tag:blogger.com,1999:blog-246953852024-03-06T23:34:11.523-05:00The Strategic Investor"Investing is at its most intelligent, when it is at its most business-like" -- Benjamin GrahamStrategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.comBlogger183125tag:blogger.com,1999:blog-24695385.post-28937998981628980482022-01-31T10:40:00.000-05:002022-01-31T10:40:51.569-05:00My take on Stolt-Nielsen a well run business in a tough industry, experiencing improving economics<p>So, I think I have mentioned Stolt before - and I must admit that I sort of like Norwegian shipping companies. It is a particular expertise of these crazy Scandinavians (Moller-Maersk is Danish, but they crowns were in personal union for about five hundred years before the Napoleonic settlement saw Norway handed to the Swedes for a century). Norwegians also operate Wallenius Willhemsen, which is a very interesting freight company that specializes in automotive transport and is moving from specialized ships (and the cost and efficiency there) to whole solutions end to end, which is pretty smart.</p><div><br /></div><div>A company that already does this, though is Stolt-Nielsen; still controlled by the founding family, the sons of the late founder, it has had its challenges like so many other freight companies. The specialties of Stolt are chemicals transport, and this they manage, often on very long term contracts, on either a stage or an end to end basis. Because 70% or so of their volume is contract (COA) they have stable revenues and can therefore manage some higher debt levels than many of the competitors, it also means that even when, during the weakness in shipping that has seen massive consolidation in say dry bulk shipping, Stolt has been profitable. They operate deep sea Tankers (specialized with multiple compartments to be able to handle multiple different chemicals), barges for inland shipping, Tank Containers (these are basically container frames with a tank inside of them instead of a box; they are much safer and cheaper, actually than the alternative, which is the liner inside of a standard container, and of course, they are fully intermodal, so rail or truck work for these as well. The also operate the storage terminals that are the lifeblood of the system - so managing chemicals that need to be offloaded for the tank containers to be reused or for the vessels so they can reload. These are very long-term assets and they are rare, at least in the locations that really matter (like Houston).</div><div><br /></div><div>Finally, they have a fish technology, focused on land aquaculture - basically an indoor, above ground fish farm focused on turbot and sole. this business lost money for some time but lately has managed to be consistently profitable as they believe they have finally "cracked the code". There is considerable environmental benefit, actually, as it reduces demand on sea-based aquaculture and also generates fertilizer and another useful by-products. They are gaining share and are able to power much of the facility with solar, as they tend to place them in pretty sunny areas.</div><div><br /></div><div>For capital renewal, they have filed to publicly list the tanker biz, though they have declined to do it so far. There is a reason they plan to do this. More on this in a minute. They also have looked to list the fish business as a stub. Both are a means to access more capital for their core strategy which they finally admitted in full in todays' results. The business has done ok, in a tough environment but has finally started to show the real EBITDA earning power that is there. Even so, the sector remains somewhat stressed. You can see that EBITDA is rising and debt levels are really starting to fall, and if 1Q beats last year EBITDA by 20-30m they will be well on their way to $600m EBITDA, interest coverage of 5x, lower debt and just all-around improved ratios. This can give them the power to reload for the next phase of the plan.</div><div><br /></div><div><img alt="image.png" class="CToWUd a6T" data-image-whitelisted="" height="375" src="https://mail.google.com/mail/u/0?ui=2&ik=7e5d5f2dc6&attid=0.1&permmsgid=msg-a:r521910623356097342&th=17e9ccfe21b7ffe1&view=fimg&fur=ip&sz=s0-l75-ft&attbid=ANGjdJ9QsCh6InTwRju-7xBZP4kTjEuQcw-E-5ivJ88Gl08q720ME21Yu47IJfvKFBqVm2f6zjPQgat3I7nyEpHaYGEaZ20bFnwnLCEmMTnG50PeP89CNf7G5ifhuMQ&disp=emb&realattid=ii_kyx81j5o0" style="cursor: pointer; outline: 0px;" tabindex="0" width="562" /><br /></div><div><br /></div><div><br /></div><div>Their goal has been to consolidate and in today's chart it is evident why this is so:</div><div><br /></div><div><img alt="image.png" class="CToWUd a6T" data-image-whitelisted="" height="375" src="https://mail.google.com/mail/u/0?ui=2&ik=7e5d5f2dc6&attid=0.2&permmsgid=msg-a:r521910623356097342&th=17e9ccfe21b7ffe1&view=fimg&fur=ip&sz=s0-l75-ft&attbid=ANGjdJ_ClG-RJ9_oKbx0Kk6OFiVSuIogsgzxOS0qO4pcMrRNMnkYqe4UHESJry5nOlNl7yKvw-rp1nqPsAHJGNyLUYf8UcbhoiOzKYhl5DryZdGjnRFP7o_wHqdWBJ0&disp=emb&realattid=ii_kyxaes9x1" style="cursor: pointer; outline: 0px;" tabindex="0" width="562" /><br /></div><div><br /></div><div>They have 10% share of a market and believe that consolidation is going to be the future here. Shipping has earned, by their own admission, poor returns over the past 20 years. Many of the smaller players are poor operating stubs from hedge funds that saw shipping as a carry trade. In fairness, management has been pursuing this strategy with JVs and also by acquiring some other solid operators, like JO Tankers. That has caused debt levels to be higher than expected, but I now expect that they will be opportunistic and strategic buyers over the next five years. I expect that they can use their size and balance sheet and operating advantages to grow their share of the market - whether through having a disproportionate share of Newbuildings (note the middle graph with the tonnage shares) and through deals (and a possible listing of the deep sea business, which offers them the potential benefits of low cost equity AND the ability to hold themselves out to financial investors in the future as a kind of "tanker trust" - for that hedge fund that wants a market exposure to shipping but not the operational headaches:</div><div><br /></div><div><img alt="image.png" class="CToWUd a6T" data-image-whitelisted="" height="375" src="https://mail.google.com/mail/u/0?ui=2&ik=7e5d5f2dc6&attid=0.3&permmsgid=msg-a:r521910623356097342&th=17e9ccfe21b7ffe1&view=fimg&fur=ip&sz=s0-l75-ft&attbid=ANGjdJ8KMIy-iExzBllCylVHB8QDf6njN2iY80HCjLcxOUK5RMWmxgqhv2ijC4yfGORovzh0TVuYP02msleNwj3Y2EDNYy-yPRQS3R7Si4gY8ixmpb0-XSN-y3S_5WY&disp=emb&realattid=ii_kyxajyso2" style="cursor: pointer; outline: 0px;" tabindex="0" width="562" /><br /></div><div><br /></div><div>Stolt is probably the only player in the space with this many strategic options. A fair question is whether this is going to be a great space in the future. I cannot say for sure. I believe that chemicals will remain immensely important to (post)modern life and that transport of those chemicals - ideally in ways that are seen as environmentally friendly (no FIJI water, please) - will be important. Transport of the chemicals means better distribution, but also manufacturing and refining of those chemicals in fewer, more efficient sites than otherwise would be necessary. Again, Stolt is probably in the best position to modernize its fleet, not only does it have certain economies and efficiencies, itis a strategic industry in Norway, a place known for generous subsidies for green projects:</div><div><img alt="image.png" class="CToWUd a6T" data-image-whitelisted="" height="375" src="https://mail.google.com/mail/u/0?ui=2&ik=7e5d5f2dc6&attid=0.4&permmsgid=msg-a:r521910623356097342&th=17e9ccfe21b7ffe1&view=fimg&fur=ip&sz=s0-l75-ft&attbid=ANGjdJ_1CO_tCAvYO76j2eBla1kU0RWvi4xTSmT-yuXWsucxT4oUrUsEd1de8aMQiZegAgV-9kUhMFPByG5i3ZgXjNvSzfkgKKIOP6WmwKNTMF0bPr8evGMh93_YYfc&disp=emb&realattid=ii_kyxatl8n3" style="cursor: pointer; outline: 0px;" tabindex="0" width="562" /><br /></div><div><br /></div><div>So, what could this / is this worth? Well, I think forward EBITDA is likely to come in around $600m, though I confess that most of the risk there is to the downside. But EBITDA now is finally over the $150m threshold, and trailing 12 month is $538m, which means that even with some seasonally weak quarters, NTM can still get close. There's about $2.3bn in net debt, tho that has been on a downward trend of late and seems likely to continue (except if they start buying other firms, but then revenue is likely to rise and profits are likely to go with it). And the market value is about $850m or so, for an EV of $3.2bn, which is roughly 5.3x. EV / EBITDA (forward, assuming the $600m). That is not exactly expensive. Lower debt and improved operations, I think, could see - a restoration of the $1 dividend (something management is committed to), further balance sheet enhancements and possibly a higher rating from the market. No guarantee, but could a more profitable growing company in a long-cycle business see a few turns or at least one, even as EBITDA rises? If so, could we see a 2x of this in the next 12-18 months; from rising EBITDA, lower debt and lightly expanded multiple? Say $200m from debt reduction, $200m from expectations of further forward EBITDA and a half turn of multiple expansion, if only from yield hungry investors being willing to accept a 3-4% yield?</div><div><br /></div><div>The risks, of course, are inflation - that multiples contract. This is a risk, but honestly, how much could they contract from here? Take out a turn and the equity goes to $200m, at which point, buybacks and speculators would surely be on the table. The dividend yield would be, what 12% even at $0.50... Seems unlikely. Also, if that happens, it means competitors should be available pretty cheaply, too and so their ability to increase operations and share would increase.</div><div><br /></div><div>Moreover, many of their costs are actually pretty stable - their assets, purchased at legacy prices are likely to retain much of their value, and some things, like the land they have, are just more and more wealthy as they go. So. I see this as pretty asymmetrical - I think they are in a key industry, I think they have very smart operations and a very good operating model and I think that bigness will give them an advantage going forward.</div><div><br /></div><div>It's not conventional, but I like being paid while I wait and I think that like many long-cycle industries, this is one that has been punished for the time it has taken to turn the ship around, even though theirs was always sailing a profitable course.</div><div><br /></div><div>I am long and have been for some time, and I think we are on the cusp of seeing this break out, so there is a chance to get in here at a very fair valuation and experience some pretty nice gains.</div><div><br style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;" /></div>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-62200709872144701552021-09-03T10:53:00.002-04:002021-09-03T10:53:45.403-04:00FRMO Annual Shareholder Letter Posted<p> One of the most important letters, and one that is not well followed, the <a href="https://www.frmocorp.com/_content/letters/2021.pdf">FRMO Corporation Annual Shareholder Letter</a> has posted. It has some very interesting details on some of the activities happening in FRMO / Horizon Kinetics operations. The creation of a tradable diamond security as a crypto token.</p><p><br /></p><p>The annual report is also available <a href="https://www.frmocorp.com/_content/10k/FRMO_Annual_Report_2021.pdf">here</a>.</p><p><br /></p><p>Growth in book value has been impressive and many small private equity and angel style investments are starting to compound into more significant operations.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-41582744986921851042021-08-27T21:16:00.002-04:002021-08-27T21:16:14.114-04:00Core Molding Technologies (CMT) New Investor Deck is out and its Fantastic<p> Definitely worth a read.</p><p><br /></p><p>You can download it here. <a href="https://coremt.com/wp-content/uploads/2021/08/Core-Molding-Technologies-IR-2021.pdf">PowerPoint Presentation (coremt.com)</a></p><p><br /></p><p>I believe this company is worth $30/sh and not less than $24 and it trades at $15. That value gap could close rapidly.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-82894300352121475292021-08-18T08:28:00.005-04:002021-08-18T08:28:52.889-04:00Earnings "Consensus" - and value<p> Short post today - but a pet peeve - why do financial reporters refer to averages as "consensus"? A consensus is a thing - it is when there is broad agreement, that is, it is a statement of FREQUENCY of observation, or a mode - an average of widely disparate values is not a "consensus", it is an average. </p><p>If you, know, 20 people come to roughly the same estimate of something, then there is consensus - it expresses a statement about the level of confidence of the crowd; they all agree with each other at least. Too often, though, analyst estimates are far apart, as when someone thinks they will earn $1 a share, someone else $2 and someone else $0.21. The average of their estimates is $1.07, but there is no "consensus" that this is true.</p><p>I think the root cause of this is that the journalists are relying on a service that claims to produce "consensus" values, so they quote that like sports commentators talking about the NFL.</p><p>But even that, I think, is derivative of an economic concept that market prices represent the "consensus" view of the value of something. Since price discrimination happens frequently, how much consensus their really is in markets is tough to say. Auctions, like stocks, perhaps, settle at prices that reflect the aggregate willingness of buyers and sellers to transact business, but even that is not a "consensus" really. This can be useful for understanding a solitary quoted market price, if that is your academic purpose, but in fact, there are still a range of values (most bids and asks go unfilled, but does that mean that their is broad agreement about the true "value" of the thing, or just that that is a place where at a moment in time a buyer and a seller were able to agree to do business, doesn't make it a consensus. The assumption that what we are doing is just a stochastic and iterative pricing exercise is wrong, just as claiming that wildly divergent views represent consensus is wrong. </p><p>Price discovery may be the goal of the AUCTIONEER or the student of auctions, but it is not necessarily the goal of the participant and quite frankly, the exact same asset can have quite different value depending on the circumstances of the buyer and seller.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-24273923838234928212021-05-03T06:07:00.005-04:002021-05-03T06:07:56.771-04:00ELLH - the worst security on the market?<p> Elah holdings - ELLH - is an NOL cashbox that has a valuation that makes no sense, but which demonstrates how illiquidity can work to keep a price from finding a level in any way commensurate with fair value.</p><p>This is a company that has $15m in assets, 735k shares, and a <a href="https://www.otcmarkets.com/stock/ELLH/disclosure">$99 price tag</a>, as of 2 May 2021. How this can be is a mystery, since it has no meaningful operations - it generated $179,000 in revenue (no, this is not in thousands), but experienced $2m in SGA costs as management set about looking for an operating company to purchase. It DOES have $1bn in NOLs, which, when you think about it, is a pretty impressive achievement. It's hard to make $1bn, but in some ways, it might be harder to lose that much, inasmuch as you have to find investors to provide the capital that was incinerated with such aplomb.</p><p>That means that the business, at one time, and likely for some time, had to be a success, growing funds internally and possibly through additions of outside capital. Also, that such a business was so spectacularly mismanaged that management could neither see the hopelessness of the situation (and therefore unload the business) or solve the competitive problem. One would expect that such management would be jettisoned in favor of new owners and leadership that can pick up the pieces. In the case of ELLH, incredibly, the stunning collapse did not result in a wholesale change of management, with the present CEO serving as a holdover; indeed the CFO who presided over the final immolation of the previous incarnation of the business.</p><p>But really, what are those NOLs worth? Alas, NOLs are among the lowest quality assets around. Sure, if you have a generally profitable business that has a bad year - like an insurance company hit with a major cat loss, or a cyclical company hit with cyclical weakness - then yes, you are likely to be able to recover or offset taxes from future profits and these are good assets. But what if you have a poor operation that loses money regularly? What if you no longer have any operations at all? Now you have a real problem: you have to find a means of earning a reliable income in order to use those NOLs.</p><p>The IRS makes that difficult - you cannot sell the company or simply merge it with another entity. The tax laws are set up to prevent NOL shells from simply selling themselves as tax shelters. No, they have to maintain a pretty stable ownership structure AND acquire assets or operations that generate profits. Since they cannot recapitalize themselves without having the NOLs largely disallowed (the dreaded section 382), the resources that are going to be available in this effort are largely going to be internally financed, which means, they have to bootstrap their own capital. And there are only so many years (about 20) in which to achieve this feat.</p><p>Now, if businesses were cheap and inflation were raging - think 1973-1981 or so, this might work out; you could have purchased a dollar of earnings for just a few dollars and then watched as revenues and profits grew in nominal terms without having to expand the business all that much, helping you to consume tax losses generated in earlier years. Of course, the real value of those recoveries would have declined, but you might subsequently enjoy a boost to valuation if inflation declined significantly thereafter.</p><p>Today, however, is a different environment. A dollar of earnings is quite expensive. And buying control of a business in present market conditions is very expensive, especially if you cannot use appreciated securities of your own as currency. $15m might buy you just $1 of earnings, but more likely will buy you even less. Yes, there are businesses that have lower multiples, but many of those, like professional services, need to be owner operated to be effective and simply cannot be sold effectively to passive capital because there isn't enough return available to future partners.</p><p>There just aren't great incentives, in a world where corporate tax rates are 21% (or 25 or 28%) for someone to cut you in on their good business in order to save those tax costs for a few years. Instead you have to look at buying and fixing a crappy business. That takes time and often generates more losses in the meantime. Moreover, how probable is it that the management that lost $1bn is going to be the fix-it people for the new operation?</p><p>Daunting as this task is, one of the biggest factors is the starting position of the firms capital, which represents the major constraint on the size of the business that can be acquired and also sets something of a "lead" on the running room available to fix a business needing some help. The larger the capital, the wider the potential target list can be and larger the scope of a turnaround can be.</p><p>So there is nothing worse than seeing a moderate amount of capital in an NOL shell being siphoned off by "management" in it's search for a new asset to acquire, but this is exactly what we see at ELLH. Management - by which I mean officers of the firm; they don't manage operations - takes some $2m a year in SGA in spite of the negligible revenues, while they look for a deal to do. The odds of them finding one have become much much longer in the past year as SPAC-mania has set hold. The amount of capital with no operations in search of a deal to complete (with incentives structured to get deals done even if a high price be paid) means that potential targets are being courted and schmoozed in an auction-like environment.</p><p>Meanwhile, the scope of potential investments is being narrowed every year for ELLH. Ok, it is true that in 2020, tax benefits associated with the CARES act offered ELLH a one time benefit of a one-time extended carryback on the losses that provided an extra tax recovery (from a higher tax period) and which generated about $4m in 2020. That has increased the cash balance of the company by about $2m, after management helped itself to half of this one time bounty.</p><p>Now, it is true that higher taxes in the future, which seem likely, could both tank asset prices and increase the value of NOLs; so the case is not entirely hopeless, but if the only upside is macro, you can find NOL shells that have similar setups, better management and lower prices. RCBN, to name one.</p><p>ELLH is in a strategic dead end with dwindling resources, suspect leadership and is trading for a premium, not a discount, so even a liquidation - likely the best option - would result in a significant capital loss.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-90926455872972371212021-04-16T09:42:00.001-04:002021-04-16T09:42:37.983-04:00Things that happen in manias<p> This is a funny story. When we have this sort of buoyancy in markets all sorts of securities trade at absurd valuations. David Einhorn apparently featured, in his letter, a business with $35k in revenue and no real assets, that has $100m valuation.</p><p><a href="https://www.cnbc.com/2021/04/15/hometown-international-nj-deli-owner-worth-millions-in-stock.html">Hometown International, NJ deli owner, worth millions in stock (cnbc.com)</a></p><p>I recognize that sometimes this sort of valuation is possible in markets that trade infrequently and in which a few shareholders control most of the shares, ensuring that funny bids or asks or unusual trades of <i>de minims</i> shares can then be extrapolated over a large, but illiquid share count to arrive at confusing valuations.