I pull together these thoughts for the Friday File throughout the week, and sometimes that means I end up feeling almost bipolar — the market sentiment on Monday was so wildly different than the sentiment this morning that our emotions can get a little whipsawed. Which means, of course, that I should be tuning down Twitter and CNBC and not paying much attention to any particular day’s price action… easier said than done.
As things close out for this midsummer week, the world is again copacetic — mostly ignoring the inflation risk and trusting the Fed, rightly or wrongly, celebrating the earnings results that continue to come out even stronger than expected, helping the market to “grow into” its valuation, and, at least this week, focusing a lot on whether or not COVID’s fourth wave in the US is going to have a big economic impact (low vaccination rates and the rapid takeover of the world by COVID’s Delta Variant have some investors looking back to last March and April and worrying that we’re in for a repeat, though that was ameliorated somewhat, at least for the US, when we finally saw both sides of the political divide pushing the vaccine-hesitant to join the immunized herd and reduce the risk of hospitalization and death).
For most of us, the temptation remains strong to make “macro” bets because the headlines and social media and our own echo chambers steer us into having a strong view, and often a false sense of certainty, about where the world is going… and the antidote to that temptation, most of the time, is going smaller — drilling down into individual stocks and markets instead, focusing on things that we might hope to understand and on companies that should survive whatever surprises the macro world is likely to throw at them. Because yes, the future panics will come as a surprise — the risk that everyone sees coming is not likely to be the risk that crushes the economy. Have some cash, be diversified across sectors and markets and styles, look for companies that are “anti fragile,” be ready for lots of possible outcomes: an acceleration of inflation, fed rate hikes, and a 30% market crash; a renewal of animal spirits and the continuation of the bull market as the reopening and stimulus-fueled growth keeps surging; or for a stock market that just bumps along without a lot of change for six months… we don’t know what the future holds, so the sensible path hasn’t really changed. Be prepared, which means also being prepared for the fact that you’re probably wrong about the world… but don’t predict.
This was also a bit of an odd week, since this is the first time in memory that I’ve written about a new stock investment… and then seen the story change so dramatically between the time of my publication and the next trading day. So let’s start there…
Pershing Square Tontine Holdings (PSTH) and Pershing Square Holdings (PSH.AS, PSHZF)
A week ago I was telling you that Pershing Square Tontine Holdings (PSTH) had finally fallen to an appealing price well below $21, and that I liked the deal for Universal Music Group (UMG) and considered it good news for both PSTH and its sponsor, Pershing Square Holdings (which I own much more of, that’s Pershing’s publicly traded closed-end hedge fund, which trades at PSH in Amsterdam and PSHZF OTC in the US). By Monday morning, the UMG deal had been scrapped, Ackman had egg on his face (not an unknown situation for him over the past 20 years), and PSTH had fallen a few percent more.
So, has my thinking changed?
Not really. I didn’t buy or sell. The UMG deal will now go primarily to Pershing Square Holdings (PSH.AS, PSHZF), so I’ll get some exposure to that anyway, and Pershing Square Tontine is back to being a regular old SPAC, at a price that is reasonable. I’m sticking with it while we see how the next deal might play out… if there is a next deal.
Given the shareholder sentiment that’s currently reflected in the warrants, with PSTH/WS at about $4.60, then PSTH should make ample sense at $21 (PSTH includes 2/9 of a tontine warrant, though that’s only available to those who stay with the shares through a business combination and don’t redeem, and 2/9 of $4.60 is almost exactly a dollar, so if you think a deal will be made and that it will be worth at least $20 a share to you after the deal is consummated, and you think the people buying those warrants have any economic sense, then the whole magilla ought to be worth $20 + $1 for that future warrant).
There are a lot of “ifs” in there, and obviously a lot of emotional response among some traders to Bill Ackman’s public cheerleading and past overpromising about deals, but the redemption value is still there and the tontine warrant does give some additional value beyond the $20 worth of trust fund cash, so I’m fine with holding and seeing how things develop in the next year or so… particularly since the maximum loss is again set at “redeem it for $20 in a year and a half.” I expect it would be better if Bill Ackman could avoid making prognostications about when or how a deal will come, but he doesn’t seem to be able to help himself — perhaps he just wants investors to love him. The real risk, and it would result in a loss to my PSTH position of about 3% and the opportunity cost of holding on until redemption, is that Ackman either doesn’t find a deal at all or that he ends up with a terrible deal.
The challenge is now back to what it was a few months ago, we just get a better price: Pershing is trying to make a major acquisition, using at least $4 billion, to buy a minority stake in a large and attractive company… and they’re trying to do that at a time when there are hundreds of smaller SPACs also trying to make deals, so the competition for anything approaching a “popular” or high-growth private company is likely to be a little crazy, and that means the risk of the SPAC incentive structure is working against us to some degree (sponsors are incentivized to make any deal, even a bad deal, because they get nothing otherwise… that’s much less of an issue with PSTH than it is with most SPACs, since their structure is more rational and shareholder-friendly, but it’s still an issue). If PSTH’s $4 billion is to be a real minority stake, less than 20% or so, then they’re hunting for pretty rare game, there aren’t all that many $20-50 billion (or more) private companies who Ackman can court, and probably fewer still who have any interest in going public if they don’t need to, so they may have to find a special situation or a family business with estate planning issues or something like that, and if PSTH loosens its criteria a bit, perhaps moving down to smaller companies, then the competition for sub-$20 billion deals is likely to be far more fierce among the hundreds of SPACs that have raised money and are facing a deadline to use it.
So failure is certainly possible — Pershing Square and Ackman are motivated by both reputation and financial reward to identify a great investment for PSTH, but that doesn’t mean they’ll necessarily be able to do so. Here’s what Ackman said about that in his letter to PSTH shareholders on Monday:
“While we are disappointed with this outcome, we continue to believe that the unique scale and favorable structure of PSTH will enable us to find a transaction that meets our standards for business quality, durable growth, and a fair price. We are highly economically and reputationally motivated to consummate a successful transaction. We will, however, only complete a deal that meets our high standards.”
I’m inclined to agree with him, but don’t have anything like 100% certainty that it will work. Despite the fact that Ackman is everyone’s favorite punching bag on Wall Street, Pershing Square is full of smart people and obviously has a willingness to push the envelope and make complicated deals that would probably deter many others… but, more importantly, we get to redeem at $20 if things don’t work out, and PSTH is no longer trading at a crazy story-driven premium price, so expectations are low and there’s a very nice opportunity for possible substantial gain now, while taking very little risk of loss. OK by me.
And, of course, owning the sponsor is still a more comfortable and safer deal than owning the SPAC most of the time, so I looked at the numbers for Pershing Square Holdings to see if the PSTH announcement caused them to adjust their net asset value (NAV). It might have, the reported NAV was $48.23 before the deal was abandoned (they report it weekly, so that was July 13), and dropped to $47.02 on July 20, the Tuesday after the deal was scrapped on Monday. That’s about a 2.5% decline for that week, the biggest NAV drop in a while, so there may have been some minor write down of the PSTH exposure, but it certainly wasn’t a big deal (the rest of the portfolio holdings generally fell almost 2% that week, versus roughly a 1% decline for the broader market, so the total impact of the PSTH relationship getting a little downgrade, if that happened, was less than 1% — the impact will be much bigger if the SPAC eventually has to redeem shares and disappear without a deal, but that potentiality is more than a year away).
And that’s of course backward-looking, and the NAV will have bounced back pretty sharply with the strong move in the market later in the week, particularly with the big pops by Chipotle (CMG) and Domino’s Pizza (DPZ), which together are roughly 20% of the portfolio. There is, of course, no reason to over-analyze one week’s action like that, but the numbers are there and the Pershing portfolio is pretty easy to track (holding less than 10 positions most of the time), so I can’t help myself.
The biggest change for the NAV at Pershing Square in the near term, assuming no other new PSTH deal is announced and closed quickly, will, presumably, come whenever PSH actually closes on the deal to buy something like 5-10% of UMG from Vivendi to fulfill that PSTH-negotiated deal, and, a bit later, when the spinout of the rest of UMG goes public and gets a price from the markets (probably a little above what PSH is paying, but not necessarily — it all depends on how the market feels about UMG this Fall).
We don’t know for sure how big a purchase that will be, PSTH had planned to buy 10% of UMG for $4 billion, and PSH doesn’t have the cash for that unless they sell something else or raise capital… but they could buy some and perhaps bring on partners, or else Vivendi will sell that balance elsewhere — given the attention Ackman called to UMG, I’m sure there are plenty of other funds angling to take a slice. Even at 5% of UMG, it might become the largest holding in PSH, or at least close to that. The biggest stake now in the Pershing Square fund is Lowes (LOW), Pershing sold down a little bit of that and other large holdings in the first quarter but, as of March 31, still owned almost 12 million shares, worth roughly $2.4 billion. The fund had only about $1.4 billion in cash available to invest at the end of June, so they probably hadn’t sold it down dramatically as of that point. PSH already has roughly 20% leverage through bond offerings and probably wouldn’t want to raise a lot more debt to finance the UMG deal, so I’d guess that they’ll be taking a little more profit on those existing positions and probably only buying about 5% of UMG for roughly $2 billion.
And, of course, Pershing Square Tontine (PSTH) matters more to PSTH holders than it does to PSH holders, but there is still an impact for Pershing Square Holdings — even though PSH doesn’t own a big slice of the actual PSTH equity at the moment. Here’s what I said about the value of PSTH to PSH back in April.
