors primarily, and so you’d have to be able to trust the decision making of the public company, but you’re just not going to know nearly as much as you think you know. Whatever you think you know it’s 10% of what is actually going on behind the scenes.
Steven Kiel: And being a lawyer and reading that type of stuff gave you even more of an appreciation to make sure that you truly have the alignment of interest. So, you do have insider ownership, you do have good capital allocation decisions made, and there’s not a very many companies out there like that, which is why you have to concentrate.
Tobias Carlisle: So, your primary area of search is the S-1s, S-3s, which are the security issuance, and your contingent value rights and things like that, so you’re looking for that transitional period?
Steven Kiel: Yeah. And I’ve found a number of different things through the years. I mean, I’ve been investment in 2012 with a bankrupt ice company, for example there’s some equity stub value coming out of that. Had a great investment in 2015, 16, 17, Intrawest Resorts, which was a company owned by a Fortress fund, where they did a huge tender offer and then ended up getting sold.
Steven Kiel: So, that type of, it depends on each situation, but you’re really looking for something that’s company specific, that has less risk and less variables outside of the company, and really something specific as to what’s going on where management has control over the situation that can control the variables.
Tobias Carlisle: Right. So, are there many S-1, are there a great deal coming through?
Steven Kiel: Yeah. You know, and I think there have been, but they, I think over time are, especially as… Give it the next couple of years, I’m actually excited about more corporate restructuring, especially with larger companies. The first four, five, six years of the fund I had invested some smaller companies obviously, we talk about Enterprise Diversified, a very small company, but I also owned obviously the Bank of America TARP Warrants, I owned Philips 66 spin-off. I had some larger companies; Iron Mountain went through a conversion into a real estate investment trust, and that an opportunity, I think it was 2014 time period. And so, those are some larger companies.
Steven Kiel: And then as the markets have reacted in the way that they have the last few years, those types of obvious opportunities start to go away, and there’s not as many company specific corporate restructurings. But as we get a correction, as we get more turbulence in the market, I think that’ll provide more mid-cap and large-cap company introspection, which would create some opportunities for me to look at.
Tobias Carlisle: So, we’ve discussed already MMA cap and Enterprise Diversified, that makes up a little bit over, maybe almost two thirds of the portfolio, so what else have you got in the portfolio?
Steven Kiel: Yeah. So, probably a little below 60% there, but I generally have top five positions make up 75% of the portfolio ever since the launch of the fund, and probably a little more concentrated than that prior to when I launched the fund.
Steven Kiel: But, we’ve got a company called West Aid that I really love; this has not been a great performer on the price side, but it’s been strong operationally. And so over the last few years they strengthened two subsidiaries, one is an insurance company, they’ve strengthened that, and they’re looking to sell it off, or possibly IPO it this spring. Then they also teamed up with Dan Zwirn and Arena Investors with a credit fund, and I think they’re up to 1.2 billion or so in assets, up from seven or 800 million over the last year or so. So, they’re growing, they reached a tipping point, I think they became profitable at about $1 billion dollars under assets.
Steven Kiel: And so, the business is doing great, its really advanced, its operationally been very strong. And the stock price though has been crushed, book value is somewhere around 337 or so Canadian, the stock trade’s at 265, which is ridiculous, but it’s great for us if we’re in acquisition mode.
Tobias Carlisle: Well, why the big discrepancy?
Steven Kiel: Yeah. It’s a Canadian company and there was some Canadian small-cap mutual funds that had closed down over the last year, year and a half or so, as you know small-cap value is not the best place to be in the last two years.
Tobias Carlisle: Its been rough.
Steven Kiel: And some mutual funds really, really struggled there, and especially in Canada. So, I think there’s some poor selling associated with that. I will say Parag Shaw, who’s a friend of mine, he’s the head of marketing at Arena, he used to be the head of marketing at Bridgewater, he’s an advisor to Willow Oak as well, and he just made an open market purchase of West Aim shares about a month and a half ago of $1 million, and so clearly he’s happy about what’s going on there.