</p><p>A better, albeit perhaps less extreme examples is ELLH, which deserves a longer discussion. I believe it might be the worst equity security I have found, certainly in the diversified holdco space. You deserve a full accounting of this one, not because you will want to invest, but because it is a poster child for what really happens with many of these "triumph of hope over experience" firms; the holdco with small tangible asset base, but laden with huge NOLs from an operating business - often discontinued - operations, leaving management with the challenge of lacking an operating base that can actually earn the profits that enable those assets to be used before they expire, and few strategic options for doing so. Indeed, I believe that the NOLs may cause management to behave in foolish ways because of the endowment effect of wanting to preseve those assets, sometimes at the expense of feeding the new or remaining business (raising external capital can limit the NOL recovery and so management may force the company to internally finance growth).</p><p>Anyway, this is a larger topic for another day, but it is a counter-example, I think, to the Klarman view that there are no bad assets, just bad prices. I get his point - free options are just that. But the endowment effects on the free option holder; the desire to make something of that option, can warp the perception of how to grow the greatest aggregate value.</p><p>In any case, everywhere I look, I see high prices and low returns. I suppose there is a real possibility that we will see huge inflation and that operations of firms will be able to grow to justify today's valuations, but today's valuations won't have moved much and the purchasing power of those assets will be greatly diminished, so the "richness" will be nominal only. More likely, we will get a period of pricing weakness, though not so long as we are in "lockdown"; imprisoned but working upper middle class types are experiencing incredible savings rates that are fueling this market surge. The end of lockdown might actually see a decline in transfers into brokerage accounts, so ironically, economic growth might actually hurt equity prices.</p><p>It's a very tough time for someone to have a consistent strategy, in part because the strategies that have worked pretty consistently since the 1940s, are not set up for what we are about to experience. The "normative" experience of US equity markets might be much more of an outlier than we think. Japan, mid-century Germany, revolutionary Russia, revolutionary China; all of these places have experienced really catastrophic results where buying the dip didn't put you on a glide path.</p><p>But in a speculative mania, where money and profits seem pretty effortless (and I will admit that nearly all of my investments have been working but I have been raising cash) it is very hard to take money off the table. Also, if we truly do get inflation, short duration assets will struggle; especially if we have policymakers engaging in financial repression on yields of short term instruments, as seems likely.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-27192728330225713502021-04-15T20:54:00.004-04:002021-04-15T20:54:56.397-04:00On Coinbase and Bitcoin 60,000<p> Below is a letter I wrote to some investor friends. The backstory is that I attended an annual meeting of FRMO Corp in 2016 or so, where Murray Stahl, the CEO, advised everyone to invest in Bitcoin. Actually, since there is a transcript of the meeting available <a href="https://frmocorp.com/_content/letters/2016_FRMO_Transcript.pdf">here</a> you can look up his story, yourself, the example is on page six. Murray has returned to the subject at length in later meetings. <a href="https://frmocorp.com/_content/letters/2017_FRMO_Transcript.pdf">2017</a>, <a href="https://frmocorp.com/_content/letters/2018_FRMO_Transcript.pdf">2018</a>, and <a href="https://frmocorp.com/_content/letters/2019_FRMO_Transcript.pdf">2019</a>. 2020 has yet to be published. I attended those to. In spite of this, I never actually purchased bitcoin, though I could have taken his "vacation" example just to see. Instead, I told myself, FRMO can make the investments for me, and I will instead invest in FRMO. Not as much upside, perhaps, but less downside. Also, that FRMO could make investments in the space that simply would not be available to retail investors.</p><p style="text-align: left;">Hindsight is 20/20 and of course, I would have made alot of money had I listened to him. But I don't know if I could stay with it, because a) this whole market feels like a mania - driven by a cult of performative "newness" that is deeply Millennial and therefore encourages action over reflection(1), and b) I still don't really know how to think about it, and therefore I don't by any of the valuation methods. This includes the PQ = MV argument that Murray makes. The circulation of gold doesn't have to equal the circulation of dollars (or of all currencies), any more than the number of Swiss francs does. I get the idea, but it seems to me that if it has utility in this way, it is as a reserve unit, not as a currency, really. </p><p style="text-align: left;">Even so, I question whether something that is so inherently reliant on large systems - the need for electricity and internet connectivity to function - can really serve as a base unit. We financialized and digitized money because of the impracticality of lugging around physical money. Bank of America spends something on the scale of $1bn a year to move coin and cash around.</p><p style="text-align: left;">But the normal pattern of abstraction and financialization is to start with an asset that exists in the real world, but which, for various reasons; weight and cost, risk of theft, or lack of divisibility (e.g. a business operation) lead to a development of a convention, a contractual relationship around that thing which makes transacting with it much easier and more practical (and expands the range of potential investors). In this case, it feels that what is happening is the opposite - that someone has constructed a completely synthetic digital construct and is now trying to make the real world reflect the digital one. It has a man-bites-dog sort of quality (and mystery) that make it perfect catnip for financial journalism.</p><p style="text-align: left;">It seems to me that "new ways to trade" have alot to do with this more than the asset classes themselves. Tulipmania, after all, was really about the intersection of three things: first, some new techniques developed by florists for grafting bulbs of different colored tulips to create new color patterns, second - and far more important - financialization of the bulbs by the creation of a futures market for the bulbs (that had to stay in the ground over winter), bored florists waiting for spring and finally, the pressures of a war. In 1637 the Thirty Years War was entering its final and most brutal decade, dramatically shortening duration preferences among pretty much everyone. So, some new technology, coupled with new trading platforms (Amazon-like Robinhood stock recommendations? or new "disintermediated" trading platforms, boredom and lockdown - the mania was most intense during winter - and the pressures of an existential threat heightened willingness to take risk for short term gains.</p><p style="text-align: left;">Bitcoin and crypto have remained surprisingly resilient even as the narrative has changed (quick quiz - what was the Byzantine General's Problem?), in some cases many times. That might mean that there really is something there; major investors are getting on board, after rejecting the early justifications for its utility. So I am totally open to the fact that it is I who am missing the thread here. If any reader wants to help me understand it; I am particularly interested in the economics of mining and how it can be that the most efficient miner doesn't manage to beat everyone else to the solutions to the validation problems. I understand why it is necessary to keep as many nodes operating as possible, but not how this is addressed; unless, Harrison Bergeron, there is a Handicapper General?</p><p style="text-align: left;">Anyway, here is my note. The Luddite's voice rings strongly:</p><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">So, sometimes I feel like an idiot not listening to Murray when he said: buy bitcoin. Being a skeptical type, had I done so, I no doubt would have exited my position by about $20k certainly by $25. If I say that figure in retrospect, then in the moment, I would likely have been exiting above $10k and certainly above $15k, with at most only a small position retained, and I would have been sure that 20 to 25k was all that was realistically possible at least at the present time.</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">I just don't see what these coins really offer. So much of what they are selling is the opportunity to speculate. At least in the 1990s the use cases were understandable if implausible. Viewed the other way, it seemed clear that they couldn't work. (It cannot be that $1 of fiber optic cable laid by anyone anywhere was worth $7 and allowed the company laying said cable to borrow $2. I mean, on some level, perhaps, but honestly not possible at scale. There was real value there tho. In that case, it was a case of finance people overplaying the capitalization of new income streams to book profits and benefits up front - "revenues" followed the capital investments, rather than the other way around. But with crypto? I just can't see it. Maybe I am too old or too dumb. I observe that the use cases and the narrative have changed multiple times and yet none of the cases have proven out.</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">It was going to be a bank-less payments system. Or a store of value (digital gold) or a supercomputer, or access to a currency trading platform or or or. A bit like the 90s, when everyhting was goign to be digitized. Eventually that happened, tho it was the people who were legacy firms in those industries that found it easiest to transition the customer experience to digital, since there were still offline processes that had to function and be managed and such. Grafting the new tech onto the legacy firm turned out to be easier than taking the tech and building a de novo competitor in an industry. I feel the same here. The capital assumptions - that all of these firms can be asset light digital properties once they adopt this tech, doesn't seem sensible either. In a sense, I think the goal is to build new social networks, but honestly, how many of those can society possibly need? The ones we have seem to be making us miserable. I get that if you could create a Mutual of Facebook, with the users owning the platform, that might be very valuable, except that the value will of necessity be very widely distributed. Is Facebook's trillion dollar valuation all that valuable if roughtly evenly distributed among hte 2bn users it claims? I guess if the most active users get a disproportionate amount of the profits, it's worth more to them, but then you also have to be constantly trying to use facebook; the usage becomes an end in itself instead of as a tool. That strikes me as literally the proof that Seth Klarman's dictum: that there are no bad assets only bad prices, is false - an asset that requires you to spend all your time investing activity on it to make it work, seems to be a truly bad asset, even though it's paying you. Its basically a job (as many "assets" are).</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">Or perhaps its specific activities that matter - like validation / mining. There, tho, the business seems to be that he who supplies the computing power to run the network gets the money. At some point, mining will likely stop, right? I mean with Bitcoin that will happen - then how do you get people to supply power to the network? Do they just get the assets transferred to themselves. Essentially demanding Satoshis as fees, right? Eventually these large pools of digital assets might loan them to people, or they might serve as a reserve currency backstopping some other payments system. Ok. but then the big aggregators simply become a form of reserve banks. How is that so different from what we have today? It's sort of anti-statist (assuming that the government or the FRB don't offer computing power to the network at rates that enable them to make this money.</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">Dunno. Maybe I am just making no sense. But I can't see what problem these things solve better than the system we already have.</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">To me, we live in an era that is again obsessed with "new era" thinking - this is applying to all sorts of things beyond the financial markets. We are questioning liberalism, the nation state, representative government, rule of law (favoring instead attainder by twitter mob) and the dignity of the individual, let alone things like economics. Alot of firms seem to be surfing the "new era" thinking; that like celebrity, famous for being famous, new era firms are investable for their newness. Of course, that can be a way to get very very rich. But - and this is where I see a real problem with the decentralized approach - commerce is generally best managed when it is headed by an individual of exceptional energy and talent. Crowdsourcing business decisions is not a winning strategy so far as I know. But maybe there are a few good examples? Economies, yes. Institutions, no, because the larger the institution gets, the more crowdsourcing is a vote for incumbency and to protect insiders, which is why external competition is so crucial to disciplining them.</div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;"><br /></div><div style="background-color: white; color: #222222; font-family: Arial, Helvetica, sans-serif; font-size: small;">Again, maybe I am just missing it. I really would like someone to explain to me what "digital trust", or whatever the latest use case is, is, so I can understand what this is really all about.</div><p><br /></p><p>(1) this is more broadly an attitude about the culture generally and about upper middle class Millennials in particular. There is a very strong attitude of Jacobin "Year Zero" thinking in which the expectation is that we can simply dump overboard everything that came before them, including the culture itself. You can hear it in the way their shortcut for "ancient history" is to refer to something old-fashioned as being "circa [insert year between 1965 and 1980 or so]. This is unwise and arrogant.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-61031289796615722412021-02-07T15:22:00.001-05:002021-02-07T15:22:37.878-05:00On Gamestop<p>In the story of Gamestop, the media has been pushing a classic David and Goliath story for the past several weeks as a few hedge funds (o<a href="https://www.investopedia.com/articles/investing/102113/what-are-hedge-funds.asp#:~:text=The%20number%20of%20operating%20hedge%20funds%20has%20grown,most%20mutual%20funds%20is%20their%20market%20direction%20neutrality.">ut of something like 10,000 funds</a>, tho the precise number is unknown) got caught in a most amusing short squeeze.</p><p>It does seem likely that online fora were the germ of the squeeze idea; clearly some relatively small investors were able to acquire decent numbers of shares in the early goings, when shares are $5, even a speculative-minded retail investor with $10 or $100k can start acquiring a solid amount of daily trading volume, reducing float and shares available to borrow or to buy to cover.</p><p>But I wonder how much of this squeeze was ultimately orchestrated by some other big funds or players; it is possible, indeed, even probable, that other funds smelled blood and also purchased? Might it have been a case of professionals gaming other professionals with a few retail investors just making out like bandits?</p><p>One theory would be - no, since if that were true, someone would be talking about it - and the media hasn't said anything. But a second view might be, what incentive does the media have to tell the story? So long as anonymous day traders with<a href="https://taibbi.substack.com/p/this-is-for-you-dad-interview-with"> fabulous but unverifiable human interest stories</a> can claim to be "winning one for dad" clicks rain down on the articles. If the story was, hedge fund A crushed hedge fund B, it would get some play among the financial literati, but would likely not seep out into the wider culture.</p><p>So no journalist is going to be assigned to get to investigate and the funds that made the money probably don't want to share, since it paints a target on their own backs.</p><p>But honestly, when the shares were at $300 and $400, how many retail investors could be buying in any volume? $10k nets 33 shares, against a trading volume in the millions. If the retail investor was buying and selling (day trading) then ok, he could round trip many times, but then he wasn't "holding the line" as a hero, but rather just a guy exploiting volatility.</p><p>No, it seems to me, that the most likely story is that some hedge funds saw movement and started buying with the intent of generating the squeeze. They would be best positioned to negotiate the private market transaction to deliver the shares the funds needed to cover once things really got going.</p><p>Moreover, one has to ask why management didn't avail themselves of the opportunity to issue additional shares; these are authorized and management could have registered more shares for sale with the SEC, EXCEPT that management wanted to sell their own shares and if there was a new round of shares sold by the company, management would be barred by insider trading rules for six months from dumping their shares. So they prioritzed themselves over increasing the financial strength of the company with insanely cheap capital. No one is telling that story, either. Note that management telling people that they would issue additional shares would have broken much of the speculative bubble.</p><p>And quite frankly, reading some of these stories of these small investors, one really has to wonder if they aren't all fabulists - a class of people increasingly taken in by a media desperate for narrative stories that play to subscriber bias.</p><p>I have owned small businesses and have worked for them, too. I have never known small business owners to be as reckless with their financing as the people described in<a href="https://taibbi.substack.com/p/this-is-for-you-dad-interview-with"> these bios</a>. Every one of these children of small business owners who had the company "implode in a week" with nothing to show for it? How many small business owners are so illiquid? It's perhaps easy to believe this if you are an employee living paycheck to paycheck, but most small business owners I know keep large amounts of liquidity on hand. In fact, one of the primary differences between founder led firms and management led ones is a demonstrable liquidity preference among founders; where managers worry about hitting all of their financial metrics to earn the largest bonus and push financial ratios, founder led firms are usually more motivated by institutional preservation and capitalized themseves much more conservative.</p><p>I understand that it was tough to get financing in late 2008 and early 2009. If you had to roll over financing of anything, it was tough. If you didn't have months of expenses in cash, you could get crushed; but I simply don't believe that we have dozens of children of small business owners using day trading to effect World Socialist Revolution.</p><p>Alas, we also don't have a media environment interested in questioning this stuff, either. The stories are "too good" to check.</p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com6tag:blogger.com,1999:blog-24695385.post-84948022413080542422020-09-27T17:03:00.004-04:002020-09-27T17:03:56.338-04:00Why Value has Underperformed: a Hypothesis<p> There has been much gnashing of teeth over the past several years about the persistence of "underperformance" of "value", particularly when compared to large cap growth. These categories are, in a sense, an artificial construct of Morningstar, and much of the comparison, I think is based on mutual funds; constrained as they are by various regulatory and strategy restrictions.</p><p>But the truth is, if you have been investing in traditional value sorts of investments - overcapitalized companies, cheap cash generators with limited growth or growth potential, expecting some sort of mean reversion on valuation, you have likely been disappointed. You may have fared better with special situations, but then again, you were likely betting on some really dramatic idiosyncratic adjustments to the income statement, the balance sheet or both. Changes that might have turned that "value" company into a "growth" company, at least insofar as earnings or cash generation per share were concerned. Other popular strategies, like investing in holdcos that can in turn make control investments in (sometimes private) businesses has similarly produced dismal results, even when seemingly smart allocators were in charge.</p><p>So why has value been so "unsuccessful"? There have been two arguments that are generally advanced, which are variants of the same hypothesis: assets, particularly large cap growth, is just unreasonably valued. I think both of these have merit, but fail to explain the other potential issue, which is rarely discussed - that the locus of value and value creation may have shifted and have done so in ways that are particularly at odds with the investment characteristics value investors need. Before we turn to this, let's quickly review the arguments about the market today.</p><p>The first is that large cap growth is simply in a bubble that has completely insane valuations against which no "investment" strategy worthy of the name can expect to compete. A common explanation for this is the rise of indexation as an investment strategy. It is understood that indexation is a cheap way to get exposure to a particular asset class - in this case stocks - with minimal fees and costs. In theory, it should offer diversification, but in practice, it is something of a momentum strategy, in which inflows occur not based on market conditions but, in most cases, based on cash flows from participants in savings schemes like 401(k)s. That money makes automatic bids for securities, and inevitably allocates the most money to the most valuable firms, which are the largest and most expensive ones. Given these automatic bids, prices tend to levitate and in the same spirit of "to whom much is given, much more is given" the bigger the market cap gets, the MORE inflows there are competing for what are usually smaller and smaller floats. It should be observed that this is the opposite of what neo-classical economics would suggest (I want to revisit this theme in other articles). Here, HIGHER prices INCREASE demand, they do not reduce it. Is such a setup natural? Can it even be said to be a market if price signals are ignored and ultimately produce the opposite effect of what market theorists say? Possibly, but it should give us pause.