Introducing Acquirers Funds®

Tobias CarlisleStock Screener6 Comments

We’ve launched a new investment firm called Acquirers Funds® to help you put the acquirer’s multiple into action.

Acquirers Funds®

Our investment process begins with The Acquirer’s Multiple®, the measure used by activists and buyout firms to identify potential targets. We believe deeply undervalued, and out-of-favor stocks offer asymmetric returns, with the potential for limited downside and a greater upside.

The returns to deep value are potentially realized in two ways:

  1. First, through mean reversion in the underlying business, and
  2. Second, through a narrowing of the discount to valuation, either through the passage of time or the intervention of activists and buy-out firms.

We take a holistic approach to valuation, examining assets, earnings, and cash flows, to understand the economic reality of each company. An important part of this process is a forensic-accounting diligence of the financial statements, particularly the notes and management’s discussion and analysis, to find information that may impact investment decisions.

We implement the strategy in a highly liquid, tax-efficient, capital-efficient structure.

Click here to learn more about our investment firm.

See Our Deep Value Stock Screener

We identify the 30 best deep-value opportunities right now in all US and Canadian stocks and ADRs (excluding financials and utilities) using The Acquirer’s Multiple®. Choose from four universes: Large Cap 1000 (free), All Investable, Small and Micro Cap and Canada All TSX.

Click here to see our Deep Value Stock Screeners.

Read The Acquirers Multiple® Book

Acquirers Funds® is guided by the strategy described in the book The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market is out now on Kindlepaperback, and Audible.

Listen to The Acquirers Podcast

Our The Acquirers Podcast we talk to value investors about how they find undervalued stocks, deep value investing, hedge funds, shareholder activism, buyouts, and special situations.

We uncover the tactics and strategies for finding good investments, managing risk, dealing with bad luck, and maximizing success.

Click here to listen to The Acquirers Podcast.

 

Bruce Greenwald: The 3 Attributes That Make a Truly Great Investor

Johnny HopkinsBruce GreenwaldLeave a Comment

We’ve just been reading through the Winter 2009 issue of the Graham and Doddsville Newsletter which includes a great passage by Bruce Greenwald on the three attributes that make a truly great investor saying:

Bruce Greenwald: There are three things that Buffett is good at—and if anyone is good at two of the three, they do extremely well.

First, and it’s something that, interesting enough, Graham wasn’t that good at, because you have to be incredibly disciplined—but you can’t take a flyer and say, well, isn’t this an option? If you don’t know, then you’ve got to have the discipline not to do it. And that’s probably where Seth [Klarman] is the best person in the world at it. It’s really
what protected [First Eagle’s] clients—because JeanMarie [Eveillard] didn’t know—so he didn’t do any financials.

You have to be incredibly disciplined—and most people aren’t. Most people fall in love with companies and deceive themselves about things.

Second, it seems to me that you have to be really good at this—and it’s something that’s developed but most people still aren’t good at it except for you guys [in the Applied Value Investing program]. It’s understanding what a franchise is. You need to understand what a moat is versus an intangible asset. Where there’s real earnings power and no one is going to enter and erode it away.

Most people just don’t understand this – they don’t understand local economies. So the second thing is that you really have to understand the economics of the business. And Buffett is just exceptionally good at that. He really understands the difference between when there’s a moat and when there’s not.

And then you’ve got to be good at valuation. And that’s part of understanding the economics. You’ve got to understand the economics and understand what you’re buying. Use all the information. Be very disciplined. Have a thorough knowledge. And it usually makes a big difference if you’re an industry specialist. Buffett has three to four industries he knows really well—consumer non-durables like Coca-Cola and See’s Candies. He’s made a ton of
money in insurance. And then media and communications. The classic case is newspapers. But what Buffett understands is that when a franchise grows, it’s earning above the cost of capital.

When a franchise shrinks it’s earning below the cost of capital so it destroys value. They’re great businesses—everyone says they used to be such great businesses. But what they didn’t understand is that a growing good business is phenomenal. But a shrinking good business is a disaster in terms of the multiple it can get.

So people were talking about 14-15x after tax operating earnings for newspapers historically. So when the papers traded down to 11x, people thought, how exciting! But what Buffett understands is that at 11x—and even if they return all of the cash without wasting any—that’s only a 9% return. And these are businesses that are shrinking at 5% a year and not throwing off much capital. So you take five away from nine and you get a 4% return. And he said a while back when we took the class out – that if he weren’t emotionally attached he would have sold all of his newspapers. But he certainly wasn’t buying them!

So one—be very disciplined. Two—really understand the businesses and the valuation implications. And three—you need to be a good judge of managers. You have to know who are clowns and who aren’t. So you have to be good at judging people. So Seth [Klarman] is probably good at this, but he’s exceptionally good at the other two.

You can read the entire newsletter here: Graham & Doddsville Newsletter (Winter) 2009.

How Can Investors Find Opportunities In The Small & Micro-Cap Universe

Johnny HopkinsPodcastsLeave a Comment

During his recent interview with Tobias, Peter Rabover, who is the Portfolio Manager at Artko Capital LP, discusses how investors can find opportunities in the small & micro-cap universe saying:

Tobias Carlisle: When you’re looking at your opportunity set, I see in your presentation you divided into, you’ve got sort of three buckets, there’s an enhanced value strategy, core value and then hedges. Can you just talk us through how you think about each of those different opportunity sets or holdings?

Peter Rabover: Yeah. So look, at the heart at the heart of it, you asked me a question in the beginning and I’m an old school value investor, and so I want low downside probability, high upside. And that’s probably 80% of the portfolios, what I would call just core value of things where I don’t think I can lose a whole lot of money, but they probably have a lot of uncertainty embedded in them. So I want 10 of those or nine of those and in each of them, that’s been the interesting transition from large cap, mid cap when I was looking at something that had like 30% upside and think, oh yeah, that’s pretty good. And here I am just like, man, unless there’s thing has like a 200% upside or 100%, I’m saying like, I’m not interested, because for the risks that I’m taking.

Peter Rabover: So to go back, that core value portfolio, I want to have eight to 10 positions in there and I want to have all of them not be down more than 10, 20% and one or two of them to hit at two or three times. And that’s kind of what has happened in the past, what I’ve sort of seen. Our losses have been smaller on our cost basis and a lot of them haven’t performed as well as we wanted to, but you’ve had two or three home runs and that’s kind of what I think the majority of the returns are composed and I like that. And then on the enhanced portion is that, there’s just companies that … My view on this has sort of evolved a little bit.

Peter Rabover: There are two to 3% positions, maybe 1% positions, and I’m looking for like five, 10 times return, but I’m okay losing like 50% of that. And it’s almost kind of like a VC model on that one, you put in 10, 20 of those and you probably lose money on 50% of them and 80% will break even but those two or three will be your Facebooks or Ubers or something like that. That’s the mindset they’re here. They’re certainly risks but are also good opportunities. And what’s been interesting is that that section of the portfolio has sort of almost been a good minor league team for some of the things we’ve put into the core portfolio as we’ve gotten comfortable with them and realize that there’s a bigger margin of safety than I thought, or our upside was just that much better, that increased the risk reward to increase the position.

Peter Rabover: And that certainly has happened a couple of times. I think I sent you a presentation today. We could talk about this later on Research Solutions, a company we own and I’ve been buying this company over a year and a half and I think we’re over 1% of ownership of the company, even though it’s a tiny, tiny nano count, but it trades $6,000 a day. And I think it’s great … I think it could be like a 10 to 50 bagger.

The Acquirers Podcast

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Micro-Cap Investing Is Like Quasi Private Equity Investing Which Provides Significant ‘Early’ Investment Opportunities

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During his recent interview with Tobias, Peter Rabover, who is the Portfolio Manager at Artko Capital LP, discusses how micro-cap investing is like quasi private equity investing and how that provides significant ‘early’ investment opportunities. Here’s an excerpt from the interview:

Tobias Carlisle: So, you said before you … Did you start in private equity or you spent some time in private equity? Can you talk a little bit about your time in private equity and how that helps you in your investment.

Peter Rabover: Yeah. Like it’s, I don’t want to oversell my time in private equity. I will say I started out my career as an auditor for US Steel for about two years. And during that time I just got to be part of a lot of deal teams and I got to see what the opportunities are there. And just from the due diligence side which I didn’t particularly enjoy working at US Steel, but I thought that was kind of an interesting experience.

I went to Serbia for six months and got to work on some potential deals there and some due diligence stuff there. And we nationalized the US Steelers or the Serbian Steelers assets as well that we bought out from the government. And I was sharing an office with our general counsel, so I got to hear like a lot of stuff there, and then when I was, I would say not private equity experience, but I was a mid cap in 2000s and pretty much everything in mid cap and the mid 2000s got bought out.

Peter Rabover: I think one year out of our 30 portfolio, we had like eight companies get bought out. It was something like a crazy number. So you got to see all those and obviously just fall on the market. And then in business school, I got to work for a shell firm that’s owned by Goldman and they were consolidating an industry. And I’d rather, that it’s kind of private for public podcast, but I probably got to work on six, seven, $20 to $50 million deals that summer and really, really down to the nitty gritty and just got to see how much value you can extract from a Tuck-in acquisition. And so, it kind of made me much more interested in the micro-cap space in some ways. Like I said, knowing why to potential acquirer could look for is interesting. Then the last four or five years, on the side as a consulting gig, I’ve certainly helped on some transactions as well more, and that’s been interesting.

Tobias Carlisle: That’s one of the attractive things about micro-cap investing, even public micro-cap investing is sort of quasi private equity. It’s like, or quasi VC too that you can get there very early opportunities.

Peter Rabover: And it’s interesting ’cause like I said, I asked my investors for three to five year lockups, there’s a fee schedule and I think for a lot of people that’s unpalatable. They’re like, you’re an equity manager and it how dare you. But I think the smarter people get and then it’s on private equity type of investment and that’s kind of, that’s the opportunity side near it. It sucks because there’s a lot more kind of like unnecessary volatility, but not necessarily volatility in the business results. But you can, a private equity firm will, or a VC firm will go and, they’ll go to their accountants at year end is like, here’s what we think, here’s our DCF, this is what our value is. And the accountants will be like, okay, we’re going to charge you $20,000 more dollars to value level three as a level three asset and there’ll be yes, great, we’ll do it.

Peter Rabover: Then they all sign off on it and everybody’s hands are shaking and the investors get that statement that says their value went up. Great for me, and so I can have that exact same company in my portfolio, like brand the exact same company in my portfolio. And then the last day of the year, somebody decides to trade 100 chairs at the last five minutes on a 10% of bid ask spread. And I get the report at same company being down 10%. So it’s frustrating because they’re kind of misleading results. I can certainly say that the SP500 is probably fairly valued in a market efficiency basis within the five points snapshot. But whereas my stuff certainly much more like longterm, more efficient. And so that’s you know-

Tobias Carlisle: It’s a double edge sword, right?

Peter Rabover: Yeah.

Tobias Carlisle: It creates the opportunity for you to trade in and out, but then you’re also subject to it once you’re in it.

The Acquirers Podcast

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Mohnish Pabrai: Great Stock Selection Starts With Rejecting New Investment Opportunities For The Flimsiest Possible Reasons

Johnny HopkinsMohnish PabraiLeave a Comment

Here’s a great interview with Mohnish Pabrai and The London Business School. During the interview Pabrai discusses his stock selection process, which he says starts with getting rid of new investment opportunities for the flimsiest possible reason. Here’s an excerpt from the interview:

Mohnish Pabrai: I’ll give it a shot of what actually happens after I see a stock.

So my objective whenever I encounter any stocks is to as quickly as possible reject the idea so I can get back to general reading. The model is not to find investments the model is to find the flimsiest reason to say no and as soon as I get to the first reason I’m done and I move on and usually two things work pretty well for getting rid of stocks really fast.

The first is circle of confidence you encounter. I mean if I look at some pharma company or something it’s gone. I don’t really need to look beyond the name, it’s gone. The second is that if I if I think I have some understanding of the business then the second is I look at very quickly the market cap, earnings, just some thumb metrics on valuation. I’m talking about less than 60 seconds and once I see that it’s not at a p/e of one it’s gone as well.

Basically we want to, or at least I want to, get rid of investment ideas for the flimsiest reasons as quickly as possible. Let’s say some some stock is really cheap, it appears to be within my circle of competence, then for one minute I’ll go to five minutes. I’ll give it five minutes and again to find something where I can just get rid of it. If I cannot get rid of it in five minutes then I’ll give it 15 minutes. All these exercises are designed to get rid of the stock as soon as possible and the inversion of that is that I’m only looking for… if I can find two or three ideas in a year I’m done.

You can watch the entire interview here:


(Source: YouTube)

(Ep.16) The Acquirers Podcast: Peter Rabover – Russian Bear, Concentrated Microcaps And Special Situations

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Summary

In this episode of The Acquirer’s Podcast Tobias chats with Peter Rabover, who is the Portfolio Manager at Artko Capital LP. Peter invests in small/micro cap companies and special situations within a concentrated portfolio. He provided some great insights into:

– Why I Have A Bear In The Background Of This Podcast

– Try To Find Companies That Can Generate 50%, But Only Lose 10% If You’re Wrong

– How Can Investors Find Opportunities In The Small & Micro-Cap Universe

– When And How To Hedge Your Portfolio

– Investor Biases Can Cause You To Miss Some Of The Best Opportunities

– How Big Should You Size Your Portfolio At Inception

– Micro-Cap Investing Is Like Quasi Private Equity Investing Which Provides Significant ‘Early’ Investment Opportunities

– You Have To Get Used To 5% Swings In The Micro-Cap Universe

– Why I Run Ultra-Marathons

The Acquirers Podcast

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Full Transcript

Tobias Carlisle: Hi, I’m Tobias Carlisle, this is The Acquirer’s Podcast. My special guest today is Peter Rabover, he’s @Artkocapital on Twitter and the locked Russian bear account. We’re going to talk to him about that Russian bear over his shoulder right now.

Speaker 2: Tobias Carlisle is the founder and principal of Acquirers Funds. For regulatory reasons he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcast participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliates. For more information, visit acquiresfunds.com.

Peter Rabover: Well, I don’t know if it’s the Russian bear, but it is a bear outfit. I thought it’d be pretty funny to put out for the podcast in the background.

Tobias Carlisle: So where’d you get the bear?

Peter Rabover: No, honestly it’s a company, it’s called Griz Coat. It’s like 200 bucks.

Tobias Carlisle: It’s a coat?

Peter Rabover: It’s a coat, yeah, with a header, maybe there’s a special … I’ll put it on at the end of the podcast or put the hat on, but it’s been great. Like you’re an adult, you’re in your late 30s and you can still get away with something as funny as that, and so I love it.

Tobias Carlisle: So you’re a value investor. I always say value captures a very broad swathe of different styles. How do you characterize your own investment strategy?

Peter Rabover: You know, and I think you saw that I did a thread on my art go count the other day on what old school value is verse what new school value is. But I think for me, value kind of represents two things, not losing money or having a low probability of losing money and just having better risk reward ratios than the market. There’s plenty of companies out there that can generate probably 50% over the next 10 years but can I find the companies that can generate 50%, sorry, not 10 years, like five years, but only lose 10% if I’m wrong. So I’m looking for those risk rewards because I know I’m fallible, everybody is fallible, and so I want to minimize my mistakes and to get a pretty good reward for taking the risks on that I do.

Tobias Carlisle: So where are you focused for the most part in terms of capitalization?

Peter Rabover: I’m a specialized, I guess very concentrated micro cap fund with a pretty small capacity and the majority of our portfolio companies that will take 10% positions in. I think our top 80% is comprised of, I want to say like nine companies. Our weighted or market caps are on average is about $150 million, and we have companies in there that are 20 to 50, and the biggest ones over a billion, but it was 400 million when I invested in it.

Tobias Carlisle: You’re sort of, you’re focused in, that’s like a nano cap to small cap for the most part.

Peter Rabover: Yeah.

Tobias Carlisle: And you’re not only holding the equity, you invest, you’ll look at the options and you look at the debt. So can you talk a little bit about both of those two processes?

Peter Rabover: Yeah. I mean, I try to stay away from debt and micro-caps actually, I find micro cap managers or nano-cap managers are even more human than the rest of us. They don’t have HBS degrees or anything like that and a lot of them are just unexperienced with debt, or managing the capital structure. So I actually try to stay away from those guys. But on that note though, there are a lot of capital structures that offer interesting risk rewards and there’s a lot of warrants out there, either recaps or Specs. And I know people hate Specs, we can talk about that a little bit, but occasional post-bankruptcy warrants, or rights offerings.

Peter Rabover: There’s a lot of things where if you stay small, our intention is to stay in around $50 million in AUM as a fund. Longterm is to hunt in those spaces where we can take the liquidity risk on and not necessarily, in a way we have a locker up at our phone, so that’s probably where I look at that. But I have a call after this with a CEO of an $8 million company who’s doing a $2 million rights offering. So that’s the market space I fish in.

Tobias Carlisle: So let’s talk about Specs for a little bit. Spec is a special purpose acquisition company and you’re presumably you’re looking at these things when they’re going to return the capital or when they’re going to do a deal. What’s your approach to them?

