We Study Billionaires - The Investor’s Podcast Network - TIP475: Mastermind Q3 2022 w/ Tobias Carlisle

Starting point is 00:00:00 You're listening to TIP. In today's episode, I invited Tobias Kyleyle to discuss which stocks are currently on our radar. Tobias is pitching First American Financial, which is trading at an attractive price level, even if you adjust for the stock being cyclical. I'm presenting North Media, which is trading at only four and a half times three cash flow if we back out equities and cash from the balance sheet. I'm also briefly going through an investment thesis of process, which is one of only four stocks in my portfolio.

Starting point is 00:00:27 It's always a blast recording the mastermind. episodes and I hope you'll enjoy a conversation as much as Tobias and I did. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Welcome to The Investors Podcast. I'm your host, Stake Broderson, and today I am here with Tobias Kyle Lyle. Hari is somewhere in India on the late flight, so we had to sit this one. out, but the mastermind group, if you call it that, is you and me, Toby. How are you today? Works for me. Good to see. Stecky. Good to see you, Toby. So, Toby, let's get right into it.

Starting point is 00:01:22 Would you want me to go first? Please. Fantastic. All right. So, Toby, I wanted to talk with you about a stock that's been on my watch list for three years, but it's a company that I've known for much longer. It was actually the company I got my very first job. age 13, 14-ish as a paperboy. So I gotta say, it's been one of the stocks that's been most on my radar, even though not as an investor at that age. So the company is called North Media, and it's a Danish company. It's a very small company and you can only buy it OTC unless you in Scandinavia. The stock ticker is K904-1B139. In case you didn't get any of that because it's all over the counter. You can find this.

Starting point is 00:02:10 transcript and it's in there. So if you want to do that, after the episode, throughout the episode, you can just go to the transcript and find it. I also going to put it in the show notes. It's a small cap company, market cap of only 200-ish million dollars. The numbers I'm going to give you here in this pitch here. It's going to be in the local currency Danish corner unless state otherwise, just to make it a little easier. It's a conversion stick, Tino, off the top of it's like 7.25 to the Danish croner. And this is like a $30 million US dollar? Yes.

Starting point is 00:02:45 So this is like a $30 million US? Oh, so, sorry, no. The market cap was $200 million. And so just sort of like to give you idea what it's probably like 220, but like the other numbers I'm going to give you would be in the local currencies, just instead of converting 20, 50 different numbers, but good question. And in case anyone is worried about currency risks, saying, hey, I'm not based in Denmark. The Danish cronor is pegged to the euro, so you can just consider it like you'll be buying a stock in euro and has been picked for in turn to now.

Starting point is 00:03:17 Everything is equal. It's probably a stronger currency than the euro if it were to break the pick, which I don't see is realistic at this point in time. So full disclaimer, I do not own a stock, but it has become a little more interesting here lately due to the reasoned. I was about to say bear market, the least it was, whenever I started preparing for this, but with the bounds and all, who knows? This is an ugly stock. It's what Warren Buffett back in the day would call a cigar butt investing. Like, this obscure small stock that's drowning in cash, making a bit of money. Anyway, so I wanted to bring this pickup for a few different reasons. I actually list 40 reasons down. So it has a large stock portfolio compared to the market

Starting point is 00:04:03 cap of the companies around 40%. It has a declining legacy business from the industrial world that's spinning off a lot of cash, but it's declining and it's secularly declining. And it also has a growing tech business. So what is North Media? You can think about North Media as three different businesses in one. The first one, that's the legacy business I were talking about before, it's Denmark's leading distributor of leaflets and local newspapers to consumers, and they also have a digital site as well. In addition, FK distribution provides packing services for Danish customers and for Deutsche Post, which is the main German distributor of mail and parcels. It accounts for 84% of operating revenue and has an EBIT margin of 22.7%. If you look at some

Starting point is 00:04:57 the historical data, last year was quite unusual. It was 28. This is probably more what you can expect. You have 66% of Danish households who are receiving leaflets. That's a negative change of 2%. And you can probably expect that to continue. And what's interesting about this business is that it doesn't require a lot of manpower. It used to require a lot of manpower. They now have a new fully automated logistics and distribution set up. And the second part of the business, is what we call the tech business, which is the remaining 16% of revenue. If you look at the EBIT margin, it says 2.1% for 2021, but there's a lot of adjustments in those numbers that you have to make. In reality, it's much higher. The numbers from the first

Starting point is 00:05:45 half of 2022 just came out today. It says 10.2%, which is more accurate, but in reality is still higher, and we're going to talk more about normalizing that later. And these social services consist of three units, and then they have a 50% interest in another company, in a fintech company. The largest unit is a rental housing platform, that's the clear leader in Denmark, which has networking effects, and it's building a similar platform in Sweden. I'm pretty bullish on the Danish version, probably not so much on the Swedish, and it's just more comes from me being a bit pessimistic, because if you present the argument that you have strong networking effects in your own country.

Starting point is 00:06:28 Why do you expect that you can just go to another country that already has strong networking effect with another platform and say that, oh, we can just do the same? But that is the most interesting of those three. The second biggest business unit for the digital services is a job seeking portal. This is a segment that grew sharply during COVID, and it's growing has a 15% EBIT margin.

Starting point is 00:06:50 The platform is the fifth-ish-biggest job platform in Denmark, depending on how you measured it. And so it's been monetized through online advertising for employers and have some other services too. I don't see them as having a distinct mode whenever it comes to this unit. And just doing like a small detail, I don't know, have you ever watched Toby the video with Peter Thiel. It's called competitions is for losers. I have a long time ago. Right. And he talks about, you know, the real, like the companies who have a monopoly, they go, you know, through lengths of saying, oh, oh, look at poor me. We don't have a monopoly at all. Like we Amazon, we're like global retail. Like we have no market here. And so, and then you have the other companies where like, look at all these monopoly power we have. And that's typically because they don't. Anyways. So this is a market that have grown a lot here recently. it's the seventh consecutive quarter

Starting point is 00:07:54 where they had double or triple digit growth. They are making some interesting investments. Bought a small Danish company for 12 million and the local currency, 4 million to the founders and they put 8 million in.