</p><p>A second theory is similar to the first, which is that many investors have been conditioned to believe that markets basically move in one direction and that novice investors looking to make "fast money" find themselves obsessed with these names. Since these companies are well known and their products and markets are well understood by retail investors, there is more confidence for retail investors in putting their money into such investments. Also, they have been rewarded for making that decision.</p><p>So both are forms of the argument for "irrationality". But while both of these no doubt hold some credit, they aren't that satisfying, since "value" investors have largely missed out on these stocks when they and their businesses were much smaller and there was incredible value being created. These firms, it should be noted, do this often with very low amounts of capital employed. True, they pay their workers (and when the true comp of these people is factored in - so much of that comp is supplied by the capital markets rather than the income statement - their profits are decidedly lower). Yet, firms like Google were incredible values at $85 when it went public. Value investors saw only insane pricing and passed. Why?</p><p>Ron Chernow, in his biography of John Adams, that had Adams chosen to invest in US Treasury securities rather than in Massachusetts land in the 1780s, that he would likely have become the 2nd or 3rd richest man in America (behind Washington). But his insistence that the true source of all wealth was land caused him to pass on buying US obligations essentially in default just before changes in government were about to restore those assets to be good credits. He could not see how those pieces of paper could create huge wealth for the holders and for the country through liquifying capital and money. It just didn't "make sense" that these contracts could create more value than "productive" assets like land.</p><p>I think today, value investors have some of the same problems - they see these SaaS companies and other "asset-light" models as somehow, phantom. They don't seem to require much capital and therefore they don't fit. It's not that value investors don't understand that low capital demands make for amazing ROCE and cash generation. It's that it short circuits certain demands "value" investors have for investment.</p><p>Let us recall that a "value investor" is not someone who buys "cheap" assets. That is a speculator. Hoping that with a fistful of cheap assets some of these things will turn out to have big value down the road is speculation and there is significant chance that many of the individual assets will have no value. It is a fine system - many VCs and other types who play percentages build portfolios just like this, with mostly losers and a few spectacular winners. But this is not "value investing". Value investing starts with LOSS AVERSION. That is why the hallmark is margin of safety. That margin is often provided in part by the cheapness of the assets, but one can quickly see why these sorts of modern growth companies cannot work for the value investor. They are too speculative. from a value standpoint.</p><p>Value investors usually look at all of the different "worst case" scenarios and are able to conclude that there is no way in which - barring losing a war on your home soil or asteroids vaporizing the Earth - for them to lose. Why? Because even if the business fails the assets can almost always be repurposed. Factories and equipment can be sold to competitors or scrap yards, securities can be sold, inventories liquidated, land sold or converted to some other form of value such as a REIT or land trust. Even the brand name might hold residual value. That is, the value investor almost always is assured of recovering nearly all of his investment in liquidation, if worst comes to worst. (Hell, sometimes, he could get an immediate return in a liquidation, because the firm is a "net net"). If business improves and becomes valued based on multiples of the income statement, he makes a great return while never really putting his capital in danger.</p><p>This simply cannot be said of the "asset-light" model. In nearly all cases, the true asset is consumer goodwill and THAT, every value investor knows, can be very fleeting indeed. Even the legendary brands like Coke have issues when consumer tastes shift to water and sports drinks. Beer companies find themselves struggling with competition from spirits, and also with non-alcoholic beverages. These are at least businesses with physical assets. What do you do with Facebook? Every value investor who has passed on FB will remind you, kind reader, to consider "MySpace"... how long did it take to vaporize hundreds of millions there? Three months?</p><p>Consumer tastes are too fickle for a value investor, no matter how good the near term economics might appear. Google's lead in search is massive, and yet even that moat is suffering as consumers looking to really buy something often do searches directly within Amazon. Advertisers follow consumers and well, if they dry up, you might look like local news, for goodness sake!</p><p>This, I think is the real problem for value investors. They cannot get over a business model in which all of the assets are <i style="font-weight: bold;">intangible and not really severable from the business itself.</i> Marty Whitman, who implores us to be "modern" value investors and consider how a balance sheet can be sliced and diced, refinanced, sold, spun, merged or otherwise repurposed in thinking about both <i style="font-weight: bold;">cheapness AND safety</i> finds little to love in the modern asset light firm.</p><p>And value guys aren't entirely wrong - if social media is too unfair, consider asset light models in traditional businesses, look at Enron, an energy company that also wanted to be asset light, at least in terms of physical assets; preferring to model themselves on a financial institution where assets could be created with signatures. In the end, the only assets it had were the low growth, low margin highly regulated utility assets of Enron International, the overseas assets, largely that the Fastows and Skillings found pointless and boring.</p><p>Yes, those assets were never going to drive the premium valuation - but they were going to prevent goose eggs in a downturn.</p><p>Value investors struggle, and likely always will struggle to invest in firms whose assets are largely people and brains that can walk out the door taking their complex web of human networks with them. Value investors want the sorts of businesses in which the people are cogs and the physical assets, the kind that can be possessed, drive value creation. This is why they struggle to buy the sorts of firms that have created brand new markets and have therefore benefitted from extraordinary returns.</p><p>At some point, of course, these markets are likely to be exhausted. Ad based models have consolidated into a few firms and those firms have needed much less physical equipment to win those ad dollars. But advertising is limited, structurally to something around 1% of output. More than that and the marginal value of the next sale approaches zero (the sales leverage of a marginal dollar of advertising constrains ad spending at around that 1%), so most of those models have simply taken market share and now hold so much market share that they will find it hard to increment sales much more; valuations there will suffer. That will not make value investments "better" (though, one supposes, it might make them less bad). Value will, then outperform, but not by having huge returns, I expect, but rather by avoiding some massively negative ones.</p><p>But maybe, like the Adams family, value investors have to think differently about value creation and about how margin of safety could work in an asset light environment. That is a topic for another day as well. </p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-33914176874545767112020-08-15T13:08:00.000-04:002020-08-15T13:08:10.519-04:00Well they did manage to raise revenue by 50%<p> But only to $10,000 - total - for the quarter.</p><p><br /></p><p>ELLH remains the WORST NOL shell holdco I have ever seen.</p><blockquote style="border: none; margin: 0px 0px 0px 40px; padding: 0px; text-align: left;"><ol style="text-align: left;"><li>Management siphons off $0.70 of book value quarterly</li><li>Revenue is up to $10k per quarter - far less than most freelance businesses generate</li><li>The only hope for the business is a deal, but unsurprisingly, the potential partners in the deal are unenthusiastic about taking on the burden of the fixed costs ELLH brings as the price of its tax shelter.</li><li>Again, large firms that could probably carry the costs are too large for a firm with such a small asset base to acquire, and the reverse (acquisition of ELLH) nullifies the tax shelter</li><li>As the asset base is siphoned off, the target set becomes ever narrower, and on average, even smaller, making the burden of carrying ELLH management's lifestyle payments more expensive.</li><li>There are indeterminate but potentially significant and likely very long tail / long term legal overhangs from prior operations, which further reduce the attractiveness of ELLH (but provide incentive for management to siphon off the assets before they can be attached, tho fraudulent conveyance remains a risk, I suppose. Still possession is 9/10th of the law, as is said).</li><li>Part of the risk in [6] is that management from the prior operations remains at the apex of the holdco. So the same people more or less who ran the prior businesses into the ground are supposed to buy and build some other business they aren't even experts in?</li></ol></blockquote><p>Amazingly this trades at more than 2x book... A massive cash hemorrhage with no operations and plenty of management lifestyle comp, with decreasing prospects as its resources are siphoned off.</p><p>Alas, the incredibly thin float makes it impossible to short this.</p><p><br /></p><p><a href="https://seekingalpha.com/news/3605980-elah-holdings-reports-q2-results">https://seekingalpha.com/news/3605980-elah-holdings-reports-q2-results</a></p><p><br /></p><p><a href="http://s22.q4cdn.com/545953618/files/doc_news/2020/Q2-2020-Financial-Reporting-Package-(8-14-20-final).pdf">http://s22.q4cdn.com/545953618/files/doc_news/2020/Q2-2020-Financial-Reporting-Package-(8-14-20-final).pdf</a></p>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-53011390151365641282020-07-30T02:19:00.002-04:002020-07-30T02:19:48.723-04:00Stephan Company: A Very Interesting Nano-Cap Moving (farther) up the Quality Curve<i>Author's Note: This article was originally published on Seeking Alpha in January of 2018. I wrote it over the Christmas break in 2017. Many of the steps have been small and a few required some charges and also cash conservation.</i><div><i><br /></i></div><div><i>However, the <a href="#" id="https://www.otcmarkets.com/stock/SPCO/disclosure" name="https://www.otcmarkets.com/stock/SPCO/disclosure">latest quarterly results</a> have largely proven the thesis, I believe. </i></div><div><i><br /></i></div><div><i>I have been meaning to publish this on this blog for some time, but for a long time, the article was exclusive to SA and afterwards I thought I might want to submit it for publication elsewhere. It deserves a revisit, as much has changed - there is a new CEO, there are many new brands, and of course, COVID has limited options for barber shops.</i></div><div><i><br /></i></div><div><i>As a prelude to an updated article, I thought it was time to publish it here.</i></div><div><i><br /></i></div><div><i>There's plenty wrong with many of the details (capital policy has changed significantly), but I want to be honest with myself and with you. I hope you enjoy it.</i></div><div><i><br /></i></div><div><p class="MsoNormal"><span style="mso-ansi-language: EN-US;">The Stephan Company: A
very interesting nano-cap moving up the quality curve.<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpFirst" style="mso-list: l2 level1 lfo1; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">The
Stephan Co is a nano-cap company with a recent history of poor performance<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="mso-list: l2 level1 lfo1; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Recent BOD
and management changes have come with a smart restructuring<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="mso-list: l2 level1 lfo1; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Management
and board are disciplined in capital allocation and very shareholder friendly<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpMiddle" style="mso-list: l2 level1 lfo1; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Business
has moved from bloated and loss making to lean and profitable<o:p></o:p></span></p>
<p class="MsoListParagraphCxSpLast" style="mso-list: l2 level1 lfo1; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Focus is
now on growth which is happening organically and inorganically<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">The Stephan Company
(PK:SPCO) has had articles written about it on SA before, in 2007 and
2011.<span style="mso-spacerun: yes;"> </span>Given the long gap and significant
recent changes to its operations, I thought it was time that a new article be
published.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">The Stephan Company is
a nano-cap stock with a market capitalization of about $10mn (3.993mn shares
out as of </span><span lang="DE"><a href="https://www.otcmarkets.com/financialReportViewer?symbol=SPCO&id=184637"><span lang="EN-US" style="mso-ansi-language: EN-US;">latest Q</span></a></span><span style="mso-ansi-language: EN-US;">)<a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn1" name="_ftnref1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></span></a>
<a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_edn1" name="_ednref1" style="mso-endnote-id: edn1;" title=""><span class="MsoEndnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoEndnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[i]</span></span><!--[endif]--></span></span></a>and
a recent history of operating challenges, but in spite of its size, it is quite
an old company that is moving back up the quality curve.<span style="mso-spacerun: yes;"> </span>Founded in </span><span lang="DE"><a href="http://thestephanco.com/"><span lang="EN-US" style="mso-ansi-language: EN-US;">1897</span></a></span><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn2" name="_ftnref2" style="mso-footnote-id: ftn2;" title=""><span class="MsoFootnoteReference"><span style="mso-ansi-language: EN-US;"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[2]</span></span><!--[endif]--></span></span></span></a><span style="mso-ansi-language: EN-US;">, the company is focused on the beauty segment,
particularly the barber shop distribution segment.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">The business is now
run by some very smart people who are incredibly disciplined in their use of
capital and also very shareholder friendly.<span style="mso-spacerun: yes;">
</span>Indeed, much of the BOD is made of up financial investors who are making
sure that the business uses its excess cash (substantially all of its operating
cash flow, as required CapEx is negligible) to return capital to
shareholders.<span style="mso-spacerun: yes;"> </span>This is the sort of high
return on capital business that you can be comfortable holding for very long
periods which offers some effectively no cost (negative cost, perhaps) real
options on growth and capital gains, and which pays you to wait while you sit
on those options.<span style="mso-spacerun: yes;"> </span>As such, for the
non-institutional investor, this might be interesting.<span style="mso-spacerun: yes;"> </span>This assumes that you can get shares; they
are quite illiquid.<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Risks:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Before we explore the
business any further, I think I should point out that SPCO is a very small
business with control shareholders who already possess over 50% of the 4mn
shares outstanding.<span style="mso-spacerun: yes;"> </span>Acquiring shares is
very difficult to do, selling them no less so (though helpfully, management is
committed to repurchases, so there is some liquidity in that regard).<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">As a small business in
the distribution segment the business competes with many other businesses some
of which have greater resources.<span style="mso-spacerun: yes;"> </span>It is
also a business that until recently had significant losses, though that was
before the restructuring.<span style="mso-spacerun: yes;"> </span>This is a very
interesting business but Coca-Cola it is not.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Given the high level
of Board / insider ownership, you have to recognize and be comfortable with the
control team as stewards of the enterprise and capital.<span style="mso-spacerun: yes;"> </span>Moreover, there is a risk that this business
will be taken entirely private and stop reporting altogether.<span style="mso-spacerun: yes;"> </span>Efforts to do just that have been made before
(by other shareholders and management) and the closely held nature and size of
the business could make this attractive to insiders.<span style="mso-spacerun: yes;">
</span>Somewhat mitigating this risk, I believe, are the DTAs, the fact that at
least one major shareholder is an RIA with separate client accounts, which accounts would be harmed by a go private transaction, and the
fact that being a public company offers SPCO some unique benefits in doing
deals.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Investors should
consider this a PE sort of investment with a very long lockup.<span style="mso-spacerun: yes;"> </span>In return, the business generates nice cash
and high returns on equity, but typical strategies for avoiding losses (eg. stops)
will not work with such a business.<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Background:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">As you can imagine
with a 120 year old company, they have had multiple operating approaches over
the years, but what matters are some recent changes, starting about five years
ago.<span style="mso-spacerun: yes;"> </span>At that time, the then CEO who had
controlled the company since the early 2000s (and attempted, unsuccessfully, to take the company
private in 2004, but who did delist the company in 2010) died
suddenly.<span style="mso-spacerun: yes;"> </span>At the same time, the
performance of the branded product part of the company headed down quite rapidly,
resulting in millions in losses.<span style="mso-spacerun: yes;"> </span>The successor
management team tried multiple strategies to preserve the business in tact,
cutting expenses and staff, moving production to reduce costs, but could not
align costs with revenue.<span style="mso-spacerun: yes;"> </span>Revenue mostly
declined but even investments in improved marketing that did stem the decline negated
through the incremental costs the benefit of stable sales.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">CEO compensation was
out of line and there were multiple lawsuits with companies and brands that
SPCO had acquired.<span style="mso-spacerun: yes;"> </span>These lawsuits
consistently resulted in unfavorable outcomes for the company.<span style="mso-spacerun: yes;"> </span>(Most of the issues had occurred under
previous management, but the road on these litigations only ended in 2012-2014).<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">The challenges in the
branded products segment masked a profitable distribution business.<span style="mso-spacerun: yes;"> </span>This is surprising, most investors tend to
expect the branded part of the business to carry the intellectual property and
the high returns on capital with low reinvestment required.<span style="mso-spacerun: yes;"> </span>But in this case, the distribution business,
specialized on a small customer segment as it is, actually has quite high
margins for a distribution business (30%) and requires almost no capital
expenditure, whereas production in branded products had low margins and
significant capital outlays required to fend off new entrants.<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Restructuring:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">As a result, the BOD
took the strategic decision in 2015 to exit the branded segment to focus on the
distribution business exclusively.<span style="mso-spacerun: yes;"> </span>They
sold off the brands, liquidated inventory, liquidated excess real estate and
separated from about 20 employees.<span style="mso-spacerun: yes;"> </span>Among
those were the CEO and CFO who were earning significant salaries for a
struggling small business.<span style="mso-spacerun: yes;"> </span>Instead the
COO was promoted to the top job and finance was outsourced to an accounting
firm with one of its partners functioning as a part time controller and
CFO.<span style="mso-spacerun: yes;"> </span>With a smaller firm, the scope of
audit was reduced and the audit contract rebid and won by a smaller audit firm,
presumably at better rates.<span style="mso-spacerun: yes;"> </span>Old
outstanding litigation was settled and the company was able to make a fresh
start with much lower operating costs and therefore a realistic breakeven
point, stable sales, good margins, minimal investment required and lots of
deferred tax assets (DTAs) from the $18mn in losses the previous management
incurred trying to rescue the branded products business.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">And look what resulted!<span style="mso-spacerun: yes;"> </span>The figures for 2013 and 2014 left the business