Peter Rabover: A lot of them come to market where there’s probably kind of three things that I can think of that they all have in common. They come to market with somewhat low multiples for people to be enticed. Sometimes they are deservedly so, and they will come with leverage, because that’s just the private equities way of going public before paying off the debt. And that’s probably, that should be a red flag right there. And a lot of them will come with some sort of warrants attached because the blank checks back nature of the transactions. And so, having looked at this for about, they’re relatively new, maybe like five years, and follow them, a lot of them are garbage.

Peter Rabover: They are not good, like, right. I think we’ve had some success but on the warrants and I think I would say the thing to keep in mind with those is, I think the recurring nature of the revenues or having some sort of value behind it, I think is what keeps the non garbage ones from the garbage ones, is one thing I can paint would think of. But, yeah.

Tobias Carlisle: When you’re looking at your Opportunity set up, I see in your presentation you divided into, you’ve got sort of three buckets, there’s an enhanced value strategy, core value and then hedges. Can you just talk us through how you think about each of those different opportunity sets or holdings?

Peter Rabover: Yeah. So look, at the heart at the heart of it, you asked me a question in the beginning and I’m an old school value in vascular, and so I want low downside probability, high upside. And that’s probably 80% of the portfolios, what I would call just core value of things where I don’t think I can lose a whole lot of money, but they probably have a lot of uncertainty embedded in them. So I want 10 of those or nine of those and in each of them, that’s been the interesting transition from large cap, mid cap when I was looking at something that had like 30% upside and think, oh yeah, that’s pretty good. And here I am just like, man, unless there’s thing has like a 200% upside or 100%, I’m saying like, I’m not interested, because for the risks that I’m taking.

Peter Rabover: So to go back, that core value portfolio, I want to have eight to 10 positions in there and I want to have all of them not be down more than 10, 20% and one or two of them to hit at two or three times. And that’s kind of what has happened in the past, what I’ve sort of seen. Our losses have been smaller on our cost basis and a lot of them haven’t performed as well as we wanted to, but you’ve had two or three home runs and that’s kind of what I think the majority of the returns are composed and I like that. And then on the enhanced portion is that, there’s just companies that … My view on this has sort of evolved a little bit.

Peter Rabover: There are two to 3% positions, maybe 1% positions, and I’m looking for like five, 10 times return, but I’m okay losing like 50% of that. And it’s almost kind of like a VC model on that one, you put in 10, 20 of those and you probably lose money on 50% of them and 80% will break even but those two or three will be your Facebooks or Ubers or something like that. That’s the mindset they’re here. They’re certainly risks but are also good opportunities. And what’s been interesting is that that section of the portfolio has sort of almost been a good minor league team for some of the things we’ve put into the core portfolio as we’ve gotten comfortable with them and realize that there’s a bigger margin of safety than I thought, or our upside was just that much better, that increased the risk reward to increase the position.

Peter Rabover: And that certainly has happened a couple of times. I think I sent you a presentation today. We could talk about this later on Research Solutions, a company we own and I’ve been buying this company over a year and a half and I think we’re over 1% of ownership of the company, even though it’s a tiny, tiny nano count, but it trades $6,000 a day. And I think it’s great … I think it could be like a 10 to 50 bagger and-

Tobias Carlisle: Well, let’s talk about it a little bit. What’s the opportunity?

Peter Rabover: Yeah, sure we can just jump into it. We can ignore the head, just think, ’cause that-

Tobias Carlisle: We’ll come back to that.

Peter Rabover: Yeah, Research Solutions is, kind of what they’re trying to do is position themselves as the Bloomberg, kind of Lexis nexus of scientific research. So basically they have two businesses and the first business is what you would call the transaction business. So they do 800 to 850,000 of just distributions of white paper. If you’re in Johnson & Johnson and you want to research a molecule, there’s 70 million papers and almost 2 million new papers written a year, like scientific papers. And so you want to search for that molecule and you got to pull up a white paper that Harvard Press has, Pub Med has or something like that and you’re going to pay 30. You’re going to pay $31 and five or six of those are going to go to the distributor which is Research Solutions. So it’s a steady business that’s kinda been declining. There’s been a general trend and I think maybe more people cheating and going to the dark web and all that stuff.

Peter Rabover: And this business is predicated on some sort of regulatory capture where people are, companies don’t want to get busted by federal copyright laws, why pay fines and be embarrassed when only you have to do is just pay $31. So I think that’s sort of going to keep this business afloat and that’s the important part because this business generates $6 million in gross profit and even now on the financials you’ll see the company has a high cost structure. Most of that cost structure is actually associated with its platforms business, which we’ll talk about. So if that doesn’t work, you can shut down that business, the platforms business and you’re just back to a company that, for a $50 million market cap has a 5 million EBIT or like a recurring cash flow EBIT that four to $5 million that can be capitalized, that can be … And the CEO has sold the similar business in the past for two times revenue.

Peter Rabover: So my point is, there’s a nice margin of safety in that transaction business that I didn’t appreciate when I got into it, but the main thing is what these guys are trying to do is call the platforms business. So basically they’re trying to be like a Bloomberg of scientific research. So when you’re a Bloomberg or a cap idea, whatever, it’s basically a lot of free information. There’s all the SCC filings, all the transcripts, presented in a very, very neat, productive way that saves you hours from hours of digging through some company’s financials for putting stuff together or figuring out who the biggest holders are. All this stuff is put together for you. And you’re still buying the white papers for $31 and then the enhanced, the really enterprise product version is, it’s more like a slack collaborative thing.

Peter Rabover: So this is the business, that’s the opportunity. As of right now, they have 281 subscriptions for $10,600 a piece, and the really cool thing about that was that last quarter was 10,100 on average that me end. So they got a 6% price increase from upselling the product, took from the lower version to the higher versions to their existing customers. To me that obviously spells much bigger profitability opportunity. They have 82% gross margins, but it’s more on the signal and the acceptance of the product by the customers. And they have all the major ones, like all the Pharma J&J, Gillyard, whatever, 3M.

Peter Rabover: So if you’re a chemical company, you have a research department, this is geared towards the research departments of corporations and eventually academia. Academia is probably they’re going to pay the 10,000, $11,000 subscriptions, but it’s a really, really good work flow of product. It clearly enhances group productivity within research departments. And as you said, there’s 280 descriptions out there, 280 companies that are paying 10 to $12,000 a year for this. So right now it’s a $3 million recurring revenue business at 82% gross margins. And all of that money it’s invested … The entire cost structure of the firm is right now invested in that product, the R&D, The SGNA and they’ve just … So they’ve taken it to the next step of hiring a sales team.

Peter Rabover: They finished out seven people. They have a pretty new strategy with SAS that they’ve been testing out before and so they’re wrapping. All this up to now has been with a 100 unique subscriptions for the free product a month. So that’s what they’re getting, but right now they’re getting ready to ramp up to 1000 unique subscriptions a month and see if they can convert that with their sales team. So maybe we’re going from 1520 seat additions per quarter to 50 to 100, and I think they’re kind of right on the cusp of that. So that 700,000 small and medium business market that has corporate departments, corporate R&D departments. That’s the market and I certainly don’t think that, that’s not going to be a 10% penetration thing, but at 7% penetration, sorry, 1% penetration, that’s 7,000 subscribers paying you 11,000 a month, sorry, a year. And we’re talking about something like 90 million in revenues and something like 80 million in gross profit, if I’m thinking about this.

Peter Rabover: Yeah, 80 million in revenue and 70 million in gross profit, but on an existing cost structure that just scales, and this company’s market cap is $50 million. So if they capitalize on this product which is obviously very good, their gross profits can be bigger than their market cap within a few years. So it’s very liquid, it trades like $6,000 a day. It’s very closely held, the CEO and his family own 35%. There is a family office hedge fund that’s owned by 25% of it. And like I said, you can probably get some blocks here and there, but to me this is the opportunity in this space where you can find things like this, be patient with patient capital at, add to this and could be a home run down the line. And I’ve certainly seen this play out before.

Tobias Carlisle: It sounds like an interesting opportunity, but let’s go back to, talk a little bit about the hedges that you, or how you think about hedging.

Peter Rabover: You know, honestly that’s just, and I almost want to minimize that, but I just want to say, I am a hedge fund in a way. I try not to be, I try to be more buffet type partnership. But last summer, we were getting crazy with our valuations and the vix was at like eight or $9. The premiums on the Russell 2000 index we’re almost, the insurance was kind of almost free. I think I could ensure my portfolio against like a 20% fall or for over six months for 75 basis points. And I was like, yeah, of course, why not? And so that produced 5% last quarter or in the fourth quarter of 2000. I took it off too early, I thought we were going to be done after October and clearly we weren’t, so I kind of held onto that.

Peter Rabover: But it’s literally an opportunity if I’m just, the whole focus of the firm is capital preservation. And I’ve probably been doing this for 20 years and I don’t like to be a market timer, but I think you can see some sort of extremes here and there and you know-

Tobias Carlisle: So you’re hedging when you think that the instrument is undervalued. So you see the vix at eight or nine, long run mean is 20, we haven’t been anywhere near the long run mean for a long time that you just think that’s too cheap, and there’s a chance that something happens so you get paid really well.

Peter Rabover: Yeah. Well, it was both, the mix was cheap and the-

Tobias Carlisle: The market expensive?

Peter Rabover: And the market was expensive. So I was like, yeah, it’s an opportunity to protect my investors money in, that’s sort of what happened.

Tobias Carlisle: When I was going through your investment strategy, you’re a bottom up fundamentals investor, I can hear that as you’re describing. If you also talk about tempered with an understanding of macro events. So what do you mean by that and how are you thinking about macro?

Peter Rabover: I am certainly not a macro guy, but you have to pay attention to things like interest rates, the yield curve, unemployment rate, GDP. On the other hand, the trompe tariffs, that’s been an issue. We have a company in our portfolio that I thought was … So my mistake and I guess the market’s mistake was domestically based, domestically sourced was, it’s called Spartan Motors. And they build all the UPS and FedEx and delivery trucks that you see out there, that’s them, and the fire trucks, they build fire trucks. So basically, really good opportunity for longterm delivery, delivery packages as supposed to double within the next three years. And Amazon and Walmart just went to one day. So these guys, the trucks business has gone gangbusters, but it’s a domestically sourced business in the sense of all their suppliers are, most of them are domestic.

Peter Rabover: But when the tariffs happened, their competitors who were buying from overseas started buying domestically and that screwed up their entire logistical chain and they have to eat some inventory and some downtime as a result because they couldn’t get the parts in time. I think that you have to pay attention to these sorts of things. And not necessarily that I’m going to say, I’m investing for like three to five years and something like, oh no, I’m going to take my position off. But I think it’s to be more mindful of the risks that you are taking on and whether you’re getting paid enough for those risks. And so that’s the opportunity there.

Tobias Carlisle: So let’s talk a little bit about how you identify opportunities. What’s your screening process or the funnel that you have to get from like identifying something through to actually putting it in a portfolio?

Peter Rabover: Yeah. It’s an interesting one ’cause I try to, the more experience you have, the more biases you have. And so I think every time I look at something, I try to come in with a good mix of yes, my experience says this is something good or, but also be open minded that I might be dismissing something that could be really, really good. I was telling somebody the story of, even as a younger investor, I’ve pitched a couple of really good things. I pitched marvel to my boss when I was 25 in 2005 and like 800 million because I think, like Thor came out and, no sorry, not Thor, iron man came out and a whole came out and this company had this entire library of characters and I was just like, man, we should buy this.

Peter Rabover: Ryan, my boss was great. Like he didn’t get it, He wasn’t in that particular space and obviously Disney bought it for like 4 billion six months later. Right. And so I want to be mindful of letting go of certain things like, right. They like to have really steady earnings and cash flows and I like that too, but I saw that opportunity and that’s the rest they didn’t want to take as for the lumpiness of the revenues, et cetera. And that was their bias. So I’m trying to figure out what my biases are. I have this great company in my portfolio called Viad and a big chunk of their business is putting on shows like the Farnsworth air show or CS and it’s an oligopoly, it’s great, but a lot of those shows are every two or three years.

Peter Rabover: So you had two years of low growth, last two years and then next year is going to hit, when all those shows are going to hit it once and that’s going be a big year, so it’s fine. That’s kinda have to you accept that. But as far as things that I look at, yeah, I like to have a clean balance sheet. I like to have some sort of margin of safety and I would say I probably focus 70, 60, 70% of my time on that, just making sure the things that are on the balance sheet are in the business are worth something. So example of a company we own like Sharps Compliance, $50 million medical waste disposal company competes with 800 pound Gorilla Stericycle. But it was worth $50 million, it had $10 million of cash and networking capital and balance sheet and it had an incinerator. There’s only like 10 incinerators in the United States, and so you’re not going to get built.

Peter Rabover: And so we’ve looked at … I spent a lot of time with my analysts looking at corps for this thing, which could have been, I think we got down to like 20 or $30 million. These guys had some routes, they cover 55% of the United States with, which usually are like one time revenues, it’s a pretty set transaction. So for $50 million you were getting $50 million worth of assets, that the market should appreciate that that’s what these are worth and a lot of opportunity if some of their business lines that they’re expanding on catch fire. And so including the drug disposal business. And so now there’s all the anti opioid stuff and you have to have a safe way of disposing of these drugs.

Peter Rabover: And these guys are installing liners, metal liners like CV’s and police stations and I think they’re up to like 4,000 now or something like that, maybe 3,800. And that’s a disposal business, you just pick this up, like always businesses become natural monopolies, and the opportunity there as far as 20, 50,000 of these liners somewhere. And if that catches, again, bigger than the kind of company’s entire market cap, but I’m getting paid on the downside. So to answer your question, the things I focus on is stability of business, quality of cash flows in it, can those assets be sold to somebody a lot of times, having come from large and mid cap backgrounds, you see what company … And I’ve done some deals and I worked in private equity a little bit in the past, so you see what companies acquired, why they acquired them and what kind of costs they can take out.

Peter Rabover: So my hidden thing for not buying companies with debt is I think that makes them much more attractive to potential takeouts. Not necessarily all of them, but on the margin, maybe one or two more of them and you just need one or two more home runs in this business to generate alpha. Something like, taken out public company costs, they all have a lot of those and that’s a fact. You have to appreciate what this company would be in private hands without at least $1 million in public company costs that most of these guys tend to have. And so, things like that.

Tobias Carlisle: So how are you sourcing ideas? Are you screening for them? Or are you going to conferences? Or are you value investors club? or what are you doing for sourcing?

Peter Rabover: I mean, I think you just kind of nailed a bunch of stuff. I certainly, I would say the biggest thing that I’ve developed over the last five years as I’ve gotten into this business and we can talk about my Twitter more in a second, but I’ve developed a really good network of people that I trust. So, even though I work by myself with one employee, a part time employee, on Twitter, I have an office full of very smart people that I talk to about all the times like, Hey, what do you think about this? What do you think about that? And you know, if somebody has a really good idea we will certainly listen to them a lot more than somebody else and sell side or something like that. And so, that’s been one.

Peter Rabover: I liked screening. I like, sometimes I’ll just pick up a few 10ks from randomly and read them. Micro-caps are, they’re smaller, they’re less complicated. If you’re a micro-cap and your complicated, I don’t want to probably have any part of this, so you can go through a lot of these. You have value investors club subzero, they’re all pretty decent, just reading stuff is probably interesting. And I’ve certainly gotten a bunch of ideas from sitting down at a conference and realizing this, I think one of our more successful investments a few years ago was a company called State National Companies. Spoiler alert, it got acquired by Markel. So that’s kind of a stamp of approval, pretty decent stamp of approval, but it was literally, I heard them at a conference and there was three people in the room and then they kind of said two or three things that perked my ears up. And I was like, oh yeah, I know what this is actually a pretty good deal. And so-

Tobias Carlisle: What did they say that you liked?

Peter Rabover: I think so, they had like two businesses. One was, they basically had an aerated balance sheet that they rented out to alternative investment players like hedge funds or just smaller independent brokers that that didn’t want to do it. And one of their big clients was Nefiller. Nefiller is very big weather cat fund, which also got acquired by Markel. And one of my LP’s is apartment portfolio manager in Nefiller, so I’m very familiar with their business. So I knew that was a good get like if Nefiller partner with these guys, that’s something. And then the other part was they had a car insurance business, but it was only through credit unions for car loans basically. Like if you got a car loan and your insurance lapses, your credit union forspies that insurance for you. And guess what? That’s not very competitive.

Peter Rabover: So I think they had combined ratios of like 86, sorry, 82, 84 or something like that, it was crazy like right there. And even Geico had 12 or 13 or something, their car insurance margins were unreal, like Ryan. So that popped up and right away and that’s just my experience having worked in large cap and mid cap and doing some deals. Like I said, those are the experience that you bring to the table to identify things. So that was something like that. So that’s an example.

Tobias Carlisle: So how do you think about risk management? And as part of risk management, I’m interested in how you construct a portfolio, how you size your positions at inception, whether you trim as they go up and how something sort of exits the portfolio.

