Motley Fool Hidden Gems Investing - We Like Cannibals*

Episode Date: October 31, 2023

*Specifically, we like share cannibals. Motley Fool Money proudly stands against human cannibalism.  (0:21) Ricky Mulvey and Jim Gillies discuss: - Economic takeaways from a trip to Las Vegas. - Share buybacks gone wrong. - An airplane leasing company that may be taking itself private. Plus, (17:30) Alison Southwick and Robert Brokamp celebrate Halloween and discuss some financial horror stories. Companies discussed: AAPL, EBAY, SNBR, AER Link to “Financial Horror Stories Vol. 2, Scary Scams”: https://www.fool.com/podcasts/rule-breaker-investing/2023-10-18-financial-horror-stories-vol-2/ Link to Motley Fool message boards: https://community.fool.com/ Hosts: Ricky Mulvey, Alison Southwick Guests: Jim Gillies, Robert Brokamp Producer: Mary Long Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Where some see heroes and others see egos, Bloomberg sees the era of billionaire athletes. A fad to some, the future of money to others. We see crypto's trillion dollar swings, the end of jobs, or the end of human struggle. We see the endless funds fueling the AI hype. While others follow the noise, we follow the money. Learn more at bloomberg.com.

Happy Halloween. Watch out for cannibals. You're listening to Motley Fool Money. I'm Ricky Mulvey, joined today by Jim Gillies. Jim, good to see you. It's good to be seen, Ricky. We're going to keep it a little later on Halloween. You just got back from Las Vegas, so you see anything weird out there? What wasn't weird out there? Yeah,

Vegas, this was my first time going to Vegas where I wasn't working. In the past when I've gone to Vegas, it's been maximum 48 hours, usually less, occasionally less than 24, fly in, go give a talk-talk in a hotel conference room, maybe they buy you dinner, hopefully they buy you a cab back to the airport, you fly out. So, this is the first time I've actually gone and experienced Vegas. And yes, the one thing that struck me was the sheer amount of raw, naked capitalism flowing through that city. And I was with my significant other who, who last time she was there was 23 years ago, and she was commenting constantly how it has grown from then. She says, I thought it was pretty crazy then.

My inner hard-charging capitalist was very impressed by the price of everything and how everyone was willingly paying it out. If you are gauging the American economy for signs of recession, do not go to Vegas. As much as I like paying for $23 cocktails and $95 to $100 filet mignons, I am happy to have at least spent a few days out of the Grand Canyon, Hoover Dam, and I'm now safely back home. Wait, you said you were impressed by the price of things? It's not cheap, very expensive. Yes, extremely expensive. From what I understand, That's not usually the way it used to be. You went to Vegas and everything was super cheap. They have decided that making money from gaming, although of course they've also changed the odds

on some of their gaming stuff to favor them. There's no $10 blackjack on the strip anymore. It's $25 blackjack. Getting a blackjack no longer pays a 50% premium. Now it pays a 20% premium. Pays 6-5 instead of 3-2. That's what little gambling I do. I like to play blackjack a little bit. Yeah, you got to go to the downtown Vegas. They still got it a little bit. Let's talk about stocks because it's the spookiest day of the year. It's Halloween. Let's find some cannibals. Companies like to reward their investors. They can pay out dividends, add some discipline, maybe some tax consequences, or they can buy back shares. A little bit less discipline, but significantly better tax consequences.

