VALUE: After Hours (S04 E015): How Warren Buffett Negotiates a Deal, Charlie Munger on $BABA, NCR Tech

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In their latest episode of the VALUE: After Hours Podcast, Jake Taylor and Tobias Carlisle discuss:

  • How Buffett Negotiates A Deal
  • Charlie Munger Halves Stake In $BABA
  • National Cash Register – A Century Of Innovation
  • Positing The Next 10 Years In Markets
  • Powell Doesn’t Know How Much A Banana Costs!
  • Oil Is The Natural Rate
  • The Real Inflation Number
  • Commodities Super Cheap
  • Buffett Buys HPQ
  • Is The U.S Like Japan in 1990?
  • Real Wages Flat
  • Fusion’s The Answer
  • Why Munger Liked NCR
  • Australian Banks Protected
  • Nintendo Founded In 1889
  • 1906 Style CRM

You can find out more about the VALUE: After Hours Podcast here – VALUE: After Hours Podcast. You can also listen to the podcast on your favorite podcast platforms here:

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Full Transcript:

Tobias: It is Value: After Hours. It’s 10:30 AM on the West Coast, 1:30 PM on the East Coast, no idea what it is, Australia Eastern standard time. I think it’s really, really early. I think it’s 3:30 AM. Bill is out today. So, it’s only going to be Jake and I. What’s happening, buddy?

Jake: Super concentrated portfolio today.


Tobias: I don’t recommend this level of concentration.

Jake: Yeah, it’s dangerous. It’s how you get, take a zero.


Jake: Yeah, unfortunately, we had a couple fillings lined up as backup posts and then had some late scratches in the lineup. So, we guys are stuck with two.

Tobias: Ian isn’t feeling well. Will rejoin us at some point in the future. Yeah, so the big news, the second comment here after Katmandu. I know there’re a few, sorry, I missed a few early ones at the top there.

Charlie Munger Halves Stake In $BABA

Tobias: Alibaba and Charlie Munger, his ongoing love affair with that stock or– What he’s done is, he’s doubled down twice as its tanked and I think it got down as low as 75. And then, I think that was close to where [unintelligible [00:01:24], where he might have bought it again and then, it’s bounced, 110 bucks or something and he’s chopped the stake in half. What do you think of that?

Jake: Yeah, hard to say. What happened to never sell? [laughs] Maybe the world changed and he changed his opinion a little bit. There’s definitely some risk, has been come to light a little bit as far as geopolitics in the last few months. So, maybe he reassessed a little. I don’t know, [crosstalk] unlikely.

Tobias: Do you think that was not obvious beforehand?

Jake: I don’t know. Maybe, he was surprised by how much sanctioning that the US did and then, therefore, that added another layer of risk that maybe the world would more likely to decouple a little bit. I don’t know. Lots of difference. Who knows what goes on the mind of a genius?

Tobias: Yeah. It looks like the way that someone who has just come into the market trades that doesn’t like just to double down a couple of times and then when you get a little bounce to chop half the stake.

Jake: I just got to get back to breakeven and then I could sell. [laughs]

Tobias: Breakeven, get rid of the margin.

Jake: I hope we’ll find out in a couple of weeks at Berkshire and then, we’ll–

Tobias: Someone’s going to ask the question?

Jake: Someone’s going to ask for sure.

Tobias: He’s not going to say, “This is a Berkshire meeting?” Those questions you can direct to me at the DJCO meeting?

Jake: No, I bet he’ll answer it. I think he’ll.

Tobias: Because he seemed very unwilling at that Daily Journal meeting. He gave the answer that everybody, who had a gigantic position in the company and ran a company would like to just say to everybody else like, “Just don’t worry about it. We’ve got it under control.”

Jake: Yeah.

Tobias: But they are fairly reasonable questions. I thought, it’s a very big stake using margin.

Jake: How about this? What if there was something internal investment possibility within Daily Journal that he thought was a better risk-reward scenario? There are other cap allocation decisions to be made there. So, maybe he saw the chance to push some money in on the business side and decided that was better use of funds.

Tobias: You keep being very kind.

Jake: [laughs] Yeah. I’m not going to throw Charlie under the bus.

Tobias: On the other side of the transaction, so, my topic for today is going to be the Buffett acquisition of Alleghany or the Berkshire acquisition of Alleghany. The narrative about the way that those deals come about is published with the SEC or it’s part of the filings with the SEC. Business Insider grabbed the filing, and it’s written up the way that that came about, and you can see how Buffett negotiates. I just thought it was an interesting– I don’t think that anybody’s going to learn anything new. It’s just the way that Buffett negotiates, but it’s good. I think for your own purposes, for your own negotiations, it’s just interesting to see how he does it.

Jake: I was never aware of that filing idiosyncrasy of having to explain the narrative before I’ve never seen that.

Tobias: Yeah, I’ll go and look at them occasionally to see what happens. They’re all very vanilla. There’s nothing particularly interesting in them, but it describes how they meet, what happens, what they discuss to some extent and then, the outcome of the–

Jake: Like, how well documented is it? Is it like, at this date, we had a meeting, and these people were present, and–

Tobias: Yeah. There is a lot of that in there. You must have to take notes as it goes along. I don’t know what’s the purpose of its service. There’s a corporate advisory M&A attorney on let us know what’s happening there.

Jake: Yeah. Is it antitrust potentially or a fair process was followed to acquire–?

Tobias: Full disclosure process.

Jake: Yeah.

Tobias: Yeah. Probably, I would say.

Jake: Not like a sweetheart deal, I don’t know.

The Real Inflation Number

Tobias: The other thing is the inflation. Inflation is going absolute bananas. I saw one thing this morning at Gundlach. Eric Balchunas is at the ETF conference, tweeted this out and Gundlach said this that, “If we calculated inflation the same way we did under Carter, inflation is now higher than it was under Carter.” That was always the story, right? But that was how Carter lost the presidency, was that inflation was running so high.

Jake: Like what would the number be then? North of 10?

Tobias: 16.

Jake: Holy. [laughs] 16, well, is that have to do a lot with house prices? Is that the big component that’s driving that?

Tobias: Energy and house prices, yeah.