Peter Rabover: I’m pretty focused on risk management, so I don’t know if you happened to catch my last letter, I kind of talked about the Valliant pharmaceutical problem, the original problem, which was, a lot of people labeled as a big giant fraud that dropped 95%. But I remember it as an investor when I add 2009, I convinced my boss to put it into our portfolio at five bucks a share and it ran up to 250. Right. And at the same time value act and the Sequoia Fund got into it as well. And how they approach that verse my old firm hung capital management approach, that was a two different ways. So every time it ran up to 6% of their portfolio, they sold it back down to 4%. They weren’t a very concentrated fund. And whereas sequoia and Value Act, they held onto the company until it became 35% of the portfolio.

Peter Rabover: So when it dropped 95%, that was a really bad year. And so that’s not to say anything, and so my fun was a long only management fee thing and those value act or their hedge funds, they’re collecting premiums. And so for them you gotta … So to me, I’m trying to find balance on the risk management. On the core, on a very semi quantitative things, I try to look at where the portfolio risk reward ratios are and whether there’s something skews them or not.

Peter Rabover: So a good example of the value problem was, we had a company called Joint Chiropractic. Great company, good business model. We got in at like five, six bucks to 18, 19 today and we’ve sort of sold out of it at this point. But what do you do when you have a 10% position that triples. So I strongly trim it and I do it at, once it gets to 15% of the portfolio, I try to take it down three or 4%, and then with joy at the end, I ran all the numbers. Even in my best case scenario, it’s probably like a $35 stock in a few years, which is great, it’s a double from here, but I think it can drop 50% from here. It’s kind of frothy, and so that risk reward ratio of two to one isn’t very good. [crosstalk 00:33:15]

Tobias Carlisle: The ticker on joint is JY and T, and I’ve seen that chart, it’s gone vertical over the last few weeks.

Peter Rabover: Yeah, no, look, it’s been, I’ll take it. And like I said, I was in it for a few years ago, and again, it’s like one of those things where I had experience with doing some franchise stuff, both as in public and in the private side. And I know what the free cashflow opportunities are and I also had a back issue, so I certainly appreciated what they were doing. Yeah, and I think the market is appreciating it as well, but I will comment that. Unfortunately they may be a victim of their own success because basically they’re doing a subscription only model without insurance and then without having to deal with a secretary and all the mailings and back and forth and you get the money up front.

Peter Rabover: And I think the industry was kind of like, one of these guys do any role blah, but these guys are putting up amazing numbers. Like right there, 50 or same store sales are like 18% still. You can get break even on this a franchise at six months. Now that’s unheard of when the franchising business and then credit to the CEO that he did, he kind of righted the ship. But I think when you’re putting up those kinds of things and in a very non very competitive space, it doesn’t take a whole lot of people to come in and roll up more franchise clinics, rebrand them and stuff like that. So look, I’m not saying that’s going to happen, but it’s a risk that wasn’t there before and it certainly decreases the … You handicap your odds accordingly of competition risk, which wasn’t there before.

Tobias Carlisle: So how big would you size at inception for something, what’s your maximum size in getting inception?

Peter Rabover: I haven’t been afraid to go down to start off with 10% right away but usually it’s about I’ll do six to eight and then I’ll just keep adding on. But sometimes I just can’t I’m a small fund we’re 5 million right now. Probably going to be eight, nine by year end. My goal is to get the 50 and so even at 5 million I’m, I’m getting to where I get to … I don’t want to be an inside a filler. I don’t want to get about 5% and that’s why I sort of limited the size of their portfolio to 50 million, where I could take a 10% position in a micro-cap that’s where I wouldn’t trigger a 5% filing, something like that. And so yeah that’s to answer your question, it’s 10%. So.

Tobias Carlisle: So when you your event driven investments, how are you thinking about event driven investments and can give us some examples of situations that you’ve put on and how they’ve worked on?

Peter Rabover: I think event is kind of like a little swirl and event could be like for me for like join the event was just delivering really, really good numbers, like write consistently. But I think what I would say is there’s a lot of the old school buffet type of investing where you could just buy a coupon clipper, like a company that you could buy for like five times cash flow and every year you hold them for five years and boom, like even if it decreases half in value and it pays out in dividends you’ve made a 50% return. So you didn’t really care what happened. As long as the results were there, you didn’t care about the stock price appreciating as much.

Peter Rabover: Whereas I think my experience over the years, it’s shown you can probably have a lot of value companies that will stay value companies for her really long time, like writing a lot longer than you care to. So I, you know, I certainly not always right on this, but I’m looking for a potential sale, a consolidation I tried to look at all of my companies as are they more valuable in somebody else’s hands? And if the answer’s yes, that’s probably something like that. And Look, I’ve certainly again, that has an insider, but I’ve certainly put some investment bankers and touch with management and some of my companies that I thought could benefit from those introductions. So I don’t know if that’s, I hope-

Tobias Carlisle: What about some examples of [inaudible 00:38:12] joint is you’re looking at just growth in the underlying business executing, but what about something that’s more of a traditional special situation where the transactions announced or whatever’s announced.

Peter Rabover: So here’s an example I’ve held and I may sound like a broken record because I’ve had this for four years, but it’s provided for 150% return since then. So it’s a company called VR like right. And so via, it is they were the last of the 90s conglomerates in the 80s, conglomerate. So they owned like Grey hound, money gram like right dial soap. They owned all these brands over the years and they’ve obviously made this decision to divest. And so now they own these two companies that are leftover and one’s called GS Global Entertainment [inaudible 00:39:10] … And so basically like I said, they an oligopoly and there’s another big one called Freeman. And you know, those two companies are essentially host all of the events, like the Farnsworth airshow show, Ces, corporate events, Mary Kay conference, something like that whatever you do, those are the events.

Peter Rabover: And look, it’s not a sexy business but it provides 10, 11% return on capital. And so it’s above its cost of capital and it grows pretty decent clip of three to 4%, same store sales every year. So and they’ve been adding higher margin and Ciliary business like audio, video, so that booths there, even though our margins pretty well actually. So that’s one business I kinda like it.

Peter Rabover: The other one that’s great, it’s called Pursuit and that’s a hotel lodging business and attraction business and they own all the lodges like in Banff, national park and Jasper, et cetera, but they also own a bunch of natural monopolies like the one mile glacier water or that quarter mile relay she’ll walk or the Banff Gondola.

Peter Rabover: And those was a great, like they cost you $20 million and they give you six, $7 million. Like it’s like there again, small businesses can have some really good opportunities, but still it’s a crazy business cause it has like 38, 39% EBITDA margins on it’s that income. And it should be a retarders aren’t as good now because of the tax law. So it doesn’t need to be read. But Vail trades at which is, has lower margins and Bayer or sorry, a lower margins in the pursuit trades at 13, 14 times EBITDA like right at some crazy number. VR as a whole company trades at seven so those two businesses need to be separated. There’s huge value to be unlocked and so in the past of the CEO has said they’re gonna once pursuit gets to 250 million in revenues and that’s probably next year unless there’s acquisitions happen sooner than they will consider spinning it out.

Peter Rabover: So there has to meet its cost of capital. But I actually think now, because pursuit is going so well and then they have something I want to talk about that in the second called the flyover asset, that it’s kind of a hidden asset. I think they might sell GES and I, and look guides, the CFO certainly open, open into it and the board’s open to it, the CEO and the chairman role as is broken out, it’s very good corporate governance and I think they have a strategic plan and they’re very fully aware that there’s a way to unlock value there and they can do it.

Peter Rabover: It’s a very low leverage firm, so that pursued business doesn’t have any debt. Most of the rates are kind of lodging companies, there’s a recapitalization potentially as well. Yeah, I think the company is like one times you’d be done. So it’s private equity dream, a private equity firm, it’s just the right size. It’s like 1.2 billion probably be 2 billion buyout if somebody decided to do it. So to me it’s got great businesses, it’s cheap, it’s a compounder. And then there’s a event on the horizon and a really good CEO that I really respect, and free cash flow in businesses, kind of oligopolistic. So I’ll hold that all day, even though it’s produced like 15, 20% returns a year, but it’s up 150 and I think it can go up another 100 from here. And so, why not? Those are perfect opportunities that I’d love to find more of.

Tobias Carlisle: So, you said before you … Did you start in private equity or you spent some time in private equity? Can you talk a little bit about your time in private equity and how that helps you in your investment.

Peter Rabover: Yeah. Like it’s, I don’t want to oversell my time in private equity. I will say I started out my career as an auditor for US Steel for about two years. And during that time I just got to be part of a lot of deal teams and I got to see what the opportunities are there. And just from the due diligence side which I didn’t particularly enjoy working at US Steel, but I thought that was kind of an interesting experience. I went to Serbia for six months and got to work on some potential deals there and some due diligence stuff there. And we nationalize the US Steelers or the Serbian Steelers assets as well that we bought out from the government. And I was sharing an office with our general counsel, so I got to hear like a lot of stuff there, and then when I was, I would say not private equity experience, but I was a mid cap in 2000s and pretty much everything in mid cap and the mid 2000s got bought out.

Peter Rabover: I think one year out of our 30 portfolio, we had like eight companies get bought out. It was something like a crazy number. So you got to see all those and obviously just fall on the market. And then in business school, I got to work for a shell firm that’s owned by Goldman and they were consolidating an industry. And I’d rather, that it’s kind of private for public podcast, but I probably got to work on six, seven, 20 to $50 million deals that summer and really, really down to the nitty gritty and just got to see how much value you can extract from a Turkian acquisition. And so, it kind of made me much more interested in the micro-cap space in some ways. Like I said, knowing why to potential acquirer could look for is interesting. Then the last four or five years, on the side as a consulting gig, I’ve certainly helped on some transactions as well more, and that’s been interesting.

Tobias Carlisle: That’s one of the attractive things about micro-cap investing, even public micro-cap investing is sort of quasi private equity. It’s like, or quasi VC too that you can get there very early opportunities.

Peter Rabover: And it’s interesting ’cause like I said, I asked my master’s for three to five year lockups, there’s a fee schedule and I think for a lot of people that’s unpalatable. They’re like, you’re an equity manager and it had dairy you. But I think the smarter people get and then it’s on private equity type of investment and that’s kind of, that’s the opportunity side near it. It sucks because there’s a lot more kind of like unnecessary volatility, but not necessarily volatility in the business results. But you can, a private equity firm will, or a VC firm will go and, they’ll go to their accountants at year end is like, here’s what we think, here’s our DCF, this is what our value is. And the accountants will be like, okay, we’re going to charge you 20,000 more dollars to value level three as a level three asset and there’ll be yes, great, we’ll do it.

Peter Rabover: Then they all sign off on it and everybody’s hands are shaking and the investors get that statement that says their value went up. Great for me, and so I can have that exact same company in my portfolio, like brand the exact same company in my portfolio. And then the last day of the year, somebody decides to trade 100 chairs at the last five minutes on a 10% of bid ask spread. And I get the report at same company being down 10%. So it’s frustrating because they’re kind of misleading results. I can certainly say that the SP500 is probably fairly valued in a market efficiency basis within the five points snapshot. But whereas my stuff certainly much more like longterm, more efficient. And so that’s you know-

Tobias Carlisle: It’s a double edge sword, right?

Peter Rabover: Yeah.

Tobias Carlisle: It creates the opportunity for you to trade in and out, but then you’re also subject to it once you’re in it.

Peter Rabover: Yeah. I mean I got, you asked me a question earlier like do I trim stuff, on a joint, something like that. Yeah, I’ll trim it and I’m not big enough but like a third of my portfolio is probably, I own like months worth of daily volume so I can’t like. And so that research solutions company I told you about it, it actually held up pretty well in October, in November. But my portfolio went up and down like this, so it’s like it went from 10% of the portfolio to like 14% of the portfolio or something like this. Without the price, it could change it. And I’m like, well, I’m not going to sell it because of that, that’s stupid.

Tobias Carlisle: You sometimes have to get used to that 5% swings in the micro-cap stuff and that’s just the difference between the bid and the ask.

Peter Rabover: Yeah. I’m much better about it now but I came from large cat world, MCAT world. And I think it just takes a little bit of getting used to having those minus one, 2% days or up one, 2% days and just be like, hey man, that’s normal, that’s what you gotta do. And I’m much more used to it now like I’m less worried on something like that, but you’re right, it’s the opportunities.

Tobias Carlisle: So how do you feel about the opportunity set in a micro-cap world for value guys at the moment? Do you think that it’s expensive? Or do you think that there’s still lots of opportunities around?

Peter Rabover: I mean, if you look at my presentation on the returns page, I have the SNP500 returns and the micro-cap returns on there. And I think like the spread is, since I started something crazy, I think micro-caps are like 5%, the SNP500 is like 11 or 12% a year. And they have under, and I think people probably, I guess I don’t view value versus growth, how people do it on the quantitative metrics and I don’t think those indexes capture that as well. I think anything that’s showing growth is going to get bit up and the old school stuff is not there. I believe the markets are mean reverting and either the micro-caps are gonna shoot up or SNP’s good returns are going to come down. Something is going to happen and probably the next five, 10 years, but I don’t know in the short term. So I’m very excited about the opportunity set.

Peter Rabover: And then the market’s drop in the fourth quarter of last year. I think micro-caps dropped like 23, 24%. And SNP was kind of right in there as well, since then the SNP’s rallied to new highs the a few weeks ago, and the micro-caps are still 20% or like 17% below their September highs. So there’s an opportunity there. So I’m certainly excited. I think if my stocks were high, all of their 52 week highs, I think I’d have like a 100% year or something or six years in here, like right now. So I’ve taken some lumps, but I think we’re doing pretty well, again, on the volatility and the … You just have to get used to it, I think that it’s part of the game.

Tobias Carlisle: It’s tough being compared to the SNP500 because it’s the best performed asset, if you can call it an asset in the entire world. So everything else looks[crosstalk 00:51:13]

Peter Rabover: Wow,[crosstalk 00:51:16] It’s such a different animal from what I do but if you’re a public markets investor, you have to compare it against something. I try to put Russell 2000, Russell micro-cap and the SNP500, so you can sort of see the range of things. I think my only correlation basis, I’m more correlated with micro-caps and Russell 2000 and the SNP500.

Tobias Carlisle: Is there a micro cap index?

Peter Rabover: Yeah. Wow, so that’s, sorry, we should have-

Tobias Carlisle: 5,000 or something like that?

Peter Rabover: No, there’s called the Russell micro-cap index.

Tobias Carlisle: The micro-cap, what are the characteristics of the micro-cap index?

Peter Rabover: I mean, I think it’s got like three, or I think it’s got like three or 400 companies and it’s, I think they’re about averages like 180, 190 million companies. I mean, a lot of these indexes will have a lot of public venture companies, a lot of Bio-pharma, a lot of tech that are, and I just don’t touch a lot of that stuff. And so there’s … But the more important than is, the reason I created the partnership is because I wanted to create and non-indexable product. I think almost every investor should be invested in the equity markets, but active managers don’t really do that well on a longterm scale against their benchmarks. It’s like I could’ve been a hedge fund manager, but the coke, I came from two great funds, private equity, pay me doing 20, and I’m going to do a billion dollar fund. And I think I’ve had a couple of opportunities for that, but I want to sit across the table from an investor and justify my fees.

Peter Rabover: And I think that’s where the opportunity is in that space. And so I think like 80% of my companies are not in any index, it’s just hard to, they’re just not liquid enough. They’re just not going to meet index standards that I think there’s the opportunity where I’m looking at. And I think even the micro-cap indexes could be wrong, but it was Barron’s article a couple of years ago, but I think the ETFs versus the indexes are, they underperform the index as pretty, pretty bigly because of that liquidity spread. And yes, I use the word bigly. I’m trying to go below where things can be indexed like Ryan, so like those warrants are nano caps and things like that.

Tobias Carlisle: I saw that you’re an ultra marathoner?

Peter Rabover: Yeah, I’ve kind of taken a break. I got injured about a year and a half ago, but I’ve, I run like 50 ultra marathons, did a 100 mile race and it’s pretty fun. You know it’s, I’m hoping to get back to it this year.

Tobias Carlisle: How long does a 100 mile race take?

Peter Rabover: Well look, I’m slower than a herd of turtles running through peanut butter’s, it took me 29 hours. A winner of that race would probably take like 15, 16, like right. And the cutoff for that race I think was like 32 hours or something like that.

Tobias Carlisle: Marathon is not Enough?

Peter Rabover: Yeah. I mean, ultra marathons are different animal, they’re off road, and I did an iron man. I did a lot of triathlons and I did road marathons and and I also try to work on Wall Street. And you just kind of realize that you just don’t fit in with a type A personalities that tend to do those races and the ultra marathon people that are much more laid back, you’re in the woods at night. You’re out there for a hundred miles, you’re going to chill out. You’re not going to care about your, 10 seconds splits, you’re going to care about having you to attrition, make sure your maps out there and you got your gear and everything like that.

Peter Rabover: And so it’s a much more comprehensive adventure than just three to four hours on a road in a city. And I think as a result, you kinda get less intense people and more, kind of people that you get in the micro-cap value world rather than the Wall Street hedge fund in the world. So maybe it’s my end, that cheesy analogy, that’s kind of how have you, so-

Tobias Carlisle: Peter, we’re coming up on time now, folks want to get in contact with you, what’s the best way to do that?

