(Ep.81) The Acquirers Podcast: Francisco Olivera – Franco’s Filter: Highly Concentrated, High Quality Companies, Liberty And Malone

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In this episode of The Acquirers Podcast Tobias chats with Francisco Olivera. He’s the President of Arevilo Capital Management. During the interview Francisco provided some great insights into:

  • Take A Concentrated Position That You Can Hold For 5+ Years
  • Capital Structure Tells You A Lot About A Business
  • John Malone And The Art Of Capital Allocation
  • Don’t Sell On Valuation
  • How To Find Managers That Create Shareholder Value
  • Don’t Get Blindsided
  • Concentrate On The Multiple In Year 5
  • $DIS Still Has Huge Upside
  • Sell-Side Analysis On $FOXA
  • The Bull Case For $QSR

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:

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Full Transcript

Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Francisco Olivera of Arevilo Capital Management, manages the Arevilo Capital Fund. He’s highly concentrated, very long-term holder. Bill Brewster says that he’s the pickiest investor he knows. We’re going to talk about it right after this.

Take A Concentrated Position That You Can Hold For 5+ Years

Bill has this great line. He said, “Francisco is the pickiest investor I know,” in a good way. What’s he mean?

Francisco: I guess, maybe I reject too many of ideas.

Tobias: You’re like Charlie Munger, you’re the abominable no man.

Francisco: [laughs] No, It’s funny. We run a pretty concentrated portfolio. So, what I try to do is, basically can I imagine myself after doing the work putting 10% or more? Maybe ideally 15. But 10%, maybe can start at 5%. So, I’ll eliminate something that’s basically just a low multiple stock. And I’m not saying that’s all Bill’s pitched at. He has pitched a lot of good ideas as well that I probably shouldn’t have rejected offhand. But with that framework, sometimes there’ll be things that are low multiple, but do I want to hold this for five-plus years? And that’s where it gets a little difficult, but it’s great to chat investing ideas with him.

Tobias: So he said, I should ask you about your filter. So what’s in your filter? Why aren’t those ideas getting through your filter?

Francisco: [chuckles] Basically with that in mind and knowing that I want to have at least a 10% investment in– I want a good value, but also being long term, you want a business that you know is going to be sustainable. But if you’re holding long term, you want that intrinsic value to grow, not just be sustainable. And just basically there, you eliminate a lot of businesses that probably will never understand just the industry period, like healthcare is just something I’ll probably never invest in. Never say never, but it’s just a little bit too tough for me, seeing where many of these businesses will be in the long term or just dealing in the regulatory part of the business. So, that’s the first filter.

The second filter is basically, if I’m going to partner with this business, buy this business, hold it for many years, to me, the management team is almost as equal importance as the quality of the business, and as a price as well.

Because if the management team is going to fool you, or they’re not going to do a good job, or maybe you thought the business was better than it was and the management team is not even that good, it could actually create a huge headwind and maybe some problems for you. So, the management has to be good. The business’s intrinsic value ideally is increasing, but definitely sustainable.

Basically, that all comes together with concentration because you don’t want to be wrong, I guess, when you’re putting a 10% position. I think sometimes you can put a 1% or 2% position, something that can basically have enormous upside, but if you’re wrong, it’s really not a big deal and you’re down 20% and you know that on that stake, and you know that basically it’s not going to work out in the markets. You can sell, it’s not a big problem for the portfolio, but if you’re down something like 20%, 50%, and it’s an impairment on that 10%, and you do that repeatedly, it could basically harm your performance long term and maybe your investing career.

So, it’s kind of with that filter being pretty strict, and knowing what I don’t know, which I guess a lot of investors say as well, but I try to be strict in that discipline and not try and– if something I think it’s a little bit too difficult to understand, I try not to put pencils down and go to the next one, or maybe just keep following it. I think that’s why the filter might be a little hard, but sometimes it’s not necessarily a good thing. Sometimes, it’s good to continually learn and follow something and maybe eventually you’ll get there, but just that initial layer of spending maybe five minutes with something and going to weeks and maybe months reading about something, you can eliminate a lot of things by having those criteria.

Tobias: Do you like to initiate at 5% or 10%? Is that where you’re trying to start them off?

Francisco: Yeah, usually try to initiate at 5% or 10%. So, it’s a big hurdle.

Tobias: And then, what would cause you to take it up to say 15% or more? What’s your biggest position at before the run?

Francisco: Before the run, in terms of the name–? [crosstalk]

***

Don’t Get Blindsided

Tobias: Just initiation, where do you like to initiate?

Francisco: I’d like to initiate at 10%, and what takes it to 15 is, I think, the downside is pretty low. And maybe even more than that, but usually at cost, I’m not going to go much above 15%. A business like that, it’s– Charter Communications held it in the portfolio basically since more than five years. I thought the downside was pretty low and the upside was pretty reasonable at the moment. And it’s done pretty well. But I think once you go to 15, and maybe even higher, you’ve just got to make sure that you’re not going to be blindsided. I try to also think about constantly being blindsided in football, basically a risk that I didn’t really understand. But you wake up one morning and there’s a news or a press release or a quarterly report that something a bomb drops and you didn’t think it was a risk.

