In their latest episode of the VALUE: After Hours Podcast, Tobias Carlisle, Jake Taylor, and Gwen Hofmeyr discuss:
- Cyclical Compounders and Market Opportunities
- Lack of Institutional Coverage Creates Opportunities
- Insights on Regional Banks
- Historical Analogies: The Hunt Brothers and Silver vs. Michael Saylor and Bitcoin
- Untangling Cyclical versus Secular
- Tiny’s Hands-Off Management Style
- Challenges in Value Investing During 2019
- Aritzia: A Lifestyle Brand Success Story
- 4imprint Group: The Amazon of Direct Marketing
- Hingham Institution for Savings: A Regional Bank Standout
- Ingles Markets: A Hidden Real Estate Gem
- Vertical Integration as a Competitive Advantage
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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Transcript
Tobias: This meeting is being livestreamed. That means its Value: After Hours. I’m Tobias Carlisle. Joined as always by my cohost, Jake Taylor. Our special guest today is Gwen Hofmeyr of Maiden Capital, an alum of Tiny. Welcome, Gwen. How are you?
Gwen: I’m doing great. Thanks. How about yourself?
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Tiny’s Hands-Off Management Style
Tobias: Let’s talk a little bit about Tiny without destroying any confidences don’t– [crosstalk]
Jake: Or, [crosstalk]
Tobias: No confidential information. What did you do at Tiny, and what was it like working for Andrew and the team there?
Gwen: I will say that it was the equivalent of being sent into the desert with a bottle of water and a trowel, and them saying, “Good luck.” I helped them with their equity research specifically related to their public securities. So, I was not very involved on the private side.
And so, as a result, given that Andrew and Chris love delegation, so they have a very hands-off management style. I was just kind of like– They brought me on and said, “We’ll see if you can add value and there you go.” They basically told me not to.
They didn’t give me pretty much any mentorship of any kind, any instruction of any kind. Sometimes they would send me ideas that they were interested in. But for the most part, I was just alone in the desert with my trowel. It was very sink or swim, and it worked out.
Jake: Did you dig any good holes while you were in the desert?
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Challenges in Value Investing During 2019
Gwen: I did. I did, actually. Well, I came to the business in October 2018. And in 2019, I don’t know if you guys remember, but it was a very tough year for value investing.
[crosstalk]Jake: You talk about decade.
[laughter]Gwen: Well, you got it. Yeah. And so, that was the kind of the year where I was like, “I don’t think that screens really provide any advantage unless there’s some broad scale aversion to analyzing a particular industry, or country or just general,” like there’s general market fear. There’s probably a little edge that you’re going to get from a screen. So, I was just like, “You know what? I’m just going to start reading about businesses without expectation.” Two of those businesses that I read about were Aritzia and 4imprint Groups.
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Aritzia: A Lifestyle Brand Success Story
So, Aritzia is a fashion company. It’s like everyday fashion. You call them like middle fashion. They’re not quite that upper tier, but they are a lifestyle brand. They’re actually founded in Vancouver, so the city that I live in.
They just have this insane culture where it’s a hot girls club like it really is. I don’t know if you’ve ever seen the movie, Mean Girls. There’s this girl in the show or in the movie called Regina George, and she’s like this hot girl. Everyone wants to be her. That’s Aritzia. So, it’s like you go in, there’s these communal mirrors that everyone has to come out of the change room and look at themselves in front of the mirror.
It’s really exploitative of envy. It’s a tremendously profitable business. In fact, it’s the second-best unit economics, at least when I was looking at it in North America, second to Lululemon at the time. If a consumer has shopped at Aritzia, 26% of their wardrobe contains products from Aritzia. This is taking off in the US as well now.
So, I wouldn’t be surprised if it’s one of the big retail stories of the next decade. I don’t know if it’s expensive or not at this point. I haven’t looked at it recently. But at the time when I was analyzing it, it was very expensive.
Again, owner-operated business. The COO joined the company in 1987 as a sales rep. Worked her way all the way up to COO. She’s now CEO. The CEO used the Great Financial Crisis as an opportune moment to enter the United States of America. So, he took advantage of choice real estate deals to get great locations. And so, that’s who we’re dealing with.
At the time, when I analyzed them, they were too expensive. But I was like, “Wow, people are losing their minds for this company. I shop at this company. This is something to keep in my back pocket.”
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4imprint Group: The Amazon of Direct Marketing
And then, 4imprint Group is the largest–
Tobias: Just before you move on,-
Gwen: Yeah, go head.
Tobias: -I got two questions. One, when you’ve got something like Aritzia, the fashion is very hot, what’s to stop the trend from moving away? The way you’re describing it with the single mirror and so on, do you remember Abercrombie & Fitch? Abercrombie & Fitch used to have the model stand right on the outside. It was like a hot girl, hot boy kind of store.
Gwen: Yeah, so that–
Tobias: It was tough to shop in if you didn’t meet the profile.
Gwen: Yeah. So, Aritzia, at the time when Abercrombie was popular, Aritzia was also popular. So, their brand, TNA, like when I was 12 years old, it was like all the rage. Every girl was wearing TNA. So, they have been a trendsetter for over 20 years, over 30 years at this point. They design all of their clothing in house. So, they’re basically just–
It could be because of the owner operator structure. I don’t know if Abercrombie was owner operated at that time, but there’s a very strong incentive for management to continue to innovate and continue to design high-quality, attractive styles. They’ve been doing it successfully for three decades, plus now.
So, you’re not wrong. It’s just that if you go to these stores like Zara or Abercrombie & Fitch, the quality for the price is not the same, and the design is not as thoughtful. Abercrombie & Fitch has been having a bit of a renaissance. They’re doing decently well, but Aritzia is very consistent in quality design.
