Chit Chat Stocks - Aaron Edelheit | La Française des Jeux (FDJ)

Episode Date: December 11, 2020

On the 11th day of Christmas Aaron Edelheit gives to you, FDJ the French lottery. If you think that US companies like Apple, Facebook, and Google have monopolistic power, you are in for quite a surprise. FDJ is by French law the only company able to operate in this business. Visit our website: https://www.chitchatmoney.com/ Subscribe to 7 Investing with the code "CCM": https://7investing.com/subscribe/ Follow Chit Chat Money on Twitter: https://twitter.com/chitchatmoney Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to 25 Stocks of Christmas presented by Chit Chat Money. Today we have an interview with Aaron Edelheit, the CEO of Mindset Capital, and we talked about a company that I'm not even going to try to pronounce, but our acronym is FDJ, that's its ticker. Yes, that's its ticker. And it's basically a French lawyering monopoly. It's a really interesting business and Aaron goes into much more depth about it. But before we get to that, we have to talk about our partners, Seven Investing. Correct. You want to go? Is it my turn? I can go. I can go. It's easy. Go for it. $10 off your first month with the code CCM at checkout.

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Money is a CCM Media Group podcast. Ryan and Brett are not financial advisors. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. Today, we are welcomed by Aaron Edelheit. He is the CEO of Mindset Capital and the author of The Hard Break, The Case for a 24-6 Lifestyle. I found Aaron on Twitter, and he has a sub stack. I'll let you sort of speak to that. But he has some really interesting stuff on there. This is your first time on the show. How'd you get into the world of investing? You know, for some reason, I've always been interested in it. And I remember my dad,

when I was like nine years old, he, this will date me, but he had the Wall Street Journal open and there was a bunch of stock tables in it. And I remember asking him what they were and he tried to explain it to me and I became instantly fascinated by it. And from a young age, kind of knew what I wanted to do, which was investing. And so that was kind of my beginning into the world of uh of how i got and i just kind of self-taught had an opportunity to invest the friend's money who sold the company early on after college um and started above my parents garage started and then grew that to a small fund and then after that uh fund i ran that for about 12 years i started buying foreclosed homes fixing them up and renting them out um and started with 16 homes

and built that to 2,500 single family rentals and sold that company in 2015. And I did a bunch of help to friends startup. And earlier this year, I went back to my roots and launched a new friends and family fund called the Mindset Value Fund and have been back to my first true love, which is investing in companies no one's ever heard of or misunderstood opportunities. Yeah, that's what we're talking about today. I don't think, I mean, I hate to put words in the listener's mouth, but I don't think any listener has probably heard of this company before we're talking about them. But do you want to say what the company is and how you found it? Yeah, so the company is called Le Francais de Joux, and it's the French national lottery and sports gambling monopoly. And so in a remarkable thing, outside of France, many people weren't paying attention. But at the end of last year, France privatized their national lottery of sports gambling

monopoly. And they still own a 20% stake. And so it went public. And now it's freely trading. And, you know, I invested in it, you know, kind of soon after, you know, it went public because I was really fascinated by it. But what makes it so attractive now is that watching the company's performance through COVID, the company's actually gotten much stronger, much more profitable than we can talk about. And it just shown its resilience to such a level that I think it's actually an incredible risk reward because you're actually investing in a lottery in a monopoly with no, you know, with no competition. And what's remarkable is for a company this size, it's, you know, almost 7 billion euro market cap that no one, you know, no one knows that exists.

and do you want to go into a little more depth on uh sort of the structure of the business the whole business model what fdj does yeah yeah so so the the main thing is there's only one lottery in france and uh fdj uh operates under a government mandate out to 2044 um but it'll probably be much, much longer than that. And so primarily, you know, one of the interesting investment cases, the reason to invest in it now is before COVID, almost all the lottery was paper scratch off, you go into a store, you buy a lottery ticket. And FDJ had a very low online participation rate. And most other countries that have national lotteries have much higher online participation. Whether it's Scandinavia, the UK, or Australia, they have something like