Many times, if you know a business well enough, you know what can go wrong most of the times, excluding a COVID type of situation. But you know that, well, this competitor is really good. You know that, well, this company can enter and really disrupt you. Basically, if you buy Walmart, Amazon is a risk. Actually, Walmart looks pretty strong today, but I guess more a mom-and-pop retail, you know that’s a risk. Sometimes, if you don’t know the name well enough, industry will enough some risk can pop up, that an expert or somebody will read the trade, newspapers on the industry, follow the company carefully, the competitors, you can basically know most of the risks.

To get it to that 15%, you got to be very, very sure that those bombs dropping are not going to really drop and that valuation is good, and then the upside is sufficient. But again, it also goes back to the management team. I like to think in terms of the management, a management team that they have your back, so they’ll understand capital allocation pretty well. And if the stock price is down and they see value, they’ll take advantage of it.

They see opportunity in the industry, they’ll take advantage of it. And usually some of the management teams that I like are just very consistent in what they say. They repeat themselves a lot because they’re trying to hammer the philosophy. I don’t own this stock, Amazon, but Jeff Bezos is like that. He’s very repetitive in the philosophy and always mentioning day one, always saying that they’re customer focused. Well, you can find many good businesses that the management repeat themselves like that, and they actually come through and execute.

So, I guess it’s obviously an art, not a science, but you put all these things together, and it’s a very low downside situation with these big risks dropping, then I’ll feel comfortable going to 15, but it’s really rare from the cost basis.

***

Tobias: What’s your background?

Francisco: I’m from San Juan, Puerto Rico. I graduated at Bentley University in 2011. I went to JPMorgan afterwards and did investment banking there in the Financial Sponsor Group. So, a lot of leveraged finance type of deals and doing financing for companies, sometimes M&A, sometimes working with the equity markets. And from there, I came back to Puerto Rico, had an opportunity to launch a private investment fund structured similar to the Warren Buffett style of 0/6/25, so 6% hurdle. And was able to do it with the backing of family and friends and then friends of friends, and going from there. It’s been a journey. So, that’s basically my short background.

Tobias: The strategy is– it sounds a little bit more reminiscent of Buffett. It’s not quite Buffett’s partner strategy. It’s more of a higher-quality business compounder over a long period of time. It sounds to me more of wonderful companies at fair prices because I’ve seen your list, which we’ll go through shortly, your key pillars. The valuation is the last thing you look at. I think you said you don’t necessarily sell on valuation.

Don’t Sell On Valuation

Francisco: Yes. Don’t necessarily sell on valuation. I’ll basically usually sell when I don’t think the business’s opportunities are as strong as I thought they were. Sometimes, it’s due to maybe something that happened in the business industry, something the management team did, maybe something else is attractive. But if you hold long enough, some businesses if they’re doing well, they’re going to continue to do well.

There might be periods that the valuation multiple looks high. But if everything is still going well and you’re still growing and they’re still executing, you should probably ride out those moments. Not to say that it can’t be bumpy, it can be extremely bumpy. But it’s really hard to find a business I think that you’re really willing to hold for a long time. If you still think it’s a good business and there’s still the opportunity there for them to grow and execute, just because it’s a little high, the multiple– there’s always a multiple that’s too high. But maybe if you bought, just to give a random number, 10 times earnings, and now it’s at 20. Not necessarily, I think that would just, “Hey, I’m going to head for the exit.” As long as I think everything’s still going well, and sometimes you’ll be rewarded for that.

I think the company I mentioned, Charter, they went through, not tough times, but the stock was very volatile. At one point, I think, in 2017, there was rumors that Verizon wanted to buy them and Sprint wanted to buy them, and maybe Altice was going to get in the mix. The stock went through the roof and then all of a sudden, no one is going to buy them. And then, they reported earnings and they had a little bit of a hiccup in their integration of their merger with Time Warner Cable and the stock just collapsed. But then, it recovered everything again a year later and more.

So, if you’re willing to– could it have been a good opportunity to sell when all of a sudden you have a lot of bidders potentially can acquire the business? Probably would have been a good time, but I wouldn’t have known that they would have had a quarterly hiccup maybe six months later, and that would have been an enormous buying opportunity.

Sometimes, the valuation is too high. I’m selling and betting that it’s then going to come be cheap again, that’s a tough bet. And maybe it’s the correct one, but it’s not one that– I wouldn’t feel totally comfortable just waiting that, “Hey, it’s going to get to a great price again.” I think when you look at the greatest business over time, sometimes they continually look overvalued, but actually, they were really cheap.

So, it’s probably– just valuation alone, if it’s valuation, and you think there’s cracks that are actually happening, this might be a good time to sell. Sometimes, one of the hardest times to sell is when the investment goes against you when you’re wrong. So, you’re taking a loss, a big loss in selling– Sometimes, that might be harder than it actually is, the multiples a little too high.

***

Tobias: Let’s talk a little bit about your key pillars. So, the first thing you look at is the business profile. What are you looking for there?

Francisco: Some of the things I’ve said, business at first that I think is sustainable. If I’m looking at a small niche retailer, I don’t know if that’s sustainable or a product that is hyped at the moment, I’m not sure that’s sustainable.

So, I’m looking for sustainability in the business. And then, I’m thinking about a business that it’s actually very strong and can maintain customers, can grow with their customers. So, to go back to the Charter example, I think broadband internet, in my opinion, their position in the home broadband is very sustainable. And then in addition to that, I thought, well, they’re going to be taking actually market share from– there’s still a lot of households with DSL connections, with copper-based connections that are very slow, more than one would think. It’s a big opportunity to increase market share and grow the business.