Starting point is 00:08:08 So the third, the third unit, just please stay with me here, the third unit in the second, digital services which is like the second unit if you want, it's called B-key and it supplies and maintains digital access solutions to customers. So easy access to lock door and cryptic keys. It's only 2.5% of the overall

Starting point is 00:08:29 revenue. And if you look at the numbers, it looks really ugly. Partly is because it is ugly, but you also have a lot of write-offs for some IT structure. It's been written off. They had the operations in Ukraine and have been, they haven't really changed the operation itself, but the IT development team is based there and it had to be relocated due to everything is happening. So if you adjust the EB for digital services, it would probably be at least 50% higher if you remove B-key and the investments that they're making there. And then they also have 50% in a company called Common Connect, which is a fintech business, that's growing relatively fast, 83%, mission on revenue, accounts to 3% of the consolidated

Starting point is 00:09:10 EBIT. The third leg in this business is the securities portfolio. If we look at the latest numbers that we have, they have 643 million. Again, this is local currency, but 643 million, and the monocab is 1634. So if you look at the latest numbers, 39% of the business is in equities. 18 stocks-ish last time I counted, tech, healthcare, all the industries, mainly Danish and American equity. The Americans are generally intact.

Starting point is 00:09:44 I don't want to derail you, but why do they have an equity portfolio? I think it comes from a few different reasons. The main thing is that the founder, we're going to talk more about the ownership structure, but the founder who owns 56% I want to say of the company, he's 82 and he's still, so he's no longer chairman, but he's, I would expect that he still has a say. What they're saying is that they want to take advantage of great opportunities if that happens. And they also have a strategy in place where they're going to spend up to 200 million from 2021 to 2024. They haven't spent a lot of that money into acquisitions. But even if they did,

Starting point is 00:10:23 giving the free cash flow they're doing, they're probably got to do short of 200 million this year. It doesn't really make sense. Like as an investor, especially in this type of business, you probably want them to pay out the cash. The owner who is, again, he doesn't have any kind of operational role. He's not no longer chairman of the board, but he is still running their equity portfolio. I would imagine it's because of those reasons. And perhaps it's better for him to run the portfolio from inside that company that he wholly controls. If you had to do that privately, of course he could transfer to another company, but if he has to do that privately, he would have to pay 56-ish percent in taxes first. So they're like probably different reasons

Starting point is 00:11:11 why it happens. But it's sort of like, now we're more going to like local tax laws and all. So, but anyways, I can understand why it sounds odd. And this, you know, as an investor, you probably would like to see a different type of asset allocation. So we would probably want as investors to go and analyze those 18 stocks. If I had to do an assessment without going into every one of the 18 stocks, but they're quite familiar names, I would probably say they might be slightly overvalued. Last year, they were definitely overvalued, but if you put them on the spot today and the fair value right now is 643 as of 31st of July, it might be a little lower. Also keep in mind, and these are generally very liquid stocks, so Dots cap stocks and mega cap stocks,

Starting point is 00:12:01 primarily invested in Denmark and the US, which is among the most expensive stock markets in the world. So if you just use that as an indicator, we probably are. slightly overvalue, but I wouldn't say, if you look at the intrinsic value, I had a chance to look at them. I wouldn't say it's more than 10, 15%ish. It's not outrageous the type of evaluation you see in the portfolio. To your point there about why they hold equities, they have this idea, which is also true, of course, that it's better to have them in equities in the long term rather than in cash. Of course, then you can make the argument as an investor. You might be even better if it's in your pockets instead of, but it is what it is what it is. The company has no

Starting point is 00:12:46 debt. They have three mortgage is spread over, spread across five properties with a long-term fixed rate. The property is a carot at $244 million. The moment is $117. I'm not going to use this in any ways in my valuation. It's just more the way that's been operated. I kind of feel it would be too aggressive to add any of that equity into the valuation, at least I choose not to. And the company has $114 million in cash too. I'm going to walk you through the math at the very end because I know I'm throwing a lot of numbers at you right now. But anyways, you're basically looking at a company with securities and cash close to $750 million, and the market cap was like $16. It's just called of 1650. So you are paying 900 million for assets producing around 200 million free cash flow.

Starting point is 00:13:40 If we look at the buybacks, just talking a bit more about the capital allocation, generally, I think the founder has done a decent job. He did purchase. I always like to look back and say, when have he sold and bought in the past? And does that make sense with the intrinsic value? I had in mind too. It hasn't been crazy numbers. There was a buyback yield of 4% in 2019, 2020, and he sold a bit back in 2021. It's only very little, though, but he sold whenever the stock was clear or valued, which you don't see a lot of founders do. It's very much like either or, so they would continue to buy back stocks, even though it doesn't make sense and there would issue shares at the wrong time. It seems like the founder have a pretty good idea of what he's doing.

Starting point is 00:14:28 The dividend is 5 days cronner, so it was just equivalent to a yield of 6.25% at the moment. And the intention is to maintain the dividend until 2024 and then revaluate. And the company went X dividend in 28 of March, and it was paid out 30th of March. So just keep that in mind. So talking about the ownership structure, I think I mentioned the founder owns 56% of the company. no other investors hold more than 5%, which by local laws are forced to disclose. Aside from North Media itself,

Starting point is 00:15:04 the dons 8.12% of the Treasury CS. Those shares are mainly used in terms of competition. It still meets the Ron Buffett rule of not giving out more than 1% in terms of delusion to reward management. The chairman of the board has recently made open market acquisitions at a price of 72 and 92.