Accounting rules require them to account for the value of that PSTH relationship, even though it hasn’t been (and might not be) realized, so even though it might be worth nothing in the end, Pershing Square Holdings does carry the value of their PSTH relationship (sponsor warrants and forward purchase agreements) at a total of about $750 million. That’s a big deal, even for a large hedge fund like Pershing Square, the total net assets are about $9 billion so that’s about 8% of the fund’s assets. That pales in comparison to the discount at which PSH.AS trades, which is currently about 25%, but it does still mean that the outcome for PSTH has a meaningful impact on PSH shares. I still vastly prefer owning PSH.AS at a discount to owning PSTH at a premium (PSTH has a trust fund/redemption value of $20 a share, not $10 like most SPACs, and there are Tontine warrants embedded in those shares so it may be worth a small premium… but since we can buy into the SPAC manager (PSH.AS) at a 25% discount, paying more than a tiny premium for PSTH seems awfully silly. I’d consider it if it falls to $21 or so, but it probably won’t.
It did, of course, and, as you saw in last week’s Friday File, I did buy some before the dissolution of that UMG deal. It took me four weeks and a big drop in the share price to begin to get comfortable with that UMG investment, and then boom! The story changes. C’est la vie.
It’s easy in retrospect to say that Pershing should have known this could happen, and that they’ve been hurt by Bill Ackman’s hubris again, but I’m not particularly worried and the outcome is not particularly negative… in the short term, because investors didn’t like the deal, anyway, so they can now daydream about better targets instead, and in the long term, because we can again rely on that $20 redemption value to reduce the downside risk.
Galaxy Digital (GLXY.TO, BPRHF) Stop Loss
I also posted a Trade Note on Monday, when a few positions were tickling around near their stop loss levels and one of them actually triggered a sale… here’s what I noted at the time:
As cryptocurrency prices tumbled today, my position in Galaxy Digital (GLXY.TO, BRPHF) hit a stop loss (roughly a 50% decline) in the Real Money Portfolio and I sold that position. It remains in the $100K Lock Box portfolio, of course, since that portfolio is not subject to adjustment.
This is not a great reconsideration or reassessment of Mike Novogratz’s company, just a risk reduction move — stocks that can rise 1,000% in a year can obviously fall 90% in a year as well, and there’s a limit to how much loss I’m willing to stomach in young companies that are based on a highly speculative asset.
I continue to have some cryptocurrency exposure, both directly and indirectly, and the reason I put some Galaxy Digital in the Lock Box portfolio was that I saw them as a likely winner if bitcoin and ethereum really manage to become institutionally important investments, and I still think there’s a decent chance of that happening over the next five years… but everything in the history of this new asset class and technology serves to remind us that it’s not likely to be an easy ride, and that institutions might slow their adoption at times when the momentum and excitement fade. No idea whether this is just a dip or the start of something more dramatic, that all depends on where cryptocurrency prices go from here, but I’ll let that position patiently wait out the excitement in my Lock Box while I protect the rest of the portfolio a little bit with this stop loss sale. There have been no major announcements by the company, their assets under management were roughly flat for June after that big surge earlier this year, I still like the potential of their plan to get a NY listing, which is typicalliy a positive catalyst, and I still like the BitGo acquisition.
(You may note that Bitcoin prices recovered a bit later in the week, along with cryptocurrency sentiment in general, and all the stock-based crypto plays shot back higher again — including Galaxy Digital, which is now back above my “stop loss” price. That’s the nature of stop losses, if you use them you have to have a short memory and move on, otherwise it will eat you up inside).
New Cloudbreak Discovery (CDL.L) Speculation (super tiny)
And there was one further new position to bring into the fold this week — I wrote about Nick Hodge’s overheated helium pitch a couple days ago, and that necessitated a new disclosure about a tiny speculation that I’ve now added to the Real Money Portfolio:
This is normally the kind of very small speculation that I might not ever even write about, but it happens to be related to a stock Nick Hodge was teasing and that I wrote about, called Imperial Helium (IHC.V), so that necessitated disclosure. My investment is in Cloudbreak Discovery, which is a ~£10 million London-listed prospect generator (CDL.L, there is no US OTC ticker at the moment). Their connection to Imperial Helium (they own ~1%) is not the primary reason I nibbled on some shares a couple weeks ago, I mostly just liked the idea that they’ve got a dozen or so staking projects, mostly in Canada, many of which are already partnered out to small companies who are spending money to explore or develop, and that they don’t plan to spend much of their own money.
That’s really the generic reason to buy any prospect generator — they presumably hope to grow up someday to be something like Altius Minerals (ALS.TO), turning very early stage prospects into spinouts to other companies, retaining some equity and a warrant, and eventually participating in the upside if that staked-out prospect ever becomes a mine. It probably won’t work (most of them don’t), but the occasional success makes up for a lot of small speculative failures in this space, and I found this one interesting enough, and cheap enough, to dabble. Since I’ve now disclosed that, it goes into the Real Money Portfolio as one of my smallest holdings, a little less than a 0.1% position. Their investor info is here if you’re curious.
The only real valuation work you could feasibly do for this little startup would be looking at the equity stakes they have so far earned in the juniors who have taken on their prospects, since those royalties they also earn are so far off in the future and most won’t go anywhere. They say they have $2.7 million worth of Temas Resources (TMAS.CX, TMASF) shares (plus a few warrants) as their largest position, and a broader partnership with Norseman Silver (NOC.V, NOCSF), of which they own roughly $2 million worth of shares in exchange for four different exploration properties (Silver Vista, Carbibou, New Moon and Silver Switchback), plus some warrants, and they own about 1.2% of Imperial Helium, which would currently be valued at about $250,000, so the only easily quantifiable stuff in their portfolio, ignoring their royalties, is worth something a little over $5 million. They also have a Convertible Debenture with Angla African Minerals, which is private, that they valued in march at C$4.5 million, and they own private shares of unknown value of Deep Blue Trading (500,000 shares, expected to go public at some point) Buscando Resources (1 million shares of that crowdfunded explorer, which also intends to go public) and Linceo Media (13,000 shares for an aluminasilicate deposit), as well as one unpartnered asset that they disclose (a South Timmins prospect in Ontario). They valued those last three as being worth a total of C$1 million back in March.
So all in, maybe $10 million worth of value for that existing portfolio of partnered-out assets, not including any other assets they’re identifying or staking or any value for the royalties that might someday (WAY in the future) flow from some of those projects, or any surplus cash on the books. It will take some time before their filings begin to make much sense, they just started trading a couple months ago and they also have some financing deals and will presumably be raising more equity before too long, but that’s at least a somewhat justifiable asset base for a company with a market cap of about $12-13 million. Enough for me to make a small bet, at least.
Just to clarify, if you’re new here: well over 99% of my stock positions or other speculative bets (warrants, options, etc.) are disclosed in the Real Money Portfolio… but there are usually a few teensy ones that I don’t mention unless they come up otherwise, typically either because I don’t have much confidence in them or I think they’re too small to write to anyone about. They tend to be dumb speculations made by my lizard brain, so you’re probably better off not hearing even more about that kind of thing anyway… but you’re a grown up, you can make your own call, ’nuff said.
Intuitive Surgical (ISRG) Earnings
We did have some actual earnings reports finally hit the portfolio as well — as with most quarters, the first two out of the gate for us were Intuitive Surgical (ISRG) and Crown Castle (CCI), and there will be dozens more in the next couple weeks. No huge change to my thinking on either of these updates, but here’s what I can tell you:
It looks like Intuitive Surgical (ISRG) will be the next entrant in the four-digits club after another strong earnings beat, with the bounceback from COVID slowdowns in elective and non-urgent surgery even stronger than had been anticipated this year. This is the best comparable quarter ISRG will have in 2021, given how many hospitals shut down surgery in the second quarter of 2020, and we all knew that was coming, but it was even better than anticipated. They posted $3.92 in earnings per share, about 15% higher than expected, partly because they shipped even more new da Vinci systems than expected, and procedures worldwide grew about 68% year over year in the quarter. That’s not going to happen again, hopefully ever, but they are back on track to some degree — the compound annual growth rate in procedures from Q2 of 2019 to Q2 of 2020 was 16.5% (the two year CAGR in revenue was 15%, so again, we’re at least back to growing nicely from 2019 levels).
Is that growth enough to support the current valuation? Not really, but that’s often been the case for ISRG — to own them here, you have to give them some extra credit for essentially being the surgery platform of the 2020s, continuing their near monopoly in this lucrative business as their competitors continue to try to get machines approved by the FDA and sold into the market, with the same kinds of delays and challenges as the da Vinci had 15 years ago, and, importantly, in a world where pretty much every surgeon trained in the past ten years has learned on a da Vinci robotic system.
I’m willing to hold because of that near-monopoly position, even though the valuation is challenging for a company of this size that probably has a “regular” earnings growth rate of 20-25% (the current valuation is about 20X sales, 70X forward earnings), and I hold mostly because I still think there’s a fair amount of room for da Vinci to continue to take share in more kinds of surgeries, and to become even more embedded in the global healthcare market before meaningful competition appears. But no, I’m not buying more at $1,000 — this is one I like to buy when people freak out a little bit over bad news, not when the quarterly conference call is full of champagne toasts.
Crown Castle (CCI) Earnings
Crown Castle (CCI) also released its latest quarter this week, after there had been a few analyst downgrades to the tower companies as their valuations got a little silly extended. There wasn’t a lot of negative comment from analysts, mostly just some downgrades to “neutral” or “hold” in the face of historically high valuations after a strong run this year.