Tobias: Abercrombie & Fitch–
Jake: Are you wearing it now? Is that an Aritzia shirt you’re wearing?
Gwen: Actually, I wasn’t. I was considering wearing my Babaton jacket,-
[laughter]Gwen: -which is one of their brands. But basically, the Great Financial Crisis hit and the stock went from, I don’t know, 30 [unintelligible [00:06:39] to $1,250. I knew that it was probably one of the only businesses that was likely to survive in the retail sector at that time, just because if you went to the mall on Boxing Day, all of the retail stores were empty except for Lululemon and Aritzia. And I was like, “Okay, well, people are obsessed. It’s a lifestyle at this point.”
Think of LVMH. There’s brand recognition. It’s a club at that point. The bulk of Aritzia’s revenue comes from Super Vans who spend, I think, more than $5,000 a year at the company. You get awarded a certain kind of membership status as well once you’ve reached a certain number of sales.
Tobias: What’s the top one called?
Jake: [chuckles]
Gwen: What?
Tobias: What’s the top-
Jake: Tier
Tobias: -Mean Girl tier called?
Gwen: Sorry, I didn’t–
Tobias: What’s the top Mean Girl tier called? How do you get queen B?
Gwen: [chuckles] I don’t know. Gosh, I think I haven’t analyzed the luxury space much.
Tobias: That’s all right. I was just joking. I was just kidding.
Gwen: Yeah. [laughs]
Tobias: It’s Aritzia. What’s the ticker, or what’s the– How do we follow them?
Gwen: It’s not. It’s traded on the Toronto Stock Exchange under the ticker ATZ.
Tobias: ATZ. Okay. Thank you.
Gwen: I think last time I checked, they do over 20% returns on equity. It’s a very profitable business. They remained profitable during the pandemic, and they were one of the only retailers during that time who didn’t lay off workers. They were investing in PR and marketing. They were paying excess profits to their workers even though they were at home, like, just a lot of goodwill. We bought up shares at $1,250, and it worked out very, very well.
4imprint Group is, I think, even better in my opinion, because they’re doing over 50% returns on capital, again, owner operator structure, and they had no debt and about, I think, $60 million or $70 million cash on the books in 2020, and the stock fell over 60%. So, I think when we were analyzing it was about £34 and we were buying at between £10 and £15 pounds during the crash. And so, 4imprint Group is the largest direct marketer of promotional products in the United States of America.
The catch, is that it’s traded on the London Stock Exchange under the ticker LSE, even though they do 90% of their business in the United States of America. It’s a very, very small market, so think like branded mugs when you go to your hotel or conference merch or whatever, they’re the best at it. They have about 5.5% market share. When I was analyzing them, they had about 2.5% market share.
I was just obsessed with the company. It was really hard to find another company like them that was publicly traded. One thing that specifically stuck out, is that they get about anywhere from $16 million to over $20 million in rebates from suppliers per year. So, basically, they’re the Amazon of direct marketing. They don’t actually have manufacturing. They’re just a giant middleman. They have a huge customer base. Suppliers really want to get on their platform, because it creates huge volume for them at the consumer level.
And so, in exchange, they get rebates from suppliers. And so, they’re getting again, $16 million, $18 million, sometimes more million dollars per year in rebates. There are, I think, 22,500 players, direct marketing companies, maybe more at this point in the United States of America. 20,500 of those do $2 million or less in revenue per year. And so, your largest competitor is earning many multiples higher in revenue just in rebates, it’s going to be really tough to compete with the level of quality and assurances that company can provide.
And so, during the pandemic, kind of like a dream come true.
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Cyclical Compounders and Market Opportunities
Gwen: So, I really love cyclical compounders, just because in the course of business, you’re just going to have these periods where there’s some broad uncertainty related that’s impacting their industry in a cyclical way and not a terminal way.
And so, there’s an opportunity for that company to get thrown out with the bathwater, because Wall Street sells what sells. And if something stops selling, they’ll stop selling it. So, whether that’s China or the UK, whether it’s an entire country or its entire industry, if it’s a reason why they could potentially lose client money, they’re going to sell the asset and they’re going to buy what their clients want.
And so, during the pandemic, the CEO comes out and he says, “Something that I think every investor in cyclicals wants a manager to say, which is the reason why we maintain the strong balance sheet that we do is, because in times of uncertainty, it represents a market share opportunity.” And right there, it’s like, “Okay. Well, that makes sense. You own 12 times or more your total annual compensation.”
It makes sense that you’re thinking long-term. But that kind of language is what I like to see. And at that point, he had been at the company for, I think, about 30 years, but in the executive role for about, I think, eight years by that point. So, a guy named Kevin Lyons-Tarr.
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Untangling Cyclical versus Secular
Jake: How do you untangle cyclical versus secular?
Gwen: So, I think that’s a very good question. I think it’s easier when the products or services that a company is providing is driven by necessary demand. So, it’s necessary for the functioning of an economy. I think cars are probably up for disruption, but for a very long time– And even today, single car ownership is absolutely necessary for the functioning of the American economy.
If you go to Omaha, if your car breaks down, you’re hooped. You have to drive a long way to get anywhere in that city. And so, I think with used car company like CarMax, whether it be in the pandemic or in the Great Financial Crisis, it’s a better business today. I think you can buy it for what you can about 10 years ago.
People need affordable transportation to get to their jobs to do their job. It’s likely that if there is a drop in that demand, that there will be a normalization over time. Cars are, again, maybe a bad example, but something that’s driven by necessary demand. It could be construction, it could be heavy industrial services, it could be energy as well, something that people need. Yeah.
Tobias: Gwen, that second, that was for your information. And the tick is LSC?
Gwen: So, it’s 4imprint Groups, so, the number 4.
Tobias: Oh, 4imprint. I’m sorry. 4imprint. Right.