On top of that, there’s probably opportunity to increase prices because over time, the product becomes indispensable to the user. You’re going to use more and more home broadband, and COVID aside because now it’s been turbocharged. Right now, people working from home, kids are home. You’re basically on the internet all the time. It’s not like some downtime during the day.

Now, it’s as important as electricity in a way. So, I saw that opportunity, sustainable business, and I think it would be really tough to disrupt their home broadband business. It can be disrupted, but I think it’s very tough to. And they had the opportunity to take market share and increase its prices over time. That was the simple thesis behind that. There’s other things at Charter, but in terms of the business profile framework, I thought that’s a good way of looking at it.

***

How To Find Managers That Create Shareholder Value

Tobias: And then, you look at management board of directors and major shareholders. So, can you just walk us through how you’re assessing each of those groups?

Francisco: Ideally, they’re intertwined– [crosstalk]

Tobias: The same people.

[laughter]

Francisco: Exactly. If I can go back to the Charter example, basically, you have the team of John Malone, Greg Maffei. They’re big shareholders that are on the board. They’re not operators in the management, but they’re very close with management, and they’re actually instrumental in keeping management and choosing management. So, you want someone who has your back and is aligned with you, ideally. When Charter closed this deal for Time Warner Cable, the team at Liberty led by Greg Maffei and John Malone, they participated in the deal. They basically maintained a really big stake. They were in the compensation committee and set really high total shareholder return targets for the CEO, Tom Rutledge, to achieve.

Basically, the stock at the time was around, I’d say $180, maybe a little less, maybe a little more. At the time, the upper limits of this potential bonus package had the stock price at well over $500. And basically, they wanted to align– with long-term shareholder return, it’s not just a one-year thing. And so basically, they have shareholders in mind because they are shareholders, so they want to make sure that the right people are at the company. They want to be at the board in case something’s– if you got to fire the CEO or put someone new or basically clean house that you want them to be there as if they were representing all shareholders. But not in every situation– that’s not the case in every company at all. Sometimes, CEOs can have such a big stake.

I think a really good one would be a Bob Iger at Disney. You see what he’s done over time. And he’s basically speaking of consistency. He’s basically said many of the same things that since he became CEO and before he became CEO of his goals. Basically, being a more global company, having tech as a bigger part of the company and focusing on brand as a key of their content strategy. Just kept saying that, kept saying that, kept saying that, before buying Pixar. They bought Pixar. They bought Marvel, expanding globally focusing on the brands. And then they eliminated other parts that weren’t with that.

So, he’s basically a very good CEO, he’s been there a long time, and he keeps executing. You want to see– you want to read the proxy and see what type of things would get them a lot of money if they executed and you don’t want that to be a little bit too out of whack with what’s good with shareholders. Sometimes, some metrics don’t necessarily equal shareholder value. But I think at the extreme, you want a situation, that big shareholder, they’re in the board, and they’re picking management. But it doesn’t have to be that way as long as it’s a management team that execute.

One of the interesting things is that I’ve read that the average CEO of the SNP kind of turns out really fast in today’s age. I actually want to see the opposite. I want to see a CEO who’s there a long time or at least a couple of years, and that they want to be [unintelligible [00:19:33] more time, not because they want to empire build or pay themselves well because they’re executing and there’s a big opportunity.

Sometimes, when a CEO comes out of nowhere from outside the company and he’s had a good reputation and lays out the strategy very strongly, that’s a great opportunity. But sometimes looking at least a couple of years and they’re doing well, they’re saying the same thing and they’re going to be there many years, it’s a great sign. At the end of the day, you want consistent management teams, they have your back as a shareholder when opportunities arise, when the stock’s not doing well. And the capital allocation is part of that really. When I say a team that has your back, capital allocation is there because they don’t have your back if they’re not doing– they’re burning cash.

***

Capital Structure Tells You A Lot About A Business

Tobias: Let’s talk a little bit about the capital structure. That’s the third thing you– What are you looking for in terms of the capital structure?

Francisco: Well, I think what I look for is that it’s optimized for good shareholder returns, but at the same time, it’s not a big risk. Any business with too much leverage or fancy financing could get into trouble easily. So, if you’re a business that is a consistent monthly revenue stream and you’re a subscription type of business, like at Charter, and you’re taking market share and you can potentially increase pricing, it’s a good business that could handle a higher leverage and maybe a business that is just dependent on advertisements and it’s not like a contracts type, subscriber type of revenue. I wanted to make sure that they’re optimized for that.

Sometimes, when managements know their business as well, they know how to put a good cap structure. And usually just having way too much cash that’s just lying around and growing, and no good use of it, and you’re not using it, probably not a good idea.

Take Apple after Tim Cook saw the light on capital allocation pre that and post that. Basically, it was extremely hard to put to work in the business, hundreds of billions of dollars. So, I see as a way of capital structure because if you’re using a little bit more– getting net debt neutral, which is what they want to do putting some debt, returning capital, because they know they print so much money. I think that’s a positive thing.

Charter, they can maintain leverage at four to four and a half times EBITDA and probably a lot higher, but that’s where you get into more– it’s a little bit of playing with fire in a sense. It’s funny, it’s a great business, great industry, but it’s a company that went bankrupt during the financial crisis, with a different management team, much more aggressive strategy. So, even a strong business like Charter, you can overdo it on the cap structure.