15 to 30% of their lottery happens, you know, online, and FDJ only had 5%. And so obviously, what was fascinating is COVID hit, you know, 90%, you know, 80% of your business is done in retail, uh businesses because they also have the sports gambling business um which again sports shut down as well so you can't really have sports gambling there's no sports right right so it was a remarkable as you imagine well france like completely shut down in uh in march um and so no one was leaving the house and so it was remarkable in q2 to kind of really in april they shut down but um in uh q2 fdj broke even so imagine there's no sports you can't go to stores like you know you have a good business when everything shuts down and you're like oh we're

just not making money now uh and then in july like kind of a one month after reopening everything went back to normal like because people like playing the lottery people like gambling on sports and so um it just showed but the other thing that happened that happened is all of a sudden it was like a forcing mechanism and all of a sudden online participation went from five to nine percent without anything that fdj was doing uh and why that's important is the online lottery has double the margins obviously if you don't have paper if you don't have you know all these things if you're not sharing with the retailers a percentage of the of the sales uh their their margins are double so you have an opportunity now where um fdj's margins are much higher and they also took out

about 80 million euros of costs you remember this is still france so it's hard to kind of take costs out of the system or they use covet as a as a kind of an accelerant um and so and now what they're doing is focusing a lot more on online and they're moving forward in that way but you know the core of the business is still just you know a lottery and gambling on sports and so what they haven't been good at traditionally especially when they were at government entity is really leaning into online really focusing on the technology and now that they're a privatized company they can do that and they've had an accelerant so it's kind of these one of these really interesting things where you're an investor and then something really really terrible out of the blue like a pandemic

happens and you're like oh my gosh i wonder what's going to happen well now we can look back and we can say the worst thing happened that you could imagine no sports total shutdown of retail and And this business didn't lose money. And instead, they were able to cut costs, become more profitable, and accelerate forward where they were going. So it's very fascinating. And that's why I happen to think that it's like this incredible bargain because there's not many businesses that are this resilient. And the company has no debt. if they convert almost 90% of their operating income into free cash flow. And so it has no

leverage and it probably should. And so the fact that it trades at a 5% free cash flow yield for an actual monopoly, they have no competitors. It's just remarkable to me at the same time, Two things of why that 5%, it may not sound like a crazy high number, but consider this, they have no competition. We've seen what happens when the worst case can happen. They are completely unlevered. And the French government debt trades at negative interest rates. What is a lottery? A lottery is a tax. That's an arm. So basically one arm of the government offers you a growing 5% free cash flow yield with huge growth potential, by the way, with sports gambling, which is very underpenetrated in France. And the other one is negative interest

rates. And then the last thing that I would say is that FDJ can borrow at 1%. So you can make a lot of accretive acquisitions, you can buy back a whole lot of stock, if that's the case. Okay. And wow. So you said that, you know, the margins double when you go from in person to online what do they have any projections or goals of what percentage of revenue is going to come from online do they want to get to the majority over time or so they're being very sensitive to that and they haven't given any guidance I'm hoping in the new year when they kind of kick off the new year and they give some projections but they're sensitive to making I believe very public conversations because they don't want to remember most of their businesses retail they

you wouldn't want to upset your retail partners right because then they may not want to sell or they'd be like wait wait what's going on why would i help this so there may be they may be working on a strategy where they um include some of the retailers in uh they give incentives for them to push some of their customers online and so maybe it's not double the margins but it's like 50 of the margins and they share uh something with the retailers so it's not like they're overly broadcasting what they're what they're going to do but i'm expecting in next year for them to share a you know a lot more about where they're going online and then i expect a lot of people to be kind of raising their numbers and in the long term it makes no sense why other