Gwen: Yeah, the number 4 [crosstalk] The ticker is L-S-E-F-O-U-R.
Tobias: Yes. LSC is because it’s listed in the London Stock Exchange. F-O-U-R is the ticker. Okay.
Gwen: Yeah. It’s a fast grower. I see no reason why they can’t continue to grow at double digit rates over the next 10 years, just given that there’s this kind of snowball effect. But I guess with direct marketing, it’s a low growth to no growth industry. But people love going to hotels, and people love going to university, and people love going to concerts and playing sports and stuff like that. So, there’s a lot of [crosstalk]-
Jake: A swag.
Gwen: -their products. Yeah [crosstalk]
Tobias: I’m surprised. That’s a lot of growth. I feel like there’s a lot of swag. I feel like you get a lot– There’s just increasing amounts of swag every time you go to an event.
Gwen: Yeah, exactly. Exactly. That’s what they do.
Tobias: Let me give a shoutout to everybody at home, then we’ll come back and we’ll have a chat about regional banks.
Gwen: Okay.
Tobias: Santo Domingo, Dominican Republic. First in the house as always. What’s up, Danny? Cleveland, Tennessee. Andhra Pradesh, India. Paso Robles, California. Lucky, you. Milton Keynes. Tomball, Texas. What’s up, Tyler?
Tallahassee. Winter Park, Florida. Mac’s in Valparaiso. Miami, Florida. It’s like through the looking glass, isn’t it? Toronto. I can see you there at home. G’day! Lausanne, Switzerland. Hawaii. Hamburg, Germany. Boston, Massachusetts. Barrow-in-Furness, What’s up, Mike? Gothenburg, Sweden. Oh. Eyjafjallajökull, Iceland. You can send me the hate mail for that one. I’ve got no idea how to say that.
Jake: Oh, boy.
Tobias: Madeira Island, Portugal.
Jake: Terrible.
Tobias: Tampa. Les is on the mountain. Coming down from the mountain, Les in Australia. Jupiter, Florida. [laughs] Gerard’s Cross. Nokia, Finland. Is that real? Good job, everybody. I hope you tricked me on the way through there. Les, you certainly got me. So, I guess the question is, what do we need to know about regional banks? Are they going to survive the next financial crisis, whatever it may be?
Gwen: Yeah. They have survived a lot of financial crises over the last-
Tobias: Collectively.
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Insights on Regional Banks
Gwen: -300 years. [Jake chuckles] So, there’s, of course, a lot less than there were in the 1980s, the savings and loan crisis of the 1980s. I don’t know if a lot of people know about that, but basically, at the time, the amount of insurable deposits was expanded, I think from like– I can’t remember. From $80,000 to $200,000. It just created a wave of really, really unscrupulous lending which resulted in two-thirds of SNLs going bankrupt over that period. And interestingly, over a thousand bankers were charged criminally during that time.
Jake: Oh, the good old days.
Gwen: Yeah, exactly.
Tobias: Pre-GFC.
Gwen: Yeah, exactly. But the difference is, is that during the Great Financial Crisis, so much of the budget had gone towards Homeland Security, for the Department of Justice. And a lot had flowed out of that kind of investigates and persecutes white collar crime. And so, today, Jamie Dimon would have– I don’t know how many multiples of the budget that would be used by the Department of Justice to investigate bankers. And so, it makes sense. I think white collar crime, actually, is at all-time lows right now, or at least it was last year.
Tobias: Prosecutions– [crosstalk]
Jake: Yeah. [laughs] Prosecutions way out.
Gwen: Let me say executions? [chuckles] Oops. No, I like bankers. Please don’t kill them. So, basically, there are a lot of regional banks in the US. There are over 600 that are publicly traded. And as a whole, there are 4,000 of them. So, there are just a lot of regional banks. As a result, people, generally, for one, just out the gate, they don’t like to analyze banks. They dismiss them as all being black boxes. They all have derivative books that are really difficult to understand.
You never know if it’s just you’re going to wake up one day and all your money is going to be gone, because there’s been a bank [unintelligible [00:18:34] or whatever. And so, there’s a lot of aversion towards analysis of the sector. There’s also a lot of apathy as well that I have personally observed. So, senior managers talking to me and saying, “I don’t analyze US Regional Banks, because there are too many.” And that type of behavior, given that I run a research firm and just to correct you, Tobias, it’s Maiden Financial.
Tobias: What did I say?
Gwen: That’s my company’s name. If I’m running a research firm and I want to produce noble research, I want to produce research with differentiated insights. If I hear investors expressing fear, or dislike, or not wanting to or just aversion to analyzing a particular industry, I get interested.
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Hingham Institution for Savings: A Regional Bank Standout
Gwen: I happened to stumble upon a bank in 2022, late 2022, called Hingham Institution for Savings, which is a regional bank based in Hingham, Massachusetts. It was because of this YouTuber that I followed at the time and–
Jake: Roaring Kitty?
Gwen: Huh?
Jake: Is it Roaring Kitty?
Gwen: Exactly. Exactly. It was Roaring Kitty. Yeah. The short interest is huge. No. I really respected this guy. And so, it’s just like, “Why is he investing in a regional bank? That’s weird.” Because I was in that camp where I was like, “I’m not going to analyze regional banks. Who can understand them? They’re too complex.”
Then, the Silicon Valley Bank crisis occurred. Silicon Valley bank, I would say it’s probably one of the most unusual banks in the United States of America, like over 95% of their deposits were above the FDIC insurable limit. In a heroic move of laziness, probably, maybe I should be careful what I say, but it makes me wonder what they were doing with their days when they decided to put over 50% of their assets into long dated treasuries. It was just like, was it just like, “We give up, we’re going to go play golf and drink wine all day”?