Going into the earnings report, I was inclined to agree on the “neutral” assessment on those cell tower REITs at these prices, I don’t want to sell great companies who own critical telecom infrastructure and should have several years of strong growth ahead as 5G is built out globally, particularly American Tower (AMT) with the boost they can get from their new acquisitions in Europe and other big international bets, but nor do I want to bet heavily on them at current prices. Sometimes, indeed often, the best thing to do is nothing — I’m continuing to hold, and if we ever do get an interest rate panic or other market collapse, perhaps AMT and CCI will fall back down to “buy” prices for me. All else being equal, better growth and diversification means AMT is a better investment bet, but all else is not equal and CCI has often been a better buy because of its much larger dividend, so I’ve put more into AMT than CCI over the past year… but CCI remains a larger holding, mostly just because it was more obviously undervalued when I first committed some meaningful capital to that space in 2018 and 2019.
So what happened this quarter? Another minor “beat and raise,” not enough to get investors excited but not negative enough to bring any real selling pressure (the shares fell by 4-5%, but remain above where they were a quarter ago) — they upgraded their Adjusted Funds From Operations (AFFO) per share forecast for 2021 by a few cents, to $6.83, which will be roughly flat with last year but 12% growth over how they say they would have adjusted 2020 numbers. Don’t worry, you get sort of used to all the adjustments with these guys, even if the financial engineering gets a little dizzying (and it got a little worse because of some Sprint contract cancellations late last year). Rental revenues are still growing, roughly 7-8% a year, and that ought to support their push to continue increasing the dividend by roughly 7-8% a year, which is their stated goal and should probably be our expectation, despite the fact that they were able to eke out a larger 11% increase last year. The next dividend hike announcement will be in October, so I’d assume that means we’ll get an 8% boost and go from $1.33 to $1.44, for an annual total of $5.76, which means that at $193 we’re getting a 3% yield.
The comparison is typically to American Tower (AMT), of course, which won’t report until late next week but has typically been the faster grower (thanks partly to large overseas businesses, where towers aren’t as built-out or as shared in many places), and which has also paid a lower dividend that is more easily supported by AFFO and growing more quickly (the annual increases have been roughly twice as bit as CCI’s, but they’re also more gradual — they raise the dividend every quarter, not every year, so the increase sometimes looks less dramatic in any given quarter). Both are trading at all-time highs, so it’s just a question of whether you want a 2% forward dividend that grows 15% a year, or a 2.9% forward dividend that grows 8% a year. Over about 10 years, if you assume that both stocks rise in value at 5% a year while keeping their same dividend growth pattern, those two scenarios work out almost identical (you do a little better than doubling your money with either), so I guess it’s no real surprise that AMT and CCI have essentially identical past-decade performance as well… but given the fact that AMT has more top-line growth and more financial flexibility, with the dividend representing a smaller percentage of their AFFO, I’d shade to them when the scenarios are otherwise pretty comparable.
CCI was more appealing from mid-2018-2019, when it had a 4%+ yield and AMT was below 2%, but AMT has been more appealing for most of the last seven or eight months after it took a big fall in late 2020, now it’s closer to being a coin flip. Forced to buy one today I’d buy AMT, but both are near valuation extremes so I’d rather wait for a meaningful dip, perhaps on the next interest rate panic… or maybe AMT will fall a little further on this little bit of CCI weakness, we’ll see. Sometimes holding “neutral” is just fine.
Intrusion (INTZ) collapses, again
Intrusion (INTZ), for anyone else who hasn’t followed the story, took a nosedive this week — that’s the old cybersecurity company, teased as a “hidden cloud” opportunity for a while, that has been trying to turn its legacy products into a SaaS service for network intrusion detection and prevention, and the reason for the latest nosedive was the disappointing uptake of that service from customers, with the pre-announcement this week that Q2 revenue would be only about $2 million, (which means that the revenue has stopped falling from the erosion of their legacy business, but it has also not seen any meaningful uptick yet from new SHIELD customers), and, perhaps more importantly, that this disappointment won’t turn around quickly (if at all) — Intrusion believes they’ll need additional capital or a strategic shift of some sort before they can achieve profitability… and, in the same press release, they also announced the surprisingly immediate departure of CEO Jack Blount, no reasons given.
Intrusion was always a “will they be able to sign customers” story when it comes to their Intrusion SHIELD product (non-experts like me need to rely not on our objective perception of the product’s quality, since we’re not likely to have a good take on that, but on whether or not customers are buying it), and the commentary they shared early this year about the number of “seats” they expected to sell led investors to get quite excited about the potential, particularly because of the Kimberly-Clark deal for 50,000 seats (which, if they sold them at full price and rolled it out quickly, could mean about $12 million a year in SaaS revenue, and that level of revenue does not seem to be in the outlook, so there’s probably some other story there in terms of rollout timeline or discounts, or maybe something worse) — I assume the reason for the departure of the CEO is at least partly that the optimistic commentary about their sales pipeline now looks like it might have been wildly irresponsible. With a small company like this, the CEO is also really the chief salesman… and though it may be too early to really judge, it seems to me he was better at selling to investors than to customers.
Intrusion won’t announce their full quarterly results for a few more weeks, but the shorts have certainly been right about this one so far — signing customers for this product is much tougher than the company implied it would be… and without rapid uptake in that SHIELD business, the company is not particularly appealing. I stopped out of my shares following the initial short attack back in May, mostly just because I didn’t have a high level of confidence about whether it would work or not, and I need some confidence if I’m going to ignore a stop loss signal, so I haven’t been watching closely over the past couple months — but it doesn’t look good, and I’d guess it will probably take some real salesmanship and a new strategy, with a lot more transparency, to get investors excited at this point.
NVIDIA (NVDA) Splits and Soars
NVIDIA (NVDA) went through with their four-for-one stock split and that hit the market this week, with each share being split into quarters to bring the share price back below $200. Frankly, I’m not sure why they didn’t go all the way, splitting more aggressively like The Trade Desk (TTD) to get the stock down to a sub-$100 share price, but either way it makes the stock slightly more accessible for folks who don’t otherwise have access to fractional share trading (which is one of the most shareholder-friendly innovations yet, in my view — and has the extra bonus of forcing you to think about how much you want to invest in a company instead of how many shares you want to own).
Other than that, no real change — other than the fact that the price ran up a bit in anticipation of the split, and, since it’s now a little more feasible for small investors to buy 100-share blocks (100 shares would now cost less than $20,000, versus more than $80,000 at the pre-split peak), it is now a little easier to manage options strategies around NVDA stock if that’s your bag. The valuation and all the other meaningful info is the same… NVDA is still a great company, and the reason I’m still willing to hold at what is in any honest world a nosebleed valuation for a large semiconductor company is that they continue to build the largest user base among AI developers, thanks largely to their “first mover” status and the fact that most people who have been studying AI systems over the past decade almost certainly learned on NVIDIA’s platform, though they’re not taking that for granted, and they continue to innovate — most recently with their latest TensorRT update that further speeds up language-based inferencing work to make chatbots and other AI systems much more accurate without losing speed. Sometimes, as with Intuitive Surgical, having the biggest user base in a growing technology conveys an advantage that can last for a shockingly long time.
I do still think you probably need the Arm Holdings acquisition to go through to comfortably justify the current valuation, and that’s under a lot of antitrust and regulatory scrutiny, but “a bit too expensive” is not enough of a reason for me to sell a great leader like NVIDIA — after all, it has been “a bit too expensive” for almost all of the past decade, thanks in part to analysts consistently underestimating the scope of their market and the enduring strength of the core gaming GPU business. Sometimes with leading momentum stocks you just have to close your eyes, trust your stop losses (or accept the risk of living on top of the mountain), and hold on.
The cryptocurrency connection also still persists for NVIDIA, with the stock often reacting to some degree to Bitcoin price shifts, though that should ease over time as they’re trying to fence off their cryptocurrency exposure to a separate product line and hopefully avoid inventory shocks or demand collapses for those products in the future (like the one that cratered the business, briefly, with a 20% revenue drop after the 2018 bitcoin collapse, when they were surprised to learn how much of their GPU demand had been coming from cryptocurrency miners… and what a big glut hit the market when they were oversupplied because that demand disappeared overnight).
GAN ltd (GAN)
GAN’s (GAN)’s update in early July, which I haven’t covered in detail yet, was an optimistic pre-earnings release, essentially saying that their revenue for the quarter will be higher than was expected (and that the full year forecasts are also rising). The reason is Coolbet, the sports gambling platform they bought last year.
The hope is that Coolbet will be a good cross-sell for GAN’s US casino customers, helping them to build their own sportsbooks (they’re using the crafty name “GAN Sports”) on top of GAN’s existing systems for customer account management, and that hope is still there, but that’s not where the growth is coming from right now — the growth is coming from higher betting volume from Coolbet’s existing direct-to-consumer gambling business in Europe and Latin America, and from a higher margin on that betting (they took 9.7% of revenue, versus 6.8% in the first quarter). Coolbet also surpassed expectations in the first quarter, so they’re clearly off to a good start, even if it might be that investors aren’t as interested in that part of the story, or don’t want to bet on an unusually high-margin quarter from a part of the company that’s not yet involved in the US sports betting market.