in a state which raised doubts about the company’s ability to continue as a
going concern.<span style="mso-spacerun: yes;"> </span><span style="mso-spacerun: yes;"> </span></span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2GeC7qYh4zt2Ry-OHsfSxbsZmlcDg7-ZgNqcZJZ726OSdy5mEK8gzOZQrGctRi99tMGfbIpR2RVrPwqJdoHF-ju5OUpbLwedZwMVjl5MwrvgXesfGm0O2LDHBxHY3nkBm_fdI/s1355/spco_historic+financials.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1355" data-original-width="1028" height="781" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEi2GeC7qYh4zt2Ry-OHsfSxbsZmlcDg7-ZgNqcZJZ726OSdy5mEK8gzOZQrGctRi99tMGfbIpR2RVrPwqJdoHF-ju5OUpbLwedZwMVjl5MwrvgXesfGm0O2LDHBxHY3nkBm_fdI/w594-h781/spco_historic+financials.png" width="594" /></a></div>Then, in 2015, the business was successfully
restructured.<span style="mso-spacerun: yes;"> </span>Revenues declined, but
costs declined much more rapidly and therefore net loss narrowed.<span style="mso-spacerun: yes;"> </span>Exiting 2015, structural costs were so much
improved that in 2016 the company earned a profit for the first time in years.<a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn3" name="_ftnref3" style="mso-footnote-id: ftn3;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[3]</span></span><!--[endif]--></span></span></a>
<o:p></o:p><p></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Moreover, a smaller
operation required less capital, so that the balance sheet could be shortened
and shareholders rewarded with cash dividends from asset sales and liquidation.<span style="mso-spacerun: yes;"> </span>Returns on capital soared, with ROA at 16.5%.<span style="mso-spacerun: yes;"> </span>ROE at 20% and RONE (effectively equity less
cash) went to 26.5%.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">If you could invest at
book value, most investors would be happy to have 20%-28% passive returns
indefinitely.<span style="mso-spacerun: yes;"> </span>Alas, at today’s prices,
an investor is paying a multiple of book, and so trailing returns are somewhere
in the 10-12% range.<span style="mso-spacerun: yes;"> </span>Except, what if
there were growth?<span style="mso-spacerun: yes;"> </span>Might return on
capital get even better?<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></b></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Market opportunity:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">To have a sense of
what kind of growth might be possible, let’s get a sense of how big the end
market is.<span style="mso-spacerun: yes;"> </span>We estimate that Stephen Co
has about 8% +/-2% of the market in which it competes.<a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn4" name="_ftnref4" style="mso-footnote-id: ftn4;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[4]</span></span><!--[endif]--></span></span></a>
<span style="mso-spacerun: yes;"> </span>4Q results are trending to about $2.4mn,
which would give the company an annual run rate of $10mn in revenue.<span style="mso-spacerun: yes;"> </span>I believe that the addressable market is
somewhere between $100-$230mn.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">We make the following
estimates of the market opportunity:<a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn5" name="_ftnref5" style="mso-footnote-id: ftn5;" title=""><span class="MsoFootnoteReference"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[5]</span></span><!--[endif]--></span></span></a><o:p></o:p></span></p>
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<tbody><tr style="mso-yfti-firstrow: yes; mso-yfti-irow: 0;">
<td style="border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">Topic<o:p></o:p></span></p>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">Low<o:p></o:p></span></p>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-left: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">High<o:p></o:p></span></p>
</td>
</tr>
<tr style="mso-yfti-irow: 1;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">[1] Men in America <o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">150,000,000<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
</tr>
<tr style="mso-yfti-irow: 2;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">[2] Men who go to the barber (vs. salon, or DIY grooming)<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">60%<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">65%<o:p></o:p></span></p>
</td>
</tr>
<tr style="mso-yfti-irow: 3;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">[3] Barber visits per year for those who go<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">6<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">12<o:p></o:p></span></p>
</td>
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<tr style="mso-yfti-irow: 4;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">[4] Product usage (shop cost) per visit<o:p></o:p></span></p>
</td>
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<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">$0.20<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
</tr>
<tr style="mso-yfti-irow: 5; mso-yfti-lastrow: yes;">
<td style="border-top: none; border: solid windowtext 1.0pt; mso-border-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" valign="top" width="151">
<p class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">[5] Estimated Market<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.25pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">$108,000,000<o:p></o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;"><o:p> </o:p></span></p>
</td>
<td style="border-bottom: solid windowtext 1.0pt; border-left: none; border-right: solid windowtext 1.0pt; border-top: none; mso-border-alt: solid windowtext .5pt; mso-border-left-alt: solid windowtext .5pt; mso-border-top-alt: solid windowtext .5pt; padding: 0in 5.4pt 0in 5.4pt; width: 113.3pt;" width="151">
<p align="right" class="MsoNormal" style="line-height: normal; margin-bottom: .0001pt; margin-bottom: 0in; text-align: right;"><span style="font-size: 8.0pt; mso-ansi-language: EN-US; mso-bidi-font-size: 11.0pt;">$234,000,000<o:p></o:p></span></p>
</td>
</tr>
</tbody></table>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">This makes Stephen Co,
a tiny company you never heard of, a meaningful player in its market, but one
that has plenty of scope for growth within its category. <o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Barber shops, I hasten
to add, are not like salons.<span style="mso-spacerun: yes;"> </span>When women
go to the salon, they tend to spend much, much more money, not just on styling
but also on product like coloring and product is a significant cost of a haircut.<span style="mso-spacerun: yes;"> </span>Barber shop haircuts are almost entirely
labor costs.<span style="mso-spacerun: yes;"> </span>Mostly you get a cut, and
there are some creams, powders, gels and disinfectants.<span style="mso-spacerun: yes;"> </span>They come in the same jars and bottles we see
everywhere, many of which are distributed by Stephen Co.<span style="mso-spacerun: yes;"> </span>But in the end, it is a negligible cost of a
haircut at the barber.<span style="mso-spacerun: yes;"> </span>(Interestingly,
this means that if you have a good distribution system, you can increase
prices, because product costs do not drive customer spend barbers can more
easily pass along those costs).</span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Growth:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">As part of its 3Q17
quarterly report, management revealed several interesting things about 4Q in
its discussion and analysis of the business.<span style="mso-spacerun: yes;">
</span>An MDA that is so revealing about events after the date of the report is
quite unusual.<span style="mso-spacerun: yes;"> </span>I cannot recall ever
seeing such a strong amount of color in Q, but the forthrightness is consistent
with a BOD and management that want to be open and honest with minority
shareholders.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">To understand the
impact let’s first understand the business through 3Q17.<span style="mso-spacerun: yes;"> </span>Nearby you find the as reported figures for
2017 </span></p><div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0z3wkvfTih0K-NHbBNHXSDBqPUH-k9MOcw6VWftPixuz_t7NVtpgwyPUOdun5G1hmfTY6lZrBAD0_oUvdDUKY3t2kRe1RXG5vPsDlPYLCa7bKnlzTACky_Ye6E3NL7jLEwnbv/s1349/spco_adjusted_for_acquisition.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="1349" data-original-width="1006" height="500" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEj0z3wkvfTih0K-NHbBNHXSDBqPUH-k9MOcw6VWftPixuz_t7NVtpgwyPUOdun5G1hmfTY6lZrBAD0_oUvdDUKY3t2kRe1RXG5vPsDlPYLCa7bKnlzTACky_Ye6E3NL7jLEwnbv/w374-h500/spco_adjusted_for_acquisition.png" width="374" /></a></div>and adjusted figures that net the acquisition back out and then annualize figures for the year based on the “going concern” – ie. pre-acquisition - structure
of the business.<span class="MsoFootnoteReference"> <a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftn6" name="_ftnref6" style="mso-footnote-id: ftn6;" title=""><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span style="font-family: "Calibri",sans-serif; font-size: 11.0pt; line-height: 107%; mso-ansi-language: EN-US; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[6]</span></span><!--[endif]--></span></a></span><span style="mso-spacerun: yes;"> </span>Returns on capital, assets and equity remain
very strong.<span style="mso-spacerun: yes;"> </span>In fact, 2017 looks like a
near repeat of 2016.<span style="mso-spacerun: yes;"> </span>But there have been
some significant changes starting at the end of Q3, with the acquisition of <span lang="DE"><a href="http://www.mdbarber.com/"><span lang="EN-US" style="mso-ansi-language: EN-US;">MD Barber</span></a></span><span style="mso-ansi-language: EN-US;">.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span><p></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">MD Barber provides
some attractive assets.<span style="mso-spacerun: yes;"> </span>First off, it
has some successful products, particularly LXIV (Louis XIV) Pomade, and it also
has a successful website and online sales and distribution arm through which
SPCO can market its products, so the business brings revenue, new products and
new capabilities in going to market that make the existing business
better.<span style="mso-spacerun: yes;"> </span>Not only that, the acquisition
involved no goodwill, suggesting that the price is quite fair.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">What about the impact
on the financials?<span style="mso-spacerun: yes;"> </span>MD Barber is a
business that had about $800k in revenue in 2016 (10% of SPCO).<span style="mso-spacerun: yes;"> </span>It seems 2017 might have been similar through
the first 9 months.<span style="mso-spacerun: yes;"> </span>We can figure this
as follows: given the relative size, we would expect MD Barber to increase
revenue by 10%, in fact, it has increased it by 11% and management indicated
this is an increase over last year.<span style="mso-spacerun: yes;">
</span>Interestingly, it is in line with the organic SPCO business, which is also
growing 9% YoY in 4Q, for a combined growth in revenue of 20%, with both units
growing something like 10%.<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">What does this mean from a profitability
standpoint?<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">One reason that SPCO
earns strong returns on capital are the high gross margins available in the
barber shop distribution business. <span style="mso-spacerun: yes;"> </span>It is
unusual for FMCG distribution companies to earn 30% gross margins, and yet SPCO
manages.<span style="mso-spacerun: yes;"> </span>I suspect that the high margins
are available because barber shop distribution is expensive; each customer
account is pretty small and not really eligible for a volume discount.<span style="mso-spacerun: yes;"> </span>This means that larger distribution players
who might be able to drive out cost mostly ignore the segment and the customers
don’t expect to have pricing power, so discounting is minimal.<span style="mso-spacerun: yes;"> </span>Also, if you look at the size of businesses
that set themselves up as local distributors of barber shop products, you can
see that they are themselves small (MD Barber looks pretty professional within
its segment and it has less than $1mn in revenue), which means that each of
them likely has considerable fixed costs that have to be amortized and limited
reach, such that there simply is not much scope to cut prices and still make it
worthwhile to stay in business.<span style="mso-spacerun: yes;"> </span>Of
course, if you could develop a platform that reduced fixed costs to serve and
were able to go on adding revenue at or near historical margins, your operating
margins could rise significantly towards your gross margins.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">We assume that MD
Barber, as an internet distributor, has lower gross margins (there have been no
details on this yet).<span style="mso-spacerun: yes;"> </span>We construct two
scenarios, in both scenarios, we carry through the 9% organic growth with
constant gross margins.<span style="mso-spacerun: yes;"> </span>In scenario 1,
we assume MD Barber has 20% margins.<span style="mso-spacerun: yes;"> </span>For
illustration, we then project a second scenario in which MD Barber has 30%
margins, nearly those achieved by SPCO.<span style="mso-spacerun: yes;">
</span>The impacts are to add $98 - $119k to gross profit.<span style="mso-spacerun: yes;"> </span>But in both cases, there should be some
incremental SGA, which offsets some of this benefit.<span style="mso-spacerun: yes;"> </span>Still, due to other efforts by management, we
believe this can be held to a much smaller increase.<span style="mso-spacerun: yes;"> </span>We assume a small increase in D&A over
the 20k per quarter that was running through 3Q as some of the intangible
assets acquired get written off.<span style="mso-spacerun: yes;"> </span>We then
annualize this effect (straight-line multiplication as the quarters are pretty
even) and get profits of $835-$921 per year.<o:p></o:p></span></p>
<div class="separator" style="clear: both; text-align: center;"><a href="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7Y4yR3AwTHYBP_fhspxE5_56LfHJSDtEIrrW0AdgNVxWnpReX4XegC-S6EiveVlhq2uXZDbuLhmSFxUNsZali8YSCL9NotCv1v2-rrM4Bp5HGpK9U88XwfQbuHaDszTQJngs7/s1415/spco_adjusted_forecast.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" data-original-height="616" data-original-width="1415" height="273" src="https://blogger.googleusercontent.com/img/b/R29vZ2xl/AVvXsEg7Y4yR3AwTHYBP_fhspxE5_56LfHJSDtEIrrW0AdgNVxWnpReX4XegC-S6EiveVlhq2uXZDbuLhmSFxUNsZali8YSCL9NotCv1v2-rrM4Bp5HGpK9U88XwfQbuHaDszTQJngs7/w625-h273/spco_adjusted_forecast.png" width="625" /></a></div><p class="MsoNormal"><br /></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">In the lower scenario,
the higher intangibles and increased balance sheet size keep ROA at a quite
steady level, although in the more favorable scenario, they increase ROA by a
few percentage points.<span style="mso-spacerun: yes;"> </span>Returns on equity
are higher in both cases.<span style="mso-spacerun: yes;"> </span>What is really
impressive, quite frankly, is that the organic growth was achieved with only
$12k in CapEx into the legacy business <i style="mso-bidi-font-style: normal;">OVER
TWO YEARS.</i><span style="mso-spacerun: yes;"> </span>That means that, to the
extent that the organic growth is independent of the MD Barber business, the
business was able to grow gross profit by about $200k (annualized) with just
$12k of investment.<span style="mso-spacerun: yes;"> </span>Long may it continue
as it means that D&A costs will fall over time further enhancing
profitability in the meantime, they shelter taxes.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Now, the question is,
where will this money go?<span style="mso-spacerun: yes;"> </span>We have seen
already that very little needs to be reinvested, even if the past two years are
a bit of an extreme example, likely no more than 30-80k need to be
reinvested.<span style="mso-spacerun: yes;"> </span>This leaves money for
acquisitions on a similar scale and setup.<span style="mso-spacerun: yes;">
</span>Assuming just maintenance capex and no further deals, the business could
have $800-$900k for distribution.<span style="mso-spacerun: yes;"> </span>With
4mn shares out, this would be a dividend of $0.20-0.225 per share.<span style="mso-spacerun: yes;"> </span>If growth on the scale of the 4<sup>th</sup>
quarter could be sustained annually, good for about a 1-2% share pickup per
year, half from organic and half from inorganic, and a deal required some $200k
in cash, there would still be enough cash for a $0.15-$0.18 dividend, before
counting the incremental sales and gross profit effects.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Now for a fun exercise
– note that management also mentioned that they are working on a deal to
monetize some of the trademark portfolio.<span style="mso-spacerun: yes;">
</span>What if they struck a royalty deal for 4% of sales on their trademarks
with a company that specializes in the retail channel?<span style="mso-spacerun: yes;"> </span>Say those products could earn $5-$10mn in the
retail channel.<span style="mso-spacerun: yes;"> </span>This would generate
$200-$400k in gross profit with substantially no incremental cost at all.<span style="mso-spacerun: yes;"> </span>The impact would be to lift Net Profit by an
equivalent amount and push it to $1-$1.3m against shares outstanding of 4mn,
good for $0.25-$0.325 cents per share.<span style="mso-spacerun: yes;">
</span>Moreover, margins would shoot might higher since the new revenue would
have effectively 100% margin.<span style="mso-spacerun: yes;"> </span>In such a
case, we could expect a very nice incremental payout, likely an amount offering
a 10% yield at today’s price, not to mention a revaluation of the entire
business upward.<span style="mso-spacerun: yes;"> </span>With ROE of 40% and
solid growth it would not be unreasonable to see the stock trade at 6-10x book
value.<span style="mso-spacerun: yes;"> </span>At current prices, it would also
offer shareholders something on the scale of 12-15% returns annually, plus the
appreciation in the shares, which might be significant.<span style="mso-spacerun: yes;"> </span>In a market environment with 2% yields and
4-5% expected returns on equities in general, you are being paid reasonably for
the risks assumed.<o:p></o:p></span></p>
<p class="MsoNormal"><b style="mso-bidi-font-weight: normal;"><span style="mso-ansi-language: EN-US;">Conclusion:<o:p></o:p></span></b></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">SPCO is a business
that generates fantastic returns on capital.<span style="mso-spacerun: yes;">
</span>The business is very well run by smart allocators who are pursuing a
variety of strategies to grow the business and further improve company
economics.<span style="mso-spacerun: yes;"> </span>Prices have risen some,
reflecting those improved economics, and yet, the company still yields
attractive payouts and offers the potential for further growth in what is
mostly a mature category.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">Obtaining shares is
difficult, but not impossible, and while current prices are not a “slam dunk”
they offer considerably higher potential returns that the overall market while
simultaneously avoiding the risks associated with herding into index products.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">This management team
has been quite intelligent in allocating capital and has required minimal
reinvestment to nevertheless grow the top line and margins.<span style="mso-spacerun: yes;"> </span>There are some hidden assets that might be
able to be monetized in interesting ways.<o:p></o:p></span></p>
<p class="MsoNormal"><span style="mso-ansi-language: EN-US;">We believe that a fair
price is likely between $3-$5 and possibly as much as $6-$8 in the right
circumstances, plus a decent yield and little risk of capital loss.<o:p></o:p></span></p>
<div style="mso-element: footnote-list;"><!--[if !supportFootnotes]--><br clear="all" />
<hr align="left" size="1" width="33%" />
<!--[endif]-->
<div id="ftn1" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref1" name="_ftn1" style="mso-footnote-id: ftn1;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[1]</span></span><!--[endif]--></span></span></span></a><span lang="DE" style="mso-ansi-language: EN-US;"> </span><span lang="DE"><a href="https://www.otcmarkets.com/financialReportViewer?symbol=SPCO&id=184637"><span lang="EN-US" style="mso-ansi-language: EN-US;">https://www.otcmarkets.com/financialReportViewer?symbol=SPCO&id=184637</span></a></span><span style="mso-ansi-language: EN-US;">; Balance Sheet, pg 3.</span></p>
</div>
<div id="ftn2" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref2" name="_ftn2" style="mso-footnote-id: ftn2;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[2]</span></span><!--[endif]--></span></span></span></a><span lang="DE" style="mso-ansi-language: EN-US;"> </span><span lang="DE"><span lang="EN-US" style="mso-ansi-language: EN-US;"><a href="http://thestephanco.com/">http://thestephanco.com/</a></span></span></p>
</div>
<div id="ftn3" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref3" name="_ftn3" style="mso-footnote-id: ftn3;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[3]</span></span><!--[endif]--></span></span></span></a><span lang="DE" style="mso-ansi-language: EN-US;"> </span><span style="mso-ansi-language: EN-US;">Data from Annual reports from </span><span lang="DE"><a href="https://www.otcmarkets.com/financialReportViewer?symbol=SPCO&id=180341"><span lang="EN-US" style="mso-ansi-language: EN-US;">2016</span></a></span><span style="mso-ansi-language: EN-US;"> and </span><span lang="DE"><a href="https://www.otcmarkets.com/financialReportViewer?symbol=SPCO&id=141776"><span lang="EN-US" style="mso-ansi-language: EN-US;">2014</span></a></span><span style="mso-ansi-language: EN-US;">.<span style="mso-spacerun: yes;">
</span>Calculations are author’s own work.<o:p></o:p></span></p>
</div>