I don’t understand the thinking behind it. But comparing Silicon Valley bank to regional banks, for example, in the SPDR S&P Regional Banking Index, which contains about 138 banks, 140 banks is unproductive, because they’re all very, very different. In fact, a third of banks in the KRE– That’s what the index is abbreviated to be referred to as. A third of the banks in the KRE don’t have any material exposure to health and maturity securities.
So, the discard of the industry in the wake of the Silicon Valley Bank crisis, where the bank went to zero pretty much overnight, got me interested in the industry, because where there’s uncertainty, there’s an opportunity. I had this bank in my back pocket. I started analyzing it and I was just so struck by its simplicity. They overwhelmingly underwrite mortgages for the most acyclical assets that you can pretty much underwrite. So, multifamily, mixed use and one to four family properties, so rental properties, effectively.
During the Great Financial Crisis, [clears throat] rental vacancy in the US went from 10% to 11%. I think that’s about 10% increase. Default rates went up over 450%. So, very acyclical asset. Actually, in Massachusetts, there was no change in the vacancy rate. It was very stable.
So, very struck by what they did as a business. I could actually look at their markets, I could understand what they were doing and I could think about that intelligently. They also have no derivatives on their book. So, there was no complexity in terms of wondering what derivatives do they own, what purpose do they serve, are they speculative or they not speculative. Also, the bank had a 30-year track record, family owned and operated, most efficient bank in New England and the most efficient bank in relation to the KRE.
So, I was very inspired and I was like, “You know what?” I’m a member of MOI Global, and I was like, “I’m going to present this bank to MOI global. How can I make it a really good presentation?” I was like, “I’m going to analyze every single bank in the KRE.” So, 138 banks, because who would do that to themselves? I feel like if you can identify a project where you would get the feeling of like, “This is going to be awful,” it’s probably a great opportunity, because it means that a lot of people probably won’t do it.
And so, I, basically, approached analysis of the KRE with a broad hypothesis that it wasn’t a lack of intelligence that caused a Great Financial Crisis, it was a lack of good behavior. And so, where there are owner operator incentive structures, which I defined as the lead executive owning seven times their total calculated compensation in stock, where there are owner operator incentive structures, there should be more positive performance at the business level economically, but also at the loan book level. So, lower charge offs, lower delinquency rates. And I was right.
So, when you look at regional banks specifically to that seven times ownership to compensation bucket, they’re about 50% more profitable, they experienced lower net charge offs during the Great Financial Crisis, they hold more cash, they’re less levered. Over 40% of them don’t have any derivatives exposure.
So, derivatives exposure is very common. I think only about 10% or 15% of banks in the KRE don’t have any derivative exposure. So, over 40% of those owner operated banks don’t have derivatives, because why would you want to hedge away short-term discomfort at the expense of long-term returns, if you’re an owner in the business, if you have a real incentive to maximize those returns. And so, the study was a way to think about how to analyze and own banks for the long-term.
Hingham was just a real standout. It was, again, not only the most efficient, but during the Great Financial Crisis, they had the best loan performance in relation to the KRE. They only charged off seven basis points of their book, whereas the KRE charged off about 1.8%, and industry wide, it was about 3.2%. So, there was, again, just really strong correlations between positive loan performance, lower delinquency rates, higher profitability, increased efficiency as well.
It seemed so obvious, but again, the work involved was really tremendous. It took me probably about 600 hours to do the whole project. That type of work just isn’t very commissioned too often these days. But there’s also this, I guess, this kind of bias towards running a bank with low-cost deposits, so called low-cost deposits, because you have to spend marketing dollars to attract those deposits.
Maybe you have branches, and web hosting and there are costs to acquire those deposits, but there’s this idea that competitiveness comes from having a base of low-cost deposits, when in actuality, it seems at the regional banking level to come from owner operator incentive structures which are really costly to replicate, because if you want to establish an owner operator incentive structure, you either have to dilute shareholders sufficiently until the CEO has a large enough dollar volume as a multiple of their earnings to create that structure, or you have to hold a gun to their head and say, buy the stock. That’s really difficult when the bank managers who oversee loan books of $300 million to $600 million, I think, even $650 million average seven figure annual pay packages.
Jake: Is that right?
Gwen: Yeah, that’s right. So, it’s like, there’s very, very little incentive to be anything but average, because there’s so many banks, there’s so much business to go around and people are getting paid a lot of money. So, what’s the point? And so, banks that are owner operated–
They tend to have different business models, but they all tend to optimize for their weaknesses. So, Hingham is very liability sensitive. As a result, the quality of their loan book gives them access to very choice low-cost wholesale funding from central banks, like the Federal Home Loan bank of Boston, because multifamily property mortgages are very highly priced collateral.
Over the past two years, Hingham has about 85% of its mortgages. Its loans allocated to commercial mortgages. But again, in that, multifamily property is classified as commercial, so it’s like, people think office– When you say commercial, they haven’t had a single commercial loan over the past two years since the Fed hiked rates go into a state of non-performance. So, the quality of their book is just rock solid. And that gives them a very good relationship with regulators.
And so, if we even go back to the Great Financial Crisis, they have this tendency where when the yield curve inverts and their net interest margin collapses, they can go to the Federal Homeland Bank of Boston and say “Hey, can I get wholesale funding that’s 150, 200 basis points?”
Sometimes 300 basis points lower than what standard advance rates would be or what wholesale deposits would generally be, because they have such attractive collateral to offer the Fed. So, this time around, they were getting as much as 200 basis points in savings right out the gate. So, there’s a way where they can provide stability for their bottom line and then they also hold a lot of liquidity, so they have a lot of cash and securities on their books.
But being a bank that is really liability sensitive when we just experienced the longest yield curve inversion on record, really difficult for people to get behind it. So, I was pushing it in from all last January to May, just because– Again, I don’t provide recommendations to buy or sell a security, but just drawing attention to its attractiveness as a business.