Peter Rabover: So Peter @artkocapital.com is probably the best email. And I try to answer as many as I can, but sometimes whenever I publish my letter, I’ll get like 20 or 30 emails and I apologize in advance that that I can’t get to everybody. And the same thing on Twitter, I’ll get like 30 messages on Twitter and I’m like, I’m sorry I can’t answer all of them, but I will try.

Tobias Carlisle: What’s your Twitter account? So it’s Artko Capitol, A-R-T-K-O, it’s just a funny account. I get to make fun of Eli Musk and Tesla and still stick to my micro-caps and just kind of, and it’s a good way to stay abreast with the market. Hey man, thank you for your time, this was fun. I appreciate your questions.

Peter Rabover: Peter Rabover, thank you very much.

TAM Stock Screener – Stocks Appearing in Greenblatt, Simpson, Griffin Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks.

The top investor data is provided from their latest 13F’s. This week we’ll take a look at:

Allison Transmission Holdings Inc (NYSE: ALSN)

Allison Transmission Holdings Inc is a manufacturer of commercial duty automatic transmissions and hybrid propulsion systems. The transmissions are part of vehicles used in agriculture, mining, transportation, defense, and construction. The company also offers genuine parts and refurbishment and maintenance services for transmissions. The largest end market is the on-highway segment, including class 4 up to class 8 trucks, school buses, coaches and motorhomes. Allison Transmission generates the majority of its revenue in North America.

A quick look at the price chart below for Allison Transmission Holdings shows us that the stock is up 6% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 8.18 which means that it remains undervalued.

(Source: Google Finance)

Superinvestors who currently hold positions in Allison Transmission Holdings include:

Lou Simpson – 3,790,722 total shares

Jim Simons – 1,968,900 total shares

Cliff Asness – 635,143 total shares

Ken Griffin – 619,373 total shares

Joel Greenblatt – 239,433 total shares

Paul Tudor Jones – 127,934 total shares

Steve Cohen – 121,969 total shares

Chuck Royce – 18,300 total shares

This Week’s Best Investing Reads 6/21/2019

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

When Everything That Counts Can’t Be Counted (The Reformed Broker)

‘You Better Be Careful And Keep Your Eyes Open’ (The Felder Report)

Why Do We Need Inflation? (A Wealth of Common Sense)

While Studying Bonds, Why Credit Rating Analysts Should Keep an Eye on the Stock Price (Fundoo Professor)

More Art Than Science (The Irrelevant Investor)

Value Investing: Business as Usual (Yahoo Finance)

Increasing Returns and the New World of Business (hbr.org)

That Time I Bought Blockbuster Debt (Epsilon Theory)

No Thank Yous (Bone Fide Wealth)

A Few Thoughts On Public Speaking (Collaborative Fund)

How to Invest and Profit in the Next Recession (bnnbloomberg)

Buy and Hold: Simple, NOT Easy (Safal Niveshak)

What Yogi Berra Would Have Said About This Bull Market (Jason Zweig)

The Problem With Academic Studies: They’re Impossible to Implement (Institutional Investor)

Charlie Munger comparing the genius Henry Singleton to “a mere almost genius” Warren Buffett (Financial Occultist)

Dan Loeb’s Letter To Sony (Third Point)

Buffett Lagging – New This Week on WEALTHTRACK (WealthTrack)

Lecture and Q&A with Students of Peking Univ. (Guanghua School of Mgmt.) – May 1, 2019 (Mohnish Pabrai)

The Lost Intro to Reminiscences of a Stock Operator (Novel Investor)

Five Questions: Investing in Human Freedom with Perth Tolle (Validea)

What Should You Invest In: Good Companies or Good Stocks? (Value Stock Guide)

PANEL: MicroCaps in Australia: Opportunities Down Under | SNN Network (YouTube)

The VC Bubble Is Putting Established Companies at Risk (Vitaliy Katsenelson)

William Green on Lessons from the Great Minds of Investing (MOI Global)

Understanding Hedge Fund Risks (Ted Seides)

The Greatest Asset Bubble of All Time (Of Dollars and Data)

Roger G. Ibbotson: The Price of Popularity (CFA Institute)

Three Things I Think I Think – Libra Edition (Pragmatic Capitalism)

Efficient Market Hypothesis: A Farce? (Price Action Lab)

MMT – In Conversation with Bill Mitchell (i3invest)

Is Traditional ‘Full-Stop Retirement’ Going Extinct? (bps and pieces)

Math vs. Emotion (Humble Dollar)


This week’s best investing research reads:

This Indicator Signals Late Cycle (UPFINA)

A Horse Race Of Liquid Alternatives (FactorResearch)

Equity Market Trend – Trade War Update (Market Fox)

Time-Series Signals and Multi-Sector Bonds (Flirting With Models)

Factor Investing Research On Steroids (Alpha Architect)

Factor portfolio construction – All alternative risk premia are not the same (Mark Rzepczynski)

The Fed’s Many Options for Tomorrow (Advisor Perspectives)


This week’s best investing podcasts:

Berkshire Hathaway Annual Shareholder Meetings (since 1994) (overcast.fm)

Anja Shortland on Kidnap (EconTalk)

TIP247: Legendary Investor Bill Miller (The Investors Podcast)

Leading Above the Line: My Interview with Leadership Expert, Jim Dethmer Ep.#60 (The Knowledge Project)

Chuck Akre – The Three-Legged Stool EP.135 (Invest Like the Best)

Episode #161: Brandon Zick, “In Row Crops You’re Generating A Lot Of Current Income” (Meb Faber)

Ep 129: Building The Lifestyle Practice Of Your Dreams By Selling Your Firm And Starting Over, with Donna Skeels Cygan (FASuccess)

The Four Most Dangerous Words in Podcasting (Animal Spirits)

Hal Varian on Taking the Academic Approach to Business (Conversations With Tyler)


This week’s best investing infographic:

The World’s 100 Most Valuable Brands in 2019 (Visual Capitalist)

The World's 100 Most Valuable Brands in 2019

What Can Investors Learn From Buffett’s Pivot On Airlines As An Investment

Johnny HopkinsPodcastsLeave a Comment

During his recent interview with Tobias, Bill Brewster who runs Sullimar Capital Group says, investors can learn a lot from Warren Buffett’s pivot on airlines as an investment. Here’s an excerpt from the interview:

Tobias Carlisle: That’s where I spend my time. Let’s talk about airlines a little bit, because you follow Berkshire very closely. You’re following the foray into airlines, but you got an interesting view on what ultimately happens there?

Bill Brewster: Yeah, well, I think and I have to credit Phil Ordway for the original idea. He sort of said to me, “If you’re interested, there’s a book called Glory Lost And Found that the guy I think, Seth Kaplan, is his name. the guy’s an airline weekly road. That is just a phenomenal summary. It’s not an easy read, but it’s a phenomenal summary of what happened over the last decade, well, 2000 to 2012.

Bill Brewster: Look, I think, bottom line is, it’s easy to look at it as a consolidation play. It’s a lot of different factors, but the healthier industry has either resulted or other factors have resulted in them capturing a lot of unit economics of the credit cards. They’re basically credit card companies with wings. As long as they don’t get too stupid and ruin what they have, I think that their future is a lot brighter than their past.

Bill Brewster: I think it’s very funny that everybody talks about them as the consolidation problem in America. I mean, their returns on assets are nothing to gawk at. On top of that, if you want to see what happens when they’re not consolidated, get the taxpayer bailout ready because the … I mean, I don’t know what it was, but 2000 to 2012 or ’14, or whenever that last merger happened, it’s atrocious what that industry does to assets.

Bill Brewster: Today, in Europe, I mean, it’s just bankruptcy after bankruptcy. The thing I love about it is I try especially being a Twitter user as I am. I try to make sure that I don’t get addicted to the things that I’m hammering into my head. To watch Buffett pivot on that, it’s such inspiring for lack of a better term. I don’t want to be a fanboy, but his ability to flip his mind and say, “You what? I don’t care how many times I stood up.” I said, “This is the worst industry ever.” Or, that I said, I have an 800 number that I dial whenever I want to buy one and he goes out and buys all of them.

Bill Brewster: The other thing that I think is sort of interesting is people have said to me, “Well, it doesn’t take a genius to bet on everything in the industry. You could just own an ETF or whatever.” Actually, historically had no aversion to making industry bets back when Clinton Care was being debated.

Bill Brewster: I mean, he said one of his biggest mistakes was not buying a basket of Pharma companies. I think the basket approach is something that I’ve learned a little bit from studying that move of his.

Tobias Carlisle: Before he invested in airlines, they all became incredibly cheap, though. My screen was full of them for a period, and I was at the New York Society of Security Analysts giving a presentation that when somebody asked about that, and I think six or seven out of 30 positions in my large cap screen were airlines at the time. They said, “Would you do it given that you know the buffet is so anti?” And I said, “Well, I have to because-”

Bill Brewster: That’s who I am.

The Acquirers Podcast

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Seth Klarman Protégé – David Abrams – Investors Need To Use A Multi-Path Approach To Business Valuation And Analysis

Johnny HopkinsDavid Abrams, Investing StrategyLeave a Comment

We’ve just been listening to a great interview with Seth Klarman’s protégé David Abrams on the Value Investing With Legends podcast in which Abrams discusses why investors need to use a multi-path approach to business valuation and analysis. Here’s an extract from the interview:

David Abrams: The first question we always ask in any analysis is – what’s the risk? So, is it the kind of asset where you could lose all your money if things go badly. Is it the kind of asset where you could lose a little bit of money. Is it the kind of asset where you know you’re going to make money. Then once you do that, the question is, this is what the upside is and is the return commensurate with that. We look at such a wide array of things. We look at credit. We look at equities. We look at companies that are growing. We look at companies that are stable. Sometimes the companies that are shrinking.

For each one you need to… there are different mental model. If I have a company that’s growing. I think the question is, how fast is it going to grow? What could make it not grow? Some of the business dynamics we were discussing before. If it’s a pretty stable thing. What are some of the things that could make it not stable? What could make it do better?

You’re trying to think about the multiple paths that could happen. There’s not one path that can happen in the future. When you look back there’s one path that happened but that doesn’t mean that going forward there’s only one path. In the future there’s multiple paths. You need to have in your own mind the range about what that could be.

You can listen to the entire interview here:

(Source: Value Investing With Legends)

If There’s A Wall Street Analyst Hammering A Company, Investors Really Need To Know Why Before Taking The Other Side

Johnny HopkinsPodcastsLeave a Comment

During his recent interview with Tobias, Bill Brewster who runs Sullimar Capital Group says, if there’s a Wall Street analyst hammering a company, investors really need to know why, before taking the other side. Here’s an excerpt from the interview:

Tobias Carlisle: Well, let’s change gears again. I don’t mean to beat you up about this one, but we did discuss it in real time. So, GE, walk us through it.

Bill Brewster: No, no. Don’t do it. No, no. Look, I think GE, when I looked at it, maybe with rose-colored glasses, well definitely, I just see their aviation business, their health care business, what their power business could have been. I think that that’s a really good lesson for me to remember where … I read Grant’s all the time, right? I should have called Grant’s and been like, “Why does Jim hate this entity for 20 years?” Right?

Bill Brewster: Then, I mean, there’s a certain amount of hubris that goes into taking any active stock position, but I probably should have listened to a lot of smart people that were smarter than me. I joke with my buddy who writes under the science of hitting investing. He and I talk a lot. I’m like, “The next time I ever open up a 10K that reads like, GEs, I’m just throwing it away. I’m done.” I still think on an asset value basis, it’s probably cheap. But-

Tobias Carlisle: It’s just got an ocean of debt, isn’t? The debt is the thing that scares me.

Bill Brewster: Yeah, well, it should there. It’s got no cash flow, so that’s a bad combo.

Tobias Carlisle: The problem for GE probably started somewhere during Jack Welch’s tenure that they could hit those quarterly earnings numbers to the penny should have been concerning. That’s probably where it started and way, way, way too much debt in there, even off 90%. If you include the debt in the price you’re paying in the EV, it was still bananas expensive, but that’s the boss of the value guy. How did you see it when it was down?

Bill Brewster: No, I think you’re totally right. I figure with the certainty of the cash flows of the aviation business, and where that was growing to, I mean, I think you can make credible argument that that alone is worth $80 to $100 billion. The healthcare business, I thought was worth roughly $40 to $50 billion. They sold that unit to Danaher for, I don’t know what was it, $24, $28 billion. I mean, even their healthcare business is not impaired by that.

Bill Brewster: You’re getting power and G casts and BHGE for close to free, which is the worst way to frame something, right? I mean, it’s free for a reason. What I also didn’t appreciate was how good of the work that Stephen Tusa has done on that name. I think that it’s easy. I think going forward, if there’s a Wall Street analyst that’s really hammering a company, I need to know, probably twice what they’re saying against it, to take the other side.

Bill Brewster: I mean, he’s just been so right and he’s done the job the right way. This ever gets back to him. Good work. That’s if you need me to tell him.

The Acquirers Podcast

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Nassim Taleb – Just Because An Investor Makes Money Doesn’t Mean They’re Good

Johnny HopkinsNassim TalebLeave a Comment

Here’s a great extract from Nassim Taleb’s book – Fooled By Randomness in which he illustrates how some investors are perceived as being ‘great’, when in actual fact they simply started investing at the best possible moment. But as time moves on it becomes apparent that their ‘strategies’ are flawed. Taleb uses two fictional characters called Carlos and John, which are indicative of some of history’s best investors:

An overestimation of the accuracy of their beliefs in some measure, either economic (Carlos) or statistical (John). They never considered that the fact that trading on economic variables has worked in the past may have been merely coincidental, or, perhaps even worse, that economic analysis was fit to past events to mask the random element in it. Carlos entered the market at a time when it worked, but he never tested for periods when markets did the opposite of sound economic analysis. There were periods when economics failed traders, and others when it helped them.

The U.S. dollar was overpriced (i.e. the foreign currencies were undervalued) in the early 1980s. Traders who used their economic intuitions and bought foreign currencies were wiped out. But later those who did so got rich (members of the first crop were bust). It is random! Likewise, those who “shorted” Japanese stocks in the late 1980s suffered the same fate – few survived to recoup their losses during the collapse of the 1990s. At the time of writing, there is a group of operators called “macro” traders who are dropping like flies, with “legendary” (rather, lucky) investor Julian Robertson closing shop in 2000 after having been a star until then. Our discussion of survivorship bias will enlighten us further, but, clearly, there is nothing less rigorous than their seemingly rigorous use of economic analysis to trade.

A tendency to get married to positions. There is a saying that bad traders divorce their spouse sooner than abandon their positions. Loyalty to ideas is not a good thing for traders, scientists – or anyone.

The tendency to change their story. They become investors “for the long haul” when they are losing money, switching back and forth between traders and investors to fit recent reversals of fortune. The difference between a trader and an investor lies in the duration of the bet, and the corresponding size. There is absolutely nothing wrong with investing “for the long haul”, provided one does not mix it with short-term trading – it is just that many people become long-term investors after they lost money, postponing their decision to sell, as part of their denial.

No precise game plan ahead of time as to what to do in the event of losses. They simply were not aware of such a possibility. Both bought more bonds after the market declined sharply,, but not in response to a predetermined plan.

Absence of critical thinking expressed in absence of revision of their stance with “stop losses”. Middlebrow traders do not like selling when it is “even better value”. They did not consider that perhaps their method of determining value is wrong, rather than the market failing to accommodate their measure of value. They may be right, but, perhaps, some allowance for the possibility of their methods being flawed was not made. For all his flaws, we will see that Soros seems rarely to examine an unfavorable outcome without testing his own framework of analysis.

Denial. When the losses occurred there was no clear acceptance of what had happened. The price on the screen lost its reality in favor of some abstract “value”. In classic denial mode, the usual “this is only the result of liquidation, distress sales” was proffered. They continuously ignored the message from reality.

How could traders who made every single mistake in the book become so successful? Because of a simple principle concerning randomness.

This is one manifestation of the survivorship bias. We tend to think that traders make money because they are good. Perhaps we have turned the causality on its head; we consider them good just because they make money. One can make money in the financial markets totally out of randomness.

Both Carlos and John belong to the class of people who benefited from a market cycle. It was not merely because they were involved in the right markets. It was because they had a bent in their style that closely fitted the properties of the rallies experienced in their market during the episode. They were dip buyers. That happened, in hindsight, to be the trait that was the most desirable between 1992 and the summer of 1998 in the specific markets in which the two men specialized. Most of those who happened to have that specific trait, over the course of that segment of history, dominated the market. Their score was higher and they replaced people who, perhaps, were better traders.

Phil Fisher’s Scuttlebutt Can Still Be Used To Find Great Opportunities Today

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During his recent interview with Tobias, Bill Brewster, who runs Sullimar Capital Group demonstrates how Phil Fisher’s scuttlebutt can still be used to find great opportunities today. Here’s an excerpt from the interview:

Tobias Carlisle: Let’s talk about Ubiquiti. What’s the story there and how did you find it? How did you value it? How do you think-

Bill Brewster: Well, that was one that my buddy had told me about it. He’s out in Silicon Valley, he used to be with the NSA. He’s pretty plugged into that whole, I guess, community of coders and whatnot. He was like, “Look, man, I’m just telling you that every single small business out here uses Ubiquiti.” I was like, “Well, why why does Cisco not just kill him?” He thinks, or thought at the time that it was a fundamental organizational principle that Cisco is more enterprise driven. Ubiquiti’s strategy is to get product out cheap, right?