But a cap structure tells you a lot how they think about the business. Why are they issuing debt? What are they doing with the capital? Why do they want to maintain a target leverage? And then, you can go peel behind that and look under the hood and say, “Okay, well, actually they want to maintain leverage at this target because this is what they’re going to actually do with the cash.” And usually weaker businesses, you’re adding leverage over time because you basically need the cash and you’re burning it in the business and kind of a vicious cycle and path towards zero. So, it informs you of how management thinks about the business, I think, by how they structure the capital structure. So, it’s something I try to think about. It comes more for my investment banking days because it was such a focus, but you can learn a lot about management teams and businesses by how they look and structure their capital structure.

Tobias: So, you’re looking– for something like Charter, it’s got subscription revenues on one side, so four to five times EBITDA debt is reasonably conservative for a business like that. Is that how you’re thinking through something like that?

Francisco: Yeah. And maintaining a leverage like that, because they’re growing EBITDA pretty well and cash flow is growing pretty well means the cash is coming in, and then you’re actually increasing the dollar amount of total debt that you have. And you’re taking all that, returning to shareholders. As long as the business is really good, and you maintain that, it can be a lot of money that comes back to shareholders. So, it’s an interesting way of thinking about it.

For Charter, for example, you have four, four and a half times EBITDA, they’re at the 4.3-ish range. And last quarter, they had $2 billion in cash. So, good cash flow. Essentially, there’s a lot of capital that they can return to the business and they invest a lot in the business. CapEx as a percentage of revenues is in the teens. Potentially can go low over a time, but it’s a business– it’s high capital intensity, but even with that, they still generate a lot of cash flow and with a target leverage range, they can return a lot of cash flow to shareholders.

***

Concentrate On The Multiple In Year 5

Tobias: In terms of valuation, can you just walk through, in very broad terms, how you value something and where you feel comfortable buying it as proportionate to that valuation?

Francisco: The multiples that I think we all like to look at are enterprise value to EBITDA, enterprise value to EBIT, also enterprise value to EBITDA less CapEx, free cash flow multiple as a percent of the market cap of the company. But what’s really important is what’s that multiple going to be five years from now, based on the current price, and that’s where I think the huge opportunities are. There’s a Warren Buffett quote that when he was buying Coca-Cola, I think the P/E ratio was in the 20s and might have looked really high, but he says, “Hey, the P/E ratio on year five was like five times,” or something lower.

At the end of the day, if you’re buying something at 15 times free cash flow, it can be pretty good multiple, especially in a market like today if the business is doing well, it’s still executing and maintaining their market position and growing because that multiple will go down. But what’s important is that it’s at 15 times free cash flow today but you’re not buying 25 times free cash flow from the free cash flow in year five. So, that’s how I try to think about things and see where– analyze where free cash flow can grow, where the earnings potential can grow five years down the road. If you look at those multiples and let’s say you’re buying something at a much higher than 10% yield on free cash flow on your five, maybe even a 15% yield, and you’re right, it’s probably going to work out well, especially if you’re right and nobody else has recognized that.

Looking how the business will evolve and how that multiple will be in the future, which is obviously an art, there’s no precision here. But that’s how I look at it. It’s informative to look at the LTM multiples in maybe next 12 months. And you don’t want to– EBIT’s at 40 times free cash flow on the last 12 months or the next 12 months, then you better be really, really right on that year five. So, you also don’t want to climb such a huge hill on that, but that’s how I look at it. But I’ll do the DCF as well sometimes just to stay grounded, but I don’t really rely on it. I just try to look at it in terms of how’s the business going to be five years from now, and is the market cap to the potential, are they going to earn five years from now, cheap in that sense.

***

John Malone And The Art Of Capital Allocation

Tobias: When Bill introduced us, he said, you’ve got to talk to Frank. You’ve got to talk to him about Malone and Liberty. So, what attracted to the Liberty complex and John Malone?

Francisco: I think what attracted to me is that they’re really shareholder minded. They know how to pick businesses that are really strong, capitalize them appropriately, and invest for the long term. So, they touch on a lot of the business pillars, the pillars of investing that we talked about. There are many businesses that I understand and they’re sustainable and can grow, they believe in those businesses. They put the right management teams, they capitalize them accordingly, and they’re very financial engineering-minded, especially Malone though. Those spin-off things that they want to isolate certain businesses or create tracking stocks, which are like synthetic equities really. They’ll try to do M&A when it’s appropriate. They’ll find new businesses to sometimes take public when it’s appropriate.

They backed it during the financial crisis in distress scenarios with Sirius XM, but also when there’s industry consolidation. I think they touch on all those things. I think it’s really attractive to me and how they talk to shareholders, and their vision long term. I’m not saying I don’t necessarily like every single business. When you say Liberty and Malone, the amount of takers that you can write off is a lot. So, I’ll be picking within that universe. Six years ago, Liberty Media had their Sirius XM stake, the Charter stake, Live Nation stake, Atlanta Braves.