The company as a whole is clearly growing nicely, they should now be profitable on a cash basis, with positive EBITDA in the second quarter… and we don’t know what the core B2B business (outside of Coolbet) was like yet in the quarter, but we do know it was growing well in the first quarter and there’s no real reason for a slowdown (other than the regular seasonality, the second quarter is fairly slow in the US compared to the NFL season and March Madness, though there were some big soccer tournaments and other global sports events).
We do know that Coolbet drove the “beat” in the first quarter and is driving the “beat” on revenue in this second quarter, too, and presumably is a big part of the reason for the huge increase in the forecast for the year. A quarter ago, GAN’s outlook was for $105.5 million in revenue in 2021, and now that forecast is “$125-135 million.” That’s a big upgrade, and it drove a spike up in the shares when this was announced, but they’ve now given up those gains… in the weaker market we saw back on Monday, they were right around the lowest price they’ve traded at this year, near $15, though there’s been some recovery since, and I ended up adding a little bit to my position as the shares remained weak late today.
We do not know what margins will look like this year, but the few analysts who follow this small cap have left their EPS estimates unchanged, they see 2021 earnings of 19 cents/share, and I will still be surprised if they can’t beat that and grow that number very quickly over the next couple years as they ramp up to greater efficiency (they were nicely profitable in 2019 before ramping up spending aggressively to expand their capacity last year). It may not be the company that investors were hoping it was when they bid up the “story” last summer, but it’s a substantially better company than it was last year, with high margins, strong revenue growth, continued growth in their core B2B cloud SaaS business as well as in the B2C Coolbet business, margins that are likely to get meaningfully better in the next few years, and no real need for capital unless they’re going to make large acquisitions.
They have meaningful businesses in three major states now, New Jersey, Pennsylvania, and Michigan, and they still think that there’s a chance they can have clients up and running in nine or ten states by early next year, though it’s hard to predict those timelines and regulatory changes and a lot of those states will represent pretty minor levels of revenue for GAN. The challenge of losing some of the FanDuel business last year, and likely gradually losing more of it over the next couple years, has been met reasonably well by winning Churchill Downs and their TwinSpires expansion to more states, and the rising tide of more and more sports betting and online gambling is very likely to keep rising in the US, in more states and with more gamblers.
The few analysts who cover the stock are a little skeptical, their forecast for revenues hasn’t even caught up with the low end of GAN’s new guidance two weeks after that was issued, but I don’t see any obvious reason to doubt that things are going well. Maybe not as sexy as Dave Portnoy was dreaming a year ago, and not a hot brand like DraftKings or Penn’s Barstool, but certainly much more reasonably valued — this remains a really strong business that was profitable before last year’s surge in costs (incurred to bring on more people and fuel future growth), with very good software margins, sticky customer relationships, and now a bit better growth than expected. That’s pretty easy to own at less than 5X sales (that’s the generic offer price for almost any asset-light smaller business, frankly, I’ve had people calling and offering me that price for Stock Gumshoe for five years now, without ever seeing our books — it must be the default in the “get rich by being an angel investor” booklet), and I still think it deserves a higher multiple — I still consider GAN a solid buy at $30, which then makes it awfully easy to buy at $15. My buy today was at $15.66. (And Stock Gumshoe? Still not for sale, sorry).
It is not always comfortable being in strong disagreement with the rest of the market, but unless there’s something criminal or evil going on behind the scenes at GAN that could crush the business, I think this is too cheap — yes, the business is competitive, and they’ll both gain and lose clients over the next few years, and may erode over the next decade if we have true megacaps taking control of the US gambling marketplace and achieving better vertical integration (meaning they might not need, or might acquire, tech suppliers like GAN)… but right now, it’s still early days, there are only three or four states that matter at all in the sports betting industry, and all the evidence I see points to GAN doing just fine against the competition as that market continues to grow. I bought at near this price back in May, as well, and, other than the fact that this is a very small company and I do want to keep my risk exposure under some control, I see no reason not to continue adding. I’ve bought below $7 and above $20, and don’t regret any of those purchases.
But I’ll balance that with one more negative thought — with the shrinking GAN relationship with Fanduel, and the fact that it’s beginning to look more likely that New York’s launch of sports betting will be restricted to just a few operators (it could easily just be FanDuel, DraftKings, MGM and Penn National), that probably increases the odds that GAN won’t get any real exposure to that large potential market, and investors might end up seeing that as a negative. Still, some risks are so ephemeral (they might not get a fair share of every state’s business!) that it’s not really worth worrying too much about them, particularly if the valuation doesn’t really “price in” GAN winning a lot of new business. New York is obviously a big market, and will drive news flow as it emerges onto the sports betting scene, but it may or may not be a great one for the operators, we don’t really know much yet.
It strikes me, on reflecting on GAN, that there are now only four sub-billion-dollar companies that are really meaningful holdings for me, making up more than 1% each of my Real Money Portfolio, and GAN is one — the others are the truly teensy Power REIT (PW), which is only that large a position because their Rights Offering was a no brainer “free money” investment, and Altius Minerals (ALS.TO, ATUSF), which I’ve owned for a dozen years (during which it has meaningfully underperformed the market). My only real qualm is that I have a much stronger sense of the management teams, strategy and likely business trajectory for PW and Altius, and indeed for “still very small” $1.5 billion PAR Technology (PAR) or Sandstorm Gold (SAND), than I do GAN, and that level of confidence in management is extra important for a small cap… but hopefully as I learn more about GAN CEO Dermot Smurfit and his team, I’ll add to that confidence.
Power REIT (PW) keeps growing, slowly
Power REIT (PW), incidentally, also made yet another small greenhouse acquisition while I was off on vacation — no real change to the business, and it’s really just the same as a bunch of similar deals they’ve made in Colorado, with a relatively small investment ($2.5 million) to buy the property and finance construction, paid back with fairly high rents over the first three years that effectively return all of PW’s capital (after a six month “free rent” period to begin), and then with a step-down in rent to a 13% yield for Power REIT after that for the rest of the 20-year term (and rent does rise 3% a year after it resets, so there’s some inflation protection).
PW is a microcap stock, with the market cap down near $100 million, reasonably priced around $40 in my opinion, but also likely to be very volatile as we wait to find out how their large pending deal to buy a property in Michigan out of receivership works out (they announced the agreement in May, but no news yet and it might take a while), and as they decide how to move forward with capitalizing the next stage of growth (since the Michigan acquisition, at about $18 million, would take a hair more cash than they should currently have available). Patient investors might wait to see if we get another rights offering or a secondary offering that could bring down the share price, perhaps, but one never knows — they did file a preliminary prospectus to raise up to $100 million more and issue more shares in early June, but they haven’t actually made an offering yet. Their investor presentation does say that their strategy is to use non-dilutive capital, including preferred stock, debt and rights offerings, and the first rights offering back in January was certainly a big hit with investors, so I wouldn’t be surprised to see them do that again — but no news on that front yet.
I’ve thought for a while that initiating a dividend would be a good way to attract investors, much like the much larger marijuana REIT Innovative Industrial Properties (IIPR) did early on, but so far Power REIT has followed a different path, and they do still have a long history of tax losses that they can use to offset income for the foreseeable future so they’re not obligated by tax law to pay a dividend, even though they are a REIT… we’ll see how it goes (IIPR had a similar market cap, about $110 million, when I first bought shares in early 2018, and that’s now $5 billion — there was a lot of dilution to pay for that growth, to be sure, but investors are happy to see dilution of ownership as long as dividends are growing rapidly, and the total return for those 3-1/2 years is now over 600%… it’s not necessarily logical, IIPR has paid out a total of only about $150 million in dividends over that time, and has raised more than $1.5 billion by selling shares, but that history clearly illustrates the investor enthusiasm for dividend growth stories).
And yes, I’ve had a couple readers ask about IIPR lately… my thinking hasn’t really changed, though the goalposts keep moving as they keep raising the dividend. My challenge with IIPR is that the valuation is getting so high that I’m a bit tempted to sell some covered calls to enhance the income yield from this position a little, but I haven’t done so — mostly because there’s still some meaningful chance of IIPR having another strong dividend growth surge in the next couple years as they begin to add debt to their balance sheet.
Risk is rising with the valuation, for sure, and there’s always political and regulatory risk to worry about with IIPR, but their many tenants are all paying their rent and as long as that happens, the price tends to follow that dividend growth… so I’m just trying to hold on. IIPR is much easier to justify buying during panic periods of bad news, at least for an overthinking number-cruncher like me, and since REIT investors tend to be very dividend-driven my strategy has long been to hold out for a premium yield — and with this level of dividend growth (likely to continue at at least 20%), I draw that arbitrary line at a 3% current yield. They will announce their next dividend, and probably a dividend increase, in mid-September, but as of now the last $1.40 quarterly dividend would annualize to $5.60, so that would be $187.
If you want to be growth-focused and forward-looking instead of waiting for a period of panic (from an interest rate scare, or a marijuana legalization scare, surprise tenant default, or just a bad stock market), then boosting that dividend by about 15-20%, which is likely over the next year but of course not guaranteed, would mean that a 3% yield using that higher future dividend assumption would get you a buy price of about $220. So you can probably still talk yourself into buying IIPR if you want, but I’m just holding.
Dream Finders Homes (DFH)
The short position in Dream Finders Homes (DFH) continues to be meaningful, with short trades representing a fairly big chunk of trading volume in recent weeks, and I can only assume that’s because of this week’s lockup expiration and a relatively high valuation compared to the average smallish homebuilder, though, to be fair, it’s also because “short ratio” is a percentage of the float, and not a lot of Dream Finders shares are publicly floated just yet.