<div id="ftn4" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref4" name="_ftn4" style="mso-footnote-id: ftn4;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[4]</span></span><!--[endif]--></span></span></span></a><span style="mso-ansi-language: EN-US;"> This is the products market, although it
supplies barber shops, it is not selling capital goods, like swivel chairs or
other furniture.<o:p></o:p></span></p>
</div>
<div id="ftn5" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref5" name="_ftn5" style="mso-footnote-id: ftn5;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[5]</span></span><!--[endif]--></span></span></span></a><span lang="DE" style="mso-ansi-language: EN-US;"> </span><span style="mso-ansi-language: EN-US;">Source: author’s own estimates.<o:p></o:p></span></p>
</div>
<div id="ftn6" style="mso-element: footnote;">
<p class="MsoFootnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ftnref6" name="_ftn6" style="mso-footnote-id: ftn6;" title=""><span class="MsoFootnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoFootnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[6]</span></span><!--[endif]--></span></span></span></a><span lang="DE" style="mso-ansi-language: EN-US;"> </span><span style="mso-ansi-language: EN-US;">Source: 3Q17 10-Q, pages 3, 5. 7 for the financials, and page 8 and 9
for the purchase accounting.<span style="mso-spacerun: yes;"> </span>Adjustments
and ratios, author’s own analysis.<span style="mso-spacerun: yes;"> </span><o:p></o:p></span></p>
<p class="MsoFootnoteText"><span style="mso-ansi-language: EN-US;">Adjustments
reverse the purchase accounting and the $56 that was paid subsequent to close
to reduce loans available.<span style="mso-spacerun: yes;"> </span>These loans
were acquired, but as of 30 September were only showing $70 as management
already partially paid down the loans.<span style="mso-spacerun: yes;">
</span>Walking through the adjustments: <o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: .5in; mso-list: l4 level1 lfo2; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Adjustments
to Equity:<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">a.<span style="font: 7.0pt "Times New Roman";"> </span></span></span><span style="mso-ansi-language: EN-US;">Rever</span>se out stock issued reducing common stock by $2 <br /><br />b. Reverse out paid in capital by $392 <br /><br />c. Reduce Accumulat<span style="text-indent: -0.25in;">ed Deficit by $33 for the costs associated with the acquisition</span></p>
<p class="MsoFootnoteText" style="margin-left: .5in; mso-list: l4 level1 lfo2; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Adjustments
to Liabilities:<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l0 level1 lfo3; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">d.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reduce A/P
by $50 for payables assumed and by $35 in purchase credit for inventory<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l0 level1 lfo3; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">e.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reduce
Loans payable by $70<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: .5in; mso-list: l4 level1 lfo2; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Adjustments
to Assets other than Cash<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l0 level1 lfo3; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">f.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Intangible Assets acquired by $645<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l0 level1 lfo3; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">g.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Inventories Acquired of $132<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l0 level1 lfo3; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">h.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Receivables Acquired by $21<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: .5in; mso-list: l4 level1 lfo2; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Adjustments
to Cash (i)<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l3 level1 lfo4; text-indent: -.25in;"><!--[if !supportLists]--><span style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Cash received of $38, <o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l3 level1 lfo4; text-indent: -.25in;"><!--[if !supportLists]--><span style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Cash Paid to Seller of $231<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l3 level1 lfo4; text-indent: -.25in;"><!--[if !supportLists]--><span style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
Cash Paid to Loan Holder of $56<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l3 level1 lfo4; text-indent: -.25in;"><!--[if !supportLists]--><span style="font-family: "Courier New"; mso-ansi-language: EN-US; mso-fareast-font-family: "Courier New";"><span style="mso-list: Ignore;">o<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
SGA Costs incurred for acquisition of $33<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: .5in; mso-list: l4 level1 lfo2; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-fareast-font-family: Calibri; mso-hansi-font-family: Calibri;"><span style="mso-list: Ignore;">-<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Adjustments
to P&L<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l1 level1 lfo5; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">j.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
$19 in SGA costs associated with acquisition<o:p></o:p></span></p>
<p class="MsoFootnoteText" style="margin-left: 1.0in; mso-list: l1 level1 lfo5; text-indent: -.25in;"><!--[if !supportLists]--><span style="mso-ansi-language: EN-US; mso-bidi-font-family: Calibri; mso-bidi-theme-font: minor-latin;"><span style="mso-list: Ignore;">k.<span style="font: 7.0pt "Times New Roman";">
</span></span></span><!--[endif]--><span style="mso-ansi-language: EN-US;">Reverse
$14 in Other Expense associated with one time acquisition costs<o:p></o:p></span></p>
<p class="MsoFootnoteText"><span style="mso-ansi-language: EN-US;"><o:p> </o:p></span></p>
</div>
</div>
<div style="mso-element: endnote-list;"><!--[if !supportEndnotes]--><br clear="all" />
<hr align="left" size="1" width="33%" />
<!--[endif]-->
<div id="edn1" style="mso-element: endnote;">
<p class="MsoEndnoteText"><a href="file:///C:/Users/DouglasPedersen/Documents/Doug/Equity%20Analysis/By%20Ticker/SPCO%20for%20Sa.docx#_ednref1" name="_edn1" style="mso-endnote-id: edn1;" title=""><span class="MsoEndnoteReference"><span lang="DE"><span style="mso-special-character: footnote;"><!--[if !supportFootnotes]--><span class="MsoEndnoteReference"><span lang="DE" style="font-family: "Calibri",sans-serif; font-size: 10.0pt; line-height: 107%; mso-ansi-language: DE; mso-ascii-theme-font: minor-latin; mso-bidi-font-family: "Times New Roman"; mso-bidi-language: AR-SA; mso-bidi-theme-font: minor-bidi; mso-fareast-font-family: Calibri; mso-fareast-language: EN-US; mso-fareast-theme-font: minor-latin; mso-hansi-theme-font: minor-latin;">[i]</span></span><!--[endif]--></span></span></span></a><span lang="DE"> <o:p></o:p></span></p>
</div>
</div><i></i></div>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-37055414384724912872020-05-30T15:27:00.000-04:002020-05-30T15:27:23.554-04:00A few good investing websites<br />
I honestly am trying to spend less time on "newsy" investing sites and focus more on fundamentals and thinking as we approach a "4th Turning" crisis period. Alas, crisis periods are nearly impossible to "invest" in in the normal sense - extrapolation and prediction are nearly impossible because there are so many macro factors that are likely to get resolved in one big cataclysm; the outcome of which is largely dispositive as it is really unknowable. Inflation or deflation? Empire or tributary dependency? Heavy industry, physical assets, or intellectual property? Legal, economic, environmental, political systems - all up for grabs.<br />
<br />
Few strategies work well and unlike the later states of the prior crisis period, securities are not dirt cheap. The right strategy in 1937-1938 was to buy net nets, which were plentiful. Today, they are hens teeth, so the downside of being wrong is much much larger.<br />
<br />
Anyway, some things you might want to check out:<br />
<br />
- The writings of famous investors on <a href="http://www.austinvaluecapital.com/resources.html">Austin Value Capital</a><br />
<br />
- The ideas on <a href="https://clarkstreetvalue.blogspot.com/">Clark Street Value</a><br />
<br />
- The smart guys at <a href="http://www.oddballstocks.com/">Oddball Stocks</a><br />
<br />
- The "cousins" at <a href="http://www.nonamestocks.com/">NoNameStocks</a><br />
<br />
- Dave Waters at <a href="https://otcadventures.com/">OTCAdventures</a><br />
<br />
Not saying these are ways to invest, but they are places to think about the discipline AND get some stuff to sift through.<br />
<br />
Recognize that most of the investors at Austin Value Cap were born in a fortuitous period from 1916-1930. Most of the great generation of post war investor-allocators were from this period, because you had your early career largely after the war and could accumulate significant assets cheaply from the 1940s to the mid sixties (Graham style investing) then buy compounders with strong yields in the 1970s and then sit back and let the twin tailwinds of lower taxes and lower yields drive the portfolio value into the stratosphere. Not saying these aren't smart people, just that Ben Graham, who was quite a bit older, did much less well because he was born at the wrong time to have the strategy truly work for him; he died before the really big revaluation could work it's magic.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-8487181406044726292020-05-29T04:12:00.003-04:002020-09-17T22:50:06.694-04:00What happens to Core Molding (CMT) from here?Core Molding Technologies is an SME focused on plastics and structural foam molding that has emerged through a series of solid acquisitions, from the heavy trucking industry. Starting in 2018, the company was hit with twin challenges of operational weakness and balance sheet weakness. It has been fighting back ever since, but the stock price collapsed - barely exceeding $1 at the depths of the Covid-19 market panic in March. The price has bounced back since, what is likely to happen now?<br />
<br />
I will spare you the suspense - I believe that the price is likely to rise, and sharply, from here. Why? Because of several cash generating levers that we are likely to see that will mitigate much of the "risk" to the lenders, who will therefore be likely willing to refinance the company, after they exact the pound of flesh that always attends distress guys.<br />
<br />
Rarely do I take this view - almost always distress debt and NOLs lead to more distress and more NOLs until at some point, the business is sold, the assets or sold, or the whole thing is refinanced with debt being swapped with equity. For much of the past 12 months, it has been hard to see which way this was likely to play out, but several recent developments have indicated that the business is likely to survive intact with the equity surviving as the successful fulcrum security.<br />
<br />
There are multiple reasons for this - the first is that the company competes as part of an oligopoly in its core market segment: plastic and lightweight composites for transports, particularly heavy trucking. The heavy trucking industry itself is quite concentrated - in North America there are four major players (Navistar/International, PACCAR, Volvo and Daimler Trucks); in Europe, you add Volkswagen/MAN and Fiat/Ivecco, but lose Navistar and in Asia you have a few other firms. However, each of these geographies is actually quite separate as are many of the supply networks, because the physical transport costs are significant. Sure, small parts like nuts and bolts are largely globally competitive, but air shields and panels and such are hugely expensive to ship if you have to pack them in containers and float them across an ocean; they take up too much space. It is far more efficient to ship raw materials to a factory co-located or at least near to the final production facility.<br />
<br />
Companies being what they are, three competitors are essential to pricing and development strategies. Each of the four North American producers does business with each of the three suppliers (CMT and its competitors). The ecosystem is balanced in this way, and so everyone can earn ok profits and returns on capital over time; it would be unhelpful to the manufacturers to drive bargains that push prices below economic returns, because starving your suppliers means that they cannot invest in your future. This is how CMT managed to be profitable from 1996 to 2017 in all years except one (no credit for guessing that it was 2001, not 2008 or 2009 that was the unprofitable year). This sort of stable business that allows for very careful planning of capex is a source of competitive advantage and allows for very solid returns on equity and capital (high teens) over a cycle.<br />
<br />
Moreover, we know that CMT has historically been a solid operator - a few years back, CMT landed a huge increase in business when a competitor irked one of the big four producers and had some programs shifted to CMT.<br />
<br />
CMT has also historically been quite conservative in finance. I attribute much of this to the board - who are all old corporate operators with conservative corporate finance perspective. CMT was actually a spinoff of Navistar (in 1998). They have chosen to avoid balloon payments on debt (though the current debt does have a balloon, but it is many years out and CMT has adequate time to earn enough to meet the balloon).<br />
<br />
Prior to COVID putting a hurt on operations, the company was earning solid returns; overall 1Q20 results were good, in spite of slow sales at the end of March. 2Q20 will be weaker, and yet, plants restarted in May and trucking has continued apace. Moreover, several new lines of business from the acquisitions of CPI and Horizon actually were up in 1Q20 over 1Q19; so there is some buoyancy in their end markets. (I estimate that heavy trucking clients actually represented only about 50% of sales in 1Q20, so diversification is happening).<br />
<br />
In spite of what will be no doubt weaker sales and weaker profits from negative absorption of fixed assets and expenses, there might still be surprising cash generation in 2Q - lower sales in the past have been cash generative as receivables are collected and inventories are reduced. The strong paydown of payables in 1Q20 means that working capital actually expanded, providing more scope for reduction to align with lower sales levels going forward. If there is solid cash generation in 2Q, the receipt of $6m in tax refunds, it seems likely that the company can completely repay its $7.8m in revolver debt by 3Q20. The large tax refund is a benefit from the CARES act, which provided the company with a farther "look back" period for applying operating losses; usually these can be applied back one year and forward 20, under CARES, I believe they can look back 3 years. This allows the company to apply losses against profits from a period when corporate taxes were higher, as an added bonus.<br />
<br />
Since it is clear that the company will be able to make its payments, there is little incentive for the lenders not to offer forbearance a bit longer, continue to benefit from a penalty default rate and get re-liquified in the inevitable refi, or agree to do the refi themselves and get the origination fees on top. I need to be clear, the issue is actually not the repayment; I don't believe anyone can expect that the company cannot repay. The issue is that the debt has covenants promising certain levels of profitabilty which, due to operating weakness, have been violated.<br />
<br />
In any case, as I say, I expect that the debt will be refinanced and when an extension of the forebearance is announced, that the stock will rise further, and with a refi, that the stock will return to something approaching book value. I make this assessment, because of the solid profitability that the company generated on an operating basis with a much lower level of revenue in 1Q20. This is a strong sign that the operating improvements the new management have been putting in place are working, indeed, have worked, and that profitability in a normal operating environment, which should see revenue north of $70m a quarter will be incredibly strong. Gross margins were nearly 17% with $64m in revenue. With $72-75m they should exceed 19%. If SGA return to 2019 levels for similar levels of revenue, operating profit would be somewhere around $6.5m a quarter (with 7,778k shares out). Annualized, this is operating profit of around $26m, lower debt balances and lower interest rates could take interest costs down around 250 basis points, which could actually lower interest expense below $1m annually. Allow $1m and you still have PBT of $25m and income tax expense of 21% puts profits a shade below $20m, vs let's call it 8m shares out (it is less). $2.50 a share in profits. For a cyclical, is that worth 10x? 12x? As a firm with a solid history of good deals, increasing success at diversification from traditional verticals AND steady expansion of customers, products and manufacturing capabilities - could it be worth 15x? Maybe that is a bridge too far, but a stock price approaching $30, call it $28 seems like a 7x return from here in say, 18 months?<br />
<br />
Management and the BoD have persistently made open market purchases throughout the last several months and quarters in spite of - nee, because of - the market weakness. They have been signalling, I think, that they are not worried about being able to be refinanced. This has continued into COVID. The CEO and COO filed form 4s earlier this month after 1Q earnings dropped and they had a window to make purchases.<br />
<br />
There are risks, of course.<br />
<br />
First off, there are the macro factors. COVID could lead to some sort of permanent shutdown. Also, I believe that we are likely to find tax rates being hiked to address the fiscal situation - a conflict, a military conflict, that is, likely with China, might be the proximate cause, but when it happens, it will be swift and sharp. That would certainly change expected yields. <br />
<br />
Moreover, CMT, though an AMEX (NYSE MKT) stock and not a big board company, will still get hit. I am old enough to remember when the Wiltshire 5000 actually had 7800 stocks (to represent the "total [listed] market". Now I think it barely has 3300; so concentration in listed stocks has increased beta. Macro factors seem likely to persist. On the other hand, trucking might have certain tailwinds in a conflict and CMT might benefit.<br />
<br />
Also, there are macro tailwinds in the form of autonomy. While the excitement and enthusiasm for self driving vehicles is overhyped, particularly in passenger cars, trucking is where much of the investment is among the majors. This makes sense - in the early days of autonomy, much monitoring will be required; planned routes and logistics infrastructure will provide the means of that monitoring and the economics of lower operating costs will provide much of the investment dollars needed. CMT doesn't have a huge spare parts business, but new truck programs and sustained high volumes as the fleet is turned over would provide a sustained tailwind enabling sustained high levels of utilization. The cash could be used to make further acquisitions that could provide diversification and reduced cyclicality when the secular tailwinds abate after say, a double long cycle.<br />
<br />
<br />
The bigger risks are probably micro. As I have noted, the firm itself has certain protections from existential competition given the need of all four manufacturers to have a reliable local supply chain. It is possible that some Asian or European firms could make a transplant; buying a competitor, for instance and potentially driving down certain R&D costs, or leveraging global purchasing arrangements - given the fact that Daimler and Volvo are both Europe-based and between them represent a majority of NAFTA production, this is always at the back of my mind. On the other hand, if the economics of this were really that attractive, that sort of consolidation would likely have occurred. Management at CMT does not seem to believe that geographic expansion makes any sense, given their specialties.<br />
<br />
A bigger risk, perhaps is in some of the newly acquired business, because some important revenue lines derive from cases where CMT is a tier 2 supplier and not only at risk for their own performance, but also for that of the tier 1. Horizon Plastics, the deal that nearly broke the company (in spite of a significant amount of equity used in the purchase in the form of cash on hand) has multiple business lines, among which are plastic fencing sold through big box home improvement stores. You know it - the white, plastic 1/2 in or so, lattice fencing that is used mostly for cosmetic purposes. This product is considered part of the "wood" category, so the category manager always has to find a supplier for it, as the category manager is sometimes booted from one of the stores. In fact, CMT/Horizon benefitted from just such a situation - where the competitor was ejected and 100% of the business was awarded to the tier 1. This situation is likely to reverse - given the situation there is considerably more tail risk that we might want. Better for a firm like CMT to know that you will get between 40 and 60% of the business than 0 or 100%.<br />
<br />
Operations could continue to be a challenge - although these really seem worked out and I have personally been impressed with David Duvall and Eric Palomaki (CEO and COO, respectively). I believe they are earnest, hardworking and smart and full of integrity. Ironically, COVID may again be a tailwind here. The operational problems that were encountered late in 2018 stemmed from a set of misjudgments by management - misjudgments that were understandable. Trucking usually operates on a 7 year cycle, with five great years and two crappy ones. After what was a long up cycle into 2016 management and the industry anticipated weakness for 2-3 years. They were right in 2017 and had already made adjustments to hiring, staffing and capital investment, adjustments that saw profitability remain strong in a down year. They were caught off-guard when the truck market rebounded without sustained weakness, and, with unemployment at 20 years lows, were unable to recruit to staff up to meet demand, overtime and expensive contract labor were required, hurting margins. Previous management had compounded this error by PPAPing a part that could not be manufactured reliably, requiring considerable rework and overtime and even so, delivery delays hurt production and clients - one client in particular - assessed penalties for failure to deliver which compounded the losses.<br />