Jake: We don’t need those.


Tobias: When you dig into that, the house pricing number was 4.4%. year on year, which to me, that seems game down a lot.

Jake: Get the fuck out of here. Yeah.

Tobias: I think 4.4%, that’s pretty standard, isn’t like? When I look at some of the luxury, Fred has some data series, and one of them is LA luxury real estate, which I tracked for a variety of reasons. One of them is like– [crosstalk]

Jake: It’s like teasing yourself or what? [laughs]

Tobias: Yeah, the definition of luxuries– [laughs]

Jake: Yeah. It’s not as luxurious as middle of the country.

Tobias: Yeah, that’s right. Livable, maybe. I’d be looking at that it’s been running at 20% year on year for a few months, maybe, a year now. Each monthly update is a 20% year on year. I don’t know where they’re getting 4%. I guess this area is maybe these places run up more but 4.4% seems like a big miss to me.

Jake: Yeah, that’s quite a discrepancy from 20%.

Tobias: What’s your topic?

Jake: I have a topic prepared on National Cash Register, which is an old company from way back in the day that–

Tobias: What do they do?

Jake: [laughs] Well, now, they do point of sale stuff, but at one point, they had a 95% market share on actual physical cash registers that retailers would use for conducting business. This is from a 1906 annual report from NCR that actually Buffett and Munger referenced in 1998 annual meeting. Buffett said, he had it at the office and he thought it was a good report. Yeah, we can get into that. Let’s do yours first. Let’s go through the Alleghany acquisition and notes that came out of that.

How Buffett Negotiates A Deal

Tobias: All right. This is, let me just pull it up, a $12 billion deal and Buffett did it in about two weeks. Buffett had dinner with the CEO, Joe Brandon and the significance of that is that, he used to work as– [crosstalk]

Jake: Berkshire guy?

Tobias: That’s right. He was a CEO of General Re. So, he’s been sending a copy of his annual letter to his old boss and they’ve caught up for lunch or for dinner, rather. That was March 7th. That’s just over a month ago. Buffett’s wasted little time giving him the bid. It’s 850 and then, he said, “Of course, it’s not subject to financing or geopolitical risk.” Berkshire won’t do any due diligence, which is always music to the ears of an insurer. [laughs]

Jake: Yeah.

Tobias: But he said, “If they hire a financial advisor, the fee gets subtracted from his offer. The deal is contingent on both sides moving quickly to craft and close an agreement.” Brandon has to go back to the Chairman of Alleghany, Jeff Kirby, and then, Kirby and Brandon go to meet Buffett in Omaha, and Kirby, who’s the Chairman presses Buffett on the price.

He wants him to raise the price. He doesn’t want him to deduct the financial advisor’s fee and he wants him to pay partly in Berkshire stock. This is quoting from the article. “Buffett reiterated the terms of his original offer indicating firmly he did not intend to change his position on those points.”

Jake: Never split the middle, huh? [laughs]

Tobias: So, you can imagine what was said there. The Alleghany goes on to engage Goldman Sachs that cost them $27 million, which if you spread that over, the bid price reduces it to $848.02 in cash per share.

Jake: Is that $850?

Tobias: That was the final bid.


Tobias: And March 20, they announced the deal 14 days after Buffett made the offer. Alleghany decides against seeking out alternative offers before signing the deal, because they know that Buffett doesn’t like auctions, and they thought he might pull the offer, and there was a risk of a deal leaking.

Jake: I thought there was open-bid period.

Tobias: There was a go shop that came after the close, sorry, after that they agreed to it, not after the close.

Jake: Gotcha.

Tobias: Gave them 25 days to find a superior offer. Goldman contacted 31 potential bidders.

Jake: Crickets? [laughs] [crosstalk]

Tobias: I thought that was interesting– [crosstalk]

Jake: Yeah, I heard Bloomstran say that, he thought that Joe Brandon might be a nice like bench for a jeep, a backup in case a little redundancy in next of taking over, when Ajit is done, which– Well, that might have been a good aqua hire in that way.

Tobias: How old’s Ajit?

Jake: I think Ajit’s in his 60s. I don’t know. I’m sure, the hivemind will chime in with the right answer.

Tobias: At the Berkshire, that’s– [crosstalk]

Jake: It’s a spring chicken. You’re just getting started.

Tobias: Decades to go.

Jake: Just getting started [laughs] for sure.

Tobias: Yeah, I thought that was an interesting negotiation. We know that Buffett prefers cash, Buffett prefers– He doesn’t like auctions and he doesn’t really negotiate. I just like the fact that the bid for us, $850 is a nice round number. $848.02. That’s just like I told you.

Jake: Yeah, that’s really telling the Alleghany shareholders like, “Hey, your management team cost you two bucks, because they wanted [laughs] to get this advice.”

Tobias: I guess, you’ve got to go and do some market analysis to make sure there’s nobody else out there.

Jake: Yeah, there’s a little box checking for the Board of Alleghany, right?

Tobias: That’s a modest $2 to find out if there’s another $10 out there.

Jake: Yeah.

Tobias: Or 50 bucks, who knows?

Jake: Yeah.

Tobias: If you are competing against Buffett, and you know that he doesn’t raise his bid, and you know that he hit Janus 70, according to this.

Jake: Okay.

Tobias: He’s only got a decade or so, a couple of decades left in that case.

Jake: Yeah, only about 30 years left on that guy’s odometer.

Tobias: Sorry. I lost my trader, Phil. What’s he’s saying there?

Jake: I don’t know.

Tobias: No one knows.

Jake: [laughs]

Tobias: This is what I was saying. If you’re competing against Buffett, you know he’s good investor. You know that he knows these businesses. If he’s bidding for it that he likes it, that it’s good and you know they won’t raise his price. So, why not just come in at 855?

Jake: Well, you could make the argument that it’s actually worth more to Berkshire than other insurance companies, because they’re so well capitalized. That now, a lot of that statutory capital that’s tied up at Alleghany could probably be rotated into something else other than 1% yielding, although rising rapidly bond portfolio.

Buffett could take it and maybe put it to better use potentially and then therefore, the equity of the flow or the value of that flow then becomes probably quite a bit worth more at that point and maybe no one else could really do that.