countries around the world would have 15 to 30 percent up you know participation and fdj would only have nine or ten percent right okay it sounds it sounds like they've had sort of a whirlwind of accidental catalysts um and that that it's blended into a pretty interesting setup uh on the sports gambling side what sports are people betting on is it just french sports or is it european um who is there that's a really question yeah i i believe it's everything um and but that it's It's right now, most of their sports gambling is what is happening inside kind of what I call offline activities. So they actually have a very small, but you can see a huge opportunity to move to online

sports gambling, which is the only place where they compete, by the way. And there's only like three or four competitors because there's very high regulatory barrier in France and high tax rates and there's and French citizens and sports gamblers much lower percentage of participation in sports gambling so right now when you when FDJ with their opportunity is to is what they've been doing is kind of in-person kind of sports gambling but there's this huge unknown, and I don't think you're paying any price for it, for how they can aggressively grow that, acquire companies, or grow their online. I don't think you're paying for any of that. But for a company that's going to be producing hundreds of millions of dollars of free cash flow

that's growing every year, it seems like an easy bet that at a minimum, they'll grow in France, and they may grow in europe or the rest of the world you know again they're producing all this cash flow and they can borrow at exceptionally low interest rates they seem like a great partner for a lot of uh a lot of companies in this area and that's why what i love about this is there's kind of these free options inside and i don't think you're paying for okay that makes sense or sorry i was just gonna say what about management um does it matter to this business it sounds like it's uh a bit one of those maybe pb and j businesses where uh whatever i don't know what the buffa quote is but anyone could run the business am i getting that wrong or does management

matter for this you know i think it does matter um uh i think it does look i i think this is one of the businesses that it's really hard to screw up. And I didn't have, I didn't, because of where it traded, I didn't think I was taking a lot of risk, but I didn't know how management was going to perform. We just really had, this is another reason why COVID is so interesting is we just really had an amazing kind of truly once in a hundred year experience of a true crisis and look at how management responded management responded aggressively they immediately you wouldn't normally think of european or french you know companies especially one that used to be part of the government to move so fast but they did they almost immediately in went for a cost

cutting plan and cut 80 million euros of costs almost immediately out of the business um and most of that permanent and then um and i i think the fact that they were break even was just, it's just a remarkable thing. And I don't, I think a lot of it has to do with how that it's just the lottery and gambling. But I think that the management is helping. And I think that that's another one of these free options is that you would think of this

as more of like a former government entity that you wouldn't have great management. But from what I can tell, that this management is actually much, much better uh than i had assumed and uh you know the the the ceo became the ceo in 2014 and had a lot of senior government experience and senior corporate uh experience and i i think that she's doing a great job and i think it's important that she has government experience because it's it's still it's such an important piece to the french government right you know

like one of the things i get asked over and over about this is well what happens if the french government changes regulations or they allow competition or all this stuff and so um it's important that she had government role in the past that she has government connections it's an important uh point to that and as to that governmental risk it's it's important to know that the that fdj still owned 20 by the french government and that the french national lottery was actually founded to help um disfigured uh wounded veterans for world war one and so two wounded veteran associations own another 15 of it and that when you actually run through the numbers of the government take rate on gambling revenue, their 20% stake, and the tax rate they

make on income tax, the French government takes about 90% of the income of the lottery. So it's just very, very unlikely that in the future, for the last 10%, the government's going to be going, oh well let's just you know change everything and hurt this company and hurt wounded veterans right um at the same time but it's still important to have government experience so so it's a it's a nuanced answer to your question i think it's a little bit of both okay got anything else before we get to the next one or no and he already sort of touched on his thesis a little bit but we could let you uh i don't know expand on the thesis or is there anything else that goes into you know why you'd like to own fgj well i just think that it's it's one of

these things where i've migrated as a value investor from it used to be i would i would get into these very small kind of when looking back rather speculative low quality small companies that i would say look it's undervalued based on this this and this right and um or that you get into some kind of cigar butt type investment or you'd look and you'd say well they have these assets and it's selling for 50 cents on the dollar of those assets and if only management would do x y and z or an activist investor is coming into and i used to be involved in a lot of those and where I've migrated is just understanding when you have an exceptional opportunity to invest in an exceptional company. People talk about Google and Amazon as a monopoly.