<br />
That mercifully seems to all be in the past. But CMT's specialty is in developing custom solutions, as when a part requires a custom fit and the integration of say a metal rod or component into the plastic. Problems with manufacturing could happen again.<br />
<br />
Another question mark remains the CFO. He is clearly not dumb, but I sometimes wonder if he is wise. Back when the company had an IR team, I was told that he was brought in with three objectives: reduce costs, improve IR and complete deals. He has achieved these things to some extent, but not always in the best way.<br />
<br />
He certainly helped reduce costs and raise profitabilty in the 2014-2017 period. I was genuinely pleased with the level of cash generation, though much of that sat fallow for years only to still prove insufficient to his ambitions. Thing is, I ask myself if those cuts weren't the real reason the company found itself so unprepared in the rebound of 2018. Some of htis might have been poor operating decisions by the former CEO, but how much of that was finance pushing for particular margin targets and forcing corners to be cut?<br />
<br />
IR has certainly improved in certain ways. There is a good investor presentation on the website (<a href="http://www.coremt.com/investor-relations/investor-presentation/">link here</a>). Moreover, Zimmer has always responded to my inquiries, for which I am appreciative. Moreover, he managed, through the operating difficulties, to provoke shareholders to attend the annual meeting for the first time in years in 2019. But not sure if that is really a good thing. He prefers to have individual calls rather than investor meetings or conference calls. The company does not present at any major conferences. This is in spite of doing deals that should have investors looking at the company less as a heavy truck supplier and more as a custom lightweight composites solution provider.<br />
<br />
Finally, there are the deals. I actually liked both deals he did at the time he did them. CPI was a deal that was entirely debt financed, though, I am not sure that it earns an equity rate of return. It is hard to say because much of the margin there (quite a bit of the revenue for Bombardier - BRP - is from CPI but some is also from Horizon) is hard to estimate. Moreover, that goodwill was impaired a few years later when management had to review goodwill as part of their normal process of looking at low P/B in market multiples. At least it was conservatively financed. At $15m, the purchase price was small relative to the cash generation of the legacy business. Moreover, the legacy business was largely unencumbered by the time of that acquisition and so cash built up. It brought them not only new customers and new verticals, it brought them manufacturing processes that were - we have been told - helpful in expanding significance with customers of the legacy firm.<br />
<br />
That cash may have burned a hole in their pocket, because the Horizon deal seems now to have been a bit expensive. It achieved several objectives, but also left no balance sheet flexibility. I have a sense that having failed to do small deals in the three years between CPI and Horizon, management and the board felt a need to do something "big" and almost sank the firm in the process.<br />
<br />
So, if we evaluate them as operators, investors and financiers, we can say that the old management turned out to be poor operators, but the new crew seems top notch, EXCEPT that perhaps the CFO also was to aggressive in optimizing cost aspects of operations and investment, both internal and from acquisition seem to have been either too parsimonious or two generous. Finally, as financiers, he has not been great. The folks who ran the company for the first two decades, who were holdovers from the corporate parent that spun the company, approached finance like typical corporate guys - conservatively. Wanting full amortization each month. One could argue that this was "aggressive" in the sense that it is inflexible to have monthly principal payments (as compared with balloons) but, it is disciplined and avoids the need to refinance or to keep large amounts of cash on hand waiting for the payoff date and earning returns well below the interest cost of the debt that the cash offsets.<br />
<br />
But in the Horizon deal, management should have demanded a different structure - knowing that the owner who built Horizon was selling to retire, they should have demanded that he take at least some of his payment in equity in the new business. This would have reduced the debt load and made it easier to meet covenants and would have made the former owner more invested in the success of the merged firm. CMT could have repurchased shares to offset dilution over time.<br />
<br />
They might have also considered some preferred or convertible debt. Rates were low, conversion provisions could have been set to ensure a premium to book and again, they would have had much more financial flexiblity. In the end, the CFO failed to imagine how bad the situation could be.<br />
<br />
On the other hand - he has managed, so far, to avoid issuing additional equity as they have worked through this, which is actually fairly impressive, tho it probably has been a reason the problems have gone on for so long. Will he get wiser? Who knows? The BoD is turning over some, and I expect that there will be a more muscular and aggressive board more focused on accountability. We shall see, but I believe that this firm has some great characteristics and offers a superior risk / return.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-741504735886440762020-05-21T04:25:00.001-04:002020-05-21T04:25:16.591-04:00Two types of Value Investors and Why Value has Underperformed<br />
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The structure of the modern company – indeed of modern business
operations – represents a big challenge in the frameworks that value investors use
to think about company values and in particular risk, reward and safety.<span style="mso-spacerun: yes;"> </span>Two structural factors: the impact of
intangible assets – and asset-light business and operating models - on business
value and quality AND the consolidation of industries into global players, are
making the calculus more difficult, particularly for one type of value
investor.<o:p></o:p></div>
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Value investing, properly understood, is an approach to taking
financial risks that seeks to minimize the risk of loss while allowing for reasonable
expectations of upside gains at rates of return that allow you to get rich (and
not just stay rich. “Get rich” returns have to be MUCH higher). Value investing
therefore is primarily focused on “safety first”.<span style="mso-spacerun: yes;"> </span>That safety is usually thought about through
looking at worst case scenarios and trying to buy at a price so low that it
offers a positive return even if that outcome occurs, or at least, only a very
low probability of loss, and near certainty that the loss cannot be very large,
not more than a few percentage points of the capital at risk.<o:p></o:p></div>
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Value investing as a mindset comes in two flavors: quality
and cheapness.<span style="mso-spacerun: yes;"> </span>Both concerns are
important.<span style="mso-spacerun: yes;"> </span>Quality matters, because crappy
assets, or even decent assets trapped inside of a crappy operation, tend to diffuse
over time and become impaired.<span style="mso-spacerun: yes;"> </span>They don’t
compound – or do so at very low rates - and so even if they are distributed at
some point in the future, the returns over time are modest. Worse, distribution
often happens at times of stress when the assets yield the lowest values.
Without quality there can be very limited expectation of upside, unless the
investor can wrest control of the assets and force some sort of asset conversion
– a liquidation, a merger, a recap, a new line of operation or business.<o:p></o:p></div>
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But paying too much for even a quality asset can produce the
same outcome.<span style="mso-spacerun: yes;"> </span>Needing an asset to “grow”
into its valuation embeds years of low or modest INTERNAL returns (market returns
can be robust) while waiting for the value to catch up to the price paid.<o:p></o:p></div>
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Value investors debate these two poles frequently – and often
bitterly.<span style="mso-spacerun: yes;"> </span>I often find myself debating
with other investors (and sometimes with myself) about the relative merits of
the two in the case of a potential investment, or in comparison of a few investments.
At issue is really a question of margin of safety, which, I believe is the true
hallmark of value investing (the estimation of which I am working hard at
improving).<span style="mso-spacerun: yes;"> </span>A big part of this divide
now, I think, is tied to the dominance of intangible assets in (post)modern
business: they have much greater tail outcomes than physical assets do.<o:p></o:p></div>
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Low price seems to offer a much more straightforward route.
It has a lot of appeal, in part because it is so quantitative.<span style="mso-spacerun: yes;"> </span>You can look at the market values of the
assets of the firm and if you can purchase them at a significant discount, then
even if they are producing modest, perhaps non-economic returns or just barely
earning their costs of capital, you still feel you have a margin of safety.<span style="mso-spacerun: yes;"> </span>In the event of liquidation, the securities/interests
you hold expect to receive a payout sufficient to at least return the capital
invested if not more.<span style="mso-spacerun: yes;"> </span>That is having a
margin of safety.<o:p></o:p></div>
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Consider, tho, what sort of things this investor wants to
buy – if the focus is on liquidation value, then the investor wants many,
ideally liquid, SEVERABLE assets.<span style="mso-spacerun: yes;"> </span>These
are the sorts of things that are easy to auction to many bidders: receivables
and rights to payment, inventories (in some cases, quick inventories at least),
assignable leases, real estate (esp cash flow real estate), even property plant
and equipment has value, especially to strategic buyers who may take a portion
of the operations and may pay for some of that business value.<o:p></o:p></div>
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This investor likes things like banks, old line industrial
firms, asset heavy companies with lots of liquidation value. His problem is
that in a world heavy on intangible, asset light models, what does he have on
liquidation?<span style="mso-spacerun: yes;"> </span>Often not much in the way
of safety.<span style="mso-spacerun: yes;"> </span>Intangible assets have much
fatter tails.<span style="mso-spacerun: yes;"> </span>If they retain their quality;
then the strong operating characteristics of the business – which often require
little or no reinvestment – mean that returns on capital will be genuinely
wealth creating, but in the event of impairment, they are often worth next to
nothing.<span style="mso-spacerun: yes;"> </span>These assets can be goodwill,
which is great while it is in place, but often worth nothing if customers flee.
Even the most “severable” of intangible assets, brand names, can often have
huge tail risks.<span style="mso-spacerun: yes;"> </span>Other intangibles, like
tax NOLs, are impaired upon transfer – by rule!<o:p></o:p></div>
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You can see the dilemma this poses for the value investor:
he sees a Facebook and can only think about MySpace and he is not wrong to
think this way.<span style="mso-spacerun: yes;"> </span>But – at least in my
case – I think the tendency is to *assume* no moat for Facebook; that it can
fall out of fashion and be yesterdays news in a matter of months.<span style="mso-spacerun: yes;"> </span>The implosions can be spectacular.<o:p></o:p></div>
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In cutting himself off from that left side of the distribution,
though, our price and liquidation value focused investor is cutting himself off
from many investments on the right side of the distribution set.<span style="mso-spacerun: yes;"> </span>These businesses produce a very
disproportionate amount of the value and so he underperforms.<span style="mso-spacerun: yes;"> </span>Constantly. As he waits for asset heavy
models to return to favor.<o:p></o:p></div>
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Worse, in a world with fewer competitors, the liquidation value
of many of the assets is also lower.<span style="mso-spacerun: yes;">
</span>There are simply fewer strategic buyers in nearly any traditional
business line to purchase the operating assets AS OPERATIONS, which always
command a higher price.<span style="mso-spacerun: yes;"> </span>So the discount that
has to be applied is larger.<o:p></o:p></div>
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Instead, the value investor has to focus more on paying up
for quality – which is harder and more “qualitative” which is also more
subjective. It requires thinking differently about what value means – that it
is possible for a person and a webcam to generate some incredible content and a
following that produces (if it remains topical) the potential for residual
income streams in the form of the modern form of “syndication” – the YouTube
suggestion set.<span style="mso-spacerun: yes;"> </span>These residuals can go
on for years. They can also disappear either from audience preference changes,
or from decisions by the platforms on which many of these businesses depend.<o:p></o:p></div>
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Quality – and being able to assess that quality – is more
important.<span style="mso-spacerun: yes;"> </span>Moreover, it may be necessary
to think differently about “quality” – that it is not always a permanent annuity.<span style="mso-spacerun: yes;"> </span>Perhaps it is something in which the investor
can realistically get a significant return in the near term – and thinking differently
about how manage that position (he will need a market outcome in most cases,
and will have to manage the position to capture and retain that gain.<span style="mso-spacerun: yes;"> </span>This, tho, might be thought of as sepcuatlive
and not value investing at all), in order to earn a solid return. <span style="mso-spacerun: yes;"> </span>Is it so bad to know that you are “guaranteed”
a solid return – enough to recover your capital and more – over a two to three
year cycle, so long as you make sure to sell, because the long term prospect is
the business is a $0.<span style="mso-spacerun: yes;"> </span>This might be like
investing in newspapers.<o:p></o:p></div>
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I think this paradigm really is a tough one for value.<span style="mso-spacerun: yes;"> </span>Value works because of cheapness and protection,
but it also assumed that financial capital would have considerable power in the
structure of the firm – that financial capital controlled the purse.<span style="mso-spacerun: yes;"> </span>But in an asset light world – very little financial
capital is required.<span style="mso-spacerun: yes;"> </span>Financial capital
is going cap in hand and begging entrepreneurs to let them put money into their
ventures.<span style="mso-spacerun: yes;"> </span>What is the likelihood that
this changes? The value investor is going to need to rethink the frameworks for investment, I think. To find a different way of seeing margin of safety and perhaps to change thinking around how to provide / ensure that margin of safety.<o:p></o:p></div>
<br />Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-55858195178446832632019-11-16T18:11:00.002-05:002019-11-16T18:41:58.258-05:00Your Tax Assets are Worth Less (than management says)<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Among the most interesting holdco
justifications is the need to protect the realizable value of tax assets, often
in plentiful supply at diversified holdcos, as the argument for diversification
is often an escape from the awful economics of the legacy business, the source
of the NOLs that gave rise to the tax assets.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">At first blush, this might seem prudent –
avoiding asset impairment is a good practice. And yet, tax assets seem a
curious rationale for a holdco, let alone a diversified one. It seems to
be a case of making a mistake by forgetting the objecitve, which is to earn
high returns on capital.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Tax assets, it must be said, come in many
forms. Those that arise from differences between tax and financial
account treatment of depreciation or similar „timing“ differences are pretty
solid assets. Like the cash cycle they are basically short term in nature
and can be expected to be realized in the near term, and no later than the useful
life of the operating assets that gave rise to them. NOL tax assets are a
horse of another color. These tend to pile up in operations that are
consistently loss making and which have few prospects for earning enough to
recover those tax assets in the future. In holdcos, the operations have
often been shut down or sold, leaving behind some capital of the cash box sort
and a pile of „assets we would like to find a use for“.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">The problem is that the IRS makes this
rather difficult. Internal Revenue Code Section 382, which sets the rules
that have to be followed in order to realize tax assets explicitly limits
several actions, like selliing or merging the firm as well as some other
complex rules. The point of the IRC is to prevent people from selling defunct
businesses as tax shelters. You have to continue to operate a business
yourself.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Finding a use for these assets is
actually remarkably tough in a world in which there is no inflation and asset
prices are sky high. Think about it this way. Imagine you are a
firm, like Hudson RPO (HSON), and you have $300mn in NOLs, supporting $60m or
so in DTAs. (Pretty good if your market cap is $35m). Now,
NOLs usually expire, so you have to earn offsetting income within 20-25
years. But even if you had 30 years, you would need to earn $10m a year
every year for those 30 years. But you don’t have operations that can
generate this sort of profit, certainly not consistently. If you did, you
wouldn’t have $300m in NOLs, you would have a balance sheet comprised of
operating assets. </span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Therefore, you need to BUY a business
that has that earning power and you are going to pay a going concern multiple
to do so. It will take something between 100-200mn probably to do this
deal. You cannot offer stock, because that would give the new firm too
much ownership and limit the DTAs. You have to pay cash. But your
box isn’t big enough for that. So you have to try and purchase lots of
little firms – you can see why diversified holdco structure seems to be the
best way to go – it is the only way to get all the looks you need. But
then you have to operate lots of subscale oddballs under one umbrella, or you
try and rollup an industry – like HVAC firms in Arizona.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Sure you can seed a business – but then
you probably don’t need to be a diversifed holdco, what you want is to become a
dominant operating company, which means you need someone who is not a
financier, probably; you need someone with a passion for solving a specific
human problem.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">There are some reasonably probable ways
to turn small piles of capital into profits – buying cashflow real estate at
low cap rates will create a stream of earnings. Except that in most
cases, it will be more efficient to hold the real estate outside of the
holdco. So really what is the point? Buy some land and become a
land trust?</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">Similarly, you could buy securities that
pay interest or dividends, but pretty soon you become an investment company,
which limits the sorts of investors you can have and forces you to go private
or become a CEF with a licensed management company. Either way, an
investment company isn’t taxed directly, so the benefits of the tax assets
disappear.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">I find the DTA thing strange for another
reason: taxes on corporate profits aren’t that high. During periods of
high taxation and high inflation, DTAs can be great – you can almost always
expect that rising revenue and rising nominal profits will enable you to use
fixed value NOLs and shelter significant tax. In the 1960-1980s, those
tax rates were about 50%. But along with the reforms that made it harder
to take deductions like NOLs, tax rates were dropped significantly. At
the 21% we have now, a dollar of NOLs is only worth 21 cents. And only
once. A dollar invested in a good business is worth considerably more
than that – every year.</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">It seems silly to trap capital inside of
such a structure in service to a tax optimization strategy at the expense of
reinvesting it in better opportunities that happen to limit the ability to
claim and shelter taxes. It is putting the tax shelter ahead of the
objective – which is to earn high returns on capital. This is the sort of
thinking that arrogant retail investor commenters on Seeking Alpha employed to
explain the brilliance of their investments in MLPs, until they blew up.