Tobias: That’s a fair point. That’s in insurance specifically and in this one, specifically. But he bids in other stuff, too. Why not just gazump him? I think that people have done that many times before, but that’s what I’d be. Folks like Kohlberg Kravis or someone like that, I’d just be swimming along behind the great white shark waiting for him meet those [crosstalk] slide in for a couple of dollars more.

Jake: Well, that’s what people are doing when they hear that Buffett bought HP and then, they go buy it right away for a little bit more than he probably did. They’re doing that effectively.

Tobias: I think in this market, you can just wait a little bit and buy it for– [crosstalk]

Jake: [laughs]

Tobias: That’s not a bad approach. Buffett’s investment universe is very constrained.

Jake: Yeah.

Tobias: I guess, you’re buying real mega caps when you’re doing that. Not that HPQ in mega cap or whatever it was, $14 billion or something.

Jake: Why not just buy Berkshire and go do something else with your life?

Tobias: Ah, it does make it sound a little easier. Yeah.

Jake: [laughs] Let him worry about it.

Tobias: Don’t have to pay that fee. Don’t have to pay that $100,000.

Jake: Yeah, $100,000.

Tobias: Fee to the management.

Jake: He is chiseling you with. [laughs]

Tobias: Dudes, hit us with questions today, because JT and I aren’t used to talking for half the time.

Jake: No, it’s just going to be a lot of tap dancing from the two of us.

Tobias: It’s over 15 minutes and good.

Jake: [laughs] Yeah, time to shut it down.

Tobias: Well, let’s do– [crosstalk]

Jake: I’m sure the Alleghany shareholders would have preferred some kind of stock and cash bid to help shield themselves for some taxes, but Buffett wasn’t forthcoming with the equity offer of Berkshire shares. Probably not surprising, right? If he was buying back last quarter-

Tobias: He’s not going to be issuing stuff to that [crosstalk].

Jake: -he ain’t going to be issuing to you at that point.

Tobias: It was brown shoes or what was the shoe? That’s really uninspiring.

Jake: They were Dexter shoes.

Tobias: Dexter.

Jake: Yeah, they were brown later. [laughs]

Tobias: That was the all-stock deal, wasn’t it?

Jake: Yeah.

Tobias: Imagine shoe holding for Berkshire shares, that’s as good as it gets.

Jake: Buffett knows the answer to what that costs everyone and he brings it up sometimes. But it’s an ever-inflating number of what that costs. [laughs]

Tobias: Oh, that’s rough.

Jake: Well, you got to rub your nose in your mistakes that way you make less of them, hopefully.

Tobias: Yeah, let’s do your topic, and then, we’ll head out the other half hour.

National Cash Register – A Century Of Innovation

Jake: Okay. [laughs] This is National Cash Register, fascinating history of this company. This came from my friend, Adam Mead, who wrote the terrific, Comprehensive Berkshire Financial Compendium. I forget the exact title of the book. I apologize, Adam.

But it’s basically The Complete Financial History of Berkshire Hathaway, I think it’s called. He has a friend, this guy named Jesse that’s on YouTube, who saw Buffett talking in the ’98 shareholders meeting, and Buffett and Munger are talking about NCR and this report, and Munger saying like, “God, you could have read that in 1906 and it would have just been blindingly obvious that this was a good situation to get involved with.” It’s an absolute layup.

Tobias: In fact, I did.

Jake: Yeah. In fact, I was long to the gills in it.

Tobias: He doubled down twice, then, he cut the position half when it bounced back.

Jake: Yeah, later. [laughs] Jesse, on YouTube, he went and was like, “Okay, if these guys liked this so much, let me see if I could track it down.” He couldn’t find it. No one had it. He asked around all over the place, I think actually got in touch with Sean Iddings, who’s friends with Ian in writing the Intelligent Fanatics and they have a chapter in one of their books about NCR and John Patterson, who is the CEO.

This guy, Jesse eventually tracks down, like, calling all these different libraries and all over the place. I think it cost him a couple hundred bucks to get a PDF recreation of it that he’s now shared with everybody and Adam sent this over. I read through it and it’s a great read. It says it’s 72 pages, but it’s really more like 35, because the last half of it is just listing of people, who work at the company, basically. Well, I want to hit some of this shareholders’ meeting or the annual report from 1906.

First of all, the company already existed and this guy, John Patterson, he was operating a general store in this little coal mining town in the 1880s. He had $3,000 worth of capital tied up in his general store and they had great margins. And yet, somehow, at the end of the day, there was no profit in this business, like, “What the hell is going on here? Where’s the money going?” It just turns out, when you’re running without a cash register, like, you just have leakage, whether it’s on purpose or not.

Sometimes, just forgetting– If people would buy on credit back then more often directly with a store. You go to the general store and get a bag of flour or whatever and like, “Okay, bill me at the end of the month and then I’ll come back and settle up my bill.” People would just forget or the record keeping wasn’t very good. The register solved a lot of this problems.

He bought one of these cash registers and in the first year, he had $12,000 of profit that all of a sudden showed up with no change in the amount of business that was being done. It’s just like a revelation. He realized like, “Oh, my God, this is such a game changer. I got to get into this business.

He gets in there, and gets control of NCR eventually, and the first few years, they sold basically only to grocery stores and cafes. By 1906, when this report was written, they’re selling to all kinds of businesses like all over the world at that point. In the 1890s, they had sales of $1.8 million. By 1905, it was $12.6 million.

The 6x sales, but there’s a 14% CAGR for 15 years, not knock your socks off, but still very, very consistent growth, just like every year, that was better business. At that point, they were all over the world and they were starting to expand in the far east.

He’s talking about how he went on this trip a couple years ago, which would have been 1904 to China and just saw, “Oh, God, there’re so many people here.” Basically, he was long civilization at that point. The more that civilization came about-

Tobias: Ooh, that’s a good line.

Jake: -in commerce. Yeah, that is a good line. What they were going for was the best machines, the most sales, which allowed them to have the lowest prices. This is basically like you’ve heard this scale economies shared that it’s been popular lately talked about Amazon or some other classic examples of just getting a big business, like, Costco is a prime example.