FDJ is an actual monopoly. You cannot compete with them with 95% of their business. and it's still growing and unlike normally you'd get like a utility and but the utility has to spend all kinds of money on capital expenditures right yeah you got all this equipment and what do you have to do for a lottery what do you have to do for sports gala you're a buggy yeah you just set up a website yeah that's right so it's like yeah you're gonna expand to spend some money on technology and everything this is an incredibly profitable business and so it's um it's just truly remarkable the quality of this business to invest at a unlevered five percent free cash flow yield with the the the lottery growing at like five percent or so in terms of revenue but the

cash flow will probably be growing in mid-teens because the change the the costs they took out because of the increased online participation then you have this total free option on sports gambling and meanwhile in the u.s draft kings sells for 24 times uh revenue and for 20 24 times next year's revenue 24 times next year's revenue and 40 times someone's estimate of cash flow in 2024 yeah that's that's a little bit of like and they're spending hundreds of millions they're burning hundreds of millions of dollars right now yeah i mean it's like all right go ahead and they have crazy competition right they're competing against barstool sports and pen and there's guy and it's like i get this incredible monopoly these free options this growth in sports gambling

for a company that i now know is really well managed that has an incredible low cost of capital that can really grow and so what's the downside that's the best part of it what's my downside of investing it's got to be very low yeah it seems like there's a lot of margin of safety there um yeah i mentioned that they're growing how do they grow is it just more people engaging in the lottery i mean they're not allowed to market it are they or well yeah they are of course they are able it's the french lottery they want the french government likes taxes you know and so it's going at like you know three to five percent a year in terms of revenue and you know they might you know raise a you know a little bit of prices a little bit of volume

increase you know come out with some new games and stuff to stimulate demand um but the real growth is in sports gambling which is it's coming off a low base but this fall i want to say sports gambling in france is up like 50 year over year wow so but again the story for the lottery for france is not so much the revenue growth is still growing at like three or five percent but it's really that margin and it's really that online penetration where they can get people you know kind of in their homes um playing and and that they can uh grow the sports gambling business and so you so it turns from this kind of boring slow growth when you look inside the cash flow and you look at the kind of free options the company has this could start really growing

yeah i think uh i mean maybe this is sort of bullish to your point but it's uh i think there's a lot of pent-up demand for wanting to engage with sports and when you can't actually be there i i think it might turn into a lot of uh engagement in the form of sports gambling instead uh but that might just be a catalyst for them moving forward that's right and it's like again it's it's not something i feel like i'm paying for right now so if they really get it right i mean sort of a freak call-out. This could be fantastic. Yeah, all right.

I got nothing else, so. All right, yeah, we're going to hit a quick break, and then we're going to try to poke some holes in Aaron's thesis. Here you go. Cox Panoramic Wi-Fi includes advanced security to help protect all your connected devices. You'll get real-time alerts.

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know this is where we provide our counterpoints and we try to poke some holes and let uh our guests refute them i should say i should say on this one we had a little bit of a trouble doing it one because i mean it was a new business for us and two uh i think that kind of shows that this might have a high margin of safety but yeah sorry i'll uh i'll go first first counterpoint um in your sort of thesis paper that you wrote you mentioned its valuation versus its peers uh and we talked about it on the first half of the show which was you know uh 24 times next uh next 12-month sales for like DraftKings and stuff like that do you think it's or do you think it's good to base the FDJ valuation comparison against some of those companies which are probably growing

no no it's just to show the disparity I mean it's a good point like DraftKings is growing the U.S. is kind of like a wide open space there are some questions on how big the market actually is versus some of their market you know some of the market caps um in there but it was just going to to show just the the incredible gap you know here you have fdj selling for like three times revenue and um it has no competition and another one sells for 24 times uh revenue is just is kind of like a wink wink nod nod but you know draft look fdj is not growing as fast um but you still have what i believe mid you know mid-teens kind of cash flow growth uh with some free call options and what i think it's a pretty attractive valuation yeah it's kind of like the uh the