Starting point is 00:15:26 Danish Kroner and the stock is trading today at 80 Danish Kroner. We also have seen some insider selling, but, you know, as we talked about on this show before, there are always many more reasons for selling than buying, you know, their stock options, their tax considerations, someone is buying a vacation home, diversification reasons. There are typically only one reason why someone wants to to buy, but there are a bunch of reasons why you want to sell as an insider. Let's talk about, I mean, I kind of feel I make it sound, all of this sound good. Lots of bad stuff too. So let me talk about some of the bad stuff.

Starting point is 00:16:07 Two things I'm really on the lookout for here. One of them is that by definition in this country, you get leaflets sent to your door unless you say no. And a long time ago, there was some jitter that, oh, should we change that? So generally, you won't get sent all times of leaflets and pamphlets and advertising to your door unless you say yes. And it's always been the other way around,

Starting point is 00:16:30 which is just very, very powerful. And my wife and I, we actually don't want that product. And so we had to go in and cancel it because we moved like a year ago. And whenever you move, it doesn't follow. And it's actually really annoying. And like the process is quite a few ways for you to stop you to make it difficult for you basically. So you'll continue to get those leaflets.

Starting point is 00:16:54 So that's a major risk since most of the money comes from FK distribution, which is the legacy business. If that piece of legislation would change, major risk. The other thing, and I want to say this in a political correct way, I'll see if I'll pause and see if I can say that. People who use this service are dying, but I want to be correct. I want this to come off. That was the politically correct version. I don't think that was the political correct version. But the reason why I'm saying that, obviously, I'm joking as I'm saying it,

Starting point is 00:17:31 is that you can track like, generally it is so that the older generation wants this and the younger generation do not want this. They can get it digitally or they don't want it or they go directly to the store that they want to shop in because they have their own apps. And so that's also one of the many reasons why you see that, you know, we have some graphs here. I can link to one of the reports. We can just see year after year that it's just slowly declining the number of people who want to receive these. And right now it's 66%. And 10 years is going to be significantly less. Then you have other costs. You know, they are

Starting point is 00:18:07 in distribution. So the price of oil, but that's going up. That has been a bit of a pain. The price of paper has skyrocketed it, which has been bad to. North media not buying the paper themselves, but the customers are buying the paper, but it has the spillover effect in terms of managing their cost in advertising. So that's sort of like those are the major, at least for the legacy business, that's the major risk that I'm looking at. Could they lose the market leading position delivering these? Probably not.

Starting point is 00:18:41 That's not the way it looks right now. Also, the interesting thing about having this type of legacy business is that you don't get a lot of competitors because it's a dying business. So it's something to consider. But it is a business that, of course, has some type of competition. You have like the former national monopoly who also delivers, but they do slightly different things. When you're doing your evaluation for this, do you model the decline in this part of the business? Did you model that in? What are your assumptions there continue to decline? like 2% a euro. Let's take a quick break and hear from today's sponsors. All right. I want you guys

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Starting point is 00:23:25 That's Shopify. com slash WSB. All right. Back to the show. Whenever I look back all the past three to five years, it's generally been like low to mid-single digits decline for the legacy business. And of course, all of this depends on do you measure in the currency, do you measure in the volume?

Starting point is 00:23:50 Whenever you look at the strategy they outlined going until 2024, they talk about a stable turnover. I would say that's probably a bit ambitious. In any case, it would be nominal numbers whenever they talk about a stable turnover. And with inflation at 8%, you know, you have to consider that too. Then you have, again, if you look at the strategy, the growth in the digital services,

Starting point is 00:24:14 which is around 16% of revenue now and probably will have different margins whenever they mature and they stop investing as much. You probably see around a 20% annual growth. Right now, they're almost offsetting each other. And that is the strategy because they actually call FK distribution that company. They actually call it the last mile in the report. And that's probably for good reason. They also have a business relationship with Deutsche Post, which is the main German distributor, but they only package to that because they have the fully automated system. They do that for 1.9 million households in Northern Germany.

Starting point is 00:24:51 They do not distribute them. And whenever that was announced, they didn't make any changes to the guidance. And so it's not disclosed how much money they're making and they say that it's a focus. I guess it's about survival and manage this slow-distance. a client, more than anything, as great as it sounds that, oh, now we're teaming up with a much bigger market. That's not where the money is. It's my best guess for North Media. The other thing that could be a bit concerning is that whenever you want to acquire companies to grow, I'm not saying that it can't be done. Of course it can. It's just very, very difficult.

Starting point is 00:25:32 It's a lot easier if you're really good at something and you grow that business. Whenever I say, that if you take out cash and we take out the securities and it's trading it four and a half times EBIT or free cash flow, even free cash will generally follow each other, which they don't do for all businesses, but it also shows like what type of business it is. It is spinning off a lot of cash. It's cheap. It's also cheap for a reason, but it's definitely not an expensive share compared to the intrinsic value right now. If we talk about potential catalysts, one thing that we as value investors to see no other years are companies who are profitable and the stock price seems to go nowhere. And you keep on, and even if it's also because they're spinning off cash, it seems like it's not

Starting point is 00:26:18 really going anywhere because it's just sitting there. So I have a potential catalyst and it's also not political correct. So that's going to be my disclaimer going into this. The founder is 82 years old and he's the mind managing their portfolio. I don't know how much longer he's going to do that. Hopefully, you know, and I want this to come across the right way, hopefully for many years I have, I don't know him, I have nothing against him. Sometimes what we see whenever the owner is not there for whatever reason, the new shareholders change the strategy and want to do something else.