Tobias: Costco, yeah.

Jake: Yeah, right. The bigger you get, the better that you can do on the pricing, the better that you can lower the cost to the customer, and then, share some of those economies with the customer. At that point, they had 4,000 manufacturing employees, 1,400 sales reps, and they had the sales training schools all over the world that were training up their sales staff. It’s funny to see basically an old balance sheet of this.

They had a bunch of acres of land, 14,000 or can’t read my own notes here. Jesus, what a mess? 13 factories, 1.4 million square feet, and every year, they were putting on 10 times as many patents as were expiring. They were just pouring money into R&D of these cash registers. What’s even more amazing, they had a list of 1 million retail shopkeepers in the US and Canada.

1906 Style CRM

Patterson basically invented direct mail. He would send literature to these 1 million shopkeepers and another 600,000 in all the other foreign countries. He had this customer list that early on like no one really had this kind of data about their potentials.

The salesmen have daily reports on who they visited, what they think the probability was that they would turn into a customer, and the number of towns that they visited per year, so they could see like, “Okay, this rep spread too thin or not? Are they hitting enough of the customers?” This is all early sales funnel stuff that probability of sale, all that stuff that you would see in Salesforce– [crosstalk]

Tobias: CRM, yeah.

Jake: CRM. These guys were running it in 1906 and crushing it. By the way, also, John Patterson invented the idea of, like, get a receipt with every single transaction. That wasn’t a thing before. Now, he’s the reason for why CVS gives us an entire book for [laughs] when you go buy a tube of toothpaste. All right, so, another thing that they had going on was, they had this idea of a welfare work that they called it, which is really early employee wellness programs.

Their factory, one of the first ones that had, lots of glass windows, so that the light got in, and they had showers, and an onsite doctor, all this medic, almost like early Google campus type of amenities that before anyone else had that.

They had $3 million in labor costs in 1905, which is about 25% of revenue, which anything 25% to 33% is what you could expect for a manufacturing facility as far as labor concentration per dollar revenue, labor intensity. You’ll like this one a lot and this is hilarious.

They invited competitors to come to their Dayton factory and see what they were up against. Just come watch, who you’re going in business to try to compete with.

Tobias: Yeah, to scare them off.

Jake: Scare them off. He thought it was a great idea, because it saved them money from wasting money on like, “You can’t compete with us. There’s no way you’re going to get your cost down as low as we have. Like look at the ship that we’re running here.” And also, obviously, that allowed NCR to have 95% market share in 1905.

They carried a 2% dividend and the rest was basically reinvested into R&D, and manufacturing, and ways to lower the cost, so that they could share those economies with their consumers. Carried no debt, no discounting ever. They had this deal, where they could say, “We’ll pay you $100 if you can ever find anyone who is able to buy one of our registers for less than what we sell it for other than a 5% discount for paying cash up front.”

Tobias: Wow.

Jake: Otherwise, it was like no discounting. “We have the best machines, you’re not going to chisel us, we’re never going to erode this brand by discounting it.” They sold these machines anywhere from $25 to $820 different sophistication levels of machine. I tried to back into what that would be today and the CPI calculator only goes back to 1913, founding of the Fed. Today, those numbers adjusted would be $720 up to $23,000, basically. So, it’s pretty high-priced item in today’s dollars, at least for a shop.

Tobias: Yeah, the top end, $23,000, that’s fancy.

Why Munger Liked NCR

Jake: That’s a fancy register. Yeah. This is why Munger, I think liked this NCR situation so much. Not only does this thing save labor, but more importantly it brings morality and honesty to a community, because it takes away really the temptation to steal, and cheat, and cook the books, basically. This idea of bringing morality in making that sort of the default, you can see why Munger is all about that for a society. It’s totally in his, like, everything that he preaches.

He talks all the time in the annual meetings about how despicable he thinks it is that when our professionals allow accounting to decay from reality and become bastardized, and politicized, and all these gross things that have happened at different periods of time, especially, the expensing of stock options when they weren’t doing that. He thought this is the reverse of that. They would give guided tours to 40,000 people a year that wanted to come visit their facilities and see how this machine was running.

Then, I looked a little bit further into what happened to NCR over time, because it’s actually still around as a public company. In 1974, they commercialize the barcode, like scanner and the ATM as well. It was an early invention for them that they really built out, and then, they got into personal computers really early on, and then, in 1991 they were acquired by AT&T, but now, they are public.

I guess, they must have been spun out of AT&T at some point. I don’t know the details of that. I was late in even realizing they were still a public company. Yeah, so, that’s NCR and this– It’s amazing to me to see all this stuff and see there really is nothing new under the sun. It’s all just been repackaged in different way. Patterson’s talking about how, they’ve even paid like an efficiency wage, basically at that time to get a higher quality cut of employee.

They’re doing all the stuff, thinking about the wellness, holistic ESG-ish, almost like the governance side of things of stakeholder as opposed to just shareholders, all that stuff was being done in 1906 as well. So, lest we think that we’re all geniuses today that are summitting new heights, all that stuff’s been done before. If we could just go back in history and look, we could find a lot of the same stuff that people think is special today.

Tobias: Couple good comments here. One is from Dylan Thompson, “The new automated registers at Dunkin go for $10,000.”

Jake: I believe that.

Tobias: So, not that far. I guess, that makes sense, doesn’t it?

Jake: Yeah, you think technology would lower the cost of the best version of something. Of course, it’s probably a million times more powerful, but then, what the 1906 version was at for $23,000.

Tobias: NCR has been cheap on occasion over the last 10 or 15 years since I’ve been doing. It’s something that I’d bought and sold a few times. I don’t know if it’s the same entity or I don’t know what the relationship is, but it’s point of sale. So, it could be related to reasonable earner and it just seems to– I don’t know what drives it, but it gets cheap and expensive. You can have a look at the stock chart over the last 10 or 15 years/

Jake: Is it a shower, not a grower?

Buffett Buys HPQ

Tobias: [laughs] There’re a few things like that. Actually, one of the things I want to talk about when Buffett bid for HPQ, he’s bought a chunk of HPQ, the funniest comment I saw was like, “After Musk bought 9% of Twitter, Buffett decided that to get his printer work he needed a 11% of HPQ.”