Tobias: In your review of all of the other banks, did you find any red flags? Like, what are the things that we need to avoid? Thanks. Good question from Tyler.
Gwen: Yeah. So, I would say with any bank where there is exposure to a particular category of loan, that is difficult to analyze. So, levered loans. So, Bank of the Ozarks, for example. 10% of their book today, at least last time I checked, it is in levered loans. That was not the case before the Great Financial Crisis. There’s no reasonable means that anybody has to understand or assess the risk of those loans.
So, I would say, a market shift in the assets that a bank is allocating capital to, that differs from what it’s done in the past. If it’s towards assets that are more inherently risky or more difficult to analyze, I would be very concerned.
Tobias: What is a levered loan?
Gwen: A levered loan is effectively like a secondary mortgage.
Tobias: Okay.
Gwen: It’s like you’re levering an already levered asset.
Tobias: That makes sense.
Gwen: Yeah.
Tobias: We’ve come to the top of the hour, Gwen, which means we need to do-
Gwen: Really? Oh, my God.
Tobias: -some veggies. [Gwen laughs] We’ll come back after this, we’re going to talk Japan, Ingles markets and active and passive. JT, take it away.
Jake: [chuckles] What if I didn’t have any veggies ready?
Tobias: Oh, you try to–
Jake: Oh, just kidding.
Tobias: Stretch. Stretch.
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Historical Analogies: The Hunt Brothers and Silver vs. Michael Saylor and Bitcoin
Jake: Yeah. Break the streak. So, we’re going to go on a little journey together. Our story starts where many wild stories begin, which is Texas.
[laughter]Jake: A land of oil wealth larger than life characters that could fill a hit TV show. If you ever watch Dallas, you might be familiar with a famed Texas family called the Hunt’s.
H.L. Hunt, the patriarch of this story, was born in 1889, the youngest of eight, on a farm in Illinois. He was homeschooled, never attended a day of school, traditional school, in his life. He later said that education is an obstacle to making money. He proved himself right as he became one of the richest oil tycoons of his time. And in fact, H.L. Hunt was the inspiration behind the character of J.R. Ewing in the show, Dallas, which, if you’re old enough like Toby and I, then you might remember that one. [chuckles]
So, H.L. had 15 children from three different wives. One of his sons, Lamar, actually founded the American Football League and was the creator of the Super Bowl. So, that’s some little fun American trivia. But two of his other sons, Herbert and Bunker, are famous for other reasons that we’ll get into.
Aside from oil, the Hunts were also passionate equestrians. They own one of the largest collections of Arabian horses in the world. And of course, they live these lavish lifestyles that you might expect of raging parties, and rare wines, and gourmet foods and you name it. So, think like Texas meets The Great Gatsby.
As we know, the 1970s were a decade of inflation and oil crises. During that time, two of the Hunt brothers, Herbert and Bunker, they engineered one of the most audacious financial moves in history when they decided to try to corner the silver market.
Now, this all started innocently enough. Silver, at that time, was priced around $1.50 an ounce. The Hunts believed at that time, like a lot of people, that inflation would erode the value of the US dollar, and they believed silver was a great hedge to protect their wealth. And so, they innocently started out buying silver for that reason. They kept buying, and buying and buying until they’d amassed around 200 million ounces of silver.
They had about a third of the world’s non-government owned supply of silver, and actually, like more than any other government. And of course, prices naturally skyrocketed from all of this, the Hunt demand and they hit it hit $50 an ounce. So, a $1.50 to $50 by early 1980. Things are looking good. Like, their cost basis from the early purchases is well below $50.
Everyone else’s stock and bond portfolios are getting killed by inflation. It’s a bloodbath. These guys are geniuses. Like any genius, you’re tempted to press your advantage and you start buying on leverage. I think everyone knows where this is going, but this is a tragedy, [chuckles] not a hero’s journey.
The other shoe eventually drops. What actually happened was, in 1980, the US government, through the Commodity Futures Trading Commission, they stepped in and they raised the margin requirements. They essentially forced the Hunt’s to have to sell to meet all these sudden margin calls. And so, naturally, the market was flooded due to their force selling, prices tanked further margin calls, this whole beautiful spiral goes in reverse. They had no choice but to declare bankruptcy, and they evaporated a vast fortune.
Their actions destabilized the global silver market, led to all kinds of lawsuits, legal settlements and actually widespread personal vilification in the media about them. And so, now, they’re broke and they’re pariahs. It’s quite the cautionary tale. Bunker made a brief comeback to wealth. He discovered and had taken title to these oil fields in Libya. But then, apparently, Muammar Gaddafi nationalized those properties, and so that went away as well. So, this poor guy.
Anyway, let’s fast forward today, and is there anything in history past that might rhyme today. So, this fellow named Michael Saylor is the founder of MicroStrategy, which is a business intelligence software company. He started in 1989. He rode the tech wave all the way up and all the way down, has kept grinding at it. But he’s back in the limelight today now due to he has a big bet on a single asset, bitcoin, in this case, not silver.
Much like the Hunts, he believes in the power of bitcoin to protect against inflation and profligate governments. This is the same thesis that the Hunt started out with. They were trying to protect from inflation. Saylor’s called bitcoin, a digital gold and a way to hedge. Sure. Fair enough.
So, in 2020, he started making this bold bet. He began buying bitcoin. Not just a little bit. I looked as of yesterday, he had I think 402,000 roughly bitcoins. Their average purchase price is 58,000 per bitcoin. That’s a $23 billion tab that he’s used to purchase bitcoin. At today’s market, call it 96, 000 per bitcoin, that’s $38 billion in assets. The market cap of MSTR is $90 billion’ish. And so, the market is pricing these bitcoin at more than double the NAV that they’re at today.