Starting point is 00:26:58 And so what I said there between the lines and going to say here now is that perhaps the new owners want to liquidate the portfolio, perhaps they want to increase the dividend payments. And like I mentioned before, I mean, we're talking about like 40% market cap. That's, you know, securities and cash. And we have a six plus percent dividend yield. It's real cash that could be distributed. It was announced back in February of 2021 that him, the founder and his wife,

Starting point is 00:27:26 has decided to give their shares to a foundation that would retain the current long-term and strategic direction of the country. company. I'm not completely sure what to make out of that, but everything else equal. I would imagine that the pressure for paying out some of those, that cash would probably increase whenever he's not managing that portfolio for a reason. I have a disclaimer here in the end. I kind of feel like this has probably been, it's probably been one of the longest pitches I've done here. or what are mastermind groups. I wanted to make sure that I made a proper disclaimer.

Starting point is 00:28:03 I am a little uneasy whenever I present a small stock like this that's bought over the counter. The listeners could potentially move the market. I remember whenever our friend, Jack Taylor was on, and he pits like this very small, I think it was Fairfax Africa, like this very small stock. It could be a complete coincidence. But whenever we release the episode, which we did over the weekend, Monday morning, it just went up. And it's such a thinly traded stock. I don't know. I'm not saying that's the case. But I checked the numbers here before. And it might not be updated, but I checked it two-thirds into the trading day.

Starting point is 00:28:45 There was 14,000 shares traded. And they're trading in dollars. They're trading around $11. dollars. And so it's not a huge volume. We are closing in on 100 million downloads here on the feed and we have, let's say, 200,000 people eventually listening to this episode. So if that's the volume of the day, it doesn't take a lot to move that price. And so what we've done as host is that we all signed this pledge that we won't take position in the stocks that we mentioned on our episodes after 30 days after it's been published. Unless we have a, really clear disclaimer of, oh, we want to buy it at this price. We want to be very upfront with it because it probably wouldn't make any difference if we're talking about Apple. I'm pretty sure.

Starting point is 00:29:32 But now we're talking about, you know, this obscure stock. And even more important, this was something that William got in, which I really like. It said the Warren Buffett rule is not to do anything that you wouldn't see on the front page on the newspaper next day. And so that is the guiding principle. And so with that, with this long disclaimer, I want to say that, I don't expect to take position 30 days after this is being published. If he was trading lower around 60 Danish Crohnter from now until it's been published, I probably am going to take a position. Right now I was trading at 80, but just so everyone know, aside, you know, unless there's some sort of opportunity cost and other stocks are more appealing, I might not buy at 60 Danes

Starting point is 00:30:14 Crohn, but it would be very, very appealing around that price. So if I have any excess cash and there's not something else that looks fantastic, it would be something I would be looking for. Toby, there was a long pitch there. Let me throw it over to you. I'm curious to hear any thoughts you have about the stock. I like these sort of positions because the downside is fairly capped. The question is, how do you realize the value in it?

Starting point is 00:30:42 And I guess with a 56% owner who's 82, with any luck, he's probably got. quite a few, he's got years and years and years. So there's no, there's no immediate catalyst. Having said that 6% dividend is pretty material, particularly in this market. And you've got the found value of like 40% of the market cap in equities. Leflit business, even though it's in decline, it's an interesting business. It's going to throw off a lot of money. They've got some competition, but it's probably, they can probably raise their prices as they go along because that last mile is pretty attractive. They do have a little bit of tricing power there.

Starting point is 00:31:25 And then I sort of missed slightly how big the digital service as part of the business was relative to the, at what point do you think that that grows sufficiently to offset the decline in the other business? To answer the first question first, it's 16% of revenue. The EBIT, the reported EBIT is 10%. whereas it was around just called 20, but I think it was 22 for the last mile. But in reality, the digital services, EBIT is much higher. B-key or account-wise are losing a bunch of cash because of ride-offs, but also because

Starting point is 00:32:04 they're reinvesting. It's probably not my favorite business either. But if you would normalize the EBIT on that, I would say would be higher than 20%. So it's something to consider. The ambition is to grow 20% a year, and I think year over year, I think the growth is 16%, I want to say. Just if anyone is like going to report afterwards, like, ah, that number is slightly off. You had new numbers coming out like, I watched the presentation like six hours ago. So some of the numbers are very, very new.

Starting point is 00:32:37 If you look at year over year for the last reported quarter, which was, it was, I want to say it was around 16%. I'm scrolling through my notes, but it's in that range. And so whenever you hear them say, well, we're going to allocate up to 200 million for acquisitions. And those acquisitions would be in the digital services. If they spend all of that money, it will grow a lot faster. If they don't spend any of that, it will take a lot longer. It is quite tricky. And it's going to be one of those, you know, remember in school and you had one of those, like the train is leaving from, you know, this city.

Starting point is 00:33:09 And it runs by 40 miles an hour. Then there's this other city and it's, you know, when do they? us. And yeah, so it's one of those. So you might say you have this 84% of revenue. Let's just use revenue and it's going to decline. It's called 4% a year. Then you have the other thing that's 16% is going to grow up a 20% a year or whatever number you think is reasonable. My head is spinning right now. There's probably something at someone in the eighth grade who are listening to this already already solved it. But that's the way it is. And you know, in terms of allocation, you know, they are, as you can probably tell, taking that cash to reinvest, of course,

Starting point is 00:33:50 also to pay out this dividend, but to reinvest in deals or service businesses because they know that's the way it's going. And the rest, they just put in equities. So it is like an interesting way of thinking about that. How much are they paying out? Yeah, so it's a bit, it's a bit tricky whenever you're talking about the payout ratio, because the payout ratio are typically measured on the net profit. But, you know, we, we, it's a bit tricky. It's a bit tricky, when you know, we, We have this change in gap rules or IFRS rules as it would be in Europe. And so whenever you look at those numbers, they are all over the place because it's marked to market.