classic um i think what you know people talk about like it's betting on horses at the track maybe draft kings is the best horse but you got terrible odds on that you can get fdj which is a quality horse that's a really reasonable uh you know odds i would change it around i would say that right now draft kings is like the hottest horse on the racetrack yeah and fdj is you own the racetrack oh no all right all right that's a better analogy okay uh no one else if you want to bet on the racetrack right right okay the uh my counterpoint is the government part so you know people get a little worried about when government's involved in a business They've owned it for many years.

I know that their strategy in the spring kind of showed that maybe they are a little lighter on their feet than people might think for a bureaucratic government-type deal. But does that show any risk there from a government policy? Could they buy it back or just kind of do whatever they want? Yeah, so just kind of going back to the points I was making earlier is the government still owns 20% of the company. Wounded Veterans Associations own another 15%. The other thing I didn't mention, and the French government, this is really interesting, actually, is the French government wanted to, wants to privatize several government owned companies in France. And they're actually in Brexit negotiations, trying to, trying to convince, trying to set up Paris as like a financial capital. and the french government i think this is part of a broader theme that's going on is that

governments around the world are starting are supporting their stock markets like never before in almost a nationalistic kind of way you look at china you look at japan uh you look at obviously the united states with all of their measures and france is kind of doing the same thing and so their first company they privatized they wanted to be a big winner and that's why fdj weren't public because there's much larger companies and they wanted to show look a french company could do well you look at the stocks stocks up like 40 this year so it's even in a pandemic has done well um but what's interesting is that this is part of a broader initiative to kind of push and as part of the ipo the french government was out trying to get retail

participation in the in fdj ipo because they want to build kind of a stock they want to encourage this kind of because there's not a lot of retail participation unlike the u.s in stocks in france and so this is part of a much bigger push as a part of the government um and and then just to the other point is what i mentioned before is that when you look at how much the government owns a 50J, plus the take rate on the gambling, plus the tax on the income tax rate, they already take about 90% of the kind of pool of money, the income coming through. So it just seems very unlikely with these broader trends, with the French government now moving to try to support their financial markets, that this could change. It's always possible. The next French government

election will be in april or may of 2022 so you you you have a little at least a little bit of time before that happens but um i just think there's a lot of things in play that make it very unlikely that anything's going to change in fbj okay and then the just to clear things up on that brexit point so you're saying that once brexit happened uh london used to be you know it was the biggest well it hasn't officially happened yet or it hasn't officially yeah i never know it's going on forever yeah i guess it's been just an ultimate never-ending story but uh so london used to be the financial hub and i guess still is for much of europe but they since one or england or great brand excuse me is trying to break away they want to bring a new one

in and they want that to be paris and that's good for that's one well yeah so but i just say is that's how france is trying to position okay it in their Brexit negotiations if you look they're taking like a really hard line they're like and they're doing all these other things like i i wrote in my report like i was just surprised when you read it is almost like france has capitalist dreams which is very different than the narrative you currently hear but they're like they announced like a 10 or 15 billion euro uh initiative to bring companies to relocate back to france they They did another, tried to convince, they convinced institutional investors to commit something like 5 billion euros for late stage startups.

There's a whole broad range of things that they're doing, which is very much signaling like, hey, we want our stock market to be more robust. We want it to be stronger. And FDGA is just a small part of that longer initiative. So I think I know what your answer is going to be, but would you want to see FDJ lever up? And then if they did, what would you want to see them maybe invest in? Yes, I think we're going to see that next year.