Now, does that make any sense? Well, why not just buy bitcoin directly instead of paying 2x the price of bitcoin to acquire one share, look through share of bitcoin through MSTR? Well, first, I’m sure figuring out the wallets and all that stuff’s a pain. It’s a lot easier to just throw MSTR into your Robinhood app. Second, just like the Hunts, Saylor has been using debt to fund some of his bitcoin purchases. That’s somewhere, I think, around $5 billion worth of debt that they’ve taken on. That might be a little bit of an old number, because I know they’ve been doing even more stuff, and it makes my brain hurt to follow it along too closely.
And then, on top of that, why would you buy just regular bitcoin in your wallet when you can get it with leverage through a corporate structure, right? That is even better. And of course, why just buy it in the regular old structure when you can buy it in an ETF that’s a single stock ETF that’s also levered up to buy bitcoin? Boy, it’s basically like leverage turtles all the way down in this.
Basically, Saylor is betting that more institutions and countries might adopt bitcoin. This demand will, of course, then cause the price to skyrocket. He’ll continue to look like a genius. He can keep issuing equity at these crazy– Well, that’s a judgment term, crazy, at these current prices.
Tobias: Elevated?
Jake: Elevated, perhaps. Higher than before. Shoot. To be honest with you, I have no idea. He might be right about this. Like, this thing could go on forever. I don’t really know how to handicap the odds of human interest waxing and waning in something like this. It seems really hard to underwrite to me.
But I did wondering, if we look at that analog or that historical comparison with the Hunt brothers, like what was the thing that tripped them up, it was leverage, plus regulatory curveball that destroyed the Hunt brothers. So, it’ll be interesting to see we’re all going to find out together if something similar happens to Saylor and MicroStrategy, if perhaps there’s a government. I know it’s a decentralized network. Don’t send me messages. But if government somehow finds a way to throw a perfectly good stick into his bicycle tire, this thing’s just going to the moon.
Tobias: Is the business of MicroStrategy big enough to support the $5 billion in debt?
Jake: Oh, I don’t think so. I think it is loss making.
Tobias: So, what are the lenders thinking there? They’ve got collateral against the bitcoin.
Jake: Just asset. Yeah. Bitcoin asset. Borrow against that.
Gwen: Asset based lending, it’s a risky practice.
Tobias: But are they linked to the other– Is the debt actually secured against the bitcoin, or is it–
Jake: Toby, I’m not going to go read the docs.
Tobias: Yeah. No, neither am I. I know you don’t know the answer.
Jake: Even if it is– [crosstalk]
Tobias: Bitcoin has been a volatile asset historically, and it has gone up and down. I remember 2020, when it was $20,000 for the first time, having started the year, one or something like that. And then, I think in the interim, it got down to three. So, if it goes, $98,600, which I don’t know what– I think it almost got to the 100 grand.
Jake: Yeah.
Tobias: If it backs up to $33, that’s below his cost, below the net debt, and it can’t service the loan. And then, you got the two by leave it on top of that could trade at a discount to its holdings. I don’t know, it’s not a sure thing. It’s not a lay down. It’s not over yet. Anything can happen. Good luck to everybody playing that one.
Jake: Yeah.
Tobias: Tell me how much you’ve won next year this time when I’m still wrong. [crosstalk]
Jake: Oh, time capsule that one, huh?
Tobias: Let us know. [Jake chuckles] Let’s talk about Japan. How is Japan going to resolve itself? What’s the next three to five years look like for equities in Japan?
Gwen: I think you answered the question before the call. Just get the government to shame everyone.
[laughter]Tobias: Yeah. Well, let’s–
Jake: Yeah. Let’s unpack it a little. Yeah.
Gwen: [laughs]
Tobias: So, what’s the situation in Japan?
Gwen: Well, I’m no expert on this. So, this is like something that–
Tobias: This is a podcast. You’re allowed to speculate.
Jake: No. Don’t worry about that. Yeah.
Gwen: Perfect. Yeah, this is not my area of expertise. I usually live in like a vacuum for research projects. Once I have a research project, I don’t read or do anything else until it’s done. So, there’ll just be these six-week periods where I’m just, “I don’t know what’s going on in the world.” And to some degree, I read the news for 10 minutes a day or whatever, like everyone does.
But a friend of mine, just last week, mentioned that there are a lot of assets that activists are starting to unlock in Japan, which is really difficult to do beforehand. A lot of Japanese companies, even Sony– I think I could be wrong on this, but I think a very large portion of Sony’s revenue comes from its insurance business.
So, there’s a lot of Japanese companies that own multiple different companies in multiple different industries and they own a lot of assets. They’re very asset rich, and a lot of them have a lot of cash and it’s just been sitting there forever. Activists have started to unlock some of that value through encouraging managers to do buybacks.
There’s this one company– I can’t remember what it’s called, but they own Disney Tokyo. They don’t own Disney Tokyo, they have a stake in Disney Tokyo. I think it’s decently large. Recently, they said they’re going to sell 1% of their stake, and apparently the stock has been ripping. Again, I’m the worst person to ask for this, because I don’t really know what’s going on. But that’s my two cents, I don’t know.
Tobias: JT, without naming names, can we discuss the story that you’re telling before we started?
Gwen: Yeah, tell us some names.
Japan’s Capital Allocation Challenge
Jake: [chuckles] Names will be changed to protect the innocent. [Gwen laughs] Well, this is just a story of capital allocation in Japan, currently corporate. The story was that a manager was meeting with the CEO and management of a company that had tons of cross shareholdings. Basically, they own equities of a bunch of their suppliers, and actually their customers, and there’s this kind of–
At one point, there was this idea of being highly integrated with each other in ownership base, and it was a way of cementing the relationship. But Western investors think that that’s a waste of capital. They’re actively trying to get them to sell it. The other thing was that they owned this giant building for their company. It was pretty underutilized, and it was relatively new also, so they just splashed out a lot of money actually for it. And so, it’s this the most intelligent thing to be doing with the capital.