If you've owned Apple for any period of time, you've probably benefited from share buybacks. If you've owned a legacy automaker, you've experienced share buybacks, but you haven't necessarily benefited. To set the table, what are the signs of a share buyback plan going right? We got Jim Gillies here, so we're going to talk about a weird little company that you haven't heard of. But what are the signs of some share buybacks going right? Well, I mean, you've already mentioned one, that would be Apple, although I'm going to give Apple a B for their share buyback program, even though Apple over the past nine years, I believe, has taken out about 30% of their starting share count. Another company you may

have heard of, eBay, has taken out, I believe, about 55% of their shares from about a decade ago. But the reason I give those guys Bs is because they buy back in any environment, but they can afford to because they've got massive cash generation, they've got super strong balance sheets, and they can pay for these buybacks through their cash generation with it really out touching their balance sheet. But they don't pay any attention really to valuation. Apple buys their shares back at 10 times operating profit, they buy it back at 25 times operating profit, I'm going to suggest to you humbly, one of those is a better deal. A company like MedPace Holdings, which I know, Ricky, you and I have talked about on the show before, MedPace was

doing fantastic in 2022. Their stock got beaten down. They basically said, hey, guess what, we're going to buy back stock. They bought back 14%, that's one-seventh, they bought 14% of their company back in two quarters, exhausted all the cash they generated for about four or five years, took it out and the CEO bought a whole whack of shares himself, over $150 million worth. That's a buyback program that's done really well because the most recent quarter the MedPace just had, they bought back zero because the valuation is no longer as compelling. I like that type of buyback much better. We'll give MedPace an A, we'll give eBay and Apple maybe a B+, plus. But you really want to see a company that can afford the buybacks by just generating their

own cash and have at least some semblance of a look at valuation. Those are the best. But the MedPace example, that's a little bit trickier in practice because generally, management teams, if they get to pick their spots, they buy back shares when valuations are high, they have extra cash flow coming in, and not necessarily when valuation is low. It's like you're setting me up for the next part. All right. Well, then let's talk about AirCap. I thought you wanted to talk about a bad buyback. Okay. Then let's talk about a bad buyback. This is a company so nice, they've done it twice. The company is called the Sleep Number Company, the makers of the Sleep Number

bed, the company formerly known as Select Comfort. They have done this maneuver twice. price. The first time in the mid-2000s from about 2004 up to about 2006 into 2007, the company is very cash flow positive, they have no debt, the stock is up and up and up, peaked at about $27, $28. Then as the economy starts going, they make beds. You might have heard something happening in 2007, heading into 2008, some sort of a credit crisis tied to housing. Surely, sales of beds is not tied to housing, right? Well, surprise, surprise, they were. Economy rolls over, this company starts making less cash than they had been making, and so they decide, well, our shares are now cheap, so we're going to buy back our stock,

and they blew their entire cash hoard they'd built up over the four or five years prior, they blew entirely on buybacks. They then said, boy, our stock is still cheap. They took on a credit line, spent another 100 plus million on buying back their stock, and then the company went cash flow negative and the credit crisis hit. Essentially, they would have been bankrupt aside from the fact that their lenders don't want the business, frankly. But the stock that had been close to $28 a couple of years earlier, bottomed in 2008, 2009 at $0.19. They had to sell, the stock started coming back, they had to sell equity to Vulture Financers basically to pay off their debt and have the company survive. They basically had bought shares back at

$25-$30 and they sold it at $3 or $4. That is not good. That is a buyback plan done incredibly poorly. Naturally, of course, management here learned. Of course, they didn't. The stock meanders along, meanders along, they started becoming one of the greatest buyback stories around the Sleep Number Company. We go into, heading into COVID, they were just buying back, buying back, and they really accelerated during COVID because, of course, everyone's trapped in their homes, hey, we're not going out, let's buy a new bed. So, the company again starts racking up the buybacks, paying any price for a buyback. stock. The stock at this point in time, I think it topped out around $160, $150 ballpark.