And they spun out the Charter sake, isolated in Liberty Broadband, another company. Then, they took Liberty Media and split it in three tracking stocks. One for the Sirius XM asset, one for at the time was only Live Nation and some cash and some smaller investments. And then, they had the Braves, the baseball team as another of the trackers. When they went to isolate the Sirius XM stake, a very liquid public company, large and buying back stock, they wanted to have everything else in Live Nation and also isolate the Braves as a pure play, the baseball team with the real estate assets. What’s interesting after that is that they bought Formula One with the tracking stock that had the Live Nation.

It basically structured as a reverse IPO in a sense. So, a public company buys a private company, but the private company is the one that becomes dominant thereafter. Even after that, during the COVID, they reattributed assets– when the Formula One asset was with Live Nation, both depend on basically having a lot of people to add events, a large amount of people. The average Formula One race has 200,000 people attending and obviously, Live Nation is a global concert promoter.

What they did was they thought those two assets having them together problematic, so they took cash from the Liberty, Sirius asset, sent it over to the Formula One asset, and Formula One sent Live Nation. There was a couple of other things that went down in that reattribution but that’s the most simplistic thing. They also issued rights offering on Liberty Sirius. I think rights offering can be pretty interesting if you’re a long-term shareholder. You’ve got an opportunity to add, and maybe sometimes get oversubscription.

Studying those complexities and those chess moves and what they’re really seeing long term, it’s something that’s actually fun and interesting, not to say that they’re all right and then they’ve been perfect. But if you follow them closely and you follow the businesses and look at closely, I think you can do really well or at minimum learn about how they think about business and growing businesses and capitalizing businesses in M&A. So, I think that’s one of the reasons why I like to follow them. Frankly, the Charter investment is one of the largest, in large part because of them.

***

$DIS Still Has Huge Upside

Tobias: Well, let’s talk about Disney because you’ve given some presentations on Disney. Can you take us through the Disney thesis?

Francisco: Yeah, Disney thesis is how Bob Iger lays out his worldview, is focus on the best brands into the content because branded content is content that you can monetize very well.

Tobias: So, when you say branded content, that means it’s a Marvel product or Pixar, and so people identify those as being high-quality videos that they can show their kids or something like that. [crosstalk]

Francisco: Exactly. It’s another way of– I guess anyone can say any content is branded to a certain extent, but you’re right. It’s high-quality intellectual property content. Everyone in a lot of media, CEOs, they all say they have the best IP, but I think they truly do have the best IP and you can tell that first because of the box office numbers, the consumer product sales and the park sales– which the parks are the parks and are so popular and do so well because of the branded content that’s in the parks.

But that’s how I look at Disney. At the center, it’s a content, branded IP, the highest quality. You can monetize that the best because it can give you multiple revenue streams. You watch in the movie theaters, you buy the movies, you go to the parks, you sell the lunchboxes, the pajamas, etc. You do a TV show, you release the books, comic book or a crayon book. Basically, it’s really never ending.

I think what attracted me to Disney initially was in 2017, when Bob Iger said, “We basically have to go direct to the consumer. We have to have our own streaming service. The cable bundle, we can’t rely on it anymore, especially for our brands.” Because over time, everyone’s going to watch content streaming. If you’re going to depend on someone else’s platform, they’re going to know more about your own content than yourself. And that’s something that they could not permit. But it was a defensive move against Netflix and others, but also an offensive move because they truly believe and I think we’ve seen that with the numbers after the Disney Plus launch, that their high-quality content can actually drive a lot of subscribers.

I think, once they announced that pivot, it became clear to me that that there was a huge opportunity for them because you’re talking about every single household in the world essentially, excluding China. And those households are going to grow towards more than a billion in having broadband in a fairly short period of time. That’s just opportunity to have a stream subscription service there. But I actually didn’t know the stock then. I try to apply sometimes as maybe a special situation mindset, it’s not what I do all the time. But when Disney announced that they were acquiring Fox, that’s when it became really interesting to me for a couple of reasons. You could buy essentially 21st Century Fox at a time.

Let me take a step back. When Disney allows us to buy the 21st Century, they had to split 21st Century in two parts. Disney was going to acquire the branded content, the international assets, a Hulu stake, a stake in Sky and eventually consolidating Sky. Eventually, Comcast bought that. That’s another story. And then, the regional sports networks for Fox Disney also had to sell. But they also had to split the Fox broadcasting station, Fox News, Fox Business as another entity. Because of regulations, ABC which Disney owns can’t own Fox. You can’t have two broadcasting stations. Only Fox News was problematic. So, the best way to do it is to cut the company, not in half exactly, but two divided.

As a 21st Century shareholder, you’re going to receive shares in Fox Corp, Fox Broadcasting, Fox News, etc. And you’re going to receive shares in Disney if you elected to. And if you did the math at the time of the announcement and even a couple of days after the announcement in weeks, you could basically buy– you could get Fox at like five times free cash flow at the time and then Disney stock. And then, what that deal was– accelerated their IP strategy, they gave also a Disney a much bigger television studio, and some channels like FX and National Geographic, which is really content that they wanted for streaming. They took control of Hulu. So, they can use Hulu to bundle it with Disney Plus. They got animation content from Fox that they could put into Disney Plus. They got family content from Fox as well that they can use. They got the Avatar movies. They got the X-Men rights and the Fantastic Four rights. Long history, but Marvel had licensed those out to 21st Century back in the day, and now within Marvel Studios, you could really propel those rights. So, those are a lot of assets, a lot more IP, a business that’s going to be a lot more global, business that’s going to have a lot more streaming in assets to fight against Netflix. It also included the assets in India. Star and Hotstar is biggest streaming service in India and they use that also to bundle Disney Plus.