And, you know, they have signaled that they could borrow up to a billion euros, which is like 15% of the company. um and i think you see a combination of a buyback and acquisitions um and i think that will be viewed very very positively as a way you know when you can borrow at one percent a lot of things can be accretive like you can make a lot of deals work yeah and i mean this might be the wrong way to think about it but with at a free five percent free cash flow yield buying or borrowing at one percent for long-term debt um that seems like a pretty good yeah you know safer safer financial engineering you know and i think what what what what that does when they do that uh which they

are they announce the acquisition they buy back stock they do bold they're sending a further signal to the market like hey we're we're interested in growing we're interested in shareholder value and that's just again um what i love is when you find something an investment that is kind of a violation of a commonly understood narrative. The commonly understood narrative or consensus thinking about France, this is a socialist country, why would you ever invest in it? And so in my research in FDJ, I've just been rather surprised over and over of violations of that narrative.

and to me when you can find that there is lots of opportunity when people eventually change their mind and join you right what would uh what would be maybe one of the factors that could cause you to sell uh something that would maybe tell you that your thesis was off um i think uh Some concerns would be, at least that it would be a disappointing investment, would be if they never levered for whatever reason. Obviously, political instability in France would be something to pay attention to. I think that if they weren't able to grow their online lottery participation, that would be an issue if they didn't make any acquisitions. So in other words, the downside here is it's just stuck in the mud and it's like this super low growth, boring company that doesn't really do anything.

And part of what I love about it is I think that there's very low downside, but kind of uncertain upside. And so the more things that they were to not do would signal that it's more of this, you know, maybe five or 10% a year upside. and then it's just an opportunity cost of what did i miss by investing in this and you already mentioned you know the the levering up a little bit as something you'd like to see them do but is there anything else that you would like to see ftj do say your ceo for a day you can make one change uh what would it be oh i'd go on an acquisition spree okay i would go buy online

sports gambling assets everywhere right right and especially in france especially in france because if you think about it if i'm the french national lottery and i have all these customers already buying lottery tickets what's my cost of acquisition to convert them to a sports gambling band yeah yeah i think that demographic does overlap i think there's huge opportunity there and then when you look at the demographics i don't have the data in front of me but the French participation in sports gambling is very low compared to the rest of Europe or the world. And so I think that's a huge opportunity. And I think that it's an enormous opportunity for them to expand.

Like, what would happen if we woke up one day and FDJ took a stake in a U.S. gambling asset? Yeah. So you're kind of saying if you saw maybe too much skew towards risk aversion, it would be a concern for you though right yeah because then i would you know now the positive thing is they've committed to paying 80 of their net income in a dividend um so they will be you are going to be now because of the pandemic it's lower this year but you're looking at like a three or four percent dividend but i think what it would signal to me is like oh this is just going to be a boring investment it's not the not the worst thing in the world but i think when i look at why i'm investing is like wow if they can hit on the one or two of these things and this isn't just

some boring french lottery this is a company that could go up multiples uh from where it's at okay i think that's all the questions i have yeah nothing for me all right where can uh any listeners that are interested in your stuff where can they find you what are some resources yeah so they can find me on twitter my handle is aaron value a-r-o-n value and then they can find my sub stack which i believe is mindset value dot sub stack i can just check real quick i should know this by heart yeah the mindset value dot sub stack okay and the book is the heartbreak uh yes the case so we didn't even talk about that it's basically uh making the business case that you should take a hard break basically take a sabbath turn off your phone turn

off your computer um and one day a week that you'll be more successful more happy have better relationships and i give i tell my story and also share lots of other businesses and successful people who take or observe a sabbath uh depending on what your belief doesn't matter what your belief is. If you're, you know, just an atheist to, you know, a Jewish person, a Christian, it doesn't matter. And like, you know, one great example is Chick-fil-A that's closed every Sunday. And, you know, and I tell that story of how it's the Sabbath is actually foundational to all of their success. Yeah. I mean, they are doing quite well. So that is a good example. Yeah. Okay. Thank you guys for listening. We want to remind you that we are not financial advisors. Anything we say

or discuss here on chitchat money is not formal advice or recommendation we'll see you guys next time