Now a lot of that is leveraged because the share count has shrunk so significantly from the previous go-round as they buy back, but they're buying back at any price. COVID kind of ends, rolls over, they're not making as much cash flow anymore. We might be going into recession, Vegas observations aside. Their cash generation has really fallen off a cliff. By the way, they also decided to supercharge these buybacks that got the stock, they shrunk the share count significantly. They supercharge those by borrowing almost a half a billion dollars, which now they have to find the money, and by the way, they're not generating cash anymore. Shame about that half-billion-dollar debt you have at short-term

debt at ever higher interest rates. The stock has gone from 150-ish, I believe it's now down to about $16, $17, so almost a 90% drop. The company is overlaid again with half a billion dollars in debt. It's now a $380 million market cap, I think. And the cash generation has again disappeared. I don't know that the stock is done falling and it's just like, okay, if we do this again, remember, buybacks should be done when you are cash generative significantly, have a strong balance sheet, maybe avoid leverage-fueled buybacks in most cases. And if you are in a cyclical industry, perhaps don't buy back stock at industry cyclical peaks. All right. So now you want to talk about a company that has a lot of debt and is executing

a ton of buybacks. Yes, I do, because I am nothing if not inconsistent. Contradictory. Exactly. Yeah. AirCap, you're talking about this with Nick Seipel on the morning show yesterday for Motley Fool members. It's the largest aircraft leasing company. This is a company that takes out a lot of debt so they can buy planes, lease them out to different airlines, that kind of thing. CEO Angus Kelly, which you pointed out was weird, basically told analysts that they're looking to take the company private at some point it's about a $14 billion company-ish, and then they're going to take out, I think, $2 billion

worth of share repurchases just this year. How is this not the sleep number story? Square that circle? Sure. First off, you've said it, they're not only the largest commercial airline lessor in the world, they're also the largest commercial airline owner in the world. That's not really well-known because airlines don't, especially post-COVID, don't really want to own planes anymore. Those are expensive. AirCap, the reason this is different is because this is a lessor. Debt is raw material to a lessor. It's like flour to Panera Bread. Now, intelligent use of that debt, of course, is required, but Angus Kelly and the folks at AirCap have a pretty good history. A lot of that debt can be tied to various planes and what have you, plus they've also got

really long-term leases with practically everyone in the world in terms of the airline companies. That doesn't bother me, although I will point out and a lot of their debt or their debt got amplified a little bit in the last couple of years because they took out a distressed portfolio of leases from GE Capital. They first were using their very significant cash flows to bring down some debt to get their leverage ratio at a predetermined level, which they've done in the past before with previous acquisitions, which they already told you they were going to do. They got to that level, then they start buying back their stock because again, there is a significant cash flow coming from leases because they lease to everybody. They make

a lot of cash and they're able to buy back stock. A lot of the stock they bought back this year alone has actually been from GE. Because when they bought GE Capital's portfolio of leases, they paid about half in cash, which was basically, they took out debt to backstop the planes, handed that cash to GE, who then paid off the debt that GE was carrying to backstop the planes. That's a bit of a shell maneuver. But okay, fine. They paid about half in cash slash debt backstopping the planes, and the other half in AirCap shares. GE, wanting to monetize those shares, has been doing a series of secondary offerings. Every single time they do secondary offerings to sell those shares into the market, AirCap steps up and says, hey, we'll buy $500 million worth of shares,

we'll buy it back from you at a slightly discount price. They're buying themselves back on the cheap. This is another intelligently done. Once you realize that the structure of a leasing company is that debt is raw material, run your leverage ratio, the cash flows are long-term and contractual. They also sell assets, so they'll buy a new plane, they'll run it for eight to 12 years, maybe that plane's got a 25 to 30-year lifespan. They're depreciating the asset all the way along, and they're selling the plane after eight to 12 years to a secondary carrier or a secondary LeSore. When they do that, well, look, they're booking gains on sale, which means their prior earnings were understated because they have been aggressively depreciating the asset. They sell