Steven Kiel: Not talking privately or any confidential information there, but when you see an insider purchase that large, from a non-CEO, COO, CFO, and he is as close to the future of the credit fund and what their asset raising opportunities are over the next few years than anyone else, he made a very large personal investment there, so that’s a great sign for the company.
Steven Kiel: And next spring too, we’ll have a resolution on the insurance company, and there’s a significant amount of additional book value there from the insurance company that will cause that difference between that current price and the book value to grow even further.
Tobias Carlisle: So, these are all particularly interesting positions, how do you transition from being a lawyer to being an investor in things like this?
Steven Kiel: Yeah. So, I mean it’s a good question, and I always was interested in things like this. Going back to even before I graduated from law school as a personal investor, I was always interested in niche things and idiosyncratic things. Things that are maybe not well know, companies that are not average, would not have been well known from the retail investor. And that goes back to probably the late ’90s, early 2000s. And I always appreciated the Buffet Partnership Letters more than the Berkshire Hathaway Letters.
Steven Kiel: We all can kind of point to Buffet one way or another as some sort of inspiration. And I read the book I think it was back in 1996, The Lowenstein Book, Making American Capitalist, and remember reading that, and being more interested in the portfolios from the ’50s and ’60s than buying say Coca Cola in the ’80s. So, I always gravitated towards those unique situations.
Tobias Carlisle: That’s funny, because when I was reading through your letters I had that, you discuss workouts and control situations, and I thought this language is very reminiscent of the Buffet Partnership Letters.
Steven Kiel: Yeah, I try to stay away from the word wonderful though, because somehow you transition from workouts and everything like that, to buying wonderful businesses at reasonable prices, which is whatever that value investors have turned into today, the word value means whatever people want to define it as. But I try to stay away from some of the more colloquial words like that.
Tobias Carlisle: It’s funny, I know it well and I’ve talked about it a lot, but that Buffet Partnership Buffet is a much different investor from the latter day Berkshire Buffet where he was in essence a corporate raider, a liquidator, he’d get control, he was pretty ruthless when he was in those early years and he’d transitioned. But I think even in the later days now where he’s in that wonderful company the Fair Price. The Fair Prices that he likes it’s still pretty cheap I think for many of the positions, a lot cheaper than a lot of modern day value investors seem to be prepared to pay anyway.
Steven Kiel: Yeah, absolutely. And he talks about the transition kind of being made into a little more of a Phil Fisher style of investor because of Munger, but if you look at Munger’s partnership back in the ’60s and early ’70s, I mean Munger was not that type of investor either. Munger was primarily a special situation investor and he had some fascinating investments with Garren and had some with Buffet as well.
Steven Kiel: But Monger took over a closed-in fund, he did a number of obviously blue chip stamps at the time too. And he was concentrated, the rumor is that, I don’t know how true this actually is, though people reference it from the Munger book, that at one point he had more than 100% in one stock, so he was levered, he was obviously much more volatile than Buffet, but at one point he apparently had more than 100% in one stock. So, he’s always been much more concentrated.
Steven Kiel: But even Buffet himself was concentrated, I mean the American Express position back in the [inaudible 00:36:55] scandal days, I think it was 50 or 60% of the portfolio. So, somehow hedge funds turned into an asset class over the last 50 years, and they turned into this portfolio that is kind of a glorified mutual fund. And that’s not what I’m trying to do, I’m trying to do things that would have been done in the ’50s or ’60s, in the era of the Buffet and Munger and Garren and others like that.
Tobias Carlisle: One of the things that I noticed from your letters too, is how small those partnerships were. I think you said Munger had 11 million, and Walter Schloss, how much did he have in his fund when he closed it down, or sort of later on?