Jake: [laughs] That is pretty funny.

Tobias: That’s when I’ve held for a while. So, I was happy to see. Happy to see big fellow coming behind me.

Jake: Yeah, you are front running the Buff dawg.

Tobias: It’s one of the few that stayed cheap that performed the whole time I’ve held since 2019 and before, but– [crosstalk]

Jake: That saying that the underlying business has improved even more than prices that–

Tobias: I wouldn’t say the business has improved so much as they’ve been very good at buying. It has grown, but they’ve been very good at buying back stock.

Jake: Oh, okay. You just have a denominator win. [laughs]

Tobias: Yeah, on a per share basis, it’s performed. That’s what I care about.

Jake: Yeah. I thought it was funny that we got everybody’s out there trying to do JPEGs on the internet, and crypto, and all this other stuff, and Buffett’s buying actual physical printers.


Jake: Oh, man.

Tobias: Yeah, it is funny. For a long time, I don’t know, it was the 90s or the early 2000s, there was like that, we’re going to get to a paperless office and it was just like, this is when I was working in law firms in particular. They were million miles away from a paperless office. But now, I run almost an entirely paperless office. It frustrates me when I print something out for some reason. I got a brother, not an HPQ. I should have been loyal.

Jake: Ooh. Yeah. What are you doing? You’re just not taking money out of one pocket and putting it in the other?

Tobias: We do go to Domino’s, the DPZ to pay off the DPZs.

Jake: There you go.

Tobias: Whatever it is like $19 a throw for a family for pretty good value.

Jake: Yeah.

Nintendo Founded In 1889

Tobias: The other comment that I saw that came through, I’m sorry, I missed the name, but “Nintendo was founded in the 1800s.” Let me see if I can find that comment. Is that right? What were they doing in the 1800s? They weren’t doing Pong or something like that.

Jake: Bicycles or something? I don’t know. It’s always the–

Tobias: Yeah, I can’t find. Sorry, whoever left that comment, I took a note, but I missed the exact– Oh, Blade. Oh, sorry. It doesn’t matter. Let it get past.

Tobias: Yeah, I think the two things that we should talk about are if we go into an inflationary environment, which it would seem to be, it seems to be more than transitory.

Jake: What was your first [unintelligible [00:32:26] [laughs]

Tobias: Blade, yeah. “Nintendo built board games back in the 1880s.”

Jake: All right.

Tobias: Playing cards. Wow. That’s cool. I think Nintendo is interesting. Nintendo’s, I think it’s interesting now. I think it’s worth taking a look at. I like Nintendo for a variety of reasons. It’s a little bit bizarre.

I think there’s been some argument that’s transitory. It’s hard to pick an inflection like a turning point in the market. If you got the turning point in 1980 or whenever the market transitioned from being was the reverse of this, it was heavy commodities, high interest rates, and–

Jake: Low profit margins, low valuations.

Tobias: Right. And equities were just smashed smithereens.

Jake: Backwater.

Tobias: And then, if you bought around the time, the volatility through that change was massive. You would have felt like an idiot for on and off for two or three years there, because– That’s a long time if you’re trying to– You are waiting your thesis to play that.

Jake: It’s the long time to play like an idiot. [laughs] I could guess.

Tobias: It is. I felt like an idiot for about 12 years in value, but you got to wonder whether that’s just bloody mindedness or whether there’s some rationality underneath. I don’t know which one it is, but I feel I would change my mind if it was obviously wrong, but maybe not.

Jake: [laughs]

Positing The Next 10 Years In Markets

Tobias: It seems to be that we’re in the reverse of that 1980-type market rate, where interest rates are low and likely rising, profit margins are very high and likely compressing, valuations very high and likely compressing. So, what do you do as an equity investor for the next two decades or three decades?

Jake: Well, I think that is probably long enough to say that any of those issues of today are washed out. But 10 years’ time horizon, I think you have to lower your expectations considerably as to what you expect to earn as an owner of capital in business.

Tobias: So, what you’re saying, over 20 or 30 years you get back to — you earn what the business earns. But for the next 10 years, there could be this compression and multiples, and compression and valuations and so. Do you have those figures off the top of your head? Or, some directional idea of how that revenue growth is probably 3% or 4%, whatever.

Jake: Yeah, I would say, well, if you look at different time periods, we did this on the show, I don’t know, three weeks ago or a month ago with Chris Bloomstran’s analysis of 10-year period chunks. And pretty consistently, you can count on 3% contribution of return for sales growth.

You can count on a 1% to 3% depending on this kind of price level over that time period, dividend yield. And then, everything else is going to be determined by change in profit margins and change in valuations or multiples. That’s where you’re starting out at a– [crosstalk]

Tobias: The Profit margins are–

Jake: 13% right now-ish, I think is where we’re at.

Tobias: What are we still saying the average is 6, are we saying 9 or what is the average? Because for a long time, that was like, you’ve got this Buffett, Grantham, and John Hussman have also said.

Jake: Invaluable. Like 6% is what capitalism will yield or else something is broken.

Tobias: Right. We’ve been well over that for 10 years now, probably.

Jake: Yeah, right. I think large tech, returns on scale, global internet companies have defied that, what we would have thought capitalism would yield? Whether that continues is anyone’s guess, I think, at this point and there’s smart arguments, I think, on both sides. But even if you kept margins here, can you keep valuations up where they are as well, call it, what, 35 on Cape right now, something like that.

Tobias: Well, 5% under all-time high.

Jake: That’s pretty high. Even any regression on that and you have to give back three percentage points per year of contribution to your return that you could expect. I don’t know. That’s what you saw from 1999 to 2009 as we worked off excess. So, that basically, let’s say, you had 3% sales growth GDP-ish.

You lose 3% from multiple contraction, you get another 1% to 2% for a dividend yield, profit margins would not shock me to see them even come back to say, I don’t know, 10% or something, which would still be abnormally high on a really long historical data set.

Well, if that’s the case, and then, you lose 1% or 2% there, you are flat now. You are flat for a 10-year period and it’s not that hard to imagine. What’s hard to imagine is which of those numbers is going to go higher to provide some kind of outsize return that would get you anything over an expected 6% yield return as an equity holder. Which of those changes is going to happen from here to get you to 6%? I don’t see that very easily.