I think the shorts are short-sighted on this one, but we’ll see how the lockup expiration goes. The biggest lockup should have expired this week, so there’s likely to be at least some selling in the coming weeks, but the big folks who own large chunks, including the CEO and other management and Boston Omaha (BOMN), have not filed any share sale notifications as of yet, and might not. Other than Boston Omaha reiterating that they really like DFH, none of the insiders have really telegraphed their intent — and really, CEO Patrick Zalupski is the only wild card who makes much difference, since he owns about 2/3 of the shares (and about 80% of the voting power), and I’m sure any financial advisors would be telling him to sell at least a little bit at some point. Not this week, at least.
Brown & Brown (BRO) upgraded a little
Brown & Brown (BRO) is a steady eddie kind of stock, their earnings compound annual growth rate (CAGR) for the current period (from 2020-2023, basically) is expected to be roughly 10%, a solid but unflashy company. I still think it’s worth paying a premium for that, since the tailwind of high and rising insurance rates should benefit them (as a commission-earning agent), and since they have such strong insider ownership and a long history of good capital allocation and steady growth, but I would resist paying too high a price if we can help it. I’ve settled on about 25X earnings as being rational for BRO, which sometimes has been a premium to the market and sometimes a discount, and the number is obviously somewhat arbitrary…. but you have to use some kind of discipline, or what’s the point of being an individual stock investor (and overthinker) at all?
Now that we’re about halfway through the year, and as I think we’re probably going to see BRO beat their pretty conservative guidance in the next couple quarters (that’s a guess, to be clear), I’m willing to start to look at 2022 estimates — if we go with the analyst estimates for next year, which is $2.12 in earnings per share, my 25X multiple gets us to a max buy price of $53 a share. That doesn’t leave a lot of room for error, of course, we’re pre-buying some earnings that haven’t happened yet, and we don’t know what the market will look like over the next six months… so I don’t feel inclined to really load up at that price, but that’s my new top end and I did add a microdose buy this week below that level. This is a great family-controlled company that I want to own for a long time, I’ll wait for really bad days to add big… but I’m willing to add small anytime it’s at a reasonable price and I have surplus cash.
WESCO (WCC) and political volatility
WESCO (WCC) has been pretty volatile of late, presumably because of chatter about the prospects for infrastructure spending rising or falling due to political fights. I have no idea what will happen with any of the big infrastructure spending plans from Congress or the Biden administration, we’ve certainly seen ambitious plans on that front fail to lead to anything in the past, but I’m not really counting on a ton of spending. WESCO’s prospects are not solely determined by some new bolus of infrastructure spending over the next decade — the bigger issue for this year will be the continued integration of their major acquisition of Anixter, which closed about a year ago, and they could always change their forecasts when they report in a couple weeks, but demand for electrical and telecom projects should remain strong, and the industrial growth that will follow all this stimulus spending is also very likely to be pretty strong.
It’s an open question whether WCC can keep this growth going into the future, but with well over $6 in earnings per share expected in 2021 the valuation is very reasonable and doesn’t mean we really need rapid growth to continue — as long as the merger integration doesn’t blow things up in some surprise way, and as long as the economy doesn’t sink into a recession, this strikes me as a pretty safe bet. It may not do as well as I think they can do (I think the shares could double by 2023), and we should have some skepticism because the company had its ups and downs before last year and has not yet established a strong trend of improving margins and revenue growth in the generally low-margin distribution business, and all of that was under the same management team that’s in charge today, but I do still think that the combined company is being underestimated.
There’s obviously plenty of room for uncertainty with WESCO. They got a gift from the well-timed acquisition of Anixter, and the opportunity to finance it at extremely low interest rates, so much of the “story” is whether we’ll look back in five years and find that gift squandered. The deal to acquire Anixter added a lot of value and attracted a big new investor (private equity firm Leonard Green & Partners bought 11% of WESCO at around the time the deal was finalized), and it dramatically improved the per-share economics of the company… but a big chunk of that improvement came because they used debt to close the deal. The leverage from debt is hugely helpful if you’re a relatively low-margin business and want to grow quickly, but leverage also always brings risk. And having a new 11% shareholder that bought in at half of today’s price means you’re also faced with possible selling risk, or activist pressure, if Leonard Green decides to exercise some influence or sell some shares. I still think we’re getting an above-average business, well-situated for meaningful spending increases by telecom and utility companies over the next few years, and I think we’re getting it at a below-average price, but in the near term it looks like sentiment about a big infrastructure deal is what’s driving the share price. They report early in August, and whatever they say could certainly shift sentiment about the merger integration or the growth potential, and therefore shift the valuation multiple and the share price.
Brookfield Asset Management (BAM) sucks in their property REIT
Brookfield Asset Management (BAM) has been busy, finalizing the privatization of Brookfield Property Partners, rebranding and relaunching one of the Oakmark private REITs with a Brookfield name (Brookfield bought control of asset manager Oaktree a while back), and, this week, pricing the IPO of Clarios, the vehicle/marine battery company that their private equity arm had bought from Johnson Controls about 2-1/2 years ago (that was one of Brookfield’s biggest ever private equity investments, bought for about $13 billion). Clarios does make some lithium ion batteries, but they’re not a next-gen EV battery company, they’re a leader in old-school lead acid batteries and are continuing to innovate in that traditional area even as they try to also push into EVs and the growing energy storage markets. The initial rumors about the IPO a couple months ago were dangling the idea of a $20 billion valuation, which would obviously be a nice return from a $13 billion purchase price a couple years ago, but the expectations have fallen far below that now, with Brookfield noting on Tuesday that they expected a valuation of “up to $10.7 billion” at the IPO. Perhaps a bit of a sign that there is some limit to the IPO enthusiasm out there, particularly for an old company that is not currently profitable, but Brookfield and their partners (mostly a big pension fund from Quebec) will still own 80% of Clarios, so I assume they’re hoping for the valuation to improve in the years to come. Brookfield has almost caught up with Blackstone now when it comes to assets under management (about $609 billion, vs. Blackstone’s $649), so it’s not a huge deal.
And just as a reminder about how much money is floating around in the investment world, that $609 billion in assets under management for Brookfield does not even put them in the top 50 asset managers… Blackrock continues to lead that group with $9 trillion under management (if you’re curious, the list includes all the big mutual fund and index ETF companies and annuity/life insurance companies, as well as more specialized institutional asset managers like BAM).
Roku (ROKU) Might Be Stronger Than Some Think
Roku (ROKU) continues to swing its weight around as a leader in the television business, they reported a strong upfront season and doubled the advertiser spending commitments from last year (the “up fronts” are when big advertisers commit to support network shows for the next year, but the same idea has been moving to the streaming biz, too, as dollars flow that way)… and they also sold Apple a button on the Roku remote for their AppleTV business (Disney and Netflix and Hulu typically “buy buttons” too, others may follow), which tells you how important access to streaming customers is, and Roku has more of them than anyone else.
The other streaming TV operating systems are of course still out there, and still competitive, and they don’t want to give up any control to Roku — but nobody is buying a Samsung or Vizio smart TV because of the great operating system, and people are buying TCL and Sharp and other TVs because of the Roku system. We’ll see how the world changes in the next few years, but Roku’s push to own the operating system through which people watch TV, both in their own smart TVs and through their streaming boxes/sticks, has an awfully good head start. And we all remember Microsoft, and how persistent a dominant market share in an operating system can be… particularly when it’s hard-wired into a lot of new hardware. Roku is nowhere near that level yet, and they have meaningful competition from Amazon and from big TV makers like Samsung, but they’re at least in the lead now, as the business really kicks into high gear with so much competition for streaming eyeballs — and they are not sitting back and waiting for others to catch up.
Roku isn’t yet in the same league as Alphabet or Facebook in building its own “walled garden” of ad content, but no TV-only platform is really on Roku’s level yet, and it’s certainly possible that they’ll keep their commanding lead. I’d say it’s even probable, not just possible, but at this kind of valuation it’s all about assessing those probabilities and deciding how much risk you can take.
Sometimes Netflix (NFLX) results end up impacting Roku shares, since the two were joined at the hip for a long time (Netflix is the first streaming service most people buy, so it’s still connected to the growth in streaming and smart TV sales, and Roku’s first streaming device was born as a project at Netflix), but the stock connection is not as direct any more — it used to be that a bad quarter from Netflix hurt ROKU shares, but Netflix disappointed this week, with low subscriber growth projected… and Roku shareholders didn’t blink.
And that makes sense, largely because of the leverage to hours viewed that Roku enjoys and which Netflix cannot — Netflix has to invest heavily in content to keep subscribers happy and engaged, and to hopefully generate occasional series that are big enough hits to drive new Netflix signups, but they get the same $$ per month whether you watch three hours of Netflix or 300 hours. Roku is very much focused on building the market for ad-supported streaming, both with ad-supported partners like Peacock and with their own Roku Channel, so they do get leverage from more hours viewed — if you watch 300 hours, you’ll see a lot more ads than if you watch three hours, and Roku gets a cut of that without incurring any additional cost.