„Look at my yield! And I get to shaft the tax man, too! I am so
smart!“. Then Kinder Morgan blows up and … crickets. Why copy them?</span><br />
<br />
<br />
<br />
<span style="mso-ascii-font-family: Calibri; mso-bidi-font-family: Calibri; mso-hansi-font-family: Calibri;">So why then do managements work so hard
to defend these assets, when they should be focused on improving the capital
base and the operations of the holdco? Well, here Whitman’s discussion of
communities of interest and communities of conflict come into play. DTAs
are a great excuse for management to entrench itself and add poison pills like
rights offerings ostensibly to protect DTAs from being limited by a change in
control, which ensures that THEY remain in control.</span><br />
<b></b><i></i><u></u><sub></sub><sup></sup><strike></strike>Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-16995656252340235312019-11-10T17:00:00.001-05:002019-11-10T17:00:33.667-05:00What I like and hate about Dividend Growth InvestingDividend growth investing, or DGI as it is often known, is a popular strategy for investing in stocks that receives immense digital ink on investment websites like Seeking Alpha and other places retail investors congregate. I think the main reason that it is so popular is that it is a strategy that works for retail investors in that it can be put into practice without too much effort and without requiring huge amounts of research. I have generally found it sort of lazy, even as I have considered the importance of dividends in my own investing. I realize that there is much value in the approach, it is the writing that is lazy - a source of poorly researched clickbait. So, I want to give it a fuller and fairer treatment here on my own personal blog.<br />
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Depending on how you count them, DGI has three (four) major virtues as an investment strategy. <br />
The first is that it is long term. I have heard several investors argue that in spite of considerable efforts by folks like AQR to reduce alpha to the impact of a set of factors, that duration - a willingness to simply let an investment strategy compound for long periods, cannot be deconstructed in this way. At a minimum, long term as in any form of buy and hold, minimizes transactions and therefore minimizes fees, which is always helpful.<br />
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A second factor, which is related to the first is that having a long term orientation of this kind pushes the investor towards QUALITY. Dividend paying firms - particularly those that are able to raise dividends regularly, are firms that are going to generate stable and recurring cash flow far in excess of reinvestment requirements. They will generally have considerable ability to apply leverage to goose returns and to do deals, minimizing the amount of equity that has to be held on the balance sheet - capitalizing on the (often unrecognized) goodwill.<br />
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Third, I think dividends, and particularly dividend growth, enables the investor to ride out periods of market volatility, or indeed just the normal up and down of the price cycle, because of a psychological "stabilizer" that is the history of rising dividends. It is so much easier to ignore the current price of a stock when looking at your gain / loss or cost basis, you get to watch a history of rising dividend payments stretching back unbroken to your first purchase. For myself, I can say that one of my long term holdings, Colgate (CL) does this for me. It was a large position when I started, and has gotten smaller as some other investments have grown faster, and as contributions have been allocated to other things, and yet, the value has increased dramatically since I bought it 15 years ago, with the dividend stream rising 5x (I DRIP dividends on CL). It is so much easier to look at THAT trend and ignore the "noise" in the price signals in the daily market moves of the stock. If CL is able to increase dividends by another 5x over the next 15 years and 5x in the 15 years after that, I will have dividends 125x my first dividend payment and will receive quarterly about 75% of what I invested. Sure, that will have taken 45 years, but so what? Would $4k invested in Social Security be worth $12k in annual pensions 45 years later? This is the power of long term thinking. There is no guarantee of course, that CL can continue to extrapolate dividends at this rate. For one thing, dividend growth there has slowed considerably in the last few years as slow top line growth has caught up with the company. The former CEO used financial leverage and engineering to keep the dividend rising, but the new CEO wants to derisk and is slowing dividend growth. Anyway, the previous CEO found that he had to do the same in the end, lest the payout ratio rise too high.<br />
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This sort of equanimity is possible because of the fourth factor, which is that dividends are valuable not so much because of the change in the duration of returns (which is the way that most academic financial writers talk about it: as risk reduction. The real benefit is that you have a source of return other than the market itself which makes you less dependent and less interested in the market volatility. Receiving your return internally - paid by the operations of the business - makes your stock much more akin to a bond. One without a fixed maturity, admittedly, but a perpetual bond is an attractive investment in many cases, particularly if there is an inflation kicker. It tends to moderate the market swings, too.<br />
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Given this, I think there is no reason to discourage this approach. In fact, I think it is an entirely reasonable way to build a portfolio of above average quality businesses while reducing market sensitivity over time and experiencing solid compounding as one gets the chance to reinvest dividends to acquire more shares.<br />
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Particularly if one pays especial attention to the price paid, some dividend stocks can offer truly excellent rates of return and the ability to purchase a long term income stream at very attractive prices and thereby lock in considerable retirement (or extra investing) income for prices that could not be purchased any other way. <a href="https://strategicinvestor.blogspot.com/2019/10/why-so-many-bac-shareholders-are-ok.html">I wrote about this in an article about BAC</a>, answering a comment from a Seeking Alpha article. A commenter was trying to understand why so many BAC shareholders were rooting for continued low prices (enabling faster and larger buybacks and therefore faster long term dividend hikes).<br />
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WHAT I DISLIKE<br />
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My problem with this approach has less to do with the theory or even the mechanics than with the commentariat on the topic. All too often dividends history serves as a substitute for fundamental research necessary to estimate the sustainability of those same dividends. In this way, it focuses its adherents on the capital account, rather than business fundamentals, as a means of evaluating the investment and this is not a good way to think.<br />
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The most common way of doing this is to have people look at questions of sustained dividend increases by selecting names from a list of Dividend Aristocrats. To the extent that this is a list that identifies quality (you have to have a good business to be able to raise dividends consistently over very long periods) and a management priority to provide a return via dividends, it is a good place to start. But when the discussion is about how many years the investor "require" to be a good investment I think it overlooks the not small probability that some long-running dividend payers can suddenly find themselves in tough going. Often these are mature tech companies, but we see it in other firms as well.<br />
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The worst sort of articles are those that focus on the yield. All to often these are really retiree clickbait, like discussions of REITs or MLPs. The emphasis all to often is on the tax implications of dividends - low taxes, or almost always issued with smugness, an idea that "return of capital" accounting provides the owner with some way to screw over the tax man. These sorts of discussions, where the author is putting the cart before the horse, focusing the reader on easy to understand things, make me crazy.<br />
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In few cases are they writing about how DGI darlings are capitalized - how many articles were written by the DGI crowd explaining how the large yields they were receiving were an indication of the instability of the firm's capital structure, analyzing how it sought new investment through net share issuance while sustaining a high yield because that yield provided access to capital markets in the form of yield hungry investors?<br />
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My problem, in short is less DGI itself - though it tends to put the investor into mature firms, these can still produce excellent returns (look at SPGI, which I purchased in Feb of 2012) - the problem is with the way that the writing inevitably ignores or elides important considerations, aimed as it is on retail "investors" with limited experience or skill evaluating business quality or prospects.<br />
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Mostly, I fear this is a result of two or three factors: first, there is an element of the blind leading the blind in this area. The analysis is superficial because it is written for people with limited knowledge and understanding by people with only slightly less knowledge and understanding. (The Dunning Krüger effect runs deep in this set). Second, the audience is one that lacks a more sophisticated toolset for some of the more important analysis - introducing lots of information that requires frameworks the reader lacks to be intelligible is basically unhelpful. At best it leads them to conclude they don't know what to make of it. This is not popular, though which leads to the third factor. Many of these articles are written not to be thoughtful and thorough, but to fast and provide lots of clicks. Quantity is much more important in building audience (brevity, at which I am hopeless, also helps), and so the nature and content of these things is set up to get people reading the material.<br />
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DGI then, is a solid strategy I believe that can help an investor focus on the strategy - the long term approach that they are taking and helps tune out the noise associated with stocks of "infinite" duration. In the end, the basic problem is that it is a hermeneutic that is too often used as a shortcut that short circuits the more difficult analysis that are required for fundamentals investing.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com1tag:blogger.com,1999:blog-24695385.post-62078425265411436122019-10-20T22:36:00.003-04:002019-10-20T22:36:39.642-04:00Why so many BAC shareholders are ok with a low share priceAfter Bank of America (BAC) reported 19Q3 earnings this week, there were some discussions on Seeking Alpha by commenters arguing for the benefits of sustained low share price for the bank. Naturally, this seemed to confuse at least one poster, and this topic has been running in the background on several online conversations.<br />
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On the surface, it seems sort of odd, doesn't it, for shareholders to actually desire LOWER prices for their portfolio positions? Don't investors want the shares to rise? Ultimately, probably yes, but I think what this discussion shows is the heterogeneity of shareholder objectives in a public company. Marty Whitman talked about this idea at length, and expressed a view that one of the biggest mistakes that academic finance has made (and reflected in law and regulation) is the substantial consolidation of the firm and the shareholders. He had a rather intelligent understanding of the various stakeholders in a firm and a Venn Diagramm-like view of overlapping communities of interest and opposition (and presumably indifference, although he didn't explore this to my knowledge).<br />
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So what is the deal with BAC and shareholders happy to have lower prices? Well, I think it depends heavily on when you bought your shares and what you think you are doing with that investment. There are many retail investors - the sort of people who post comments on SA - who purchased these shares some time ago. Many purchased them in the 4th quarter of 2011, after Warren Buffett got 700mn options at $7.14 and the share price, after a brief spike, subsequently crashed to a low of $5 in early December of that year. Much of this 4th quarter move appears to this writer to have been tax loss selling, as the minute 2012 came rolling around, the shares went on a run to $12 in a matter of weeks. I digress.<br />
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The point is, if you loaded up as a retail investor in late 2011, you were probably thinking that the bank was not on death's door, although it was price as though this was the case, and that eventually the business would be capable of generating solid profits per share and paying large dividends. Eight years later, that reality has come to pass.<br />
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At this point, if you are that sort of retail investor, you may be doing this sort of math: this stock is a cheap pension. Let's say you purchased 10,000 shares of BAC at an average cost of $7. You might have done much better than this, but let's not push the envelope too far. Looking out to 2021, you can reasonably expect the dividend to reach $1 and rise from there. If 50% of the 2019 shares can be bought in by 2031, not unreasonable if the company gets a few more years of being able to net repurchase 10% of the shares out and then steadily works at a mid single digit net repurchase rate, EPS should rise to something on the order of $6 a share without any organic growth. If the dividend rate were to rise to around 50%, you could be looking at a $30k pension 20 years after the investment of $70k. Moreover, just taking the expected returns from 2021 (of $10k - $1 per share on 10k in shares), you would have expected to receive $100k back on your initial investment BEFORE getting at $30k rising annuity pension. This probably understates the capital return because it is unlike to remain at $1 for ten years before rising to $3. If it advanced linearly over the 10 year period, the average would be $2 per share, good for a $200k return, or 3x the initial investment while STILL holding that investment and being entitled to the same $30k rising annuity pension.<br />
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This ignores the dividends likely to be paid between 2016 and 2021, which are good for a couple dollars per share in total.<br />
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Moreover, if the bank is able to increase earnings through cost control and a slow growth of the balance sheet and a slow shift toward greater tangible value (assuming intangibles remain stable) perhaps total earnings might grow 50% over the period, enabling EPS of $9 per share (good for an earnings yield on cost of well over 100% per annum) and a payout closer to $45k.<br />
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Compare that to Social Security, where an upper middle class earner can be expected to contribute over $12k per year (don't forget, employees pay the employer half of the the 12.4%) for 40 years ($480k) to have a similar pension. The difference is, the BAC investor, who might have been a typical GenX 35 year old in 2011, paid MUCH less, doesn't have to wait to 67 to collect - his 30k BAC "pension" is available at 55 after returning 2-3x his initial investment. He gets to collect for 12 more years - worth a stunning $400-$500k more, not to mention the ongoing rise in his income thereafter (his annuity at 67 will be much much higher than Social Security). Finally, unlike an insurance annuity, this investor retains ownership over the principal which is likely to be capitalized at some 20x-25x the dividend payout. $700k-$1.2m in 2031 will be worth less than at present, but this is a simply massive return.<br />
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But a not considerable amount of this return is based on teh ability of the bank to repurchase shares cheaply, which, so far, the market has allowed for.<br />
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I get that it is frustrating. If a significant portion of your portfolio is invested in BAC, then you have not seen that portion of your brokerage statement drive a result since 2017. If you are being paid to manage money and have promised investors that you will beat the market over certain time periods, you may find it difficult to hold BAC even as it gets objectively cheaper.<br />
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There are also risks, not least of which is credit quality and other macro factors like interest rates. Then there are the fintech firms that are looking for ways to reduce the dependence on the centralized ledgers of banks and the permissioned system of transaction verification. These could be near mortal threats to the fees that banks are able to charge for operating the payments system. Though in the end someone has to perform the underwriting functions associated with credit and banks are likely to continue to do that better than most other firms.<br />
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BAC has several other attractive features - among them the fact that it cannot do acquisitions for additional US deposits. When I first purchased BAC shares, this was a major highlight for me. Alas, it did not prevent the acquisition of Countrywide. Inasmuch as countrywide was an effort to get more control over the creation and marketing of mortgage backed securities to improve the position of BAC investment banking (the old Credit Suisse First Boston securities business that BAC acquired with BankBoston, but which they struggled to grow into a bulge bracket bank - not for lack of trying), it was also a deal that could be done that avoided the deposits question. Such a deal could be done again (let us hope that it will not be). BAC has the option to enter foreign markets with retaail banking, but they can wait for a very favorable time.<br />
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For these reasons, I have not sold BAC shares in some time, although obve $30 and in particular above $35 I think that the price to tangible book suggest that it might be time to trim. But then I think, hold onto your shares (I have trimmed from my 2011 position becuase BAC was getting to be too large and becuase there were other things to purchase and finally because I perhaps lost sight of some of this along the way. I believe that a few stocks like this are the key aspects of having a strong portfolio. Knowing, as an investor, that you will not be destitute, provides you with much more leeway to pursue more speculative positions that have high risk reward characteristics.<br />
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The longer the stock remains cheap - so long as management remains committed to repurchases - the faster and more likely it is that the scenario outlined here will be a success.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-46665393495027678842019-05-27T20:22:00.002-04:002019-05-27T21:32:58.709-04:00My take on the FCA Renault MergerSeveral people have asked me what I think about the merger of Fiat Chrylser Automobile (FCAU) and Groupe Renault (RNO-FR; RNSLY OTC). Full disclosure, I own shares in FCAU.<br />
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I will admit to being a bit surprised at first, not at the merger, but at the partner, FCA chose. I had thought that they would instead look to merge with PSA (Peugeot Citroen) becuase, in my view, PSA has stronger engineering and leadership. That said, I think there is quite a bit of industrial logic, although Renault, with its special relationship with Nissan, comes with some challenges that might be helped by an FCA tie up, or might not be.<br />
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I will give you my thesis and then talk about some of the logic and then take some of the analysis to the brand level, where I think things are always more difficult to analyze (although it tends to be where much of the analysis is done in - and of - the industry).<br />
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My thesis is that FCA and Renault are merging because they have the same basic view of the industry: that consolidation is necessary - and they have a similar approach to how to manage it. Moreover, both firms have demonstrated an ability to take industrial firms in adversity and resuscitate them and to manage complex tie ups across regions and product. Yes, the Renault Nissan alliance is showing strain. But it has worked with both firms far stronger as a result. Less well known in the US is the success that Renault has had in rebranding and reviving Romanian car manufacturer Dacia and Russian LADA. Both of these brands remain popular in Eastern Europe and needed careful stewardship by the sponsoring French firm.<br />
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Thus, my contention is that what management at both firms have decided is that the most important aspect of the industrial logic is to have managements that have the same objectives and focus and approach to managing industrial tie ups. There is also a basic industrial logic, of course. It wouldn't make sense to merge with a restaurant roll up no matter how much alignment there is at the managerial level. Automotive firms, though are tricky. The brands are sticky and powerful. The ecosystems that sustain them are complex and job rich, therefore tie ups are popular political events as much as they are economic ones. Given the set of pressures, it is important to avoid DaimlerChrysler style managerial conflict. You need to have teams that work together and which are not going to raise too many sacred cows protecting jobs, plants, systems or products in any one market or market area.<br />