I saw it as they’re going on steroids in their strategy and you can buy it with 21st Century, you get Fox at really, really low multiples, either that multiple is going to increase and make my money there or basically I’m getting Disney stock cheap if that multiple is going to stay low for the Fox assets.

After that, there was a bidding war in everything, and it worked out well. Then, COVID reversed all of that for Disney because they had to close their parks. But I think just having that IP, being able to participate in streaming, in the flywheel with the parks and consumer products was just an enormous opportunity for them.

And actually, streaming might be the biggest opportunity that Disney has had as a company ever. So, that’s very attractive. When they announced that they were going– they did this whole investor day presentation when they were laying out their Disney Plus strategy. They basically said they were going to be, by year five, 60 to 90 million global subscribers. In nine months, basically, they got to 60. And they’re not even in Latin America or Brazil or all of Europe or all of Asia today.

So, there’s still a huge opportunity that they’re going to expand globally. And you’re not fully penetrated in the markets that they’re in obviously, because they’ve been in only nine months. They’ve only had one show that’s original content, I guess, two if you include Hamilton the movie. But The Mandalorian, Star Wars universe television show, it’s basically their only out of the ballpark hit because all of the production has been shut down. They already had really highly anticipated Marvel shows out in other content as well.

Even with the content that they had in most of their library, they were able to generate– basically acquire so many subscribers, it really bodes well for the company. The streaming services that they have today already have 100 million subscribers. Netflix is at 192. They’re just getting started internationally. So, you basically have a business that the content is so good that they can basically build another Netflix or a half of Netflix inside of it. But you still have a really good business in the parks, which prints money in the normal environment, and incredible business as well with consumer products.

A great studio business that basically has 30% to 40% box office market share. So, in the normal environment, that’s really attractive as well. It’s really a promotional vehicle because they’re releasing 10 movies a year. Sometimes, when people think about, “Hey, streaming is the future. You shouldn’t go to the theater.” Well, they’re releasing entire movies. It’s basically like a concert and then you can watch it in streaming. Some of those movies are just better to watch in theaters.

When you think about that flywheel, that opportunities that they have, I think it’s really attractive. I don’t think– the media has hyped this streaming wars, but I think no one’s going to catch up to Netflix. Disney just has a unique opportunity because of the value of those brands. And then, everyone else is just basically walking with blindfolds on, I guess.

Tobias: Yeah, I have a seven-year-old daughter, so of course I have Disney streaming service, and I watched Alice in Wonderland the other day, the original. It really holds up. It’s a stunning piece of artwork. I was blown away because I haven’t seen it probably since I was a kid and didn’t really–

Francisco: Oh, wow.

Tobias: This is when they hand-painted every single frame. It’s truly artwork. I couldn’t believe how good it was, so it’s much better than I remembered at the time. I’ve got two quick questions. What did you make of Bob Iger pulling the ripcord and then sort of jumping back in?

Francisco: I think there’s been a lot of headline type of things because– Bob Iger, if he looks back, he probably would have wanted to step down in a more calm environment. There’s some people who said, “Hey, he knew COVID was going to blow up, so he was going to resign and then make his track record look good because it’s going to be a disaster.” I don’t think that’s really what’s happening.

Tobias: It was very abrupt.

Francisco: Yeah. Very abrupt because it was in late February, and really the markets were really realizing then of the risks of COVID. So, I think it was abrupt. I don’t think it probably wasn’t handled the best way. Here’s two things. He’s still going to be on through 2021 and the company. He was going to be originally CEO of the company through 2021. But he’s really taking a step back to handle some of the content things. He doesn’t need to be day to day in many of these businesses. COVID aside, I think it’s a move that makes sense. The CEO that they pick, which I actually think it’s a great pick, even though the media didn’t think he was going to be the chosen one. Bob Chapek is an incredibly good CEO. He has experience in all sides of the business. Maybe the Hollywood star-driven part is not his forte, but he’s going to be next to Bob Iger in all these important meetings, and meeting people and understanding a little bit better about that business through the next 18 months or so, or a little less.

It wasn’t handled as well but I think the role that Bob Iger has now is like maybe a Chairman, John Malone type two Greg Maffei if we’re talking about comparing it with Liberty. And I think Bob Chapek–he looks like a really incredible CEO. Here’s one thing that Chapek did I think is really impressive. As they are expanding Disney Plus globally, they’re closing down Disney channels. All the Disney channels on Europe and Asia, and probably going to happen in Latin America, they’re closing them down. So, basically they’re burning the boats . We’re here to do streaming or not. I think it’s an incredible move. He’s thinking about the business a lot differently. Where can I spend more efficiently? what do I need? What do I not need? Many people thought they were going to take Hulu internationally. What they’re going to do actually, start a streaming service with the Star brand and it’s pretty a really smart move. If you take Hulu internationally, you’re going to basically take Comcast for the ride, because Comcast owns a third of Hulu. And there’s a put-call provision so that they’re going to sell their stake in four years. But if you’re taking Hulu internationally, you’re going to increase the value of Hulu substantially. So, using the Star brand that’s more recognized in Asia, but maybe in Europe, you can penetrate easier. I think he’s doing really, really well.