Bill Brewster: Robert Pera is the founder. He’s an old Apple guy and he left. His whole strategy was like, “Rely on the internet and rely on distributors.” I said, “I don’t you know if I believe this.” A short report comes out, I’m reading the short report, and I start looking around my house and I realized that my wireless network runs on Ubiquiti. I had paid somebody to come set it up. I have all these wireless access points, and I just started calling people. I started with the sales guy. I was like, “I gave you a fair amount of money. Now, you’re going to give me some intel right?”

Bill Brewster: Then I just kept asking people for leads. I probably talked to, I’d say, six to eight people. I mean, probably six, if I’m really thinking about like real conversations. But I just asked them, I’d say, “Why are you guys selling this product?” Right? Almost invariably, what came back is, “It’s stable, and it’s cheap and our customers like it. We make money and we don’t feel like we’re overcharging.” I said, “Okay, well, why not Cisco?”

Bill Brewster: They were at that point, still installing some of the more expensive equipment was Cisco equipment. They’ve since transitioned. But it just got me really interested that the story was, “We’re not marketing, we’re B, to B, to C.” Every one of the people that I talked to, like the story checked out. Then, when I looked at that, I mean, there was a short overhang on the stock, and I just didn’t really buy that. He gave an investor day. People hated it. I loved it. I mean, sometimes people want to have like an abnormal result in a normal package.

Bill Brewster: I think when you’re looking at a lot of these entrepreneurs, like if they’re socially awkward or something, I mean, they’re not normal, right? I mean, this guy has created a multi billion dollar company, like he’s not going to be like you or me, probably.

Tobias Carlisle: I’m pretty socially awkward, Bill.

Bill Brewster: Yeah, well, you might be the next billionaire. I hope you are, Toby. People would tell me that I’m socially awkward too and here I said so. Well, I should but I digress.

The Acquirers Podcast

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(Ep.15) The Acquirers Podcast: Bill Brewster – Brewster’s Millions, A Masterclass In Business Analysis

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Summary

In this episode of The Acquirer’s Podcast Tobias chats with Bill Brewster, who runs Sullimar Capital Group. During the interview Bill provided some great business analysis into a number of companies including AB InBev, GE, Netflix, and Ubiquiti. He also discusses:

– How He Went From The Flooring Business To The Investment Business

– Why I Don’t Steer Away From Leverage

– What I Liked About Investment In AB InBev, GE, Netflix, and Ubiquiti

– Why Don’t More People Use Dollar Shave Club vs Gillette

– Business Valuation Analysis Is Not Just About Metrics – Case Study

– Phil Fisher’s Scuttlebutt Can Still Be Used To Find Great Opportunities Today

– If There’s A Wall Street Analyst Hammering A Company, Investors Really Need To Know Why, Before Taking The Other Side

– What Can Investors Learn From Buffett’s Pivot On Airlines As An Investment

The Acquirers Podcast

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Full Transcript

Tobias Carlisle: All right, man. You Ready?

Bill Brewster: I’m ready.

Tobias Carlisle: Let’s do it. Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is my good friend, Bill Brewster. He’s a reformed lawyer who spent some time running a flooring franchise through the dark days of a housing bust in 2008, 2009 before someone finally gave him the intelligent investor and he became a full blown value investor card carrying member of the Berkshire cult. He runs Sullimar Capital and he writes some of the most penetrating, interesting research that I have read and it’s all based on deep research that he does. We’re going to talk to him right after this.

Speaker 3: Tobias Carlisle is th founder and principle of Acquirers Funds. For regulatory reasons, he will not discuss any of the Acquirers Funds on this podcast. All opinions expressed by podcasts participants are solely their own and do not reflect the opinions of Acquirers Funds or affiliate. For more information, visit acquirersfunds.com.

Tobias Carlisle: Hi, Bill, how you doing?

Bill Brewster: Doing well, Toby? How are you doing?

Tobias Carlisle: I’m very well. You have to explain to us how you can be running a flooring franchise through the depths of the housing bust in 2008, 2009.

Bill Brewster: That’s a fair question. I should probably explain it to myself. I was in law school, as you had mentioned. I guess a curse of being in Chicago and a benefit too I got really into options, studying, and trading, and whatnot, and learned pretty quickly about halfway through my first year that law school, and being a lawyer was not necessarily for me, right?

Bill Brewster: I finished the first, probably a year and a half and I talked to my now wife, and I was like, “I don’t know that I want to do this law thing.” And she said, “Well, you got to finish.” When I finally completed it, I passed the bar. I said, “All right. Well, now what I’ve never really wanted to be a lawyer.” I thought that a franchise system would sort of put some barriers or lend some business expertise to sort of supplement the weaknesses that I had.

Bill Brewster: In retrospect, there were some calculations that I probably could have done a lot better. Some of it was timing, some of it was me. But it was not a good marriage.

Tobias Carlisle: Well, you’re a good business analyst. I’m interested, how did you think about that opportunity as you’re going into it, and what was wrong with it?

Bill Brewster: Well, so back in the day, the company that I chose to join has successful franchises around it, right? So they built successful brands. I was looking at, boy, if I can own sort of the flooring equivalent of what they built in other home services, that’s going to be fantastic. I missed a couple really key things and that’s probably a good lesson and motivated reasoning right there. But I’m in Chicago, right? They’re telling me, “Hey, this is what we think the average marketing spend, should be and we know how to own a neighborhood and this and that.”

Bill Brewster: Well, I mean, what is a good marketing spend in Omaha is not a good marketing spend in Chicago, right? I mean, I miss it says scale I miss it says, my defined market, I tried to spend too much money on too large of a market, right? I probably should have just tried to own a block with the amount of money that I was trying to do. I tried to own neighborhoods. Long story short, I think that I learned that there is a different business that the franchisor runs than the franchisee runs, and a lot of great franchise or brands are built on the marketing dollars of franchisees. So-

Tobias Carlisle: Now that you’re a value investor now, and I always say this, but value is a very broad church. How do you characterize yourself as a value investor?

Bill Brewster: Yeah, sorry, sorry for the alarm, if you can hear that. Anyway, so I was saying to you when I transitioned out of the flooring franchise, I was fortunate enough to get a job at BMO Harris bank. In Chicago, I underwrote loans. In between that time while I was waiting to start, because they had credited analyst programs, and I had to wait to go into that. My grandma’s friend sent me three books, and two were Bogle books, and one was the Intelligent Investor. I don’t know. I think that guy has a sixth sense of humor to do that to me.

Bill Brewster: I could just be naively indexing and super happy, I guess.

Tobias Carlisle: Right.

Bill Brewster: But I just think Buffett talks about it, when you read it, it either clicks or it doesn’t, right? I’m not a hardcore like quite value guy. I see a lot of merit in that strategy. I think when you’re running a research based process, one of the things that’s tough about just doing price to book or EV to EBIT, or whatever, whatever you want is, it takes a long time to dive into an idea. Then let’s say it rewrites on you in six months. If you sell it, it’s a taxable event.

Bill Brewster: In a non taxable rapper or in something that doesn’t take as much time, I’m a full endorser of that like three quant strategies. I just don’t know that, for what I’m trying to do, it’s the best way to get where I need to go, right? I think I’ve adopted a little more monger.

Tobias Carlisle: You’re treating them like more of a … You view yourself as a business owner, you’re doing a full analysis of the business and I watch your Twitter account pretty closely, and you dive into the conference calls and all the notes as much as you possibly can. Are you looking at more leveraged companies? Is that what you feel that’s where your insight is going to be best applied?

Bill Brewster: Yeah, well, I would say I don’t steer away from leverage, which is potentially destructive habit. That said, I just think it’s important to keep leveraging context, right? One idea that I pitched last year was ABM Bev. I know why people don’t like that. If everybody liked the idea, I’d argue it’s not value, right? But I think it’s important to look at debt ladders, to look at the covenant structures. When is the debt maturing? How hard can they push the debt markets going forward?

Bill Brewster: I like to look at credit default spreads, I like to look at just sort of how the bonds are trading. I think I have a lot of respect for the credit market, and I probably need to learn a little bit more about it to be candid.

Tobias Carlisle: Let’s talk about ABM Bev a little bit. What was your attraction to it and why was that distinctive to what the market was saying?

Bill Brewster: Well, I wouldn’t say uninformed variant perception on management, but I do think that with management teams, stock price drives narrative a lot of the time. Back in 2015, 2016 these guys could do no wrong, they had the 3G virtuous cycle. I think they probably overpaid for SABMiller, their stock price gets hit, and now they’re morons. I just think they have admitted that they miss things, the world has changed a little bit on them, beer volumes are declining. But part of it is they are a management team swimming upstream a little bit.

Bill Brewster: Part of it, I think, is people aren’t taking a step back and just really thinking about the big picture. ABM Bev has almost doubled the gross margins of their nearest competitors. Their operating margins are salivatingly fat, and they have a distribution system that’s built out that I don’t know if it quite rivals Coke, but I can’t think of too many more envious or enviable distribution system.

Bill Brewster: Over the long term, I think that that’s a hand I want to play and I think beer is a drink that has been consumed for a long, long time. There’s premiumization trends in the US and developed worlds. In the developing markets I think it’s a scale game, right? How many minutes do you have to work to get your buzz on? If they have such a scale advantage, and they can distribute that in front of people, they’re competing with people making alcohol in the bathtub. Over the long term, I want to be that product pusher.

Tobias Carlisle: You don’t like the pruner that the toilet one?

Bill Brewster: No, no. Look, I mean, people have to do what they have to do to escape sometimes, right? But I do think that beer offers the occasion to have people do that. They’re innovating, they’ve got some brews that are not traditional brews that they can get in front of people that are cheaper and we’ll see. I mean, in five, seven years, maybe people look at me and say, “Boy, had you missed that?” I’ll say, “I don’t know, I was an idiot.” But, yeah, I’m willing to put my chips in.

Tobias Carlisle: Interesting. An interesting business, because it seems to be reasonably resistant to the economic cycle when things get bad, if anything, people drink more. And so, they seem to do quite well through those periods. But I remember coming into my screen, maybe a year or so ago, Sam Adams … and I’m just blanking a little bit on the name of the stock, but I’m pretty sure the ticket i Sam. Sam Adams also got unusually cheap, and I guess that’s all of the premium boutique beers pushing him. Was that sort of the move away from macro, as they call into micro? Was that the driver of the undervalued, do you think?

Bill Brewster: Yeah, I think that’s probably some of the overhang on a lot of these stocks. I mean … So Heineken has, I would say, a better aggregate brand portfolio, right? If you just had to bed straight brands, Budweiser I mean, you’re really long lager in the US, which is under attack. But I think what’s under appreciated is US revenues are maybe … I don’t know. I think it’s 28%. I think is the number but let’s call it 25 to 30% of revenues.I mean, it’s ultimately an emerging markets play and I think that people focus.

Bill Brewster: I can’t sit here and tell you, yeah, more assets chasing the same share of throat for lack of a better term is a good thing for the US business. But I think they’re going to manage, okay.

Tobias Carlisle: I don’t think I can drink any more micro beers. I’ve had enough of the IPAs, like the passion fruit flavored beer. I really just want … Give me the thing that tastes as close to water as you possibly can. Just give me the regular robot that’ll do me.

Bill Brewster: There you go. Well, Bud Light. It’s not even made with corn syrup, right?

Tobias Carlisle: Let’s say yeah. Let’s talk a little bit about, how do you sighs positions? Do you like to stay fully invested? Do you carry cash? How diversified do you like to be? Do you look at industry concentration and so on? When you’re constructing your portfolio considering a new position, how do you think about those things?

Bill Brewster: That’s a great question. That’s something that I’m working through every day, trying to think through that. Now, if I’m tinkering, that’s not very good, right? But I just did performance attribution for myself. It’s not audited. I’m not an RA, please don’t listen to what I’m saying here. That said, cash drag has hurt me over time. I was fortunate, I guess, or smart. I don’t know which one, but I deployed a lot of capital from November to January. A lot of it was late December and a lot of it was high Beta, if you want to take that approach to it, right?

Bill Brewster: I don’t view the world through that lens. Netflix is something that ended up in my portfolio, which is not a traditional value play. I have a little bit of concerns about the business model, but I do think I see the world through scale a lot, right? ABM Bev, I like cable companies and I do think that over time, the scale advantage on Netflix is something that I’m comfortable betting on. Okay.

Bill Brewster: Now, how much am I comfortable with that, right? ABM Bev is 10% of what I run. Netflix is three. Now, Netflix is not the reason that my performance has been good over the last couple months, because it’s only 3% I guess it went up to four and a half or whatever but at costs, I’m much more comfortable with the stability of Budweiser’s fundamental business and business model than I am Netflix at this stage and valuation. I just try to think … I mean, I don’t think anybody that’s long Netflix isn’t a little nervous when the earnings call comes out that they’re not hitting a growth pocket, because if they do, it’s going to be painful, at least from a volatility perspective.

Bill Brewster: I would be more inclined to size that position big if fundamentally I thought the story was still together and everybody bailed on it because growth. I’m fairly long charter. Also, that’s another large position for me. My view on that was they had an earning score where they had some integration issues that they had released and is on the back of a buyback at higher prices and deals that fell through and I think people sort of threw in the towel, or at least got dejected, right?

Bill Brewster: I pulled up all their old transcripts, and I was reading through and they had laid out. Like this building migration is a real risk. It’s not a small risk, it’s a risk. Here we are, fast forward two and a half, three years, and the building migration happens, the risk materializes itself, and the stock’s off huge. I think that I had lived through an integration at BMO Harris, it was miserable. I bet it’s still miserable over there. I mean, trying to get people to change software is like going to the dentist, everyone complains.

Bill Brewster: You’ve got … One organization feels like they’re being talked to in a way, another one thinks that they know every … I mean, it’s not ideal, right? Sometimes I think, at least in that case, the financial community models out in M&A integration to go perfectly, and then life happens. Then maybe somebody who’s IRR or something gets hit, and they say, “You know what? I’m done with this.” I like to scoop into those situations.

Tobias Carlisle: But do you think because you think ultimately that is a problem that they can solve that they can get that under control? When they do, then it’s largely back to business as usual?

Bill Brewster: Yeah. Well, fundamentally, I mean, what I love about that entity, when you listen to them talk, they talk about, “How can we keep our …” If you think about … I’m just trying to think about how to explain it. If you think about a building that’s built and it’s like 55% fall, and they just want to keep hammering users into that building, right? Their ideas, we’re going to charge a cable price, that’s low enough that the competition isn’t going to be able to beat us. We’re going to maximize the amount of money per home, we pass.

Bill Brewster: I think that when you get that type of strategy, and you get the local scale benefits, you can undercut your competition once the game is sort of one. I think that where they are combined with John Malone, and that whole you can bet against them. But I’ll take the other side of that trade.

Tobias Carlisle: I mean, that was one of John Malone’s. I hate to say innovations, because it’s a reasonably obvious position now, I guess, for the benefit of hindsight. But he saw that if he could get scale, and TCI, this is a story in the outside. He saw that if you get scale and TCI, then he would have better buying power, infrastructure becomes much cheaper on a per user basis because it cost you the same to put it in the ground, however you do it.

Tobias Carlisle: Then, the more people you hammer in, the better your metrics start looking. Is that what charter is trying to do?

Bill Brewster: Yeah, I think so. I view Netflix through the same lens, right? I mean, back when you were building out cable pipes, you had free cash flow negative, financial statements, and everybody could look at that and say, “What the heck are you doing?” You get to 300 million users. On a per user basis, these content numbers that are eye popping, are going to be a lot less eye popping, and they’re also going to be really, really hard to compete with. But Netflix is rich. I mean, I don’t think anybody’s going to sit here and pitch it but true value investment, right?

Tobias Carlisle: Well, how do you feel about competition from someone like YouTube? Google’s got similar kind of distribution, but the advantage that they have is that people will upload this, this gets uploaded to YouTube for free and this will get dozens of years. Then, Joe Rogan uploads his for free and that’ll get multi millions of views, but that their content costs are nil.

Bill Brewster: Yeah, yeah. No, I know and Joe Rogan’s too went up to three hours of your day, right? That’s a fair amount of attention.

Tobias Carlisle: Right.

Bill Brewster: I personally cut Netflix, I said, “I don’t like this, I’m spending all my time searching. What am I doing?” Then it took me like a month to re subscribe. Really, what got me comfortable with how they understand their business is if you look at their … Forget about their income statement because it’s not worth looking at, look at their cash flow statements, right?

Bill Brewster: I mean, if you look at their cash content spend, and their marketing and selling spend, I just aggregate all that and say, “Okay, well, this is the cost of acquiring a customer and keeping them.” They’ve been remarkably consistent on their projected customers or projected subs.

Bill Brewster: If I saw that go way out of whack … I mean, that’s sort of my KPI, right? I feel like that’s a good indication that they’re executing on their plan, and they have the long term view, then I’d have to rethink what I’m looking at. I understand I’m sort of pitching like looking at eyeballs here. It’s not that the investment I’m trying to hang my career on, but I see a lot of merit in it. Let’s see.