Starting point is 00:34:23 And so whenever you see the market decline, as you've seen, it's going to look really, really ugly. And then last year it looked fantastic. I want to say it's around, it's less than 50%. Let me see if I can find the exact number here. Yeah, I would expect that because I would expect the free cash flow to be around 200 million The 20 million shares, they pay five. So, yeah, around 50% right now would be the payout ratio, give and take.

Starting point is 00:34:52 So the way that I would think about this is you have, it's a $200 million US market cap. 40% of us in equities, which let's say they're worth roughly what they're worth. There might be some good stuff in there that's going to grow over. But let's just treat that as cash for the moment. So you get to, it's $120 million in market cap, sorry, $120 million in enterprise value, paying out, you need $12 million in dividend on the $200 million, $24, and then another $12 million. Yes, next year because the 6% is fixed. Sorry, 6% that dividend is fixed. So it's 12 and then 24.

Starting point is 00:35:32 So you're getting a lot of your capital back. And then inside you have a business that's still throwing off a lot of money, plus these. two others that are growing pretty rapidly. It's reasonable risk-adjusted bed for where it is, and the 6% dividend you're getting paid to hold it. Downside is minimal. Upside is at some point it gets taken care of. Yeah.

Starting point is 00:35:55 This kind of position that I like. If I were Toby Carly with the basket approach, I would like this type of company in my portfolio. I own, as of yesterday, I bought a news stock yesterday. I probably don't have time to talk about it today, but we can always do it next time. I have, with that, I have four individual stocks. I tend to run a pretty concentrated portfolio.

Starting point is 00:36:17 I also have other type of investments, but for my individual stock picks. What do you hold? What's your new portfolio? I have Berkshire. I have Alibaba, Google, or Alphabet. And keep in mind, whenever you're listening to all this, like the one thing is what's trading it now,

Starting point is 00:36:35 another thing is the price you bought it at. not that I did well on that. I actually just added to my position today at $89. So whenever this comes out, who knows? Who knows how much it has lighted cents. And yesterday I bought process. Is it the South African company that's a chunk of 10 cent? Sort of.

Starting point is 00:36:56 So they did this swap NASPRs because they want to unlock the value. So they made that with an incorporated then process. The control is still with NASPR's. but the values of the business is with process. And if this sounds complicated, it's because it is. And so I bought a small position. I bought enough to pay attention, but not so much if I'm completely off in what I'm doing.

Starting point is 00:37:22 That really affects me. And I sort of like do that just to make sure that I keep up and then double down if I realize that there's something there. And if it's not, I typically tend to sell it. I really like to have very few equities I focus on that. time. What process is doing right now is, it's just interesting now that we are talking about it. I bought it that just for fullest closure. I bought it at 63 euros and 90 cents. I did it while the net asset value was 101 euro per share. And so what's interesting about it, because

Starting point is 00:38:00 you know, they did decide to unlock the value. And I think this was announced probably in late June. I can't remember exactly, but they own a lot of 10 cents. It used to be 45%, but now it's significantly less. I want to say of the top of my head, 27%, whatnot. I looked at it this morning, but I kind of wanted to have in front of me. All right. So they have numbers that they actually update on the daily basis, which is very, very nice. The net asset per share right now, euros is 100 euros and 50, 50 cents. The net asset value in billions of euros. is 142.7, and that's not at all what it's trading at right now. And so if you just look at Tencent in itself, what it has now is $107 billion. And so what they do right now is that

Starting point is 00:38:52 they are selling Tencent shares, even though that's fall into into intovenson. They sell that to buy back prosos in the market. So the way to think about this is, using generic numbers, they are selling a dollar for 60 cents to buy it back at 40 cents. Selling a dollar for 60 cents to buy back at 40 cents? To narrow the gap between the two, is that the idea is that what they're trying to achieve? Yeah. Right now, if you bought the share, you actually get more 10-cent stock in fair value that you're buying it for. Plus, you get all the other businesses for free. I know it sounds on. a lot of times that something is trading below net asset value.

Starting point is 00:39:38 But in this case, it's primarily marketable securities. Not all of it, of the listed assets they have 112.7 billion euros, and they have 31.3 in unlisted assets. And that comes from analyst consensus and post-money valuations. It's difficult for me, whenever I read up on the portfolio, it's difficult for me to say it's worth 31.3, but I'm pretty sure it's worth. worth more than zero euros. And so that's the first part of the thesis.

Starting point is 00:40:11 Whenever I look at 10 cents too, which is sort of like, I know I'm derailing conversation completely, 10 cents looks really cheap to me. And so I'm buying something that's probably already discounted through a vehicle that's already discounted. Plus I'm getting, what is that, almost a third of that in extra free businesses, if you want, from their unlisted assets. It is what it is. I'm not only throwing a lot of numbers at people, but I'll make sure to link

Starting point is 00:40:45 to some resources and everyone can take it up on themselves. Have you seen something like this before, Toby? Oh yeah. Yeah. That's Britain butter for Deep Valley. It's good stuff. Right. Are you looking at something like this right now? No, my pitch is something different, but we'll get to that when we get to that. Right. Can I ask, because whenever I saw it, I was like, huh, this is interesting. Do you have anything in your portfolio? I know I'm really putting in the spot here, but is that a part of your strategy

Starting point is 00:41:18 or are you using different metrics to find the companies? I'm looking for operating businesses now. My main focus in the funds is operating businesses that are throwing off free cash flow and are using it to make material buybacks. For the most, that's the kind of stuff. I like them when they're growing by themselves, but I like to see management exercising some discipline around. I think the stock that I'm going to pitch is a good example of that.