When the manager asked that question, there was practically crickets from the other side. Like, they hadn’t even really thought about it. Like, he’s suggesting a buyback with the cash instead of some of these other things, and it just wasn’t even on the radar. And so, that’s how far things can go potentially from a low base as far as quality of capital allocation and thinking about opportunity costs.
I think I said before we started that– I’m actually relatively sympathetic to their treatment of the entire stakeholder structure and not just thinking about shareholders only. So, making sure that lifetime employment thing, that maybe that’s a little bit extreme, but that’s a nice ethos of protection for your employees, being in good graces with your regulators, your customers and your suppliers. But the owners of the company also have to be winners in this as well.
Maybe US style Western capitalism might be a little bit too far in that direction, you know, when Milton Friedman said something like, “Your only job really as a business person is to make a profit.” I actually think that’s actually not wrong, if you think about it over a really long-time horizon, and like, what’s the way to ensure the duration of a good profit, is to make sure that everyone along your stakeholder group is participating in a win-win relationship with you. But if it’s a shorter-term profit, then that’s how you end up with taking advantage of some of those stakeholders, and that’s not a very long-term sustainable situation. But anyway.
Maybe, the eastern version is a little bit too stakeholder versus shareholder. So, maybe there’s a happy medium that can be found. I think Western companies could think a little bit more holistically and eastern companies should probably be, especially the Japanese version of spending money on everything except for returning it to the shareholders could probably benefit from a little bit more Western style capitalism. So, that’s my observation.
Tobias: Wise, JT. Wise words. Let me give a quick shoutout. Ballynamullan, Ireland. Helensburgh, Australia.
Jake: Oh, stragglers
Tobias: Washington D.C. Cincinnati, Ohio. Dubai. Boneroo–
Jake: We did this already.
Gwen: [chuckles]
Tobias: We got some more. I got a good story here. “Bunker was luxuriating in the pool at the Golden Door Spa in CA when COMEX announced their silver futures margin requirementa had changed. It was the end for him.” Good story. And what was the name of the commercial of the bank?
Gwen: The bank? Hingham Institution for Savings.
Jake: HIFS is the ticker.
Gwen: So, H-I-N-G-H-A-M, Hingham. The ticker is HIFS.
Tobias: HIFS. Good stuff.
Gwen: Yeah. [crosstalk]
Tobias: Should we talk Ingles Markets?
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Ingles Markets: A Hidden Real Estate Gem
Gwen: Sure. So, Ingles Markets is a family-owned regional supermarket located in North Carolina with operations in South Carolina and Georgia as well, but it’s headquartered in Asheville, North Carolina. I was commissioned to analyze land companies back in the summer by this investor named Swen Lorenz. He runs a firm called Sarnia Asset Management, and this great blog called Undervalued Shares. He had read my report on Hingham, and he had written an article about it. And so, as thanks, I offered to do a project for him and he loves land, so he wanted me to go find a land stock.
And so, I started by analyzing traditional land securities, agriculture, livestock, and quickly realized that there’s not a lot of securities in North America in those traditional landowning industries. I also concluded that if I were going to produce a body of work that might provide differentiated insight into a company, it’s unlikely that I’m going to find that if I am analyzing a small pool of securities.
Tobias: What is it? St. Joe’s and–
Gwen: Yeah.
Jake: [unintelligible 00:49:17] probably.
Gwen: Yeah, exactly.
Tobias: What’s the cotton farmer that’s unlisted?
Gwen: Oh, I can’t remember the cotton farm.
Tobias: Good cotton farms in the US and Australia. It’s unlisted.
Gwen: No. I don’t know. Isn’t [unintelligible 00:49:31] company?
Tobias: Hive mind. Hive mind. Tell me.
Gwen: Hive mind? Okay. Yeah. [Jake laughs] Oh, I can’t remember any.
Jake: There’s this fruit company, isn’t there, that you can—Oh, that they make phones, but–
Gwen: [chuckles] There are several fruit companies, a cranberry company that owns a lot of cran– I think they’re the main supplier of cranberries in North America. But it’s a dark company. I think if you bought a share, if you managed to buy a share, it’s really difficult– You could probably talk to management, but it would be one of those obscure names.
Tobias: Sorry, Gwen. Keep going [crosstalk] derail.
Gwen: Yeah, no worries. So, yeah. So, basically to– I went down this rabbit hole where I was like, “Okay, if I’m going to find land that people are overlooking or under analyzing, I need to analyze industries where land ownership is not an expected feature.” And so, I put together a list of 753 companies between $20 million and $2 billion in market cap, and I proceeded to go through each of the reports to see which ones disclosed land ownership.
From that, I identified 72 companies that disclose acres owned to the tune of about 63,000 acres. One of them stood out in particular. There were several. If you read my report on Ingles Markets, it’s available on my website. There’s several that stood out, but Ingles especially stood out because of the way that it disclosed its land. So, in its annual report, it says that it owns 160 acres adjacent to its warehouse, its distribution center, and it owns 29 parcels of land or something like that.
But when you actually look at the footnote where it’s accounting for the cost of its landed property, if it really just owned 160 acres, it would turn out to be worth $9.2 million per acre, which is just impossible. There’s no way that commercial– [crosstalk]
Jake: Tokyo palace type of–
Gwen: Exactly. There is no way. So, I was like, “Okay, I think that these guys own a lot more than what they’re disclosing.” It’s not that they’re doing it illegally. They’re accounting for the land and the buildings. But they’re just not telling, they’re understating the significance of their portfolio. So, I was like, “How can I figure out how much land and buildings they own and what it’s actually worth?”