Steven Kiel: Yeah, something like, I forget was Schloss had specifically, but it was also not very large. And if you think about in today’s dollars, Munger I think was 50, 60, 70 million in today’s dollars. Schloss was somewhere around there as well, Schloss was much more diversified of course. But even Buffet, was what three or four hundred million or so at one point, kind of in today’s dollars. And maybe eventually made it up to about a billion but that was through appreciation alone. And there’s a lot of billion dollar hedge funds today. And back then it would have been one of the largest, if not the largest, fund at the time. Certainly size limits what you can do, absolutely.
Tobias Carlisle: And Buffet’s investments were reflected, the size of his fund reflected those investments though. I’ve gone through and particular, even when he was talking about the transitional type investments like American Express, the rest of the portfolio was these tiny net liquidation positions.
Steven Kiel: Yeah, Dempster Mills and others like that. Yeah, and these were companies that were obviously not… I mean even the Berkshire Hathaway at the time, and others like that. And you can certainly do more gram related things, and back then valuations were much, much cheaper on the balance sheet side than they are today. But you could do those types of things as well, so I think you can still do them today, you just have to be concentrated.
Steven Kiel: You know, West Aim, [inaudible 00:38:58] Capital, Enterprise Diversified, or I own a company called [Pindroll 00:39:02] that went private about a year ago, and it’s a cash box, and it trades at 75% of net cash, trades at 150, 160 thousand dollars a share because they did a reverse split. But there’s still things like that out there, but a lot of them turn into what they call one day stocks. They’re at a particular price.
Steven Kiel: Pindroll for example is just going to be where it is at, and then one day it’ll do a transaction and it’ll go public again. And it could go up three or four times from where it trades at now or where it’s valued at now, based on that transaction. And it’s kind of interesting but it also requires discipline on your part as a portfolio manager, it requires alignment from your investors as well to make sure they have an appreciation for what you’re trying to do, knowing that there could be volatility on the results, that doesn’t mean there’s volatility on the operations though.
Tobias Carlisle: Given that it does require this level of discipline, and the opportunities are infrequent or rare, do you tend to carry cash?
Steven Kiel: Well, I think if I was larger, if the fund was larger, when it becomes larger there’ll be more cash set aside as an option. There’s the idea that you do want something there to take advantage of sharp drops, or to take advantage of unique opportunities that come up very quickly. Historically I haven’t had cash on the side, I’ve been fully invested. I do keep a black swan style hedge odd, with the idea of being able to sell it in order to generate cash to put into a watch list item or if there’s a sharp drop.
Steven Kiel: There’s the old saying that the market’s got to take the stairs up and the elevator down, and probably more so than ever today because we’ve got electronic trading, we’ve got all of the issues with index funds and other pressures. That black swan style kind of protection there is probably not a bad idea. So, I’ve done that and it’s been helpful to generate cash.
Tobias Carlisle: What have you done, how have you structured that?
Steven Kiel: Yeah. So, I haven’t gone into a whole lot of detail because some of the instruments we do this with are not the most liquid things, so we don’t want to give it away too much. But it does involve some sort of volatility or option, or something like that, that moves very sharply when the markets drop quickly. And I don’t want to continue to own it, it’s not a market hedge, it’s not a portfolio hedge, it’s something that, when the market gets a sharp correction, I want to sell it within a short amount of time. And there is no better example of this than, again going back to the election when Trump was elected, you remember the markets were down.
Tobias Carlisle: Very well.
Steven Kiel: Very significantly that evening, and that hedge, I think at the time my fund was worth seven million in assets or something like that, and the hedge itself was a billion dollars, that was worth a billion dollars. However, the market opened up the next day, because if you recall about five in the morning eastern time, Carl Icahn woke up and said I’m going put $1 billion to work the next day, and the [inaudible 00:42:14] recovered, the free market recovered, and I think the market actually opened up. And I never had the opportunity to sell the hedge, the instrument did not allow for non-market hour trading.
Steven Kiel: But it was fine because the rest of the portfolio benefited obviously from the markets going up, and some specific holdings we had, but that would have been a tremendous amount of protection and cash that would have been generated that I could have put to work in that turbulent time period.