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Starting point is 00:44:56 This and other information can be found in the income funds prospectus at fundrise.com slash income. This is a paid advertisement. All right. Back to the show. All right. Let's do it, Toby. So the one that I'm pitching is first American financial.

Starting point is 00:45:14 It's a $6 billion market cap. to $7 billion in enterprise value, so it's about a billion dollars in debt. Dividend yield is 3.5%. Over the last, say, five or six years, return on invested capital has varied from about 12.6%, which is about run of the mill for listed companies to as much as 21% last year. But that was probably flattered by the property market. So first American financial, what they are, they're a title insurer. That's not a business that many people will be familiar with, but the idea is that in the US, there's no centralized government depository

Starting point is 00:45:52 or record of who owns real estate. So when you buy real estate, you're always running the risk that the person that you're buying it from doesn't have a clear title. And it's a catastrophe. If you buy something and there's somebody else owns the property or there's some encumbrance against the property

Starting point is 00:46:13 where somebody else can come, and interfere with your clear title to the house that you live in, you don't want that. So there are a number of these companies around, and First America Financial is the biggest, that have these very extensive, comprehensive databases of title chains, so you can see that you are getting clear title to the property. So as the purchaser of a house, you buy title insurance, and it just guarantees that if there's any issue, then you're going to be made whole to the extent that you can be on your house acquisition. And so it's a no, it's mandatory, but it's a no brainer for somebody buying a house to go and get title insurance because it's such a small amount of money relative to the cost of the house and then you protect it.

Starting point is 00:47:03 So the suppliers of, for the seller of insurance, it's actually, it's a good business for them too because it's not like prop, you know, personal. It's not P&C, it's not properly in casualty. It's nothing like that where there's big payouts. It's not balance sheet intensive. What it is, it's just like a due diligence process. As long as their systems are good and they've tracked it, it's very unlikely that they're going to need to make a payout. It's sort of part of the, it's just part of the diligence process of buying a house.

Starting point is 00:47:34 So the business itself is very, it's very profitable, it's very dependable. The issue, of course, is that it varies a lot. with the property month. When there are more property transactions, they make more money. When there are fewer property transactions, they make less money. They also need it for, you need it for a refi and you need it for a sale or purchase. You make more money from a sale or purchase than you do from a refire. It's about two and a half times as much for a sale or purchase versus a refi. First American makes about, or they made $9 billion last year. So it's a great business that resulted in about $618 million in.

Starting point is 00:48:13 free cash flow on a $7 billion enterprise value, so it's like a 9% free cash flow yield. Over the last, say, six or seven years, that's varied from as from as little as like $12 million, $18 million to $600 being the best, average is about $200 over that period of time.

Starting point is 00:48:33 The reason that it's cheap is that we're likely going into housing markets collapsing a little bit over here. There's some statistics today that I saw that the housing there is in California which tends to be more boom bust than in the other state it looks like we're going through like a 2007 or 2020 type there are as few transactions going through it was those two periods so it's possible they're not going to have great years for the next few years but the business is it's just it's so hard to compete with something like this if you don't have that database to start off with so there's a handful of competitors these guys are very good

Starting point is 00:49:11 at buying in local markets. They've got sort of 550 offices. They've got 20-something thousand employees. So it's a business that requires some. It is a little bit hands-on. And they buy these little title insurance companies in specific markets where they don't have coverage. But otherwise, the presentation on the website is very good.

Starting point is 00:49:36 It shows you what they do with their, what they do with their cash flow. They've been very good at buying back stock. pay a dividend, it's about 3.5% or yield at the moment. So that's what I like to see, that they do a great job buying back stock and they pay out the cash flow to the extent they can. It's a great looking capital structure. And it's a simple business that it's readily understandable. So I think it's the business consistently earns more than its cost of capital, which means that it definitely has very chunky value there and it's hard to compete with it.

Starting point is 00:50:06 So it's a sort of business that I really like, small, simple, clear. people need it and the cost to them is minimal compared to the larger transaction that occurs when they buy it. So that's it. I love your pick. As always, Toby, you know, the big question, Mark, is how bad is this going to be? With the interest rate going up, the recession coming, at least the bond market is telling us that a recession is coming. I had a chance to look at the most recent slide deck. I'm sure to link to this, but if you look at page 7 in that deck, it goes all the way back

Starting point is 00:50:46 to 2000 and what happened after the bust of the dot-com bubble. And you can just see how like with the refinancing, even though it was, even though it was primarily located in tech, at least that's how we think back at it. You saw a lot less refinancing and origination as well. Pre-tax margins at the time was around 5%. And then you saw the peak. It turned profitable soon after that. It was already profitable, but a lot more profitable.

Starting point is 00:51:18 And then you had the 2008 great financial crisis. Then you saw negative pre-tax margins for some time. Since then, it's only going up, and it's now around 17, 18% pre-tax margins. You can see that they estimate slower sales. And who knows how bad it's going to be. I've been burned by Picks like, I wouldn't say like these because I think this is more solid, but I've been burned by some oil stocks in the past. And you know how it is with sickle stocks, or at least you learn after you've been burned

Starting point is 00:51:51 with sickle stocks, that they typically tend to look really appealing whenever they trade at really low multiple. And the rest of the market knows that something bad is going to happen, which is why trades at a very low multiple. and then the profit just disappears and the multiple seems not to matter at all because it's what is minus time affinity whenever you do the math. And so I guess that's my main concern with a company like this. I don't know how bad's going to get. I just don't know the market well enough. We've seen whenever we had recession in the past, that's not going to go well.

Starting point is 00:52:26 The question is how high is the interest rate going to go? Well, we're already into the, we're sort of into the fall in property market, that's going on right now. So the data that I saw today says that it's the number of transactions going through in California is comparable to 2020 and to 2007, which are the two worst, sort of the two quietest periods in the last like whatever it is, 20 years or something. The business has been around for quite a while. They can track, you can see the data in that slide deck that goes all the way back to 2000. And it has, it has good years and it has bad years.