Tobias: Yeah. That’s the problem. Everything’s really stretched, all the levers have been pulled.

Jake: The levers have been pulled. The other component of that is the share account.

Tobias: Right.

Jake: We saw that over the last 10 years, basically, a self LBO by Corporate America like, “Lever up the balance sheet, buy back shares, reduced share count to drive up EPS to make your bonus as the management team if you’re linked to EPS.” Can you pull that lever again? You’re going to re-lever even further from where we are of the corporate balance sheet? Boy, that starts to get pretty tough to– [crosstalk]

Tobias: The funny thing is, I would quite like– [crosstalk]

Jake: If rates go up.

Tobias: The really undervalued stuff that I hold, I would really quite like them to do some of that stuff.

Jake: [laughs] Right.

Tobias: I don’t necessarily need them to lever up. I just take the free cash flow, and use it to buy back some stock, and do that consistently. Because when you look at companies that have done that like the O’Reilly and AutoZone as classic examples who just buyback machines. HPQ, too, has been doing that. They get nice charts and I like the fact that there’s a little bit of a flaw there, too. So, they get a bid when they fall over.

Jake: And it makes it easier that just psychologically, every tick down you’re like, “Yes, buying back at a lower price for daddy. Come on.”

Tobias: Anti-fragile.

Jake: Yeah, it is in a way. It makes it a little easier to stomach drawdowns when you know that.

Tobias: Management’s doing something about it.

Jake: That’s the nice thing about having a good capital allocator at the helm is that, you have multiple ways to win there.

Is The U.S Like Japan in 1990?

Tobias: It seems pretty straightforward. It surprises me that there aren’t that many companies that do it, but anyway. I saw an interesting quote from Buffett over the last week, where he said, I don’t know if he was necessarily predicting that the US looks like Japan in 1990. But it sounded to me that’s what he was saying and I think he said, “It’s not going to be quite that bad as Japan in 1990.” But if it is, the setup for guys like us, the deeper value guys, that’s usually pretty good for us or it works pretty well for us, low valuations work okay, particularly if you can find something that’s buying back stock.

Jake: Yeah, you had a great paperback in 2009 I think on Japan and that value worked actually quite well. There were multiple cycles within a malaise period of however long it’s been for Japan, where things did get cheaper and more expensive, especially, I think the dispersions blew out at different points, but it was masked with a quiet average. So, no one really was paying attention to what was happening under the hood. If you were buying at those time periods, I think you actually did quite well even with going nowhere as an index.

Tobias: The paper that I had up is just buying on price to earnings, price to book, price to cashflow. There’re some weird ones and that is, it’s like an academic paper where some of them were– There’s a few weird metrics and they’re not really growth metrics. But anyway, those metrics don’t work. So, [chuckles] pay so much attention to them.

Yeah, so, John Battle has got a good question. “Was Japan the global reserve currency in the 1990s?” No. I don’t know. This is where macros are hard. There are like any number of differences between Japan and the US, and the other one is that Japan had all of those cross shareholding, so there could be no activism. So, nobody could take those undervalued companies and take them over and– [crosstalk]

Jake: Take them over capital.

Tobias: Yeah, none of that could happen. It had to work its way off in a different way, whereas if everything gets really cheap in a state, it won’t stay really cheap for long, because there’re so many guys who are activists or there’ll be operator type to go in there and tear it up. So, I don’t think that Japan is a particularly good proxy. But there’s enough value investors here that at least if you’ve got cheap enough that’d be a bid for those things if they went down. I don’t know.

Jake: Yeah, I think the analogy breaks down some, too. The US is just a much more dynamic economy. You can make the argument we were even more dynamic when we allowed failure and allowed the changing of ownership of businesses to hands that might have been better stewards of that capital. When we block that, I think we do look more like Japan then, and we do start to become more of a sclerotic and less dynamic. So, I think the US can find its roots again in that and– [crosstalk]

Tobias: What makes it that doesn’t happen in the States?

Jake: I think we have maybe better bankruptcy laws for one thing. I think a lot of it’s cultural, too.

Tobias: But what makes you think that hasn’t happened recently? What’s the recent change versus the way it used to be?

Jake: I think just cheap debt, and has allowed a lot of companies that probably should have gone under to still keep existing, and “zombie companies,” their earnings are less than interest expense, so they’re just accruing more debt to stay alive. I don’t think that’s healthy for capitalism. I think that’s much more akin to cancer and probably needs to be extricated.

Low Rates Can’t Stay!

Tobias: Yeah, those low rates can’t stay. It just seems like the rates are going up.

Jake: Well, who knows? I would have said that quite a while ago, but–

Tobias: We’ve been talking about mortgage rates have gone up.

Jake: That’s been wild, hasn’t it?

Tobias: Mortgage rates are going vertical. Mortgage rates haven’t gone up this fast in the data, something like that and now, we’re at 5%.

Jake: Like a half percent a day or on some days. Just absolutely insane.

Tobias: It doesn’t seem to have done much to have cooled the market, though.

Jake: Yeah. That’s the thing about macro. That’s really hard is there’s so many moving– There’s no inventory then like, “Okay, well, of course, it’s still going to stay hot,” I guess. Maybe everyone’s just trying to get in before the rates get so high that they can’t. They want to lock in that mortgage today as soon as they can. I don’t know. There’s lots of– Macro’s hard.

Australian Banks Protected

Tobias: There’s a question here. “Am I long Australia?” Australia’s like Canada in the sense that there’s a big basic materials component to it, which is second to the banks and financials that is the biggest component. In Australia, it’s half the index.

Jake: Really?

Tobias: And then, a third to 20%, I think is basic materials. And then, everything else– [crosstalk]

Jake: What are the big banks in Australia?

Tobias: There’re four big banks. There’re four big commercial banks, Commonwealth, National Australia, ANZ. ANZ as we call it in Australia, and I’m blanking on the fourth one.

Jake: Yeah. I’ve never even heard of any of these. [laughs]

Tobias: They are giant banks. This is the thing they are very, very big. They’d like to go overseas and make an acquisition every now and again and just write off the entire acquisition. They are [crosstalk] buy any overseas.