Tobias Carlisle: Let’s see, eyeballstheold.com metric.

Bill Brewster: Yeah, that’s exactly what I’m a little concerned about.

Tobias Carlisle: When you put that … I mean, to be fair and I don’t mean that as a criticism, but every one of their eyeballs actually is a subscription and a fee paying subscribing customer. It’s real revenue, it should be a very good business. That’s exactly the kind of business that you want, recurring subscription revenue. They don’t have quite fixed costs, but it doesn’t cost them any more for 1,000 people to watch than it does for a million people to watch the same content run.

Bill Brewster: Yeah, you get some operating leverage out of it. I would say, the real … Sometimes I think people get carried away with subscriptions, right? The real value in subscriptions is you’re locking in your monetization. If you look back at when Adobe went subscription, or when Microsoft went subscription, their fundamental problems are people spend like 90 bucks, and then they wouldn’t buy something for three more years, right?

Bill Brewster: Well, if you can charge them 10 bucks a month and lock them in it on the three year example or …let’s call it two, you’re turning $180 or $90 into 40, right? I mean, that’s huge. I think that you can make a fair argument that media, at least the movie business, there is some volatility in ticket sales, right? But if you can collect up front your subscription, you can sort of reduce some of the, I guess, unknowns that are coming with the revenue stream. I think that there’s merit and subscriptions actually adding value in that industry.

Tobias Carlisle: I think that’s one of the most interesting insights to come out of the Dollar Shave Club, that they said, it’s crazy that Gillette charges is so much for each individual razor. We’re just going to charge you whatever it is $1 or $2 or $5 a month. But because you’re doing it on a recurring basis, and you don’t necessarily go and buy razors on a regular basis from Gillette. So you buy them when you when you think you need to and then you remember, they actually managed to get more money out of people for their spend on razors than Gillette was getting out of them, which is kind of a brilliant insight just by making it a recurring regular payment.

Bill Brewster: Yeah. I mean, if you looked at my Mac three right now, I should change the blade, right? But I’m not going to, so I should probably be on a subscription model from the business standpoint.

Tobias Carlisle: When you’re undertaking evaluation, just in general terms, what’s the process that you go through? What do you sort of … You look for a metric for each individual company or you’re doing a DCF or how do you do it?

Bill Brewster: I think about what’s out of the gate now. I just talked about Netflix, so add this one back, right? But what’s my out of the gate free cash flow yield and then I try to compare that among … I mean, I’ve sort of borrowed this from Buffett but what would I get on the tenure, right? Then, what do I think the growth path is and what do I think returns on incremental capital are? That’s sort of how I figure out, “Am I interested in this business?”

Bill Brewster: Then, there’s other things like my favorite investment that I did was intrepid potash. That was a price to book thing, right? It wasn’t a fundamental price to book screen, it’s a company that I had known because I banked, and they got into perceived distress, and it was distressed. But the company was trading for something stupid, like I mean, maybe $200 million EV, or maybe it might have been even 160. But they had just put $550 million capex into this company and it’s a mining company. It’s everything no one wants.

Bill Brewster: But I was digging through the credit agreements, and I realized that Farm Credit owned the needed majority of, I guess, voting rights, so they could drag along the pensions with whatever the pensions didn’t matter anymore, right? Farm Credit was formed for the purpose of helping farmers and commodity type companies get through down cycles, so I was reasonably confident that they were going to amend their side of the credit agreement. I knew the bankers that BMO. I didn’t know what they were doing, but I think highly of them, especially in the food group.

Bill Brewster: I just figured, they’re going to get this done. It took a lot longer than I thought it was. I mean, there were some times that I was pretty nervous, but that wasn’t very hard to DCF. I just knew if it re rated close the book, which it should be at least 80% of book, given the returns on capital that that business should generate, that I was going to win. Then it’s a matter of how long and do you want to pay the tax? But I was pretty comfortable with that one.

Tobias Carlisle: How long ago was that?

Bill Brewster: I think it was 2016, June of 2016ish.

Tobias Carlisle: There were a few companies globally, a few potash companies globally that were in distress about the same time. I remember there was a Canadian traded down, it was a net net. Then you got the entire potash mine, I guess it is for free. And I-

Bill Brewster: Yeah.

Tobias Carlisle: I remember seeing that written up on a few different websites. What was the driver of the … It’s fertilizer, so I guess it’s demand for agriculture that drives the demand side. Is that the case?

Bill Brewster: Yeah. Well, I mean, potash is really interesting. It was a cartel. I forget when they broke up. I want to say it was 2010 or 2011. I’m pretty sure it’s Belarus and another country but they produced all the potash or could potentially produce all the potash that’s needed, right? So because they were a cartel, it was supply restricted. I think that when you look at how long a potash mine takes to … I mean, this is a terrible business, right? But how long it takes to bring a mine online and once you’ve committed to that capital, you’re going to do it.

Bill Brewster: All these projects were undertaken at exactly the wrong time, the cartel breaks up, everybody starts losing money, you have large exit costs. It’s it’s a recipe for just irrational behavior for a really long time. I’m not going to call it bottom, but I think 2016 is a reasonably decent bed at the bottom, and it just happened given opportunity.

Tobias Carlisle: You felt that $550 million in capital spend was probably a reasonable proxy for what the whole thing was worth.

Bill Brewster: Yeah, yeah. Because they were digging out these low cost mines, right? There’s like two parts of the business. Basically, they’re geographically advantage so they can pump water into lakes, and then use the sun to just evaporate the lake and then go scrape the lake and get their potash, which is basically just like salt, right?

Bill Brewster: They had to shut down the part of their business where they were going under the ground and mining. But all the capex was basically spent to improve those lakes and then improve their processing. I felt like that those are reasonably good dollars. That’s not like you’re not buying a hole in the ground for that.

Tobias Carlisle: Because that’s the thing-

Bill Brewster: You’re buying a hole in the ground, but not quite.

Tobias Carlisle: Literally, like a hole in the ground with a layer on top. That’s the thing I always-

Bill Brewster: That’s right. That’s right.

Tobias Carlisle: That’s the thing that always makes me most nervous about the mining place as a value investor as a deep value guy. Particularly, I don’t mind looking at them. But the thing that I’m always most nervous about is at the very peak of this cycle, they’ve dropped a huge amount of money into it, then is that actually representative of what this thing is worth in the down cycle or over the full cycle. It’s hard to know. I’ve never really been able to arrive at the correct answer because the thing that we’ve been grappling with over the last 20 years is, what is China’s impact? Is China’s sort of demand artificial?

Tobias Carlisle: I’m not going to be there in the future or is this just the way that the world is like China is going to have this gigantic demand for basically the supercycle. Remember the supercycle?

Bill Brewster: Oh, I remember yeah back with the bricks. This is going to be awesome. Internet [inaudible 00:28:52].

Tobias Carlisle: Where did the supercycle go?

Bill Brewster: I don’t know. I’ll tell you what? ABM Bev is brought me down into Brazil a little bit and the bricks are not the bricks anymore. They got to come up with something. I guess we got Fang now. But those are probably a lot more sustainable than the bricks but time will tell on that statement.

Tobias Carlisle: Let’s just switch gears a little bit and talk about LaCroix and National Beverage which is one of your favorite positions.

Bill Brewster: Yeah. Well, that one I … That Ubiquity sort of rhyme. Lacroix I had a lot more personal knowledge with and both of those opportunities came up because of short reports. That was one of those opportunities where there are some corporate governance problems at LaCroix. I mean, they’re just are. It’s National Beverage Corporation. That said, they had a super clean balance sheet and even if they were paying this entity off to the side, I figured, well, the auditors can get at least audit cash flow and they can audit debt and there’s no debt.

Bill Brewster: I’m in the Midwest, I just looked around at what was going on with … I mean, they were winning all kinds of end caps at grocery stores. I thought it was just going to be like this beautiful brand that turned into Coke and I was a young Buffett. There were some other transactions that had occurred was just taken out by, I’m pretty sure, Dr. Pepper Snapple and it just made a lot of sense to me that LaCroix should be worth materially more.

Bill Brewster: Now, we’ll see how the story ends up. I was on the Twitter and Mark Otis was short. I always get nervous when code is just short. Anything that I like, I was dabbling, I exited. But I was dabbling because it’s sold off a lot. He had seen discounting and he was pressuring in a short. I was happy I was out, but it’s a good lesson on how quick the world can change on you because I thought that brand would be there forever. It still may be but this is quite a hiccup.

Tobias Carlisle: I like it as a category because I think everybody recognizes that the obesity epidemic for one of a better word is probably tied closely to how much sugary water everybody’s drinking. These things offer an alternative that has some flavor. I’ve seen it described. It’s like watching the … When you flick between channels and you see the snow on the screen, whatever that’s called. Or it’s like somebody else drinking soda in the room beside you. That’s the taste of it. It doesn’t taste good. But I don’t mind it. Actually, I enjoyed it. I drink some of it and it tastes all right. Maybe it’s a little bit too … There’s too many bubbles in it something like that. The next one that comes along is going to be low fizz.

Bill Brewster: Well, out there they say that they like Topo Chico and that’s more effervescent than LaCroix. I don’t know, we’ll see. We’ll see.

Tobias Carlisle: If you go through Texas and other areas like that Topo Chico is everywhere.

Bill Brewster: Oh, it’s huge. It’s huge. Just my buddy’s out there and he was from Texas. He was like, “I don’t know, man. Topo Chico’s taken off.|” I said, “Well, I don’t know, I don’t know.”

Tobias Carlisle: I hate to use this name in vain. But Chris Cole, he visited me when I was in Playa Vista. This is in California. He saw the big boxes of Topo Chico and he bought some because he couldn’t … I don’t know if there’s some sort of supplies you out there. But he’s like you can’t get them this cheap. He put a polythene.

Bill Brewster: Just going to wholesale it. One of the fun things about investing is in the scuttlebutt that I was doing, I have a friend that used to be in marketing. He was telling me that LaCroix would hire the firm to do their advertising, right? They knew that they didn’t have the skill to compete against Coke in TV. We said, “All right, what are we going to do?” They came up with that pop party can?

Bill Brewster: I guess, rumor has it that they hated the can but it tasted really well. They were smart enough to say, “You know what? If it tastes well, let’s see how it goes.” Their game was, “We’re going to win on premise conversion?” Right? When you walk by this box, it’s going to pop up out of the aisle, and somebody is going to grab it. The thing that I like about that and a lot of people complain that their Opex was too low relative to sales and what Coke is.

Bill Brewster: But if you have just those colors on the box, convey a brand image to you and it’s organic. When you roll out a new flavor, you just flip the colors. If coke wants to release a lime, sugary drink, like take out a rebranded Sprite. I mean, there’s a ton of money that goes into that. Now, arguably it’s more durable. I mean, we’ll see. But I like the packaging. That was a not insignificant part of my thesis combined with Instagram was like everything and there’s a bunch of social signaling like drinking LaCroix, so I’m cool. I mean, it was like the perfect storm to blow up.

Tobias Carlisle: I can never get used to the pronunciation because there’s a British TV show that they showed in Australia when I was a kid called Absolutely Fabulous. There’s a fashion brand, I think called Liqua and somebody on the show mispronounced that as LaCroix and then corrected. Oh, it’s Liqua sweetie. Then that was sampled by like EDM, electronic dance music group and so the whole song was just it’s Liqua sweetie. I can’t call it LaCroix, but I guess I’m doing it.

Tobias Carlisle: Let’s talk about ubiquity. What’s the story there and how did you find it? How did you value it? How do you think-

Bill Brewster: Well, that was one that my buddy had told me about it. He’s out in Silicon Valley, he used to be with the NSA. He’s pretty plugged into that whole, I guess, community of coders and whatnot. He was like, “Look, man, I’m just telling you that every single small business out here uses ubiquity.” I was like, “Well, why why does Cisco not just kill him?” He thinks, or thought at the time that it was a fundamental organizational principle that Cisco is more enterprise driven. Ubiquity strategy is to get product out cheap, right?

Bill Brewster: Robert Pera is the founder. He’s an old Apple guy and he left. His whole strategy was like, “Rely on the internet and rely on distributors.” I said, “I don’t you know if I believe this.” A short report comes out, I’m reading the short report, and I start looking around my house and I realized that my wireless network runs on ubiquity. I had paid somebody to come set it up. I have all these wireless access points, and I just started calling people. I started with the sales guy. I was like, “I gave you a fair amount of money. Now, you’re going to give me some intel right?”

Bill Brewster: Then I just kept asking people for leads. I probably talked to, I’d say, six to eight people. I mean, probably six, if I’m really thinking about like real conversations. But I just asked him, I’d say, “Why are you guys selling this product?” Right? Almost invariably, what came back is, “It’s stable, and it’s cheap and our customers like it. We make money and we don’t feel like we’re overcharging.” I said, “Okay, well, why not Cisco?”

Bill Brewster: They were at that point, still installing some of the more expensive equipment was Cisco equipment. They’ve since transitioned. But it just got me really interested that the story was, “We’re not marketing, we’re B, to B, to C.” Every one of the people that I talked to, like the story checked out. Then, when I looked at that, I mean, there was a short overhang on the stock, and I just didn’t really buy that. He gave an investor day. People hated it. I loved it. I mean, sometimes people want to have like an abnormal result in a normal package.

Bill Brewster: I think when you’re looking at a lot of these entrepreneurs, like if they’re socially awkward or something, I mean, they’re not normal, right? I mean, this guy has created a multi billion dollar company, like he’s not going to be like you or me, probably.

Tobias Carlisle: I’m pretty socially awkward, Bill.

Bill Brewster: Yeah, well, you might be the next billionaire. I hope you are, Toby. People would tell me that I’m socially awkward too and here I said so. Well, I should but I digress. Anyway-

Tobias Carlisle: If we’re talking … Well, let’s talk about socially awkward. Big Larry Holdings, you went to the-

Bill Brewster: Oh, gosh. That’s quite the transition right there.

Tobias Carlisle: You’re not quite, you’re not … I know some people who are in the cold. We both know somebody in the cold.

Bill Brewster: Although some of the shorts might say they’re the same person. Yeah, we do know somebody that’s in that call. Look, I think that Sardar appears to me to be the type of guy that if it’s working out, you can look past and when it’s not, he’s a crook in people’s minds. I talked to Shane Parrish there and then subsequently at Berkshire. Shane, had that thing called perfectly. I guess in 2010, he saw some stuff that he didn’t like and he wrote a letter and got out.

Bill Brewster: But I hope I’m not talking out of school, Shane. But he’s an interesting … I mean, it is absolutely true that there’s a guy that stands up and asked a question and says, “I’ve been with you for six years, I believe. Everybody told me not to believe. I’m starting not to believe what should I do?” Sardar just picks up a peanut, puts it in his mouth and looks at him. He’s like, “You got to answer that question for yourself.”

Bill Brewster: Okay, man. This guy is underwater after six years of believing in you. I mean, there’s no sympathy in that guy. He doesn’t care. I don’t like the entity because I don’t like what’s going on at Steak ‘n Shake, and I don’t like the debt that they have.

Tobias Carlisle: What about the … For me, I followed Sardar when he was little on fund before I moved to the States. It’s at least 2009, 2008. I’ve kind of been following him to the extent that I could. He was written up in sort of some Texas, local newspapers. This is pre Steak ‘n Shake. I thought this guy’s a very clever investor and he’s an activist, so I’m sort of interested in what he’s doing. I followed him all the way up to when you got control at Steak ‘n Shake. Then a few things, tweet me selling your signature and branding it under your own name. That’s odd behavior. If you’re a celebrity, capital allocator, maybe Buffett could get away with that. Buffett never do it, but maybe-

Bill Brewster: Maybe they would never do it. That’s the thing, right?

Tobias Carlisle: Maybe he could get away. If he endorses something, probably people are going to go and buy it because he’s endorsed it. But if you’re an unknown, that’s a really unusual move and it needs to be kind of justified in some way. Then the related party transactions and that insane compensation scheme. From my perspective, it makes it uninvestable because you don’t know even if he does very well, how much of that falls through to you as a shareholder, not enough. There’s somebody crimping the hose on the way through, there’s a hole in the hose.

Bill Brewster: That’s exactly how I think about it, too. Then on top of all that, and I might not have this right, but I think I do. If you’re a shareholder there, your real interest is in the Lion Fun one and the Lion Fund two. The Lion Fund one might on those Cracker Barrel shares, but it’s not. I mean, look, I guess when you’re dealing with a controlled company, you don’t have that much say anyway. But if that Lion Fund one has a 12-year or a 10-year lockup with two year options, or whatever it has. I mean, I don’t know what the terms are. But you’re even further removed from the assets that you think you like and he’s charging. I don’t know if it’s 0620 or 0625.

Bill Brewster: I mean, I don’t know how much upside to Steak ‘n Shake, and Western Sizzlin’ and Run-Off, and Maxim magazine, and Cracker Barrel have. I hope people in the entity do well, but it’s not something that interests me.