And the recognition that Roku is the biggest gatekeeper for streaming video continues to rise — whenever one of the streaming video companies has a big event or big new content release, like a new Disney+ premium movie or, this week, the Olympics coverage from NBC and Peacock, those partners are incentivized to sponsor Roku’s home screen to highlight their big offering and generate more streaming hours (with Roku also likely earning commissions for new subscriptions sold as a result, or getting a small share of the ad revenue). The advantages of scale, and of having a huge and fairly steady audience (if you have a Roku TV, particularly, you’re pretty wedded to the Roku home page), really start to accelerate when there are lots of deep-pocketed publishers and advertisers who want access to big markets, so Roku’s audience of ~50 million households in the US (a total of about 53.6 million active accounts as of last quarter), gradually growing and expanding overseas, is still, I think, somewhat underappreciated… and the video delivery and TV advertising markets are so overwhelmingly massive that they’re really just getting started. Traditional pay TV subscribers in the US, satellite and cable, are gradually “cord cutting” to go to streaming, but that number is still at 75 million, down from about 88 million in 2019, and that traditional business has such dramatically higher revenue per user than Roku or any other streaming-connected company… which means that there’s still a lot of room for Roku to surprise us in the decade ahead.
I have a hard time buying super-expensive large companies, which is a personal hangup — it’s much more comfortable to buy things that are obviously undervalued, or at least small enough that it’s easier to imagine huge growth potential, but it’s also true that the big tend to get bigger. Among the sub-$100 billion companies (Roku’s market capitalization is currently about $50 billion), I do think Roku has a better chance than most to be among the next wave of trillion-dollar companies in the 2030s. I try to have a little discipline, and did stop out of part of my position when it dipped to a stop loss early this year, though I also bought that back when the price fell to $300, which has been my reasonable “buy” point… but I also think that some of the very best companies with massive addressable markets and incredible leadership in their segment (Shopify and Roku among them, for example) are worth owning a little piece of even if your stomach turns at the valuation. You have to be willing to handle those downturns if you want to own transformational growth companies, the odds are very high that these stocks will fall by 40-60% at some point in the next decade, probably more than once, but they’re also the kind of leading companies that could feasibly generate 10X-20X returns in that time if they maintain their market leadership, and both of those companies clearly are still focused on building their market share and improving their products. As someone who grew up in the markets very much sympathetic with the idea that some stocks are “too big to grow,” it has taken me a long time to learn that there are a lot of exceptions to that particular rule. Inflation is among us, and I guess $1 trillion is the new $100 billion. Heck, $50 billion, given our relentless focus on the trillion-dollar tech giants, seems almost like a mid-cap company size now.
I’ve been willing to go up to 15X sales in buying ROKU, and with revenue growth growing so fast that number continues to evolve — for 2021, with estimates of $2.75 billion in revenue, that would now mean we can support a $41 billion market cap valuation (or $310 per share)… and if you want to be more aggressive and use 2022 estimates of $3.75 billion, that would be a $56 billion market cap ($425). You can make your own call on which numbers make sense, but I find it helpful to tie my rationale to specific numbers, it helps to keep me from trading solely on sentiment. ROKU has been in that range from $300-400 for a few months, but now is close to setting new all-time highs thanks to a new wave of enthusiasm for advertising-related names that was driven by the surprisingly strong quarters out of Twitter (TWTR) and Snap (SNAP), but who knows, perhaps it will dip again… they report their next quarter on August 4, and I’d assume that would be the next catalyst for the shares, but I also wouldn’t have predicted that a good quarter from Twitter would send ROKU up 10%, so on any given day it’s a game of craps. You can roll, or you can sit it out.
It’s not just ROKU booming today, incidentally — all the ad names tend to move together on any perceived good news for the sector, so Alphabet (GOOG) and Facebook (FB) and Pinterest (PINS) and The Trade Desk (TTD) and Magnite (MGNI) and lots of others all had strong days today… investors are assuming that SNAP and TWTR are a sign of ad demand bouncing higher, not companies that are taking share out of their competitors, and we’ll all be watching the reports from Facebook, Google and Amazon (AMZN) next week to see if they further encourage investors to bet on a growing ad market.
Another Insurtech Idea?
Yet another new insurtech company is entering the fray, this time it’s Kin that’s going public, through a merger with Omnichannel Acquisition Corp (OCA). They have a very similar pitch to Lemonade (LMND), with the focus on online service and speed, only instead of a “good for the world” company they’re offering somewhat of a mutual structure, with profits beyond Kin’s take effectively shared among policyholders, sort of like you’d see at Vanguard or State Farm (not necessarily directly in the form of a check, but some effective policyholder ownership).
Kin is much more marketing focused than the other insurtech folks, and are merging not with insurance or financial services-minded folks but with a SPAC that is focused on omnichannel and influencer marketing, so it might be interesting… they do have very solid unit economics compared to Lemonade, partly because their concentrated on homeowners’ insurance in just a few high-disaster states (Florida, California and Louisiana), so the story is similar to Lemonade but the annual premiums are much higher because they’re selling into riskier businesses (Lemonade does their customer acquisition by starting with renters insurance and trying to hold those customers as they move up the ladder to home ownership and other insurance needs, so their customer acquisition cost is lower but it also takes longer for those customers to earn back that cost). In fact, the numbers look very similar to Metromile’s, with reasonably appealing unit costs that ought to be scalable, but the growth is a little stronger.
I’ll want to look a little more about how they’re managing risk, particularly since their strategy of building through high risk states makes me a little nervous and they aren’t very established yet, but color me intrigued — the SPAC’s ticker is OCA, OCA/WS for the warrants, if you’re interested in digging in a bit.
Beacon Street MarketWise (MKTW) Finally Public, Despite Redemptions, Makes a Lot of Money From You
Speaking of SPACs, the going-public SPAC merger for the Stansberry/Palm Beach/Empire/Investorplace/Casey/Bonner newsletter group, previously called the Beacon Street Group, was approved this week and started trading yesterday as MarketWise (MKTW), so we’ll keep learning more interesting details about the financials of the newsletter business — investors were not enthused, they approved the merger… but the shares were also briefly down below $9 on the day after the approval (they’re back above $10 now, for the first time in a long time), so it wouldn’t be surprising if there were quite a few redemptions from the SPAC trust account as well. And, in fact, it turns out that there was a massive surge of redemptions, a pretty wholesale rejection of the deal by shareholders when it came to their money, even though they didn’t vote “no” with their proxies — they disclosed that 38.7 million shares were presented for redemption at the meeting, which means that of the original $414 million available for redemption, essentially everyone who was eligible (some insiders were not) elected to take their cash and leave the party, and from that $414 million trust only $26.5 million is actually left. I don’t know if that’s the last word, there may be some change to the final number.
That means the insiders at MarketWise have much less of a cash-out opportunity than they had planned, originally most of that $400 million was designed to be paid to MarketWise’s private owners, who were cashing out to some degree, and they were planning to be left with mostly just the $150 million in PIPE offering cash as their growth capital. And since those insider shares are tied up for a little while, some for a real lockup period and some just because the new shares being created have to be registered and hit accounts, the price might be wacky for a bit. It’s generally true that most of the initial public float for a newly merged SPAC in the first days and weeks comes from those original public SPAC shares, since insiders and PIPE investors are often locked up, and in this case almost all of those original public SPAC shares were submitted for redemption and therefore disappeared, so there won’t be many shares available for trading for a little while for MKTW — which means the price might be bouncy for if investors decide to fight to buy or sell with not a lot of shares to go around.
That will solve itself over time, but it might make for a nutty week (or more). And since there was no cash left over to distribute to the sellers as part of the deal consummation, given those redemptions, I assume that there will be some meaningful insider selling once the real lockup periods expire (6-12 months, according to the original investor presentation). I wonder to what extent the various MarketWise newsletters and trading services will cover the stock, or will be allowed to analyze or mention it.
The positive take is that they don’t really need growth capital because they’ve been generating cash flow on their own — and the valuation is looking pretty compelling. MarketWise thinks they’ll have nearly a billion dollars in billings in 2022, almost doubling the 2020 number, and even with the SPAC redemptions that reduce the share count it should still be a $2.6 billion company at $10 a share.
If the business goes along as well as they think it will, that’s a valuation of only about 3X 2022 revenues… and even if things falter in a weak market for a while, which is possible but not predictable, those subscribers are still on the books and tend to be pretty sticky, and they had $360 million in revenue last year and $550 million in billings (mostly subscription revenue not yet received), so the valuation right now is at less than 10X 2020 revenue. Pretty cheap for a fast-growing subscription company that has no big capex needs, high profit margins, and converts about 30% of revenue into free cash flow.
The first quarter numbers in June reiterated what a great business a financial newsletter publisher can be — they’ve got more than a million paid subscribers, and their marketing prowess and upgrade “funnel” have driven their average revenue per user up to $825, with high margins and low capex (a $5,000 newsletter is not meaningfully more expensive to produce than a $49 newsletter)… and with another 10X that number of subscribers sitting on their books as free members, ready to be upsold.
If you happen to have a few moments to spare while trying to clear your email inbox, reading through MarketWise’s investor presentations is a good way to remind yourself that we, dear readers, are the commodity — the entire goal is to drive subscribers into that “ultra high value” bucket by getting them to eventually buy a bundle/lifetime deal for $15-30,000 (with, like a time share, ongoing maintenance fees of at least a few hundred bucks).