Jake: Straight away, day one. [laughs]

Tobias: There’s this idea that they protect the four big banks, the government protects the four big banks. Really there’s no competition, though, it’s hard to compete. But they never go out of business either, so the kind of like regulated utilities.

Jake: Okay.

Tobias: Every now and again, someone does an analysis of it, because it’s been so long since there’s been a recession in Australia. Someone does some analysis– WestPac, thanks, thank you very much. Someone does an analysis, where they say, “If you take like–” The last time there was a recession in Australia and you look at the damage to commercial credits, and housing credits, and then, you translate that forward to today to the leverage that they’ve gotten their banks. All of these banks have wiped out.

Jake: They’re all zeros.

Tobias: [crosstalk] Yeah. I just don’t think it’s going to happen like that. I personally had that view about 15 years ago. That’s how long that’s been rolling on, keeps on rolling on. I don’t think it’ll be that bad, but who knows?

Jake: They’ve got to have a lot of China exposure, right? Isn’t that a pretty common thing for Australian companies, especially commodity based?

Tobias: Yeah, but the commodities are all smashed to pieces already.

Jake: Yeah, okay.

Commodities Super Cheap

Tobias: I know, we get some criticism for talking macro all the time rather than an individual names. But here’s the problem. If I look at my screen, all of this stuff, it’s super, super cheap right now. It’s all commodities, heavy commodities like BHP, Rio, all those kinds of names from the screens? I don’t know. I get a lot of scar tissue on me for owning all of that stuff. It’s hard to go back in and buy all that stuff. But then, that’s probably the way everybody [crosstalk] feels, too.

Jake: Buy, it’s cheap.

Tobias: and Jake: Yeah.

Jake: That’s how you get a mispriced bet.

Tobias: I’d rather buy it now than 10 years ago. I did buy it 10 years ago.

Jake: What kind of ROEs did the big banks down there get? You have any idea? You said they’re pretty levered. So, maybe it is high.

Tobias: I don’t know. I would say, close to 20%.

Jake: I’ve been shocked to look at some banks and see what the ROEs are over time. They’re just way higher than I would have ever imagined for something that seems so commodified, which providing money.

Tobias: I don’t know what does it low rates. [crosstalk] Well, your credit card at 25% and your savings accounts of 0.1.

Jake: Yeah, that’s another bad spread, if you can get people into that labyrinth.

Tobias: I guess, it’s part of the problem. “Aussie/Canada/USA commodities need a re-rate vs less appealing jurisdictions?”

Yeah, I don’t know what the answer is to the macro picture, but it probably is worth having some of those– [crosstalk]

Jake: I don’t even know what the questions are. More or less the answers. [laughs]

Tobias: That’s fair. Yeah, I might be in that boat, too. I might be overestimating how much I understand here. Yeah, macro is part of the equation. That’s what I think, too. Maybe the answer is, you shouldn’t be in stuff when macro is part of the equation. I don’t really like energy for that reason. There’s one number that you got to get right, although, probably when it went negative. That was a pretty good sign that you should own a bit more energy.

Buffett Says Ignore Macro But…

Jake: Yeah, that’s a good point. I’m reminded. I bet we will see this again, which I don’t know if you remember this, but in 2010, there was everybody in– I think a lot of value guys, especially too, but they all said like, “Yeah, you know what, we probably ignored the macro too much.’ We were just like, “Oh, we’re just bottoms up stock pickers.” I don’t know if you remember, I think even Einhorn was saying that at that point.

Tobias: Yeah. Later, too. I would say 2015, 2016.

Jake: I’m going to guess that that’s a cyclical thing as well, where we’re going to hear that same story again in two or three years, there’ll be a lot of guys who said like– Maybe it’ll be the growth guys this time like SaaS bros, who are like, “Yeah, we probably should have thought about the macro a little bit more.”

Tobias: It’s hard to know like Buffett says, “Ignore it,” but then, Buffett’s clearly– [crosstalk]

Jake: But then, he’ll rattle off a thousand numbers of different like–

Tobias: Right.

Jake: Oh, the GDP of Swaziland in 1987.

Tobias: And then, he’ll go and have a swing at silver just as a–

Jake: Right.

Tobias: The Chinese oil company, CNOOC. What was that?

Jake: Yeah, PetroChina.

Tobias: PetroChina.

“Canada rate hike is tomorrow, market is expecting a 0.5% increase. Neutral rate might go around 2.5% to 3%, we’re at 0.5% now.” Yeah. We’re sitting well below the neutral rate. That’s what I think, too.

Jake: What does that mean? You mean some natural rate of interest?

Tobias: I think so. Something like that. Yeah.

Jake: What the hell does that even mean, though? How do you know if the–?

Tobias: Well, you don’t unless you let the market go and find out. Nobody knows that. That’s the point. Except for J Powell. He knows.

Jake: Okay.

Tobias: And all the PhDs [crosstalk].

Jake: Rudy Havenstein knows what the [unintelligible [00:51:10] is. [laughs]

Tobias: Rudy’s probably got a better idea than anybody else does.

Jake: Well, he’s been around for 200 years now, right. When was he born? In the 1860s or something? [laughs]

Oil Is The Natural Rate

Tobias: Hit us up with some questions, dude. “Oil is the natural rate?” Yeah, I like that one.

Jake: That might be some truth to that.

Tobias: Yeah. Oil spiking, oil might do the job that the Fed’s not doing. Oil might be doing the job.

Jake: I’ve heard that said before that the price of oil is the aversion of federal funds rate. I’ve thought about this before about the energy intensity of an economy and I’ve tried to look this up before. If you’re going to more intangibles and part of that is saying like, at the end of the day, we’re all just fighting entropy. We’re trying to put in energy into a system. I mean, energy in a lot of different ways, not just physical energy or the sunshine hitting earth to provide all the energy that fights entropy on earth.

Tobias: You mean Qi?

Jake: Yes, right. If we are all really at the end of the day just rearranging things to make them more productive than they would be in the natural decay of entropy, it can be in the form of information, we’re rearranging information. It can be in the form of molecules that we’re moving around that are more useful to us.