Tobias Carlisle: You know it’s funny, I’ve had variations of those hedges on, I’ve had front month VIX calls, I’ve had out of the money-
Steven Kiel: Don’t give it away, don’t give away the secrets.
Tobias Carlisle: Like you I’ve never cashed one in, and I’ve had some pretty monster winners. I’ve have some HYG Puts, and I used the Spitznagel just buying out of the money puts on the market. So, the HYG is the high-yield index, but I had the VIX calls at that same time, and I woke up, or late at night, it might have been 22% of my PA, and again, expired worthless. I’d never cashed one in, but they’ve all been at various stages, very significant portions of the portfolio.
Steven Kiel: That was a wild night, and I remember I was actually in California, I was in San Diego at the time, and it was such a wild night for the markets. I stayed up all night and to be able to be three hours behind as well, three hours behind New York, and to see Carl Icahn at 2:30 in the morning is making these announcements on CNBC.
Tobias Carlisle: Do you think he bought?
Steven Kiel: I don’t know.
Tobias Carlisle: How did he transact?
Steven Kiel: You should go back and check the 13Fs or something like that to see what he did, but his statement alone seemed to be enough. And it worked out, I mean when you think about the reduced regulatory environment approved, especially with the banks and lending and business optimism, it certainly was beneficial to the market and has been for the last few years. And nobody else could have got through a corporate tax cut. Nobody was talking about corporate tax cuts at the time.
Steven Kiel: Actually it was probably a negative for Arquitos though, because at the time I was benefiting from these net operating whilst carry forward companies. But I had the Bank of America Warrants, other people owned the financials, and there was a sharp move over the next month or two after the election that otherwise would not have occurred.
Tobias Carlisle: Do you know, one of the things I think that gets lost in the shuffle a little bit, that move actually started on the Thursday before the election, and I sometimes wonder about that, I don’t know what that means.
Steven Kiel: Yeah. I don’t know either, maybe there’s a predictic style element to it that some people with larger allocations than us might have known something. But it certainly benefited the banks though, and the warrants themselves were… I started my fund on April 10th 2012, and I had been running managed accounts for three years before that, I owned the TARP warrants there, I owned my personal account, and so that was the first thing I had bought, the Bank of America TARP Warrants. And we look back at Brian Moynihan as being kind of a leader right now, but with him and Jamie Diamond are really the most stable sober leaders of these large banks. But that wasn’t the case back in 2011, 12, and Moynihan did not have a reputation he does now really until Buffet ended up buying into Bank of America. In some ways he diluted shareholders in order to increase his credibility, and Buffet got a great deal there.
Tobias Carlisle: Seems to have worked for shareholders?
Steven Kiel: It works for shareholders over the long run as well. But those were the warrants I bought, I liked what Moynihan was doing in that time period, I was most comfortable, I thought that waws the lowest risk. And also, I thought there would be some interest rate increases, and when you think about the deposit base of Bank of America, they had the lowest cost deposits because of the retail network and things like that. And they obviously would benefit the most then if they were interest rate increases, and that hasn’t happened, but the banks have still benefited and Bank of America has still benefited because return of capital is so high, relative to what it was before. I mean they’re all over-capitalized still.
Tobias Carlisle: Those Bank of America TARP Warrants were very interesting, I didn’t get to them until much, much later. But I remember the stock hadn’t done anything for a long period of time, and I think I’d bought them, I don’t think there was much premium in them at all at the time that we bought them, and they were trading, they didn’t have to go up very much at all to be materially in the money. And I think they were 2021, or 2023, they had a long time to run, and basically you were getting a free hit if it went up. That was about the full extent of my analysis.
Steven Kiel: Yeah. And well, and plus they weren’t priced appropriately for a number of reasons. The [inaudible 00:47:15] doesn’t really work on these long dated things, the strike price themselves dropped, [crosstalk 00:47:25] started. And now ultimately the B warrants, they expired worthless, those are the old [Mara Lynch 00:47:31] ones I believe, the [inaudible 00:47:34] price was 3079, and they expired worthless.
