Price Drives Diligence | The Acquirer's Multiple®

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Price Drives Diligence. Here’s an excerpt from the episode:

Bill: Yeah, I can do it. I guess the security that resides in my portfolio that is both the biggest and is most on my mind is TransDigm. And when I bought it, I bought it the week of March 16 to March 20. And it’s a company that I had followed because I’d followed aerospace, I’d messed around in GE in the past, I messed around in the airlines in the past. So, I had a view on travel and the airline sector and the aerospace supply chain. And I had a general sense of why I think the TransDigm and Heicos of the world rightfully have some compounder bro following.

I was never really able to get there on the valuation. I just thought that at the prices that they were offered at, you had to have a view on the business that I wasn’t really comfortable with. And that week of March 16 to March 20, everyone in the world was panicked because of TransDigm’s leverage, which I understand, but when I was back at the bank, when companies would go to work out, we wouldn’t really talk about leverage all that much. It was all about liquidity. And you got to have the liquidity to get through.

Now, obviously, that presumes on the back end for someone like TransDigm. I think they have a slug of debt that’s maturing in 2025 I think it was. They’ve got to be able to refi it. So, you need to have the trends of travel going in the right direction to get people comfortable rolling the debt and whatnot. But their maturity profile was not one that I thought warranted real quick concerns over bankruptcy that were imminent. And I have a couple of people that I talk to a lot that had called me to ask about their covenant issues. They have a springing covenant, if the revolver is 35% drawn, and it was pretty clear that it wasn’t gonna happen.

When you mix those questions in with the price action and the uncertainty of what was going on in the market, it was pretty clear to me that it was panic selling, and people that maybe were comfortable holding businesses while the outlook was rosy, being uncomfortable with a distress time. And the questions that I had to ask myself to buy the security there are so much different than the questions that I have to know– I don’t even know what to tell people about it now.

Tobias: How much has it moved in that period?

Bill: I mean off some of those buys, 100%.

Tobias: Yeah, okay.

Bill: Today, it’s down 5%, so whatever, but it’s 10% of my portfolio, I bought it hard when I swung. It’s just been a face ripper. It’s even outperformed the rally. So, I trimmed it on Friday. It got to 13% of my portfolio and the valuation just got a little stomach-churny.

Tobias: Yeah, you don’t wanna take that kind of bet at 13% of portfolio. [laughs]

Bill: Yeah. I took down 3% of the portfolio and brought it back down to 10%. But it’s hard to now have 10% of the portfolio in a company that I don’t have is– I don’t know how to analyze people in this security, and I think at these prices, that’s what you need to do. What I’m somewhat falling back on is, I believe I made a really good buy. I believe the cash flows will be there. They give special dividends and cold hard cash. I think I will get some in the future. But it’s odd to be in a scenario where when I bought it, I asked myself, “Are you willing to live through a 50% drawdown?” And I’m actually looking at the exact reverse.

Tobias: Can you hold through a 50% gain. [crosstalk]

Bill: No, but I don’t even mean it like that. That’s not what I’m trying to say because it’s everywhere. But I have been talking about– just last week, I talked about Spirit AeroSystems and Hexcel is two things that I thought were sort of interesting that– honestly, I was thinking of paring down TransDigm, I own a little Heico, not much because that one’s never really got all that cheap. But I wanted to pare down those to go into the other, the more cyclical ones was sort of where my head was at. And all of a sudden those have ripped. The freaking United Bonds that I said that I liked at 11 are down to 7. The speed at which stuff is moving, I don’t even have the time to do any of the work that’s necessary to have a view on the stuff. Like the second [crosstalk] is gone.