The moving molecules around the atoms of the world require energy. If your economy is more based on moving molecules around, you’re going to then have a higher energy intensity and therefore, probably that oil as a federal funds rate makes more sense for that. But if you’re largely intangibles in your economy, which we’re over half of the investment in our economy is in intangibles now and not in physical Capex, maybe energy intensity, it makes it may be less of a of a relevance to it. I don’t know. It’s just something I’d sit around and daydream about.

Tobias: I like that idea, but the bitcoin miners are pretty energy intensive, aren’t they?

Jake: No. I said useful energy usage.

Powell Doesn’t Know How Much A Banana Costs!

Tobias: Is that a product of us just being so– We’re right at the very top of that chain of intellectual property, where you push down all of the stuff that’s easier to do, which tends to be the manufacturing stuff, which way it gets offshore–

Jake: In other countries, yeah.

Tobias: And you own the IP and the knowhow here and the distribution is coordinated from here at least. But that’s still a cost that factors in somehow and you have to feed everybody here. You have to get stuff around here. Those costs are still real.

Jake: Yeah, I think that’s the best argument to me against deflation in the next five years is that, if we have to reconfigure a supply chain that doesn’t include as much of the productive capacity of the rest of the world, it’s just going to be more expensive for everything.

Tobias: Yeah, China’s going to be on the wrong side of that divide for us, anyway.

Jake: Well, I hope not for everyone’s sake.

Tobias: Yeah.

Jake: I think the less advantaged you are, the worse this is going to hurt too, which is the real bitch of all this stuff is that, Powell’s not missing a meal. He doesn’t give two shits about how much a banana costs.

Tobias: That’s a $100 million man.

Jake: No.

Tobias: How much can a banana cost? $15, $25?

Jake: Yeah, exactly.

Tobias: Just get six.

Jake: Right.

Tobias: Yeah.

Jake: If that’s the case, it’s going to hurt the people who can afford it the least to be hurt. That really is bothersome to me.

Tobias: We talked about this before filling up the gas tank in the car. I do that cartoon thing, where the eyes pop out of my head every time I pay for it.

Jake: Yeah, no doubt.

Tobias: I do have the luxury of not having to worry about that much for us.

Jake: But you don’t fill it up by a half of a tank, because you’re like, “Well, I don’t know where I’m going to get the money for the other half of the tank”

Tobias: Right.

Jake: That’s some people’s daily existence.

Tobias: That’s what I’m saying, I’ve got that luxury. But there are lots of other– If you divide the cost to fill up the tank by the hourly wage, it just gets scary.

Jake: Yeah.

Tobias: And rent, too, like rents got to normalize to–

Jake: Maybe worse there.

Tobias: Yeah. It’s got to normalize to housing prices, or housing prices have to come back, or a bit of both. I think that’s what’s happening this year. I don’t think there’s been any slowdown in housing prices or not that I’ve seen, maybe there isn’t. But whatever they call it, the rent’s going up 20%, 25%, too.

Jake: The rent is too damn high.

Tobias: The rent is too damn high.

Jake: I had it right all along. How did he not win?

Tobias: It’s a great slogan. It’s easy to remember. “Sticks in the mind.” Yeah, how did he not win? It just shows that it’s rigged.

Jake: It’s rigged.

Tobias: Made a recount.

Jake: [laughs]

Tobias: Yeah, real wages aren’t up. They’re not up that much. I don’t know if they are up much at all. That’s a funny thing. You get a 6% bump and your purchasing power has gone down 2% over the course of the year. Can’t do that too many times.

Jake: That’s the official number.

Real Wages Flat

Tobias: Yeah. “Rent prices have doubled in the last few years.” Yeah.

“The reshoring of productive capacity is the foundation of the idea that AUS/CA/US natural resources need to re-rate. Safety of supply is the new most valuable thing.” Yeah, that’s interesting.

Jake: Yeah. Well, just even imagine how much more expensive it’s going to be when they want to just add more inventory to the whole system. Just in time, we realized it was like, a little just too close to the edge. Even just the working capital to create all the inventory that will allow us to run the supply chain, that might take 2% out of profit margin in the next 10 years. I could believe that.

Tobias: Yeah, that’s optimistic probably.

Jake: [laughs]

Tobias: “Real wages flat since about 2000.” Yeah, I think that’s right. I think the last time I looked at was like, the peak of–

Jake: 1970 or something, wasn’t it?

Tobias: No, no, no. It was 2000. It was Bill Clinton, 2000 was the peak of real wages and then, it’s been down since then.

Jake: Oh. Well–

Tobias: Certainly, feels like–

Jake: We almost need a technological Hail Mary to connect somewhere to just make all this stuff move.

Tobias: Fusion.

Jake: Yeah, fusion or 3d printing like something breakthrough that we just like, “Oh, okay, never mind.” The goods and services have gotten so big now that doesn’t matter that we have all these other problems. It’s all solved now.

Fusion’s The Answer

Tobias: Fusion’s the answer. Fusion means as you’ve pointed out to me unlimited, clean drinking water, that solves all water problems.

Jake: Food. Yeah.

Tobias: Electric cars.

Jake: Cheap energy is a prime mover that solves many, many issues. It’s probably nuclear. It might be the even better answer there.

Tobias: That’d be a good first step. Get some money in there, get some technology in there.

Jake: Imagine, 1950s, when we were working on this and they were talking about how energy is so abundant and so cheap that it wouldn’t even make sense to meter it. It’s too cheap to even meter it. It doesn’t make– Use it as much as you want.

Tobias: That’d be great.

Jake: Like breathing air.

Tobias: On that note, we’ve done it, JT. We made it.

Jake: Ooh, I need a break. I’m going to go lay down for a while. [laughs]

Tobias: Yeah, Black Death, thanks. [laughs] “Black Death also increased real wages in the 1300s.”

Jake: No, that’s not the denominator that you want to shrink.

Tobias: Until the King declared that it was illegal for people to move farms or to ask for higher rates. So, everybody had to get back to their farms and get paid the same rates, even though there were fewer of them. That’s tough.

Jake: Oof. Don’t do that.

Tobias: Thanks, amigo.

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