As you might guess, the first hurdle is the toughest one, getting you to pull out your credit card — it looks like they get only about 6% of their free subscribers to upgrade to a paid membership… but once you’re paying something, anything, you immediately become the most valuable prospect imaginable — a third of paid subs, they say, even those who just sign up for a $29 or $59 subscription, will eventually upgrade to a $500-1,000 subscription, and a third of those high end subscribers will upgrade further to that “ultra high” level. That means almost a half of a percent of their free members end up eventually buying a $15-30,000 package. Which means a new free member is worth at least $75-100 in the end, even if you ignore that middle step of the $500 upgrade subscription, which means they can spend heavily to bring subscribers in and still have high margins… it’s a GREAT business, and that’s why they’re fighting so hard to get you to sign up for a free sub or a low-end $50/yr subscription, once they get you in the door they know exactly how to push your buttons and get you to upgrade (well, not you, I mean, but, you know, regular investors).
Of course, despite the attractive financials for the company, I can’t buy it — the conflict would be too direct, since I write about these publishers a lot. But there’s a lot to like in those numbers. The skepticism, I assume, comes from the fact that investors, especially those who consider themselves professionals, like to look down their nose at the investment newsletter business, and don’t like these heavy marketers (for good reason, in many cases)… and, perhaps more justifiably, from the fact that MarketWise is going public at what has been a fantastic time for investment newsletter financial performance, driven by the big mass of new investors who got interested in the stock market over the past year, and had planned to use essentially all of that SPAC money (now redeemed, so no longer available) not as growth capital, which investors prefer, but as cash compensation for the sellers. If we’re at the peak of that investor sentiment, and the markets crash or just get boring for a couple years, selling newsletters will get tougher and cancellations will likely rise — though I expect the big players like MarketWise and the Motley Fool will hold up better than most.
I found it interesting that we’ve been getting some context and industry insight from individual deals that they use as examples in their presentations, too — we already know that the launch of Whitney Tilson’ Empire Financial Research was a big success, that organization has grown nicely, but they also provide some detail — the launch, which really took off with big mailings in late 2019 and early 2020, brought in 3,000 paid subscribers and 10,000 free subscribers, and net revenue of $11 million. The business has since grown to 83,000 paid subs and $32 million in net revenue as of 2020, with several more newsletters being launched by Tilson and his newer colleagues to drive more signups. That’s a very rapid buildup for a new business, and I assume MarketWise would like for it to be a blueprint for future projects.
Whitney Tilson was already a brand, well known by investors and with a good following in the media, and not every new business or editor is going to launch with anywhere near that level of success (though a lot of newsletters do try to recruit or borrow star power, grabbing on to not just well-known financial pundits like Tilson but also past Fox News or CNBC anchors or politicians when they can get them to endorse them or join the company), but that’s a reminder of how much money is involved with these teaser pitches that we look at every day. Crazy. And they know that the main driver is that marketing funnel, of course, and obviously put a high value on their ability to write new pitches — they even added their head copywriter, Mike Palmer, to the MarketWise Board of Directors, a name that might sound familiar after the many promo letters he’s signed over the past dozen years (along with a couple other familiar names for Stansberry watchers who are going on the Board as well, like Steve Sjuggerud and coin dealer Van Simmons).
You can see why companies like MarketWise advertise so much, and push the teasers so hard — clearly, it works, with the subscriber count, from both marketing and acquisition, almost tripling in two years. Even if that was an exceptional period because of the very successful launch of Tilson’s Empire Financial, or because of the COVID boom in investing in general, it’s still exceptional (Stock Gumshoe’s email list, in case you’re curious, has grown only about 20% in that time, about the same steady pace we’ve grown at for 13 years). I don’t know if it “works” for their subscribers, I’m sure that’s much more hit or miss depending on the newsletter or service they might have bought in recent years, but certainly it’s continuing to work fantastically for Porter Stansberry, Bill Bonner and all the other established newsletter folks who are now presumably significant owners of MarketWise. I’ll be curious to see what redemptions look like as that info comes out, but it’s clearly a pretty compelling value if they are able to continue on anything close to this current trajectory… and unlike the SPAC shareholders, the people who pony up for $2,000 subscriptions or “lifetime” package deals at $20,000 don’t get a redemption option, so as long as Mike Palmer and his writers can keep spinning the sales copy, and the editors can, on balance, do at least a decent job of picking and analyzing investments, those subscriptions will probably keep generating a lot of profit.
The Only Asset With No Down Years?
And speaking of the Stansberry gang, I’ve had lots of folks ask me about inflation-protected investments of late, particularly following the pitch from Stansberry’s Dr. David Eifrig about the asset class that has “never had a down year since 1992” — so I thought I’d spend a moment on that. Here’s how Eifrig pitches that special report in one of his Retirement Millionaire ads…
“The Only Asset With NO Down Years Since 1992? (It’s UP 2,010%)
“Few Americans know this, but there are two assets we’ve studied over the past decade, which have proven to be among the best ways to protect and grow your wealth, even in the worst type of monetary crisis.
“I believe it’s critical you learn about these assets right now – and the best ways to buy them.
“During World War II, for example, when millions of families lost their entire life savings through inflation and government seizure, one of the assets I’m going to tell you about enabled some families to not just survive, but also protect, preserve, and grow their money.
“That’s why at my firm we call it: ‘The Most Valuable Asset in a Time of Crisis.’”
If you’re feeling at all nervous about the world, those kinds of pitches sure strike a chord… what else does he say about it?
“This asset is up over 2,010% over the long term since 1992, without a single down year.
“I repeat – it has NEVER had a down year since 1992… that’s 29 straight years of positive returns!
“This should be on the front page of every financial newspaper in America… but very few Americans know anything about it.
“I’ll tell you everything you need to know and the best possible ways to invest. Now of course, all investments carry risk, even this one. So please, do not spend more than you are willing to lose on this or any investment for that matter.”
That’s “farmland” for the “never had a down year” asset, something Stansberry has been touting for a dozen or so years now, following Barton Biggs’ cheery comments about the value of owning farmland in his widely-read (or at least widely-bought) book, Wealth War & Wisdom, which talks in part about how owning a working farm protected both wealth and life during past crises, including World Wars I and II in Europe.
I don’t know which farmland investments Eifrig prefers, but buying farmland as a passive investment is possible, as is buying a “gentleman’s farm” if you want to be more involved, or even an individual land purchase if you want to be a farmer’s landlord, though asset prices have inflated there the way they have everywhere else.
Probably the easiest route is through the farmland REITs and similar investment funds, either private or publicly traded. There are some private platforms for investing in farmland, including FarmTogether and AcreTrader, often they work sort of like crowdsourcing deals and you buy into a particular piece of property (though they also sometimes have collected funds you can invest in to share the risk), and I have spent a little time looking into some other private vehicles in this area, including Farmland LP and Iroquois Valley Farmland. Private investments in this space, whether they’re REITs or partnerships or whatever else, tend to have investment minimums in the $10,000-50,000 range, (with lockups, so they are not to be entered into without careful thought), and I’m sure there are others I don’t know offhand — the world of unlisted “alternative investments,” particularly alternatives that generate some kind of income yield, is booming.
The two publicly traded ones I’m aware of are Gladstone Land (LAND), which tends to buy more value-added farming properties (think orchards, not wheat fields), and Farmland Partners (FPI). Both are small, not super liquid, and have low yields and low returns on equity, and trade at a premium to their book value, but they do give exposure to farmland and should, all else being equal, rise in value if farmland continues to rise in price over time. They’ve done OK, mostly because of a strong run this year — here’s about five years of total returns for those two, compared to the Vanguard Real Estate ETF (VNQ) and the S&P 500, just FYI:
If you’re really worried about the “SHTF” moment when people are standing at your front gate with pitchforks and torches, and you can’t get to the grocery store, probably better to make friends with a local farmer, either buy part of their operation or their land if you can, join them as a CSA/farm share customer partner as a small scale personal move, or start up your own garden or buy a little plot outside of town, depending on where you live. For most of us, unless you want a drastic change to your lifestyle, going out and buying a little hobby farm is not exactly an option… and frankly, if we’re buying assets that are inflated in value there are others that I’d prefer over private or publicly traded agricultural REITs at the moment. Still, a subject worth pondering… we all gotta eat, and inflation does hit food. And land.
The most interesting farmland REIT I’ve done a little research on recently is the Iroquois Valley Farmland REIT, which is private and therefore not liquid (like a lot of private REITs, there’s no easy or automatic redemption and you have to commit for at least five years, though they do pay a dividend that you can elect to take in cash or reinvest, it looks like that dividend has recently been somewhere in the 3% neighborhood — you can see their basic info here). Iroquois shares are sold basically at something like 1.1X book value, they use a third-party appraisal and then add a 10% premium when they update the value of the shares each year, which is probably lower than the valuations of liquid farmland REITs… but you also tie up the money and don’t get easy access. And the value won’t pop to “crazy” as quickly as publicly traded REITs might, so there won’t be any manic repricing that lets you sell at a crazy premium. The minimum investment is around $10,000.
Part of what’s interesting about Iroquis is that they’re investing to convert farms to “certified organic” in partnership with their tenants, which also increases the value of the land over time given the demand for organic products, and might provide above-average yields to support higher rents (though no guarantees there). There’s at least one other relatively accessible private fund doing something similar, called Farmland LP — they’re a “converting farms to organic” private investment fund, mostly in Washington and Oregon (Iroquois Valley doesn’t have a proscribed geographic area, but most of their farms are in the midwest).