Tobias Carlisle: When you moved into it though, I thought this is potentially Steak ‘n Shake potentially. I can see Shake Shack is huge, right? That’s become an extremely popular place for its great branding, easy to get into lots of stuff to like about Shake Shack. Maybe not the price, but I like everything else. But Steak ‘n Shake, I can see if you’re a clever operator, maybe you can get control of that and turn that into a Shake Shack.

Tobias Carlisle: After something that’s just been forgotten about for a very long time turns around starts doing very well. I mean, there’s a potentially huge upside and something like that. But that’s not the way it’s turned. For me, that’s enough.

Bill Brewster: Well, I mean, that’s the value dream, right? You find an asset that’s been forgotten about by the market and the narrative switches and it rewrites and then if you can get earnings growth on it, I mean, that’s how you get 100 bagger. I don’t think this is going to be that. I mean, one of their biggest problems, in my opinion, is Steak ‘n Shake is just … I mean, their financial results are terrible right now and they’re going to need to change all that. They think they’re going to do it by franchising, but the unit economics on the restaurants aren’t working as it is. So, how are you going to sell the franchise to somebody?

Bill Brewster: By the way, you got to roll debt in 18 months. I mean, I’d been at banks, and I would not think that the bankers are having a fun conversation right now. But-

Tobias Carlisle: That’s it. There is a price that I do think it’s starting to get sort of optically cheap, and there is a price that I could buy it, but probably not where it is, would have to be just like stupid cheap, I’d probably buy some.

Bill Brewster: Well, here’s the only problem with that and this is where I go back if it was in like an ETF or some tax advantage rapper. Let’s say you buy it, how long is it going to take to rebate and then you got to pay tax? I don’t know. That one’s tough for me.

Tobias Carlisle: Well, let’s change gears again. I don’t mean to beat you up about this one, but we did discuss it in real time. So, GE, walk us through.

Bill Brewster: No, no. Don’t do it. No, no. Look, I think GE, when I looked at it, maybe with rose colored glasses, well definitely, I just see their aviation business, their health care business, what their power business could have been. I think that that’s a really good lesson for me to remember where … I read grants all the time, right? I should have called grants and been like, “Why does Jim hate this entity for 20 years?” Right?

Bill Brewster: Then, I mean, there’s a certain amount of hubris that goes into taking any active stock position, but I probably should have listened to a lot of smart people that were smarter than me. I joke with my buddy who writes under the science of hitting investing. He and I talk a lot. I’m like, “The next time I ever open up a 10K that reads like, GEs, I’m just throwing it away. I’m done.” I still think on an asset value basis, it’s probably cheap. But-

Tobias Carlisle: It’s just got an ocean of debt, isn’t? The debt is the thing that scares me.

Bill Brewster: Yeah, well, it should there. [crosstalk 00:44:58]. It’s got no cash flow, so that’s a bad combo.

Tobias Carlisle: The problem for GE probably started somewhere during Jack Welch’s tenure that they could hit those quarterly earnings numbers to the penny should have been concerning. That’s probably where it started and way, way, way too much debt in there, even off 90%. If you include the debt in the price you’re paying in the EV, it was still bananas expensive, but that’s the boss of the value guy. How did you see it when it was down?

Bill Brewster: No, I think you’re totally right. I figure with the certainty of the cash flows of the aviation business, and where that was growing to, I mean, I think you can make credible argument that that alone is worth 80 to $100 billion. The healthcare business, I thought was worth roughly 40 to 50 billion. They sold that unit to Danaher for, I don’t know what was it, 24, 28 billion. I mean, even their healthcare business is not impaired by that.

Bill Brewster: You’re getting power and G casts and BHGE for close to free, which is the worst way to frame something, right? I mean, it’s free for a reason. What I also didn’t appreciate was how good of the work that Stephen Tusa has done on that name. I think that it’s easy. I think going forward, if there’s a Wall Street analyst that’s really hammering a company, I need to know, probably twice what they’re saying against it, to take the other side.

Bill Brewster: I mean, he’s just been so right and he’s done the job the right way. This ever gets back to him. Good work. That’s [inaudible 00:46:53] if you need me to tell him.

Tobias Carlisle: Let’s talk about some of the areas that you’re hunting now. Financials, what do you like in there and why do you like them?

Bill Brewster: Well, I think I like the big money center banks. I think from what I read, th community banks and the big ones are probably the winners. The ones in the middle, probably aren’t. I’m not a financial specialist, so do your research elsewhere. But I think that a lot of people are fighting the last war there. Look, wells, it sucks to have these headlines come out over, and over, and over again. The other side is look at how they’re performing and how long have these headlines gone on. I mean, that bank is a pretty clean bank, relatively speaking.

Bill Brewster: When we used to compete against them, they used to come in with massive holes sizes. If you’re putting together, call it a $50 million facility, we would have a limit that we’d be comfortable at and it would usually require three banks to come into the facility. Wells, it just come take down the whole thing. Then they say, “All right. Well, with this $50 million commitment, we’re going to own all your cash management, we’re going to do all your credit cards, we’re getting all the ancillaries.” That’s a really, really tough business to displace over time. That’s one that I like.

Tobias Carlisle: They’re very sticky. Everybody’s relationship with the bank is incredibly sticky, because it’s just such a pain to move all of your payments up. You’ve received your salary, and then you move on with your permits. It’s a nightmare to do. Even with those bad headlines, it doesn’t really mean much I don’t think to the ultimate consumer of those products. Maybe there are some people who are so offended by that they moved their accounts away. But I think that there are a lot more people who sit there offended and plan on moving their accounts away than people who actually did that. Where are you going to move them to? It’s not everybody’s in basically the same boat.

Bill Brewster: That’s right. I think, the Facebook narrative last year can teach you a similar lesson. What people say and what they do are different.

Tobias Carlisle: Facebook’s an interesting one, though. I certainly use it very, very rarely. I wonder if the engagement is done a little bit. I don’t know anything about it.

Bill Brewster: To the extent that they report, everything is all cylinders are firing. They don’t report hourly and stuff like that, right? But as far as the user numbers, it’s looking pretty strong, so we’ll see.

Tobias Carlisle: What’s the metric of the daily average user?

Bill Brewster: Yeah, dal and bow, right? But it’s like anything and I’m sure it’s some sort of burrito principle like the 80, 20 rule. I mean, if you looked at some of our Twitter usage, some of us are much more valuable to Twitter than others.

Tobias Carlisle: Well, I have a full blown Twitter addiction. So-

Bill Brewster: Yeah. I do too, I do too.

Tobias Carlisle: That’s where I spend my time. Let’s talk about airlines a little bit, because you follow Berkshire very closely. You’re following the foray into airlines, but you got an interesting view on what ultimately happens there?

Bill Brewster: Yeah, well, I think and I have to credit Phil Ordway for the original idea. He sort of said to me, “If you’re interested, there’s a book called Glory Lost,” and found that the guy I think, Seth Kaplan, is his name. the guy’s an airline weekly road. That is just a phenomenal summary. It’s not an easy read, but it’s a phenomenal summary of what happened over the last decade, well, 2000 to 2012.

Bill Brewster: Look, I think, bottom line is, it’s easy to look at it as a consolidation play. It’s a lot of different factors, but the healthier industry has either resulted or other factors have resulted in them capturing a lot of unit economics of the credit cards. They’re basically credit card companies with wings. As long as they don’t get too stupid and ruin what they have, I think that their future is a lot brighter than their past.

Bill Brewster: I think it’s very funny that everybody talks about them as the consolidation problem in America. I mean, their returns on assets are nothing to gawk at. On top of that, if you want to see what happens when they’re not consolidated, get the taxpayer bailout ready because the … I mean, I don’t know what it was, but 2000 to 2012 or ’14, or whenever that last merger happened, it’s atrocious what that industry does to assets.

Bill Brewster: Today, in Europe, I mean, it’s just bankruptcy after bankruptcy. The thing I love about it is I try especially being a Twitter user as I am. I try to make sure that I don’t get addicted to the things that I’m hammering into my head. To watch Buffett pivot on that, it’s such inspiring for lack of a better term. I don’t want to be a fanboy, but his ability to flip his mind and say, “You what? I don’t care how many times I stood up.” I said, “This is the worst industry ever.” Or, that I said, I have an 800 number that I dial whenever I want to buy one and he goes out and buys all of them.

Bill Brewster: The other thing that I think is sort of interesting is people have said to me, “Well, it doesn’t take a genius to bet on everything in the industry. You could just own an ETF or whatever.” Actually, historically had no aversion to making industry bets back when Clinton Care was being debated.

Bill Brewster: I mean, he said one of his biggest mistakes was not buying a basket of Pharma companies. I think the basket approach is something that I’ve learned a little bit from studying that move of his.

Tobias Carlisle: Before he invested in airlines, they all became incredibly cheap, though. My screen was full of them for a period, and I was at the New York Society of Security Analysts giving a presentation that when somebody asked about that, and I think six or seven out of 30 positions in my large cap screen were airlines at the time. They said, “Would you do it given that you know the buffet is so anti?” And I said, “Well, I have to because-”

Bill Brewster: That’s who I am.

Tobias Carlisle: They’re all cheap. It always does make me nervous because when I fly, I can see every single plane is absolutely packed to the gillS. There’s not a seat open on the planet flight pretty regularly. I fly to different parts of the country, so I’m seeing. I think it’s a reasonably representative sampling of what’s going on. That does make me nervous because it means it’s peak yield for the seats, maybe oil is cheap and so this is as good as it’s ever going to get.

Tobias Carlisle: But then I guess the other argument is, well, there’s a finite number of slots for these planes to land in. It’s not like it’s going to be very hard for any kind of upstart to come in and compete.

Bill Brewster: Yeah, yeah. I think that’s largely true and they can make the planes a little bit bigger. I don’t know how much more they can densify them. I mean, I think they’re pretty much at their maximum density. Something that makes me a little nervous is Delta is adding more premium seats that feels relate cycle to me. They don’t think it is but that’s TBD. I think, going forward, it might be satisfactory.

Tobias Carlisle: Well, the sit density that’s interesting, but one of the things that I have noticed, sometimes I’ll fly in one direction to where I’m going and it will be that the configuration where there’s three seats on each side and four seats in the middle, so it’s a very big plane. Then on the way back, it’ll be that middle of row is just not there and it’s like the six seats across. I think that they’re definitely getting the plane run for th-

Bill Brewster: Oh, yeah.

Tobias Carlisle: … for the flight. Both of them are packed, so they’ve nailed it.

Bill Brewster: Yeah, well, I mean, the 737 and the 8320, I mean, those are awesome machines, I think to the extent that they continue to standardize their fleets. They are not going to capture any of the economics of that, right? I mean, in my view, it all gets competed away, but it benefits consumers in that it can reduce the cost of flying. As Buffett likes to say, “So and then what?”

Bill Brewster: Well, they’re probably going to expand too much if oil is low, but if it’s high, they’ll probably pull back on capacity expansion. They’ve been able to manage through it, I mean. I think the overhang currently that exists on the stocks are everybody wants to see what happens in a recession.

Tobias Carlisle: Right.

Bill Brewster: My biggest fear with Delta is that it’s going to sell off and my main man, Warren is going to come over the top of me with a cash offer and lock in my loss. I’m going to be like, “Oh-

Tobias Carlisle: The taekwondo.

Bill Brewster: … yeah. I was right and I lost look at me.” But it’ll be interesting to watch it. Four of them control 80% of the seats will see how rational they can be.

Tobias Carlisle: It’s funny if one of them … I don’t think one of them goes to … I don’t think there’s a zero in there. I don’t think it’s a donut, but I heard there’s a great how I built this with Herb Kelleher, which is one of the … And they brought it out again recently, when he passed away. Herb Kelleher, who was the CEO, sort of founder, creator of Southwest. He said that the biggest problem in this industry is when one of those companies fails, it’s very easy for one of the other businesses to just go and pick up that plane. Now, the acid flat onto a route like a day later, it’s back in service.

Bill Brewster: Yeah. Well, there’s a reasonable argument to be made that that’s why maybe the leasing is a better place to play here, right? Because with the advent of the ultra low cost carrier model, there’s probably going to be somewhere to move that plane and who really cares? I mean, as long as your credit risk isn’t terrible, you’re probably going to keep generating some least revenue. I understand the merit in that.

Tobias Carlisle: Bill, we’re coming up on time. Just before we go, you’re a father three boys and-

Bill Brewster: Yes.

Tobias Carlisle: … homage to the great, man. What’s your most recent-

Bill Brewster: The third is Warren Graham. So-

Tobias Carlisle: That’s fantastic.

Bill Brewster: Yeah, if anyone’s tired of the Buffett Talk, I’m sure there’s a nice eye role there. I did it. My wife gets embarrassed about it. I love those guys so much because they’re free thinkers. I mean, what I know who they are, if they weren’t so rich, no, I would not, right? But I understand why people knock Buffett. I know that they see some stuff that he does is inconsistent, or he gets these sweetheart deals. That dude earned all the sweetheart deals he has, and he’s not going to sit here and tell you everything he’s thinking. He’s not going to … I mean, life is inherently inconsistent in some ways.

Bill Brewster: I just really respect everything that they’ve given me, and I hope my third kid has the chutzpah to do it his own way, and I hope he’s successful. That’s why he got the name. Plus, Warren G is a great rapper.

Tobias Carlisle: I love that quote, a foolish consistency is the hobgoblin of a small mind. I think that’s Thomas Jefferson, but I might be wrong about that. If-

Bill Brewster: Yeah. That is a good one.

Tobias Carlisle: If folks are interested in following you on Twitter, what’s your Twitter handle?

Bill Brewster: @BillBrewsterSCG and I write @sullimarcaptal.group. You can always email me through that.

Tobias Carlisle: We’ll put the links to that in the show notes. It’s always going to be on the YouTube show notes. That’s the easiest one to find, but you’ll find them on … I always publish them and push them out through anchor. I don’t know if they necessarily appear on every website. But if you need them, you can always come to acquirersmultiple.com/podcast and all of that. All that content will be there.

Tobias Carlisle: It’s been really fun chatting to you, Bill. Thanks so much for spending the time.

Bill Brewster: Yeah, man. Thanks for having me. Good seeing you again.

Tobias Carlisle: Pleasure.

Bill Brewster: All right. Take care.

TAM Stock Screener – Stocks Appearing in Greenblatt, Ainslie, Griffin Portfolios

Johnny HopkinsStock ScreenerLeave a Comment

Part of the weekly research here at The Acquirer’s Multiple features some of the top picks from our Stock Screeners and some top investors who are holding these same picks in their portfolios. Investors such as Warren Buffett, Joel Greenblatt, Carl Icahn, Jim Simons, Prem Watsa, Jeremy Grantham, Seth Klarman, Ray Dalio, and Howard Marks.

The top investor data is provided from their latest 13F’s. This week we’ll take a look at:

DXC Technology Co (NYSE: DXC)

DXC Technology is a vendor-independent IT services provider that started trading in April 2017. DXC was created via the amalgamation of Computer Sciences Corporation, or CSC, and Hewlett Packard Enterprise’s Services business. The combined company has enviable global scale, with annual revenue of around $25 billion, over 170,000 employees, operations across 70 countries, and broad industry exposure. In addition, the firm has roughly 6,000 clients, of which over 200 are within the Fortune 500.

A quick look at the price chart below for DXC Technology shows us that the stock is down 42% in the past twelve months. We currently have the stock trading on an Acquirer’s Multiple of 7.94 which means that it remains undervalued.