that, they book extra gains, the proceeds from those asset sales get washed into, again, new purchases of planes, but also into buybacks. It tend to be a virtuous circle. I would encourage anyone interested in the aircraft story to go back from about 2010-11 to just before COVID, see how the cash flows they generated during good times and how they paid off the prior example of the GE. Back about 2011, they bought the aircraft portfolio from AIG and what they did there, and it's the same playbook. Yeah, you're right, Ricky. In that conversation on the conference call with CEO Gus Kelly, the question was, hey, your valuation is really low, would you consider taking the company private." He basically said, yeah, if the valuation stays where it is,

at some point, we're being so aggressively buying back our shares, at some point it's going to make sense. There's your marching order, Fools. Get that valuation multiple up, otherwise, the company is going to go away. Generally, when I think about aircraft companies or airline companies, I think of low-margin businesses with just changing migraine-level headaches. I know leasing is different than operating an airline, but looking at some of the recent earnings for JetBlue and Delta Airlines, JetBlue's got engine problems, there's flying limits at major airports, you got waning domestic demand, higher oil prices is a problem. There's always something new where there's some macro problem going on.

This is a lot of the customers. What's so much better about leasing out planes, operating planes, owning planes in the background than running an airline? Sure. Well, it's the lessors don't have any of those problems you've just described there. that's the problem for the airlines. The lessor buys the plane, leases it out, long-term contractual cash flows, and just says, have at it, and everything is insured and what have you. They don't have the operating costs for running these things. They don't have all of the oil and gas and all the fuel volatility, we'll call it. They don't have those as an issue. what the lessors are, they're just asset providers. There's the concept of discretionary spending,

like maybe we can squeeze an extra row into the airline if we move the seats a half-inch each along the way, and maybe we can up capacity and we can change the routes or change the elevator. There's various ways that you can lower your costs as an airline. Another way is actually having the most up-to-date aircraft, kind of like what AirCap strives to provide. But the one thing that airlines can't do without, it's kind of built-in, they kind of need planes, right? It's kind of need planes. And so, your choice is either lease or own. And to own is expensive, and then what do you do with the asset? And especially coming out of COVID, when a lot of the financial structures of the airlines are strapped, it's just easier to lease.

And again, here is AirCup. Jim Gillies, as always, thank you for your time and your insight. Thank you. You just found out that your sales team is at risk of missing quota. Don't panic. Just ask Rippling AI. Since it's built on your real-time people and business data, Rippling AI can pull metrics from Rippling and Salesforce into a meeting-ready dashboard showing quota attainment, headcount

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access today, rippling.ai slash fool. If you want to chat about the show, I've been getting more active on our Motley Fool members boards. It's at community.fool.com. I'm still posting the show on X, but I don't know. I've been batting more ideas around, chatting with listeners. I've found that it's generally a more positive and thoughtful place than major social media outlets. So, if you want to check those out, it's community.fool.com. All right. Up next, Halloween theme continues. Allison and Bro have some financial horror stories they're sharing. Our first story, the naughty Rob the Nice. So, you know, we lock our doors at night to prevent the monsters from sneaking in, but that doesn't

always save us from the creepy and the crawly because sometimes the monster is already inside the house. Our first tale begins with Mary Ellen Nice, whose husband of 61 years died and left behind a substantial estate that she could rely on for the rest of her life. Her son, Chip Nice, became the executor of his father's estate and eventually moved in with Mary Ellen to take care of her as she gradually showed more and more signs of dementia. Now, in such cases, a good son would take care of both his mother and her money for her benefit, but also for the benefit of his siblings, since they'll be the folks who eventually inherit the money that the mother doesn't need. But apparently, Chip wasn't such a good son or really a good brother. He got Mrs. Nice to execute a

fraudulent power of attorney, gained access to her retirement accounts, and withdrew money for his own benefit. Now, for several years of this, one of Mrs. Nice's daughters, Julianne, caught on to what was happening and sued to have Chip removed from their mother's house and finances. A year later, Chip passed away and Julianne was put in charge of her mother's care and money. She looked through all her mom's past tax returns and saw all the retirement account distributions and all the taxes on those distributions, which totaled more than $500,000. Now, Julianne decided to refile the returns and seek refunds from the IRS based on the argument that these past returns overstated her mother's income. After all, Mrs. Nice didn't actually get the money, so why should she have to