Starting point is 00:53:02 but it's quite, it is reasonably consistent. And even if we go through this period of time where there aren't as many transactions, people will still buy and sell property and there will still be refinances going on. From that perspective, it's not like an oil and gas business where they don't know what the price of the commodity is going to be in 12 months time. Negative numbers are possible. It turns out. I didn't realize that was a possibility in oil and gas, but it is evidently and then also

Starting point is 00:53:26 very high prices. It's nowhere near as cyclical as that. And it's not like they're investing into that. They participate along with transaction volume. And so what I think will happen is what we're seeing now is the slowdown in transaction volume. And that's why the stock is cheap. And that's probably why you can look at the valuation. It does look like it's the cheapest valuation in 10 years.

Starting point is 00:53:47 But as you point, that's likely a little bit misleading because it'll be on peak numbers when we're going through the bus right now. But I think that if you look out further, if you think out three, five, 10 years, this business is still going to be there. The business is still going to be going. The business is the normalized run rate for this business is it could be sort of a half to a third where it is now. But the downside, I think, is very limited. The downside is virtually non-existent. It's hard for this to be a zero. It's hard for this to fall much more.

Starting point is 00:54:21 I think this is not the stock price that I'm talking about here. This is the business itself. I think it's hard for the business to slow down much more than they're currently enduring, which will probably come out in the next few quarters, you'll see how bad it is. But even in that scenario, I don't think it's that bad because it throws off lots of free cash flow. It's conservatively capitalized.

Starting point is 00:54:43 And it's just hard to compete with, nobody's going to be coming in and competing with this business. It does have other competitors, but these guys have got, they're like 23% of the market share, something like that. Very solid. That is very solid. I just think it's a,

Starting point is 00:54:57 the upside may not be huge, but the downside is very limited and it should earn a reasonable return from here. I completely agree with everything you said, Toby. I think that the downside is for sure is very, very low. They talk about how 25 basis points on the Fed funds rate adds up to another 15 to 20 million a year. So part of that is, of course, a hedge. If you had to do the apples-to-evil comparison, just, of course, consider a how much the investment income is compared to how much cash flow they're doing. But just to give

Starting point is 00:55:33 some numbers, so the market has like $6 billion. The price of free cash low is 8.2 today, some recording. And what's interesting about their investment portfolio, they have 6% in equities of their $9.5 billion consolidated portfolio. And might sound crazy to you if you compare to a company like Berkshire, but most companies are not like Berkshire or like Geico. They are managed by other asset managers. The bond yield right now is 1.8%. The average rating is AA, and the duration is 4.3 years. And so there is something, I guess, an hatch offsetting there.

Starting point is 00:56:21 Whenever I see stocks like this with First American, And whenever I see the one with North Media, I am thinking, oh, let's have 30 stocks like that. Let's not be super concentrated, have three or four stocks and let them just throw off that cash. And let's make mean reversion do its magic. Is that where you're at right now in terms of constructing a portfolio? Or let me ask you another way, because who would that type of investing be right for? So I use it. That's how I invest. I like to buy a portfolio because I've seen people get too concentrated into individual names and blow themselves up. I don't think that you're going to have

Starting point is 00:57:09 any problem with the names that you have, but I just, I have seen people get caught. Everybody's looking at the upside. Everybody forgets about the downside. The downside is the place that I start with. I want to make sure that none of them can blow up. I want to make sure that they can muddle through even in bad markets for their, for their, even in bad markets for their businesses. And then I also like to see management that in the event that you do go through something like what these guys are probably facing,

Starting point is 00:57:37 that has a track record of buying stuff. Because that creates that anti-fragile kind of quality where they take advantage of the undervaluation. And, you know, if all else being equal as a shareholder, you want the price lower because that, that means that you are going to be concentrating faster into the business as they buy back,

Starting point is 00:57:58 as they buy back stock. So my portfolio is filled with these sort of companies that throw off lots of free cash flow that have to grow reasonably, but might be a little bit more cyclical. The cyclicality is something that management can take advantage of and buy back stocks so that you're over time, you own more and more of the underlying business. So that's essentially the strategy. I don't have to be as deep in the weeds in any given name because I can, as long as most of the pieces fit in a portfolio of 30 or 100 names,

Starting point is 00:58:36 depending on how big, you know, the small and micro-c portfolio is much more diversified for the simple reason that they are, less high-quality businesses, and they are much more subject to the other things that go on around them in the economy. they are very sensitive to you. I think that it's hard to, it's hard to lose too much on these and it's probably likely that they deliver reasonable returns for the capital invested. That's basically what I'm thinking about it. Interesting.

Starting point is 00:59:07 And I guess two points to that. The first one in case everyone is like, so a stick then invested 40% in Berkshire and third percent in Google and third percent in Alibaba and then just. bought one share of process. So my three Cs are now four Cs, but process is very, very little. That's 20% of my portfolio. So just before Toby, you get too concerned and like,

Starting point is 00:59:33 something is going on there. So it is what it is, but it's the small portfolio I have with individual stock names. To your point about First American, I love what they're doing right now with the buybacks. It's interesting tracking what they've done in the past on that. Since the beginning of the year, they repurchased approximately 6% of their shares. It's a lot.

Starting point is 00:59:55 And this is a company that's trading at 8 times free cash flow. So, like things are going fast. And like childmonger is saying, beware of the cannibals. And this surely is one. I don't think this is going to go out of business. I also just want to clarify that. It's been, it was incorporated in 1889. And even though that's no guarantee that it will continue, a lot of saddlemakers

Starting point is 01:00:17 also incorporated around that time, I'm sure. It doesn't seem like this company is going anywhere. So I just wanted to clarify that. Do you have anything you wanted to add to North Media to First American financial? Anything? I like these positions. I like North Media as a pick. I think that you will see the investors podcast bump when this goes public.