Jake: Neither does anyone else. [laughs]

Bill: Yeah. So, my default position has been to hold what I know I own because I do like the asset quality. If it costs me some performance, at least I can go to bed at night knowing that like I’m not– in order to play a different game, I would need to be gambling. And that’s what I am trying to avoid. But it is been tough to watch the stuff that I think is cheap just like fly on me before I can even open up the 10K. It’s crazy. [crosstalk]good segue into your topic, Toby. [laughs] [crosstalk]

Jake: I think what Bill’s touching on though is an important idea in that, at different price levels, there’s different skillsets required. And probably at expensive prices, you have to be an above-average analyst to expect to do well. But when the game shifts to low prices and fear, then you have to have a psychological edge, and you don’t have to be as good of an analyst, probably when everyone’s just trying to dump and get to cash as quick as they can.

Tobias: Just need some mangoes.

Bill: Yeah, I think that really is the issue because fundamentally what that bet came down to, and we’ll see if I’m right over time, but is do you think that travel will rebound. And the amount of research that I’ve done in the past, I was comfortable owning airlines and all that, I didn’t have to answer that question. That question, it’s already been answered. So, then the question to me was, do they have the liquidity and do I think they’ll be able to roll the debt? Those to me were like the questions that mattered. And even people that I really respect that have owned it for a long time that bailed on it, some of them were like, “I just don’t deal with distress.” I don’t really mind distress all that much if I understand what’s going on.

Tobias: Well, here’s my question. If everything is moving as quickly as this, are you rationally being Davey Day Trader? Are you behaving rationally trading the stuff faster because there’s some stuff in my portfolio, I like it at one price, I’m not smart enough to analyze it where I hold it now. Now, do I punt now? It’s not day trading, but you gotta trade a lot more. I almost wrote a piece saying this is one of those weird times where value goes and I made it on the way down, where value guys gotta do something they’re not comfortable with, which is do a lot of trading. I didn’t really think about on the other side, but now I’m looking at some of these positions. There’s still cheap stuff around that hasn’t moved, and I’ve got this stuff in my portfolio that’s like, now you gotta have a view.

Bill: Yeah. I think that’s the tough thing. And I guess that, taxes start to get involved. Somewhere in March, I was still chewing through short-term losses. So, it was like, “Oh, well, I can trade this.” I was incurring some short-term losses for that matter. But I’m through that. So, the questions get harder now. Now, it’s like, “Well, do I wanna trade an asset that I think legitimately I bought at a good price that has a good fundamental cash flow underneath it for a puff that I might have to pay taxes on later?” And my answer has been no. But if I look back and I underperform going forward, it’s not gonna shock me. I mean, TransDigm and Heico– I said it, gut-churning. I mean they’ve come off a little bit from where they were, but on Friday, I was just looking at them, “How the hell are these businesses trading at this price right now?” I get it. I do get it on a spreadsheet, but I’m not sure I get it, if that makes sense.

Jake: The irony of that, I don’t know if you guys have seen that meme where it said like, Sub 100 IQ. It’s going up, buy it, bro. And then 100 to 130 is, things are messed up. How could you be buying? The feds intervening. And then 130 IQ above says, it’s going up, just buy it, bro. It’s so different than what you’re talking about, Bill.

Tobias: Well, that’s been true for the last 12 years. Anytime you’ve done anything risk managed for the last 12 years, you’ve just been an idiot. Even as recently as the March drawdown, anything you were doing to protect yourself, it turns out that was dumb because we’re back to all-time highs. From March 5, 2009 to today, just a straight line up, except for a few pullbacks, which were– evidently they were all buying opportunities, buy the dips, maybe the Robinhood guys are right.

Bill: Well, look, the other part about the TransDigm thing is, I say like, “Oh, the questions are easy.” I bought a fair amount of the debt too. I mean that was yielding 11 and its coupon is seven and a half, I like that. And I was like, “All right, I guess if I’m wrong on this at least maybe I can protect myself on the debt.” And I feel like fucking Buffett after ‘09 when he was like, “Yeah, I should have just bought all the equity.” What was I even thinking about the debt for? It was stupid. I think it was smart, but in retrospect, it’s just like, “Man, you’re dumb to worry about risk at all.” [crosstalk]

Tobias: Because you only live through one path of all the possible paths.

Bill: That’s right.

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