pay taxes on it? The IRS disagreed, the case went to court, and the court sided with the IRS. So not only did Chip deplete his mother's portfolio by making fraudulent withdrawals, but also by creating a tax bill of more than $500,000. So the lessons here are, well, unfortunately, people become less cognitively sharp and more vulnerable as they get older. And when someone is no longer able to manage their affairs, the person who steps in is often a son or a daughter. But that doesn't mean that person is qualified to handle the finances, either in terms of knowledge or, frankly, morals. So make sure you have a plan for who will manage your parents' money when they're no longer able to, and you should have a plan for your own money as you age. There should be a way for all

interested parties to keep an eye on what's happening. If one sibling is in charge of managing mom and dad's money, the other sibling should at least get account statements or be able to log into their accounts and see what's going on. I should point out that I learned this case from Ed Slott's IRA Advisor newsletter. Ed Slott being a national IRA expert and author of many books, as well as the main man behind the irahelp.com website, which is an excellent resource. And in the newsletter, Ed wrote that a diligent financial advisor can potentially prevent elder abuse and scams. And I think he's right. Getting an objective, experienced financial expert involved might be another line of defense. Gather around, children, because I'm

going to tell you a story of when dreams become nightmares. Join me as we enter a haunted house of financial terror, because this is the curse of the HDTV dream house. Mwahahahaha! Thunder, Thunder. All right. Thanks to Steven Goodell of Money Magazine for the article I'm about to crib liberally. All right, here we go. It was probably a hot, sweltering day because this story begins and ends in Texas. The Cruz family pulls up to their new dream home. Don, his wife, Shelly, and their 10-year-old Donald marvel at the 6,000 square foot mansion that towers above them, more than seven times the size of their old house in Chicago. They can hardly believe it. After many years of trying, out of 39 million people, they won HGTV's Dream Home sweepstakes.

The lakefront home came fully furnished, along with a $250,000 cash prize and an SUV. I feel like I'm looking at someone else's house. This can't possibly be ours, Shelly said as she beheld the massive great room with its 30-foot ceilings and 6-foot-wide fireplace, the master bedroom suite, the hot tub, the indoor elevator, and the outdoor pool. But little did they know of the financial terror that was lurking in the shadows. In the 10 years that HGTV had been running the sweepstakes, the Cruzes were the first to make the fatal, okay, not fatal, but still unfortunate decision to actually live in the house. And it wasn't long before their dream house turned into a financial nightmare. They were used to living

off of $40,000 a year. So Don thought they could survive for quite some time on the $250,000 cash prize. But then the financial gremlins emerged. Upkeep on the house was $2,900 a month. Homeowners insurance ran $7,000 annually. That's on top of a $1,000 a month mortgage payment for the house back in Chicago, which they kept just in case. Smart thinking, by the way. All right, fixing up the family boat that cost $11,000. A dog run for their three dogs was $6,000 between family and friends eager to visit the dream home. The cruises had company nearly every weekend for about, you know, a thousand dollars a piece in entertaining. They donated 40,000 to charity and they splurged spending $5,000 on Christmas presents, $2,000 for scuba lessons and an $1,800 go-kart.