Starting point is 01:00:40 Yeah, I'll make sure to. I'll touch it just to be clear. Okay, great. Yeah. Not because I don't like it, but because I think that there will be bump. All right. Okay. Yeah, let's see what's actually be interesting to see what's going to happen. Hey, Toby, before I let you go, as always, please give the audience an opportunity to, where can I learn more about you, your funds? What do you do? My funds are the Acquirus Fund, the tickers ZIG,

Starting point is 01:01:09 it's 30 names, domestic US, following along the same strategy that I just outlined before. and I have a smaller microcap fund. The tick is Deep, D-E-E-E-P. And I have a website, Acquireasmultable.com. I'm on Twitter at greenbacked.com, sorry, Greenback at G-R-E-N-B-A-C-K-D. And I have some books out there as well

Starting point is 01:01:32 that sort of articulate the strategy in more detail if you're interested in that. Most recent one was the Acquirous Multiple, which came out in 2017. It's on Amazon, along with everything else. All the links are on Acquirers Funds, choir as multiple and the two funds have their own. So it's always fun being on stick.

Starting point is 01:01:54 Thanks for having me. Yeah, always fun chatting. I look forward to next quarter already. As you can tell, I already prepared my pick process. Anything that's on your mind, not that you can't go back on your word, but any kind of stocks you're looking at right now? Well, I hope that we have. I mean, I think that we're, I don't see anything that's screamingly cheap, given this little run-up that we've had since mid-June.

Starting point is 01:02:21 But I do see a lot of, you know, the operating margin for the S&P 500 has come back from 13%, which was at its peak, which is extremely high. It's 10%, which is still high. And I think that that trajectory is true for many businesses they have seen. And who knows whether it was because 2020 and 2021 were unusually good years or if there is some real slowing in the economy. I do think that it's the latter because you can see that in other figures like housing is slowing all of those other things. I think that you're seeing that in businesses.

Starting point is 01:02:55 So I don't see anything that's growing so rapidly and likely to continue to do so that you can justify a big premium for the business. So I have this thought that we're probably likely to go. through, I think we're midway through probably an extensive bear market. I don't know, but that's my sort of gut feeling. When I look at where all the multiples are for the market itself and where I look at the underlying trajectory of the earnings, I sort of feel like we haven't cleared the decks yet, so I suspect that we will.

Starting point is 01:03:29 So I'm hopeful that when we come to do another mastermind, there will be some screamingly cheap stuff, probably that'll mean that we're willing to another bust. I would say to people out there who I've been through two now. I've been through the 2000 bust and the 2007, eight, nine bust. 2020 was a, was a flash crash. And there was a bust in 2018, sort of towards the end of the year, and there was a bust in 2016 as well. I think that people have now been conditioned to expect that these things recover really quickly.

Starting point is 01:04:01 This is not as deep as 2020, but it's sort of been much more extended in terms of time. This is what real bear markets look like. Like it's not so much the collapse that kills you. It's the rallies being sold to lower lows that just wears you down over time. And I would just mentally prepare potentially for another, could be another year to 18 months of this before we see the real bottom. And I'm saying this with the market within kissing this into all-time highs. So I don't know when this will come out.

Starting point is 01:04:33 It could be clear that's already happened by the time this comes out. That's sort of my gut feel. So I'm not nervous about the market. I just think that you should be mentally prepared for more carnage as we go along. You have these small rallies and you feel like now you're out of the weeds, especially if you haven't experienced the markets for a long time. And what happens is that they're selling to a new low, as you were mentioning. And it just exhausts you to a point where a lot of people just lose faith.

Starting point is 01:05:03 And that's whenever things get ugly. And I want to say, I want to say to you, so please correct me if I'm wrong, but last time we have one of these conversations, you said that in the first two-third of a bear market, it lost a third of the value. You're nutting. So, you know what I'm going to this. And the last third, you're losing two-thirds of the value. Yeah, it's that one-third of the two-thirds, the first two-thirds in time leads to one-third of the loss. And then the last third in time is two-thirds of the loss. And that's a Ken Fisher line, but I've heard that from, also from the British Quality Investor. What's that gentleman's name? Just escaping me at the moment. In any case, it's an average bear markets are 18 months to two years and the bulk of the selling occurs at the end.

Starting point is 01:05:54 It's that final spasm of selling that sort of indicates the end of it. The same thing happened. The 2007-2009 crash started in 2000, June. 2007, by June 2008, it had almost rallied back to almost, to all-time highs. It didn't quite get there. But then all of the selling happened from June 2008 in Q4, 2008, and Q1, 2009. So it was quite drawn out. And so I don't know what the equivalent is now, but we could be. And the other odd thing is that the ARC complex, complex, the profitless tech that started selling off in February 2021. So that's now well and truly 18 months of selling the market itself didn't sell off until

Starting point is 01:06:40 the start of this year. But that's what happened in 2000 as well. It was all a little bit delayed. And so the whole thing was quite delayed. And so I think it's impossible to predict where the market goes. I should say that first off, the reason that I say this is just you need to be mentally prepared for, and I'm mentally prepared for another 18 months of sort of carnage here. Let them be the last words, mentally prepared for 18 months of carnage.

Starting point is 01:07:08 Hey, Toby, fantastic. It's always always good, fun speaking with you. Thank you so much. My pleasure. Thanks for having me. Good to see you again. Thank you for listening to TIP. Make sure to subscribe to Millennial Investing by the Investors Podcast Network

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We Study Billionaires - The Investor’s Podcast Network - TIP475: Mastermind Q3 2022 w/ Tobias Carlisle

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