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Both Fiat and Renault have proven themselves capable of this.<br />
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One more thing - a solid tie up of this type creates further incentive for an outsider, like Marchionne and Ghosn, to step in to lead the combination of the entity without legacy allegiance to either side.<br />
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In short, this seems a continuation of the strategy that both firms have pursued independently and successfully. The meeting of the minds at the managerial level was likely too good to pass up even if another firm might have made more sense on paper. Firms don't exist on paper. They are people and the people need to be able to work together.<br />
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Since the rise of Marchionne to the chief executive role of Fiat, the strategy has been one of consolidation and scaling. Fiat deftly pursued several incredibly shrewd recapitalizations, starting with forcing GM to pay it $2bn to invalidate the put option that Fiat had with GM. That provided just enough money to invest in a small vehicle platform (that became the Panda and several other small vehicles), two small engines and an upgrade at Maserati. Those programs all worked stupendously and with some other smart restructuring, Fiat was able to buy Chrysler out of bankruptcy.<br />
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Again, capital allocation was masterful. Chrysler had, as part of its divorce from Daimler, several solid platforms including the old M-Class (164 chassis) and the old E-Class platform (211 Chassis), on which it had planned to build the Dodge Caravan, and the 300. These two platforms were well engineered and well designed and by 2009 had all of the "bugs" worked out. There were a few issues to mate those chassis with the different bodies that FCA wanted, but most importantly, what FCA realized was that it platforms that, for its customers, could go for years with little capex, allowing for that money to instead be invested in RAM and in Jeep, brands that could earn significant premia and very good contribution margins.<br />
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Along with some "slimming" of Fiat Industrial and a spin of Ferrari, both of which raised significant cash, FCA, which had started with a terrible product plan and no money, found itself with strong product and brands, decent operating margins and net industrial cash. (Recent performance woes at Maserati suggest that there might not have been enough investment there as the company got really focused on building the Alfa Romeo product - incredibly compelling product, it must be said, but the Quattroporte was allowed to age, even though I think it still looks great).<br />
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But in spite of all of this focus on internal cash generation and recapitalization of the business, the fact remains, the strategy from the get go has been to scale up in car manufacturing. 15 years after Marchionne took the helm and a year after his death, nothing there has changed. Sure, Marchionne took $2bn to avoid a merger with GM. That seemed to run against the strategy. Except that it was already obvious that GM, particularly a Rick Waggoner-led GM, which kept promising that prosperity was right around the corner, just as soon as xyz problem (often pensions and postretirement costs) was behind them they could invest more in product and win in the market, was never going to be able to invest enough in Fiat for either firm to survive. GM was a dead man walking, and Marchionne didn't want that deal - at least not with Old GM.<br />
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Instead, he picked what seemed a weaker partner in Chrysler. But here, I think, Marchionne was smart. He knew that the organization had some good assets that needed proper deployment with proper capital allocation. He also knew that the organization was looking for leadership - it was not going to be able to put up much of a fight when Fiat started to make changes. GM was still far too ossified. Chrysler, after 10 years of German and PE occupation, was ready for leadership ready to cultivate its unique strengths.<br />
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Once he had FCA, though, Marchionne often went seemingly without shame, cap in hand to other manufacturers to try and get them to merge with him. His pandering to New GM and Mary Barra was particularly shameless, but his point was always the same. Even with six million units, FCA was not big enough for what is coming. Given the complexity, he needed a partner that saw things his way.<br />
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Renault, it must be said, was in a similar way. It was an early proponent of buying and upgrading weaker players and it was aggressive in the way it went into Eastern Europe to find scale for its systems. Ultimately, these investments, under Louis Schweitzer, proved sound. Moreover, snatching Nissan during a moment of weakness was a masterstroke. Here, like Chrysler, you had a company that had some strong product, but lacked the ability to really get it to market effectively. Renault raised the capital necessary to both control Nissan and to invest in the Pathfinder platform that revived the brand in the US. The price was low, which sticks in the craw of so many Japanese. It seems strange that 20 years on, they have never thought to complete the merger and become one integrated company. I suspect that after the FCA merger, there will be more pressure to do so. The larger value of a merged Groupe Renault FCA will reduce the logic for Nissan to try and acquire more of Renault (it is blocked from this anyway by Renault's control of Nissan's board). It will be easier to accept the unequal nature of the relationship when Groupe Renault FCA is the much larger entity.<br />
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On the platform front, this merger should enable significant reduction in duplicative investment in factories and in product. The auto industry faces a unqiue set of challenges in which the nature of the offering is set to change in some very fundamental ways. Once this happens, the competitive attributes are likely to change in ways that are possibly going to reduce the importance of brands and differentiation in the product and focus more on cost and convenience. Much of the value add may turn out to be post-sale / delivery and so investments in factories and large and complex product platforms may chagne. Of course, they may not. Cost is likely to become a bigger factor as is the ability to amortize investments in platform architectures for IT services and solutions over large unit volume is likely to be immensely important.<br />
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This is why consolidation is nearly certain. FCA and Renault compete for many of the same customers, albeit often in different markets. There should be opportunities to imrpove European operations and margins for both firms. FCA gives Renault a variety of routes back to the US and the means to tap into US supplier networks, particularly around connectivity, electrification and autonomy. It also opens LATAM more effectively for Renault Nissan.<br />
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The Nissan arrangement also allows for more collaboration in SUVs in the US market and in Asia. I Suspect that they are not done looking for tie ups. They still lack the premium brand like an Audi or Mercedes that can earn extra contribution for selling upgraded versions of the lower cars architecture. Maserati is not really fulfilling this role, though I expect Wester to be able to fix the problems. There will continue to be a tension, I think between Maserati and Alfa as both have product portfolios that are smaller than competitors.<br />
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There will be challenges straightening out the brand identities, I think, of Fiat, Renault, Dacia, LADA and possibly Lancia. Chrysler, which has been repositioned as the autonomy brand and is also likely to need some work, Dodge too. But these things can be evolved over time, or killed where they are found to be excessive.<br />
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In short, I think FCA has done well here. I think Renault also needed to change the dynamic with the friction in the partnership with Nissan and both firms have a deeply strategic and long term approach to the business.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-41398333510659895282018-06-25T03:37:00.000-04:002018-06-25T03:37:04.816-04:00Berkshire's Annual Meeting has not been improved by expanding the formatI have been listening to video of the 1994 Berkshire meeting which covers the Q&A. As always, Warren and Charlie have some insights about investing and human nature. Berkshire was quite a different business then than it is today. It was more heavily in insurance and owned many fewer operating businesses.<br />
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My take is that the meetings were more interesting when shareholders asked questions and those shareholders were fewer in number and likely savvier investors, on average, as a group. Questions were much more focused on investing and on business and much less about macro policy. I have a sense that the celebrity interlocutors that they have brought in to ask questions have not improved the quality of the questions. I get why they do it - there are just so many people now who have an interest in the business they need a way to filter things and to group questions.<br />
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I suspect that to a significant extent there are two factors at work. First, that the new format encourages people to emphasize questions that are *popular* rather than useful. If hundreds or thousands of people ask in one format or another, question X, then a tendency will be to ask that question because lots of people want the answer. Media personalities are very concerned about the quantity of eyeballs more than the quality of eyeballs. Second, and relatedly, I think there is greater awareness that the meeting has wide following in a community of interest much wider than that of shareholders and necessarily that audience has more utility in questions about what books to read or how to have a good life. But of course, those are not necessarily the questions that help one understand how to value Berkshire which remains, I believe, the chief purpose of an annual meeting of shareholders. Third (I know, I said two factors … but this is perhaps point 2b) I think the questioners, being sort of special invitees, just don't think it is their job to be that challenging. The best question asked at this years' meeting came from an 8 year old shareholder who was at her second meeting and asked why BRK has moved from high returns on capital businesses to low return regulated utilities.<br />
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In any case, I think there probably is value in listening to them at these meetings. This is how the circus really got going, after all.<br />
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<a href="https://www.youtube.com/watch?v=fjXZbW8ALRA">Here is the link</a>.<br />
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P. S. Bill Ackman and Carol Loomis asked questions.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-3221523277799002112018-06-24T00:54:00.001-04:002018-06-24T00:54:13.121-04:00Strategy and Political EconomyStrategy is actually the study of differential outcomes. Why do some businesses succeed wildly while others, with similar talent and effort come to nothing?<br />
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This is an essential issue in investing; a few firms will produce excellent returns on capital and have almost unlimited ability to reinvest that capital. They will (and have) become the dominant share of all tradable equity securities. Finding just one, as an investor in an early phase pretty much guarantees you the ability to get fantastically rich without having to work all that hard. (Depends on how lucky you get, in terms of finding said firm).<br />
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Occasionally you can find one of these firms who is essentially *known* to be a big winner trading at silly valuations and have a risk free ride to pretty good returns (though in most cases not nearly as good as some early investors, but Apple, Amazon, Bank of America, S&P Global, Microsoft, Bassett Furniture and Ford, among others have offered opportunities to earn staggering amounts for late entering shareholders).<br />
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The thing is - what is important to understand is how a business will compete within its industry, to understand the scale and scope of that industry and then to recognize that almost all of the gains will go to the top firms or people and that this is true in all fields of human endeavor, whether it is art, literature, sports or enterprise. Riding the wave of the Pareto distribution is really the secret of success. The problem is, it is extremely difficult to determine which actors (in the sense of one who takes action, not in the theatrical sense) will get to ride that distribution. I am not sure it is possible to know with much certainty, although being marginally better at determining it can make you a very much better investor (because the irony is that there aren't huge differences between people at say the middle and top of the distribution in terms of starting talent and resources - at least early in the game. After awhile of course, the compounding effects of opportunities, networks and resources tend to spin some far out the distribution).<br />
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Jordan Peterson, who is a political theorist and philosopher talks about why Pareto is such an important principle of societal organization and how deeply embedded it is in human experience. While he is really talking about a critique of Marxist organization, he is illustrating the core challenge of investment; <b><i>finding those opportunities that offer the investor the chance to spin off the end of the distribution while guaranteeing that one doesn't run the risk of winding up on the other end of the distribution.</i></b><br />
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A fantastic short excerpt and well worth one's time.<br />
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https://www.youtube.com/watch?v=i0iL0ixoZYo<br />
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<br />Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-62083825969352759832018-05-04T17:21:00.001-04:002018-05-04T17:27:59.963-04:00Fun Infographics about Warren Buffett<br />
Like most value investors, I have spent lots of time studying Buffett and Munger. You can absorb much of their principles from reading their letters to shareholders. Books like the <a href="https://www.barnesandnoble.com/w/snowball-alice-schroeder/1100833080?ean=9780553384611#/">Snowball</a> are also helpful in filling in key details and context.<br />
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The simplest lesson in business valuation probably was the <a href="http://www.berkshirehathaway.com/letters/1989.html">1989 Berkshire Hathaway shareholder letter from Buffett</a>.<br />
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In this nice set of infographics (not yet complete as of this post), Visual Capitalist does a nice illustration of Buffett's from his early years to his ideas to his empire.<br />
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<a href="http://www.visualcapitalist.com/warren-buffett-series-early-years/">http://www.visualcapitalist.com/warren-buffett-series-early-years/</a><br />
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<a href="http://www.visualcapitalist.com/inside-warren-buffetts-brain/">http://www.visualcapitalist.com/inside-warren-buffetts-brain/</a><br />
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<a href="http://www.visualcapitalist.com/warren-buffett-empire-giant-chart/">http://www.visualcapitalist.com/warren-buffett-empire-giant-chart/</a><br />
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<br />Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-36775723950727525492018-01-30T14:42:00.003-05:002018-01-30T14:42:48.604-05:00Greatness from Megan McArdleThe most indispensable blogger we have.<br />
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At 43, I understand EXACLTY what she means.<br />
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https://www.bloomberg.com/view/articles/2018-01-30/megan-mcardle-s-12-rules-for-life<br />
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<br />Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-36082950639437478632018-01-23T20:59:00.003-05:002018-01-23T20:59:52.679-05:00US Household Assets by Net WorthThis is a great graphic by Visual Capitalist. You can see how assets are spread across income groups. Note that this Makkimoto chart shows the relative distribution across groups, it doesn't show the spread of total assets or of the size of the groups (it would be cool if the vertical dimension were used to have the areas correspond to the actual amounts, but probably the top group would become very hard to distinguish.<br />
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<a href="http://www.visualcapitalist.com/chart-assets-make-wealth/">http://www.visualcapitalist.com/chart-assets-make-wealth/</a><br />
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Not surprisingly, less well off folks have a greater share of their wealth in liquid assets (everyone needs some cash and checking) and in "use" assets, those assets that, while they have financial resale value, are really a form of consumption (transportation and shelter).<br />
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It is also pretty clear that if you want to be really wealthy, you need to have a successful business in which you are a significant shareholder or control person. Since large, successful businesses are pretty rare (even small successful businesses are tough to operate, I speak from experience here, but will start another business soon), very few people can be truly rich. But passive investments, particularly cashflow real estate (which is also a business but except for skyscrapers or PUDs are also small) can make you quite comfortable.<br />
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You have to think about your personal strategy and what you want.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-48843829297371743192018-01-19T16:58:00.003-05:002018-01-19T16:58:28.226-05:00The future of returns: an ongoing seriesLong time readers know that I am pretty bearish on the ability of investments, as a whole, to earn historical rates of return. It would be nice, of course, if they could, since with low inflation, high rates of return would mean an increase in *real* returns and the ability to fulfill the fantasy that we can all be rich. Just put a little bit aside every week or month and watch the power of compounding make you a very comfortable person.<br />
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Logically, though, this is impossible, since as "everyone" did this, competition for goods, services and assets would drive prices higher.<br />
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Alas, among the most fanciful are the most "sophisticated" investors - pension funds. Public pension funds have a major weakness, they are run by politicians and public employees, who desire attractive work conditions: easy jobs, comfortable pay, job security, and cushy benefits like attractive pensions.<br />
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Politicians like to give this constituency what it wants (<a href="https://www.bloomberg.com/view/articles/2018-01-18/how-public-unions-enthralled-the-u-s">see Megan McArdle on this topic</a>) but prefer taxpayers not know what this costs. Since many of the actual costs can be shifted to the future (for a different electorate and politician set to deal with and when later pols can deny responsibility) assumptions about the future tend to be pretty rosy.<br />
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Here is Jason Zweig, one of the best financial journalists we have, <a href="https://blogs.wsj.com/moneybeat/2018/01/19/can-we-be-brutally-honest-about-investment-returns/">writing about this topic.</a><br />
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Happy do discuss in more detail.Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0tag:blogger.com,1999:blog-24695385.post-85734366421120865672018-01-15T20:53:00.001-05:002018-01-15T20:53:06.582-05:00From the Screen of the Strategic InvestorPhilosophical Economics has a <a href="http://www.philosophicaleconomics.com/2018/01/future-u-s-equity-returns-a-best-case-upper-limit/">really nice essay</a> on returns and what investors can expect going forward. The news is bad. We concur that returns are likely to be well below the experience of the past 40 years, even taking into account that the decade from 1999-2008 was truly abysmal.<br />
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For many reasons, valuations in 1999 were at absolutely incredible levels. Valuation-indifferent buyers of equities, largely focused on low cost index products, who have to buy every month because of the need to save for retirement are a major factor.<br />
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We believe that many historical rates of return are driven higher by one time factors that will not recur and therefore, we will see a significant revaluation, which will punish investors (particularly GenX and particularly early cohorts).<br />
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Note that the author has not accounted for changes in tax policy. Over time these things are somewhat cyclical, however, markets tend to experience significant downward valuation as taxes rise (since it reduces earnings and EPS, and also because it discourages redeployment toward better uses and finally because, investors care about their real after tax return and if you raise taxes, then the nominal pre tax return must go up to provide stable after tax returns and this means prices - at least relative to earnings, have to decline).<br />
<br />Strategic Investorhttp://www.blogger.com/profile/06847403858456772158noreply@blogger.com0