within a year the cruises had just 36 000 left from their winnings but perhaps most terrifying of all to pay off the tax bill of 672 000 that came with the house car and money as well as cover some other expenses they had some unfortunate medical bills they had decided to take out a one million loan, which had monthly payments of around $8,000. Within three years, their fate was sealed. The family was out of money and four months behind on loan payments. The cruises huddled in the living room. Don sobbed. There was nothing left to do but auction the house for sale and hope that the proceeds covered their bills. So while all this happened 15 years ago, strangely, the allure of the HDTV dream house continues to call to Don. When asked in 2020, if he regretted

winning, he said he'd do it all over again. He'd return to the HDTV dream house if he won today. Okay. So I guess I need to take away here. And the best one I'm seeing is classic. Just take the money and run. According to country living magazine at the time of publication back in 2018 of the 21 people who've won the dream home over the year, only six or about 28% actually lived in the home for more than a year. The vast majority either took the cash alternative or sold the house back to the developer within a year of winning. And the big reason for selling out is the tax bill, because that is no joke. Federal taxes alone are in the ballpark of $600,000 to $700,000. And if you had that lying around in the first place, you could just buy your own damn dream

house. So what do we know of the next HGTV house of horrors? Not a whole lot. It's located in Anastasia Island, Florida near St. Augustine. And this December, you too can enter to win it if you dare. Our third story, a tale of tractor terror. So no collection of tales of money mayhem is complete without a good story about bad estate planning. After all, and I'm sorry to break the news to you, but we're all going to die and we're all going to leave behind a bunch of stuff. Yet according to Caring.com's 2023 Wills survey, two out of three Americans do not have any type of estate planning documents that would tell our survivors who should get all that stuff. So our final story is about Cecil George Harris, a farmer in Saskatchewan who rode out into his

fields on June 8th, 1948. At one point, he climbed down from his tractor to do some maintenance. Unfortunately, he accidentally knocked the tractor into gear and got pinned underneath it. He wasn't found until 10 hours later. He was still alive, but he died the next day at the hospital. Now, Cecil didn't have a will, or so people thought. After Cecil's death, neighbors noticed that there were some words scrawled under the bumper of the tractor, and they read, quote, in case I die in this mess, I leave all to the wife, Cecil George Harris.

Now, this is known as a holographic will. In other words, a handwritten will accompanied by the writer's signature. And some courts do not consider such wills valid, but others do. So, for example, Aretha Franklin's estate was recently settled based on a will she wrote in a notebook found under a couch cushion a year after her death. In Cecil's case, his will, scrawled out on his tractor with a pocket knife, was indeed accepted by the court. However, because wills are required to be filed with the court, the fender had to be removed and kept in the courthouse. In 1996, it was donated to the University of Saskatchewan College of Law for public display, and you can find pictures of it on the interwebs.

The lesson here, of course, is to get an estate plan. And it's quite shocking how many people die without estate planning documents. People you'd think would know better. People like Abraham Lincoln, Jimi Hendrix, Martin Luther King, Sonny Bono, Picasso, Buddy Holly, Ulysses S. Grant, and Prince, just to name a few. and without those documents, the courts decide who gets what. It could take a lot of time and a lot of money. In Prince's case, the first bank appointed to be the administrator of his estate had to drill into the vault that held the master tapes of his music because apparently Prince was

the only person who knew the combination. And it took more than a year after Prince's death for a court to name his six siblings as the legitimate heirs to his estate. It was finally settled in 2022, so six years after he died, valuing the total estate at $156 million. At that point, two of the six heirs had already passed away. In Cecil Harris's case, his quick thinking while he's pinned under the tractor spared his family some of the difficulties that come from dying without a will, but you can't rely on being able to write out your intentions during your final moments. So make sure you get at least a will, but a will is just one aspect of a solid estate plan. It should also include healthcare directives that allow someone to make healthcare decisions

for you, including whether you want to be kept alive by artificial means. It should also include naming guardians of your minor children if you have them and who will manage their money until they become adults. And in many cases, it could include the creation of one or more trusts. All this is best arranged with the help of a qualified, experienced estate planning attorney. And with that, happy Halloween, everybody! If you want more spooky stories, Bro went on our sister show, The Rule Breaker Investing Podcast, to share them. The title of the episode is Financial Horror Stories, Volume 2, Scary Scams. I will include a link in today's show notes. As always, people on the program

may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear. I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.