Iroquois is more familiar in structure to me, a private REIT that just continually raises money at their assessed value and uses it to buy more farms, paying an annual dividend… Farmland LP runs funds that might not generate cash flow for a while and which are more “locked up” in that sense, but at the end of the fund’s life the assets will be liquidated and the money distributed back to shareholders, like a venture capital fund. I like the familiarity of Iroquois more, I like the REIT structure, but it might be that Farmland’s Limited Partnership fund structure makes more sense in the end, for tax or other reasons, I don’t know — and I do particularly prefer the somewhat better geographic diversification of Iroquois and the likelihood of steady dividends that one could choose to reinvest or take in cash. Both have that social mission of expanding organic farming and adding value to the land, and working with small farmers, and I do like that, though I don’t know what dollar value to put on it. Mostly this would just be yet another “let it compound” way to profit from rising demand for organic food and the generally rising value of US farmland, which all these folks will tell you has historically increased in value by 11% a year (they’ll also tell you, if they’re honest, that they have no idea whether or not that will continue).
Kind of tempting, though I’m early on in looking through the terms of these deals and I’m not in any rush to commit to any of them. I do know myself well enough to know that if I ever become a meaningful real estate investor, I’ll have to do so through a manager or fund, evaluating land and/or tenants is not ever going to be my strong suit, and I really value the diversification of funds in this area, even if I know finding just the best farmland or the best tenant, and using a mortgage to lever up my exposure, would probably be more lucrative.
Many private REITs and partnerships are either restricted to accredited investors, or so loaded to the gills with self-dealing expenses and high salaries that it’s better to avoid the group entirely than to consider investing without doing a lot of research, and the fact that they’re pushing “organic” and have a social mission doesn’t necessarily mean that they’re “good guys” (though I do give some credence, at least, to the fact that Iroquois Valley is also a Certified B Corp. — it’s not a guarantee that the company is great in all ways, but getting that designation is at least somewhat rigorous). So we’ll see, maybe I’ll get into farmland someday, anyway… for now, I’ll keep defending my little plot of backyard tomatoes from the squirrels and supporting my local farmers, and I’ll whistle along and not worry too much about the barrage of pundits scaremongering us that we’re on the verge of a Weimar Germany social and economic collapse.
And there was a second asset in Eifrig’s tease, if you’re curious…
“In this report, I’ll also tell you about another asset that offers you a powerful way to profit during a currency crisis – yet it has absolutely nothing to do with gold or bitcoin.
“I first recommended folks begin buying this asset back in 2009 – I even showed how to possibly get it at your local bank.
“In the past year, for example, the price is up more than 62%… but in a currency crisis like the one that’s coming in America in the years to come, this asset could soar as much as 10 times higher.
“I strongly recommend you make at least a small purchase today.”
That is almost certainly a repeat of a long-teased pitch Eifrig has had about seeking out silver coins at your bank or in your pocket change — either the commonly known “junk silver” or, if you’ve got time to go around and ask all the tiny bank branches what they might have in the back of the vault, the transition-era half-dollars that had a little bit of silver in them and sometimes get forgotten.
The spiel that we first wrote about from Eifrig eight or nine years ago was that a few partial-silver half dollars (dates from 1965-1970) are still in circulation since some folks don’t know often use half dollars, or don’t know they’re silver (other coins lost their silver in 1965), and if you ask for them at the bank (“Do You Have Half Dollars?” is the best guess about what he was teasing as the five “magic” words back then), you might end up with some silver. 1965-1970 half dollars are 40% silver, pre-1965 are much more scarce and well-known and are 90% silver (as were pre-1965 dimes, quarters and dollars). Searching for those coins is time-intensive and luck-driven, but there’s no real downside if your time is cheap — half dollars will always be worth at least 50 cents, and when people care about silver they’re worth far more. Just know that eagle-eyed coin sleuths have been winnowing the silver coins out of the circulating currency for 50 years now, and you’re not likely to find them in any kind of exciting numbers (if you find any at all) unless your local banks are very, very sleepy.
If you don’t have time for that kind of stuff, maybe just spend a few moments thinking about the “anti fragile” nature of your portfolio when it comes to inflation worries or a “currency crisis” — do the companies you own have strong brands and pricing power (like Chipotle, for example, which just announced this week that they’ve had to raise prices because of rising input costs… and have seen no reduction in demand as a result), or do they own irreplaceable assets? If they’re in a highly competitive line of business and have low returns on equity or low margins, inflation is likely to hurt them more. Especially if they carry a lot of debt.
And yes, Chipotle (CMG) does pop to my mind every now and then — both because it’s a major holding of Pershing Square, which I mentioned way back at the top, and because I have a select group of stocks in my “I’m an idiot” list that I like to revisit from time to time as an exercise in self-flaggelation… I owned Chipotle way back in the pre-financial-crisis days, when it still traded in both A and B shares and had McDonald’s as a major shareholder, and sold in 2008 sometime, probably in the $100-150 neighborhood (I don’t remember, and looking it up would be too painful). That was a nicely profitable investment and a market-beater, and it seemed like an expensive stock when I sold it, but it has since returned another 1,000%+ for those who could hold through the three major drawdowns in the interim (it fell 60-70% or so in the financial crisis, dropped something like 40% in 2012, and then fell 60% or so during the first e coli scare a few years ago). Everyone who’s been investing for any length of time has a few of those “I’m an idiot for selling” stocks, for me the two that percolate to the top tend to be Chipotle and Tencent, both sold more than a decade ago… I’ve made tons of mistakes in the past 20 or 30 years, of course, but those are the ones that stick with me. And remind me that I should try to avoid selling great companies just because they’re “kind of expensive.”
Not a lot of companies really “win” in inflation, and it’s generally bad for stocks if it persists for a long time, but companies with valuable brands or similar assets, good pricing power, flexible balance sheets, and strong margins hold up better than others, and have the best chance to still be leaders whenever we come out the other side of the next crisis. The world adjusts to inflation, albeit sometimes not instantly or equally, and strong companies tend to stay strong.
And for your smaller short-term savings account? Remember those Series I Savings Bonds from the government that I harp on from time to time (most recently back in April) — you only have to tie your money up for a year, but they’ll perpetually reset to keep up with CPI inflation. You won’t make any money, but you won’t lose any purchasing power, either (at least, not in CPI terms).
But don’t overdo your preparations for a worst-case scenario. Panic sells newsletters, but it rarely ends up being much help to the rest of us. We each have different needs, and I of course don’t know what your portfolio or risk tolerance look like, but most of us need our portfolios to grow. If you need growth, you can’t be overly defensive — even at times when the market looks like it’s objectively pretty expensive. Taking no risk gets you nowhere, and investing in stocks means you risk a 100% loss… but also, if you can hold on to good companies, the potential for 1,000% or higher gains.
That is the gift of the stock market, that you can be really wrong and still only lose your investment (as long as you don’t use borrowed money, so be careful with margin loans)… but you can be really right (and patient) and make 10X or 20X your investment or more. Think of that, if you will, the next time you consider selling a great growth stock just because it has doubled — sometimes it works out, but in so many cases that’s a “shoot yourself in the foot” situation. You don’t want to risk 100% losses and settle for 100% gains — selling and taking profits feels good, as indeed the market drives us to action and makes doing anything feel good, but if you’re doing that with 30 positions you can’t consistently cut your winners off at the knees and hope to succeed. You have to let the averages play out, and let the great ones become fantastic, because the losers will lose that 100% (or nearly so, in some cases), and you’ll need to count on the odds, and your stock selection, bringing you some some much larger winners to make up for the inevitable losers. If you can’t let those holdings ride higher to at least some degree, you’re almost certainly going to be better off using index funds or good managed funds for that “I need growth” part of the portfolio, and taking that decisionmaking away from yourself — if not with all of your money, at least with some of it.
And on that note, I’ve got a few growth-focused quotes for you to ponder as I let you go on your merry way this weekend. Someone on Twitter, it was probably Chris Mayer, pointed me to a reminder sum-up of Thomas Phelps’ great book, 100 to 1 in the Stock Market, that someone posted on their blog many years ago (Mayer’s book, 100 Baggers, is partially, at least in spirit, a 2018 update of Phelps’ 1970s book on finding huge long-term winners), and a few excellent points pop up there, these are just a dozen out of hundreds:
“If you don’t buy what has to be sold, you never really need to sell anything.
“The basic reason very few of us have made 100-1 on an investment is that most of us haven’t even tried to do so.
“The greatest gains in the market have been made by simultaneous increase of earnings along with increase in PE.
Increased earnings is just arithmetic progression, both are almost geometric progression.“Risk is an essential element in the quest for capital gain. Don’t be dismayed by a loss. Recognise it as one of your costs on the way to a net gain.
“A perfect track record can almost certainly mean that you are also letting a lot of good opportunities pass you.
“Patience is a virtue, have it if you can, seldom found in a woman, almost never in a man.
“Look for stocks that professional managers like, but are not sure of.
“Many stocks could have been bought at 52 week highs for many years and still turn out 100 to one winners. All one has to do is identify them and stick to them.
“Stay with your most successful stock investments as long as they are increasing their earnings.”
And, of course, my ultimate favorites:
“In no civilization has the value of currency increased, ever.”
“In investing one always deals with probabilities and possibilities, and no certainties.”
May the probabilities always fall in your favor, dear friends, and I hope you have a wonderful weekend. More to come soon…
Disclosure: Of the companies mentioned above, I own shares of and/or options on Alphabet, The Trade Desk, Amazon, Cloudbreak Discvery, Metromile, Pershing Square Holdings, Pershing Square Tontine Holdings, Roku, Galaxy Digital Holdings, Intuitive Surgical, Power REIT, GAN ltd., Altius Minerals, PAR Technology, Sandstorm Gold, Innovative Industrial Properties, and Brown & Brown. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.