(Source: Google Finance)

Superinvestors who currently hold positions in DXC Technology include:

Lee Ainslie – 5,356,833 total shares

Cliff Asness – 3,981,537 total shares

Ken Griffin – 1,696,137 total shares

Alexander Roepers – 721,968 total shares

Wally Weitz – 618,500 total shares

Joel Greenblatt – 439,744 total shares

Paul Tudor Jones – 9,342 total shares

This Week’s Best Investing Reads 6/14/2019

Johnny HopkinsValue Investing NewsLeave a Comment

Here’s a list of this week’s best investing reads:

Howard Marks Memo – This Time It’s Different (Oaktree Capital)

When Does the Stock Market Go Up? (A Wealth of Common Sense)

Meatless Future or Vegan Delusions? The Beyond Meat Valuation (Aswath Damodaran)

This Is One Of The Worst Risk/Reward Setups In History (Felder Report)

Ackshually… (The Irrelevant Investor)

A 2% tax on America’s 75,000 wealthiest families would raise $2.75 trillion (The Reformed Broker)

A Conversation with David Perell (Jason Zweig)

The truth about growth and value stocks (McKinsey)

Swedroe Reviews New Book on Behavioral Investing (Validea)

Idealist, I Am (Vitaliy Katsenelson)

Can Machines “Learn” Finance? (AQR)

If 98% of the Funds don’t Beat the Market, Why doesn’t Everyone just Invest in a Low Cost Index like S&P500? (ValueStockGuide)

Being Wrong When You Get It Right (Of Dollars and Data)

Investors Have Fewer Reasons Than Ever for Home Bias (Morningstar)

How to Win Any Argument About the Stock Market (Fortune)

The Case Against Small Caps (CFA Institute)

i3 Insights: Survival = Risk Management (Market Fox)

Investing as a hobby (Medium)

Q&A With Kimbal Musk, Cofounder of Square Roots & Board Director at Tesla, Space X, and Chipotle (Collaborative Fund)

The Art of Thinking Clearly (Barel Karsan)

What are the Chances of Finding an Active Manager with Skill? (Behavioural Investment)

Jeff Bezos Explains Why Amazon Makes No Profit (YouTube)

Secrets of Sand Hill Road (Venture Capital and How to Get It) — Know Venture Capital Before You Get Married to a Venture Capitalist (25iq)


This week’s best investing research reads:

Short Squeeze (csinvesting)

Three Charts I Think I’m Thinking About (Pragmatic Capitalism)

The 2% Position Risk Rule: Facts and Fiction (Price Action Lab)

How Important Is Stock Market To Economy? (UPFINA)

Quantitative Styles and Multi-Sector Bonds (Flirting with Models)

“What is an Oddball Stock?” (Oddball Stocks)

Cheap Versus Expensive Countries (FactorResearch)

Are momentum models better than moving average models? Some useful tips (Mark Rzepczynski)

Value Factor Valuations Over Time: US and Developed (Alpha Architect)

Emerging Markets Debt Outlook (Advisor Perspectives)

Where to invest in the next 10 years, 20 years and 30 years? (13D Research)


This week’s best investing podcasts:

David Abrams – Applying a Fundamental and Value-Oriented Approach to Investing (Value Investing With Legends)

#1309 – Naval Ravikant (Joe Rogan)

Russ Roberts on Life as an Economics Educator (Coversations With Tyler)

TIP246: Part 2 – Berkshire Hathaway Shareholders Meeting Q&A – Warren Buffett & Charlie Munger (The Investors Podcast)

Dad Cat Bounce (Animal Spirits)

Jerry Neumann – Why Venture is Hard – EP.134 (Invest Like The Best)

Episode #160: John Huber, “Stock Prices Fluctuate Much More Than The Underlying Businesses” (Meb Faber)

Patrick O’Shaughnessy – O’Shaughnessy Asset Management (First Meeting, EP.01) (Capital Allocators)

Ep 128: Advising Small Business Owners By Helping Them Increase Their Own Enterprise Value, with Justin Goodbread (FA Success)

Frank Holmes: Keynote: New Technologies will Disrupt Mining, Investing, and how to Spot Opportunities (Palisade Radio)

Wall Street’s Endangered Species

Tobias CarlisleStock Screener1 Comment

Twenty years ago in the spring of 1999, Piper Jaffray’s Daniel J. Donoghue, Michael R. Murphy and Mark Buckley*, produced a research report called Wall Street’s Endangered Species (incredibly, the link is still live 20 years later) that was hugely influential on my investment process. The thesis of the paper was that there were a large number of undervalued companies with strong fundamentals and solid growth prospects in the small cap sector (defined as stocks with a market capitalization between $50M and $250M) lacking a competitive auction for their shares. Donoghue, Murphy and Buckley argued that the phenomenon was secular, and only mergers or buyouts would “close their value gap:”

Management buy-outs can provide shareholders with the attractive control premiums currently experienced in the private M&A market. Alternatively, strategic mergers can immediately deliver large cap multiples to the small cap shareholder.

This led to the emergence of activist investors in the small cap sector over the first decade of the Oughts. A similar phenomenon exists now in the SMID cap space.

Endangered species report

The document was drafted from the perspective of a M&A team selling corporate advisory services:

Many well-run and profitable public companies in the $50-250 million market capitalization range are now trading at a significant discount to the rest of the stock market. Is this a temporary, cyclical weakness in small stocks that is likely to reverse soon? No, these stocks have been permanently impaired by a shift in the economics of small cap investing. This persistent under-valuation is sure to be followed by a rise in M&A activity in the sector. We have already seen an uptick in the number of “going private” transactions and strategic mergers involving these companies. Management teams that identify this trend, and respond to it, will thrive. The inactive face extinction.

Donoghue, Murphy and Buckley’s thesis was based on the then relative underperformance of the Russell 2000 to the S&P 500:

The accompanying graph, labeled Exhibit I, illustrates just how miserably the Russell 2000 lagged the S&P 500 not only last year but in 1996 and 1997 as well. Granted, small cap returns have tended to run in cycles. Since the Depression, there have been five periods during which small cap stocks have outperformed the S&P 500 (1932-37, 1940-45, 1963-68, 1975-83, and 1991-94). It is reasonable to believe that small caps, in general, will once again have their day in the sun.

They argued that the foregoing graph was a little misleading because the entirety of the Russell 2000 universe wasn’t underperforming, just the smallest members of the index:

However, a closer look at the smallest companies within the Russell 2000 reveals a secular decline in valuations that is not likely to be reversed. The table in Exhibit II divides the Russell 2000 into deciles according to market capitalization. Immediately noticeable is the disparity between the top decile, with a median market capitalization of $1.5 billion, and the tenth decile at less than $125 million. Even more striking is the comparison of compounded annual returns for the past ten years. The data clearly demonstrates that it is not the commonly tracked small cap universe as a whole that is plagued by poor stock performance but rather the smallest of the small: companies less than about $250 million in value.

Stocks trading at a discount to private company valuations

The underperformance led to these sub-$250M market cap companies trading at a discount to private company valuations:

Obscurity in the stock market translates into sub-par valuations. As shown in Exhibit IV, the smaller of the Russell 2000 companies significantly lag the S&P 500 in earnings and EBIT multiples. It is startling to find that with an average EBIT multiple of 9.0 times, many of these firms are valued below the acquisition prices of private companies.

And the punchline:

Reviving shareholder value requires a fundamental change in ownership structure. Equity must be transferred out of the hands of an unadoring public, and into those of either: 1) management backed by private capital, or 2) larger companies that can capture strategic benefits. Either remedy breathes new life into these companies by providing cheaper sources of capital, and by shifting the focus away from quarterly EPS to long-term growth.

Increasing M&A activity

The market had not entirely missed the value proposition. M&A in the small cap sector was increasing in terms of price and number of transactions:

Darwin’s Darlings

Donoghue, Murphy and Buckley argued that the value proposition presented by these good-but-orphaned companies, which they called “Darwin’s darlings,” presented an attractive opportunity, described as follows:

Despite the acceleration of orphaned public company acquisitions in 1997 and 1998, there remains a very large universe of attractive public small cap firms. We sifted through the public markets, focusing on the $50-250 million market capitalization range, to construct a list of the most appealing companies. We narrowed our search by eliminating certain non-industrial sectors and ended up with over 1500 companies.

We analyzed their valuations relative to the S&P 500. The disparity is so wide that the typical S&P 500 company could pay a 50% premium to acquire the average small cap in this group without incurring earnings dilution. Those dynamics appear to be exactly what is driving small cap takeover values. The median EBIT multiple paid for small caps in 1998 was roughly equal to where the typical S&P 500 trades.

We honed in on those companies with multiples that are positive, but even more deeply discounted at less than 50% of the S&P 500. Finally, we selected only those with compounded annual EBIT growth of over 10% for the past five years. As shown in Exhibit VII, these 110 companies,“Darwin’s Darlings,” have a median valuation of only 5.8 times EBIT despite a compounded annual growth rate in EBIT of over 30% for the past five years.

The emergence of activists

Donoghue, Murphy and Buckley identified the holders of many of these so-called “Darwin’s darlings” as “small cap investment funds focused on likely takeover targets:”

As detailed in the description of our “Darwin’s Darlings” in Exhibit VIII, management ownership varies widely among these companies. For recent IPOs of family-held businesses, management stakes are generally high. For those that were corporate spin-offs, management ownership tends to be low. We frequently find large blocks of these stocks held by small cap investment funds focused on likely take-over targets, leading to a surprisingly high percentage of total insider ownership (management plus holders of more than 5%).

Regardless of ownership structure, these companies typically have the customary defensive mechanisms in place. They are also protected by the fact that they are so thinly traded. In most cases it takes more than six months to accumulate a 5% position in the stock without moving the market. Hence, we expect virtually all acquisitions in this sector to be friendly. There is no question that some very attractive targets cannot be acquired on a friendly basis. However, coercing these companies into a change of control means being prepared to launch a full proxy fight and tender offer.

In When Wall Street Scorns Good Companies, a Fortune magazine article from October 2000, writer Geoffrey Colvin asked of Darwin’s darlings, “So why are all these firms still independent?”

The answer may lie in another fact about them: On average, insiders own half their shares. When the proportion is that high, the insiders are most likely founders; they have enough stock to fend off any hostile approach, and they haven’t sold because they aren’t ready to give up control. Not many outside investors want to go along for that ride. Thus, low prices.

But there’s still a logical problem. Since the companies are so cheap, why don’t managers buy the shares they don’t already own– take the company private at today’s crummy multiple, then sell the whole shebang at an almost guaranteed higher price? Going private has in fact become more popular than ever, but what seems most striking is how rare it remains. Of Piper Jaffray’s 1999 Darwin’s Darlings– 110 companies–only three went private in the following 12 months. That makes perfect sense if you figure that many of the outfits are run by owner-managers whose top priority is keeping control. Announce a going-private transaction and you put the company in play, and even a chummy board may feel obliged to honor its fiduciary duty if a higher bid comes along.

Thus we reach the somewhat ugly truth about Wall Street’s orphaned stars: Many of them (not all) like things the way they are–that is, they like staying in control. The outsider owners are typically a diffuse bunch in no position to put heat on the controlling insiders. The stock price may be lousy, but when the owner-managers decide to sell–that is, to get out of the way–it will almost certainly rise handsomely, as it did for the 19 of last year’s Darwin’s Darlings that have since sold.

So shed no tears for these scorned companies, and don’t buy their shares without a deep understanding of what the majority owners have in mind. In theory the spreading corporate governance movement ought to protect you; in practice the shareholder activists have bigger fish to fry. Such circumstances may keep share prices down, but that’s the owner-managers’ problem. At least, in this case, the market isn’t so mysterious after all.

The report predicted for the emergence of the activists in the small cap sector. Observing that stock prices rose dramatically when owner-managers of “Wall Street’s orphaned stars” decided to sell, and outside investors were “typically a diffuse bunch in no position to put heat on the controlling insiders,” activist investors saw the obvious value proposition and path to a catalyst and entered the fray. This led to a golden decade for activist investing in the small cap sector, one that I think is unlikely to be repeated in the next decade. Regardless, it’s an interesting strategy, and an obvious extension for an investor focussed on small capitalization stocks and activist targets.

*Donoghue, Murphy and Buckley in 2002 founded Discovery Group (unfortunately, the link is dead), a fund manager and M&A advisory that took significant ownership stakes (up to 20%) in companies trading at a discount to “fundamental economic value.” If anyone knows where Donoghue, Murphy or Buckley went, I’d be happy to chat to them.

This website, and my firm Acquirers Funds®, employs a similar deep-value strategy in the SMID cap space. If you’d like to learn more, contact me at tobias@acquirersfunds.com.

What Are The 20 Best And Worst Countries To Invest In According To The Human Freedom Index

Johnny HopkinsPodcastsLeave a Comment

During her recent interview with Tobias, Perth Tolle who is the Founder of Life + Liberty Indexes discusses some of the best and worst countries to invest in according to the ‘human freedom index’. Here’s an excerpt from the interview:

Tobias Carlisle: You may be not allowed to say this but Alpha Architect, they’re going to be providing the underlying ETF. You provide the index, the underlying ETF and the ticker again is FRDM. I have to very careful about the way that I pronounce there because Australians slur through our words. So I always do the American pronunciation for the ‘R’ which I know gets me a lot of grief back home. But FRDM, freedom is the ticker. One of the things that when we first met I didn’t quite realize there was an emerging market focus for your first fund. We discussed and something that I’m very interested in, which are the freest countries in the world?

Perth Tolle: Yeah, so some of the Nordic countries are very free. Hong Kong and Singapore are considered very free. So Hong Kong, Singapore-

Tobias Carlisle: Hong Kong?

Perth Tolle: Norway. Hong Kong yeah because remember there’s a slight time lag in the data. So Hong Kong is still considered very free by especially economic freedom standards. They’re number one as far as economic freedom in the world, tied with Singapore. We are expecting to see that come down as China gains influence in the region, but as far as economic they’re still the highest out there.

Tobias Carlisle: And where does the US rank?

Perth Tolle: I have to look that up but I believe it’s somewhere around 18. Let me look it up.

Tobias Carlisle: Well, I looked it up this morning.

Perth Tolle: Okay.

Tobias Carlisle: And I saw your tweet about.

Perth Tolle: You’re just testing me then?

Tobias Carlisle: No, no, no. Well, a little bit.

Perth Tolle: I only look at emerging markets.

Tobias Carlisle: You’ve got give me the top 100 from one to 100, go. No, I wouldn’t do that to you.

Perth Tolle: Exactly.

Tobias Carlisle: Do you know the reasons why? So why is America at 18 and not sort of say closer to the very top?

Perth Tolle: Yeah, so one of the things I’ve heard from the people that compile this index, who are great. Is that the war on drugs and the war on terror caused our scores to go down. So in the last recent years. So a lot of government spending and interference and things like that. That’s what I heard.

Tobias Carlisle: And because 10% of my listeners are Australian. Where does Australia rank? Do you know?

Perth Tolle: Very high, it’s very high.

Tobias Carlisle: No war on drugs or terrorism.

Perth Tolle: Why don’t you tell me since you looked it up? But it is very high.

Tobias Carlisle: I’m happy to hear that.

Perth Tolle: Yeah. I’m going to actually look that up right now since you’re testing me and now I’m curious where Australia… At least I know it’s really high. So I can’t actually see the screen right now. Don’t do anything weird. If anyone else wants to look this up there’s a couple ways. This is done by Fraser, Cato and Friedrich so if you go any of those you can find it, and right now I am going to Cato and I’m just pulling the data and then I will rank. Source countries. So Australia they have a human freedom score which is the composite score. Eight point five eight out of 10. Their rank is four.

Top 20

(Source: cato.org)

Bottom 20

(Source: cato.org)

Tobias Carlisle: Four. Human freedom?

Perth Tolle: Number four. So extremely free.

Tobias Carlisle: So who’s one, two, three? New Zealand.

Tobias Carlisle: Chile.

Perth Tolle: No, Chile is not. Chile is below Australia. This is a whole 160 countries, so I’m going to just sort by rank. New Zealand, Hong Kong, Switzerland, Australia.

Tobias Carlisle: Wow, that’s a good outcome. Behind New Zealand. Shout out to my kiwi buddies. You’ll be able to remind me of that one next time we see each other.

Perth Tolle: Yeah.

Tobias Carlisle: It’s probably based on how you play rugby which unfortunately Australia’s not doing well there.

Perth Tolle: No, this is the composite score. So this includes human freedom and economic freedom. If you look at just economic freedom, Hong Kong is number one.

Tobias Carlisle: Good sevens rugby there too. So thanks very much for that, Perth. That’s very interesting.

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Michael Burry: Don’t Try To Dig Your Way Out

Johnny HopkinsInvesting Strategy, MIchael BurryLeave a Comment

Following is an excerpt from Michael Burry’s MSN Case Studies in which he provides some great advice for investors who are tempted to take increased risks in order to dig themselves out of a hole, saying:

A key phenomenon driving the recent stock market advance is the need for so many fund managers to catch up. Having had discouraging years through the end of September, many professional investors took on increased risk in order to dig themselves out of a hole. I warned against this tendency during the last Strategy Lab round. The math of investing requires a 50% gain to wipe out a 33% loss, and the only catch-up tool most professional investors have at their disposal is to take on increased risk.

Moreover, the year-end represents a nail-biting finish to a very grand one-year performance derby. The winners of the derby reap massive rewards. For most, missing a year-end rally would be fatal to such aspirations. Hence, just as happened twice earlier this year, Wall Street has climbed the wrong wall of fear; the common fear has been of missing the next bull market, not of further stock market losses. Fundamental valuations have been cast aside in the scramble. And once again, in the short run, mob rules.

One argument that has been used to sell and to sustain this rally as the real thing is the idea that the stock market rallies 25% or so 4-6 months in advance of an economic recovery. Therefore, as a rally reaches those proportions, predictions of a recovery 4-6 months out become ever more confident and full of bluster. Yet, to borrow a phrasing, the market has predicted two of the last zero economic recoveries in 2001 alone! Circular logic remains an oxymoron.

Of course, even if we have economic stabilization or recovery, it would be wrong to assume that this would be a boon for stocks in general.

Indeed, for most investors, it would be better to watch interest rates. Interest rate changes become more significant in stock valuation when valuations are very high. That is, investment in a stock with a price/cash earnings multiple of 25 will be much more sensitive to interest rates than investment in a stock with a price/cash earnings multiple of 5. Rising rates paired to a richly valued stock market ought not result in a significant new bull market, despite an expanding economy. To put this in other terms, most widely held stocks have already (over)priced in a substantial economic and earnings recovery – even as they sit far below their highs of yesteryear.

Contrary to the somewhat absurd notion that all we have to really fear is missing a rally, I truly only fear permanent and absolute capital loss. Over the course of this round, I will place my investments as very good opportunities arise.

You can read Michael Burry’s MSN Articles here: Michael Burry’s MSN Articles.