Steven Kiel: But it was an interesting thing to look at it, if you’re interested in Bank of America, why not own a little bit of a different instrument? And that’s kind of been the way that I’ve approached it since the launch as well. When you find a large company, if you have a different way to play it, where you might have an additional opportunity.
Steven Kiel: Joel Greenblatt talks about this in You Can Be a Stock Market Genius, that when you have an asymmetric situation you can really juice those returns without taking on really too much additional risk. And that was exactly the opportunity there with the TARP Warrants.
Steven Kiel: And even Berkshire Hathaway for example, through the years I’ve done long dated options on them when its gone to a price below what Buffet is bought at. There were times when it was 1.2 times book, 1.3 times book five years ago. You could buy these options two years out with a strike price at 1.2 times book at the money, and I made 100, 200 300% returns on some of those positions, they were one or two or three percent positions. But certainly at some point over the next two years if it trades at 1.2 times book, it’ll increase a little bit, and your downside risk is minimal and your upside risk is what the options are several times more than it would be with the stock itself.
Tobias Carlisle: Yeah, I agree. I’m a big fan of those leap warrants and I freely admit that I got the idea from Joel Greenblatt, it’s a great idea.
Steven Kiel: [inaudible 00:49:12] yeah, You Could Be a Stock Market Genius book has so many great tools. Goofy title, but really in depth strategies that you could apply today, and the leaps are a big thing, and because the options… I really do believe that the options market did not exist back in the day in the same way that it does today. You’d have to create private options back in the ’50s, ’60s and ’70s. But I truly believe that Munger or Buffet or Garret, or others like that during that time period, would have really taken advantage of some of those anomalies, especially in the asymmetric style opportunities and situations.
Tobias Carlisle: Yeah, I couldn’t agree with you more. It’s one of those places that I still think you find really wildly mis-priced things all the time, because I think that there are a lot of folks who use Black-Scholes to something to value them, and if you approach it like a value guy where you’ve got a view on one direction over another, and something that’s got no volatility because it’s just been boring, or it hasn’t done anything for a long time, you get some wildly mis-priced options in there.
Steven Kiel: Yeah. I mean it’s all about arbitrage, your arbitraging the models, and if you’re going two years out and you have a fundamental view. Yeah, I did that with Intrawest Resorts, that was the company that Fortress had in their private equity fund and was partially public, and they did a tender offer at 750 a share, and ended up getting bought out at I think it was 2375 a share about a year later. And when they bought 10% of the company back at 750 I bought stock, I bought options, I loaded up because the pricing was attractive, and the options.
Steven Kiel: But you knew that it wasn’t going to be sold at $13 or $15, it was going to be sold at $18, or $20 or $24. And that’s ultimately what happened, and so the Black-Scholes models don’t take into account the idea that Fortress is the fund that they owned it and it was in year 11, and they needed to sell this company at a premium because it was the last position they held in a fund that was a 2006 vintage. So, they needed to do everything to juice the final returns of this holding, and that’s not going to go into these models.
Tobias Carlisle: So, that’s fascinating Steve. If folks want to get in contact with you, what’s the way to do that?
Steven Kiel: Yeah, so you go to the website arquitos.com, A-R-Q-U-I-T-O-S, I’m on Twitter as well, @Steven_Kiel. And you can find me, I think I go to websites and send an email and things like that. I actually outsourced my operations, Arquitos operations to Willow Oak Asset Management, so you can always get in touch with some of our operational staff there, the primary contact for Arquitos, she works at Willow Oak. And then come and see me at Berkshire Hathaway or The Daily Journal in some of those meetings.
Tobias Carlisle: Yeah, I’ll be there this year. I’ll make sure to say hello.
Steven Kiel: Absolutely.
Tobias Carlisle: Steven Kiel, Arquitos, and Enterprise Diversified, thank you very much.
Steven Kiel: Great being here with you Tobias.
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