There’s a good article on Bloomberg about him about how he’s thinking about the business. Bob Iger will– for example, he negotiated with Lin-Manuel to get Hamilton directly to Disney Plus because it’s a movie that was going to go to theaters. He had a big hand in terms of getting the NBA to play basketball in their Bubble in Orlando in Disney World. So, negotiating like a statesman in a sense. Adam Silver from the NBA, with the heavy hitters in content. I think it’s good that Chapek is there, and over time I think he’s going to give more– Chapek’s role is only going to increase and it’s good. You’re basically talking about a celebrity CEO in a sense that has done an incredible job, no one could have imagined how well he’s done. If you read some of the books about Disney before he became CEO, and even Bob Iger’s book, it’s almost a miracle that he became CEO, and it’s amazing the brands he was able to acquire and how he turbocharged Disney globally and with more brands.

So, it’s a difficult role to step in. If you want to make sure you’re doing a good transition, it’s good that Iger either stays as chairman, Chapek as CEO and over time, Chapek goes on his own. The first earnings call after Iger said he was going to not be CEO anymore, he basically gave an introduction, but that wasn’t part of the Q&A and then Chapek wasn’t the name of the board initially. “Oh, is Iger coming back?” Well, after the New York Times article came out, basically saying all these things and criticizing Disney, a couple of days later, they named Chapek on the board, and I thought that was a huge sign like, “Hey actually, you’re wrong. He’s really important to us.” Quarterly earnings call after that, Bob Iger wasn’t even on. When there’s interviews, it’s Chapek. I think he has his hand on the wheel. So, you’re right that it was a little messy, but it’s worked out. It’s been working out well.

***

Sell-Side Analysis On $FOXA

Tobias: The other question is, so you’ve sold the position in Fox and I saw on your letter that you thought that the acquisitions were questionable. When you’re talking about the acquisition of the position in the first place now that you say it was a special situation, do you mean in the sense that that was the cheaper way to buy Disney, was to buy it through Fox? Just talk us through the sale of that position and was that maybe planned initially? Are you unhappy with the acquisition policy?

Francisco: Two things. I did acquire to basically get Disney at a discount and it also added to Disney because I wasn’t sure how many shares I was going to get in Disney. But I actually liked the Fox strategy. So, what they were saying was, “Hey, we’re not going to be in this Hollywood movie business and competing on TV shows against HBO, Netflix, and Disney. We’re not going to put movies in theaters. We’re going to focus on live. We’re going to get more sports and more news, and that’s going to be our focus and we’re going to be able to drive pricing in terms of the bundle.”

The bundle has issues, but people keep subscribing because of news and sports. And obviously the best package that they have is the Sunday package for the NFL. They’re in the Super Bowl rotation. They have Thursday Night Football. They have college sports. And they have Fox News, which is extremely controversial, but it’s a lot of viewers and is a very profitable business.

And then, I thought so that business just prints cash pretty well. So, I could hold that a little multiple and eventually once you got it, you didn’t get it at five times earnings because it had appreciated but what I thought was, well, hey, in theory, they generate so much free cash flow, just returned to shareholders, they’re going to do extremely well.

Normally, it doesn’t play out that way. The Murdoch family are really good capital allocators over a time and good business owners. But I started to realize that they started making– they tiptoed, “Hey, we’re not necessarily going to buy back stock.” And it was a business that wasn’t levered at all. They had a lot of cash. And after they went public, they delayed. “Hey, the board has to meet and then we’ll decide on the buyback.”

We know in practice that if they want to get a buyback done, they could schedule a board meeting whenever they want. They didn’t have to wait six months or so. That was like, “Okay, so we’re not clear on the capital allocation strategy.” And then, they bought this business credible, which is basically– I didn’t think it had anything to do with the businesses that they had, more like a fintech type of business. That was a little bit weird to me, and maybe it’s a great business. Maybe it’s a home run, but I saw it as a red flag. I had done well with it. The multiple, yeah, it was low, but now I’m not really sure what they’re going to do. And I sold, it wasn’t a big position and really the focus was on Disney.

I’ve been proven a little bit right because they had a big stake in Roku. And then, they sold it in the panic in March, basically at a price that’s even lower than the low because it was a Wall Street offering at the discount. If you look at the price, it’s basically– I think it was under $60 that they sold at the low. And they took that capital to buy a free streaming service called Tubi, if I’m not mistaken. It’s a business that– and what they call AVOD, advertisement video on demand and it competes with Pluto TV which ViacomCBS owns. It competes with YouTube really as well. They try to make it as if it were a cable type of product but free.

Maybe they can do well and they can promote their brands and do well, and maybe it’s a good deal but you sold Roku, a business that has a lot of potential at a distress situation. And, hey, it’s easy to Monday morning quarterback when anyone sold in March of 2020. But I’m just not sure where they were going. They said they weren’t going to be in streaming or really compete with Netflix. Now, they’re taking this video-on-demand service that competes with a lot of people. It came down to the capital allocation. I think the business is going to be fine.

I think they’re going to probably keep the NFL rights. Fox News is going to do really well. They’re going to be able to increase prices for the bundle because no one can afford to drop Fox or Fox News. But at the end of the day, the family controls it and they probably have an ambition to build. And building from that position is a little hard. That’s how I got to the sell.

***

The Bull Case For $QSR

Tobias: Final position. Restaurant Brands. It’s an interesting group of businesses in there. Particularly, in this period, how do you think about Restaurant Brands? What was the initial thesis and what do you think about it now?