County tax record analysis. So, about a thousand county tax record queries later across 400 counties, and I had identified about 3,600 acres owned over about 450 or so properties worth about $1.4 billion. Today, the market cap is $1.4 billion and then enterprise value is about $1.6 billion. Thankfully, a lot of county tax records will tell you the effective date of an improved property. So, I was able to do a depreciation estimate for this portfolio. I discovered that there’s about $658 million that is fully depreciated. So, that’s just missing from the equity portion of their balance sheet.
I also discovered that they use real estate as a means to– I’m going to say this, this is my opinion, but in my opinion, they use real estate to restrict competition to maximize store placement. So, they have a very similar offering to a Kroger, which is why you see very few Kroger’s or Harris Teeter’s competing with them in their markets, because they will have a gas station, and a Starbucks and a pharmacy.
Again, a large format grocery store that’s appealing to that middle, upper middle class American that has a lot of convenience on site, so you can go get your groceries, you get your gas. A lot of them are also positioned in residential shopping centers. So, they own a very profitable shopping center leasing business, which again, it’s like, they’re not malls, they’re more like residential plazas. So, they would have like a hairdresser, a spa and they often have a goodwill, like a discount store or they’ll have a Dollar Store. So, there’s a lot of value embedded in the properties that they operate within.
So, not only did I identify this highly valuable real estate portfolio, it’s also a huge boon for their competition. So, they actively use it to restrict competition to position themselves and strategically advantageously. It’s to such a degree that during the pan– at least in 2022, when inflation started spiking. I think the average profit margin of a grocery store in the US was about 1.4%. Theirs was 5%. [Jake laughs] So, they had this huge operational leverage because of–
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Vertical Integration as a Competitive Advantage
They’re also very vertically integrated, so they have one of the largest distribution centers in America within, I think, gosh, like 280 miles of all of their locations that supplies over about 60% of their stock. They have their own milk distribution and production business that I think accounts for a majority of their dairy products. So, there’s a lot of vertical integration and there’s a lot of focus on just one market on just on their region, which is Northwest North Carolina.
Jake: It’s almost like a company store from the mining days, where it’s [laughs] got everything.
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Lack of Institutional Coverage Creates Opportunities
Gwen: Yeah. And so, there’s an extremely valuable asset there, but there’s no institutional coverage of the company. And so, the market has never that I’ve observed– I do know one investor who reproduced the study on their own, but there was no analysis out there that had a full excavation of the real estate portfolio, what was it worth, what was it used for?
The funny part about it is, is that the asset is not impaired in any way. It’s like a very highly competitive, inflation resistant, recession resistant business that has this very profitable shopping center leasing business that’s growing at 15% per year, that’s doing 85%, a EBIT margins I would say after CapEx. Yeah, it’s tough, because they don’t disclose the tax that they– If the operating expenses include tax when they discuss the leasing business and the reporting. But in any case, we could say EBITDA margins after CapEx is 85%.
Jake: Why be public?
Gwen: You know what? GAMCO is a 5% shareholder in the company, so Mario Gabelli. I believe it was 2018, they got involved, because management decided that they weren’t going to do quarterly earnings calls anymore. So, they have great reporting, but it’s tough to get a hold of them. They did an activist campaign to try and restore that communication, and they remained shareholders even after it failed.
I think that it’s a huge hedge towards a manager like Bobby Ingle, the guy who is the chairman of the company of taking it private is that it’s probably worth about $4.7 billion to $5 billion. I estimate over a 10-year period trading at $1.4 billion today like GAMCO would– I can’t speak for what they would do, but I can only assume that it’s likely that the company would probably give back valuation in courts either after the fact. So, yeah, I think that it’s probably too cheap for them to do it.
Jake: How much does the family own of it?
Gwen: The family owns about 21% of the company.
Jake: Okay.
Gwen: Yeah. They’re not doing anything wrong. They’re paying down debt. 10 years ago, debt to equity was 130%. Today, it’s like 30%. In the 30%, they are incrementally adding value to the business every single year. In fact, if you look at the CapEx, about 85% of their reported CapEx is the acquisition of property. So, they have actually very capital light.
Jake: It’s just a real estate business with a side grocery business on the–
Gwen: It’s a real estate business. If you look at the rent that they’re saving on their grocery stores, I think it’s about $60 million per year. If we apply a cap rate of 6%, 6.5% of that, that’s, I don’t know, $800 million plus valuation. They’re not being valued like that in any capacity. It’s a really valuable asset. And so, yeah, very interesting.
Just one of those odd situations where you find a lot of value on the asset side of the business and on the operating side of the business and there’s no impairment. It seems to be commonplace in day and age that there’s just a general decline and the kind of- [crosstalk]
Jake: No one cares. Yeah.
Gwen: -analysis. That’s why I started my company, because how is it in such a small industry that Ingles has no institutional coverage at a $1.4 billion market cap. There’s plenty of small cap shops out there.
Tobias: What’s the ticker, Gwen?
Gwen: So, the ticker is I-M-K-T-A.
Tobias: IMKTA. That’s Ingles Markets. We’ve come up on time. So, if folks want to follow along with what you’re doing or get in contact with you, what’s the best way of doing that?
Gwen: So, you can follow me on LinkedIn. Just my name, Gwen Hofmeyr. You can also email me just Gwen@maidenfinancial.io. You can also visit my website, if you get confused. That’s pretty much it. Those are the two ways.
Tobias: Jake Taylor, any final words?
Jake: No. Squeezed all the toothpaste out of the tube already. [laughs]
Tobias: Thanks, Gwen.
Gwen: Thank you so much. [crosstalk]
Tobias: Thanks, everybody. We’ll be back next week, same channel, same time. It might be one of our last shows for the year. We’ll see how we go. See you everybody then.
Jake: Thank God.
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