Francisco: The initial thesis, I basically once Burger King bought Tim Hortons. It was a trigger for me and actually a big part of the stake at a time. I bought it through Tim Hortons, knowing that I was going to get Burger King stock, and then they rebranded to Restaurant Brands. I had studied what they had done with Burger King over time. It’s business that they bought really cheap. They took the wholly owned restaurants and sold them and had a mindset of having more of a royalty type of business. So basically, they don’t own any of the restaurants, they get a percentage of the revenue and they own the real estate in many parts. It’s a business that it had okay margins and they took them to 70% EBITDA margins because it basically became a royalty business. They help the storage, renovate, and expand globally.

I’m from Puerto Rico. They have more Burger Kings in Puerto Rico than China at the time they bought Burger King. And obviously now, they have way more in China. I had seen and studied what 3G had done with Burger King. So, the trigger was once they bought Tim Hortons– and I think they were going to stop at Tim Hortons. And then, reading about Tim Hortons, I thought it was a great business. They were going to raise margins, they were going to take it globally. Tim Hortons thesis hasn’t played out exactly like that. They’ve had troubles with Tim Hortons, and they fought with some of the franchisees in Canada.

But then, they bought a Popeyes. There’s a huge opportunity there. When they bought it, they had less than 3000 restaurants. KFC globally has over 20,000. They do a really good job on marketing with all brands and they reinvigorated Popeyes with that, released the chicken sandwich, which has boosted same-store sales dramatically. This past quarter ending in June, Popeyes same-store sales were in the 20s. Basically, it has to do with everything that they’ve been doing with the chicken sandwich and promoting the brand. At a high level, it’s a great business model because it’s a basically a royalty type of business. They’re very good managers that are focused on growing those businesses. They have in total over the three brands about 24,000, maybe 27,000 restaurants off top of my head. Yeah, I think it’s 27, and they announced that they want to take it to 40,000 restaurants globally. I think Popeyes going to be a big driver of that.

What I’m confident is, I’ve seen how they executed with Burger King and how they can execute with Popeyes, how can they probably do still really well Tim Hortons. During COVID they’ve benefited with a– not benefited, but they haven’t been as hurt as other restaurants because they have drive-throughs. Drive-through is big driver of their sales anyways, before COVID and now it’s like everything. It turbocharged their delivery offering and their apps being up to date and then being available, and all that Uber Eats of the world platforms.

So, on an LTM basis, free cash flow is about a little over a billion dollars, $1.1 billion. Market cap is around 25, 26. Normal [unintelligible [00:57:59] pre-COVID, they were at 1.5 billion of free cash flow and growing. As we get to a more normal environment, as they keep growing the brands in terms of same-store sales, as they tap the global opportunity to continue to expand Burger King, by the way, but also expand Popeyes and Tim Hortons.

I think if you get to those restaurant targets of 40,000 restaurants– and you don’t need to get there to do really well on the stock, but if you get to those levels, I think the stock is overwhelmingly cheap. And 3G, which for some people, they’re controversial, but you have a team that is very shareholder focused, very long-term focused. The companies that they own for decades, they try to put in the best management teams, and the CEOs don’t do well, they put in a new one. Yes, they’re very cost-conscious, but they’re also growth oriented. It’s not a business that you can really cut more costs anyway. The Restaurant Brands have a business because, anyway, it’s a royalty business. At some point, you just have to focus on how you make your restaurants better and how you grow.

From that perspective, I think it’s a really attractive business to own and they’ve been stressed tested now to a huge degree. I think the CEO has done an incredible job. Once COVID happened, he penned a letter to shareholders. They took down their revolver entirely to have more cash on the balance sheet. But then they pay down the revolver, they still have a good amount of cash. And maybe this year, they won’t be opening probably a significant amount of restaurants on a net basis, but it’ll allow them to evaluate which ones are weaker and then go back to close those and then go back to growing and expanding globally.

As an aside, they’ve won awards in Cannes marketing, Burger King has won awards there. They’re really focused on the marketing and the products. Burger King released the Impossible Whoppers with Impossible Foods and that was like a big hit for them. So, they’re thinking about all types of aspects of the business, how they can make it better, how they can be more relevant to the consumers with these artificial needs, but also refreshing products. The Popeyes chicken sandwich was an amazing hit. So, I think they’re really, really business-oriented, growth-oriented and it’s a controlling shareholder that’s there, it’s going to have your back and their opportunity to grow and execute with their brands is enormous.

The cherry on top here is, if they’re able to do another deal, they have chicken, they have burgers, they have coffee and donuts, they could potentially go after a pizza business. Ideally, would have been nice if they had bought Domino’s a few– that one’s gone away. But I think there’s eventually will be opportunity to M&A, but with the business that they have, I think it’s still a big opportunity.

***

Tobias: It’s absolutely fascinating. If folks want to follow along with what you’re doing or get in contact, how do they go about doing that?

Francisco: You can follow me on Twitter, Francisco Olivera, the handle is @FrancoOlivera. In Twitter, I’m happy to chat with anyone and bounce off investing ideas.

Tobias: And your website?

Francisco: LinkedIn, but don’t have a website.

Tobias: Francisco Olivera. Thank you very much.

Francisco: Thank you, Toby. It’s a pleasure.

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