Andrew Kuhn – Page 4 – Focused Compounding

Andrew Kuhn August 28, 2018

KLX Inc/KLX Energy Services Spinoff

Member Write-up by Yuvraj Jatania

Spinoff Background

In May 2018, KLX Inc. (KLXI) announced an agreement to sell their Aerospace Solutions Group (ASG) to Boeing for $63/share in an all cash deal.

The deal was based on a successful spinoff of KLXI’s Energy Services Group (KLXE) because Boeing had no interest in buying this part of KLX’s business.

The management team led by founder, Chairman and CEO, Amin Khoury, initially tried to market the energy business for sale to trade and financial buyers. Bids were received from a mixture of competitors and PE houses in the range of $250-$400m but management felt very strongly that these valuations undervalued the potential of the business based on the rapidly improving market conditions, the higher market value of comparable companies and strong forecasted financial performance of the business.

Instead they decided to initiate a spin off which would allow them to run the energy business as a standalone, publicly traded entity.

Our investment opportunity lies in the spinoff of the energy business which will trade on the NYSE under ‘KLXE’.

The spinoff is expected to take place before the end of Q3 2018. Not long.

KLX Inc

KLXI is a US listed company which used to be part of BE Aerospace (BEAV).

BE Aerospace was founded by Amin Khoury in 1987 through an acquisition of an aerospace interiors parts manufacturing and services business with only $3m in revenue at the time. Khoury grew the business and sold the manufacturing side to Rockwell Collins in April 2017 for $8.6bn and retained and managed the services business which became known as ‘KLX Inc’.

KLXI operates through two distinct and unrelated businesses:

1. KLX ASG – Aerospace after-market services and parts/consumables for commercial and private aircrafts

2. KLXE – Onshore oil and gas field services – focused only on serving North American onshore Exploration and Production (E&P) companies

KLX Energy Services Group

The energy business was founded through a quick succession of acquisitions in 2013-14 of seven regional oilfield services companies which each operated in the major shale basins in North America – the Southwest, Rocky Mountains and the Northeast. The execution and integration of the acquisitions was managed by Khoury and his executive team.

The business provides well completion, intervention and production services and equipment to major oil and gas E&P companies. Their customers include Conco Phillips, Chesapeake Energy and Great Western amongst others. These companies drill and create wells in the shale basins looking for oil and natural gas. When they have a pump issue, equipment gets stuck or loss, a valve becomes faulty or loose, or any other well-related issues they call in technicians or equipment and tools from a company like KLXE. Historically, some of these players would resolve these issues by having an in-house team but now a majority of them outsource the support services to companies like KLXE as the work is considered non-core to their daily activities.

One of the very attractive features of this type of business is …

Andrew Kuhn August 24, 2018

BUKS follow-up: A catalyst could emerge within a month

Member write-up by VETLE FORSLAND

I wrote up BUKS on the website earlier this month. After discussions with Geoff, we agreed that a follow-up article was relevant, as there were important parts of the thesis that I left out in the original write-up (which you can read here if you missed it).

https://focusedcompounding.com/butler-national-corp-buks-an-illiquid-ben-graham-style-mini-conglomerate-in-aerospace-and-casinos/

This article will focus on a real estate deal that could act as a drastic catalyst for the stock, which is desperately needed.

BUKS’ real estate deal, and why it’s a bargain

BUKS has a buyout option on the Boot Hill Casino, which they have been renting since 2009. They are paying $4.8 million in leases annually on the property right now. If we cap this at an aggressive rate like 8%, we get a valuation on the property of $60 million. BUKS has the option to buy the very same property for $45 million – or $16 million below what we can expect is a conservatively fair price.

That difference alone is worth BUKS’s entire market capitalization.

And, that $60 million valuation isn’t just from a lease cap assumption. The CEO himself, Craig Stewart, said in an earnings call that the official appraisal is «significantly higher» than the $45 million price tag, which he again claimed was «definitely substantially under» appraised values. Understandably, an analyst on the call asked for specifics on the appraisal value. He didn’t get a clear answer on his question, as it’s confidential, but Stewart claimed $55 million was «close» to the fair value presented by the bank they’re working with, when he was pressed on the subject. Stewart also revealed that it will cost $1 million to get the deal financed. So, what does this mean?

I got the impression that the leasing contract expires in 2034, as they agreed on a 25-year lease in 2009 (2009+25=2034). Therefore, if they don’t buy out the casino, BUKS is stuck with $77 million in leasing costs over a 16-year period. Instead, they can buy a property for $45 million, when it’s worth 30% above that figure, and then finance it with a one-time expense of $1 million – sound good yet?

If BUKS wanted to, they could buy the casino, and instantly look for a buyer, and potentially make 70% of their market cap in one transaction. However, there is probably more value for the company if they keep the real estate for themselves and cut lease expenses.

What does this mean for the stock?

Obviously, this is a good deal for the company, and the value added to the firm should be reflected in the stock price. However, there is clearly a lot of value in BUKS already that the market is either not seeing, or blatantly ignoring. It might very well be the latter, and I explained why in my original write-up. In a nutshell, the executives, represented by the CEO and his brother, his cousin and his son-in-law, are using BUKS to get generous salaries year in and year …

Andrew Kuhn July 12, 2018

LEAPS: The Joel Greenblatt Way to Bet on Entercom (ETM) and GameStop (GME)

Member Write-up by VETLE FORSLAND

Investing in companies with big upsides (and big downsides) with LEAPS, instead of common stock, to up your return (and minimize risk)

If you believe that a stock is excessively mispriced, and you want to buy that stock, there is a way for you to translate a say, 30% gain into a triple digit gain. It’s called LEAPS, or “Long-Term Equity Anticipation Securities”, and if used wisely, it is one the best ways to leverage your investment returns as a retail investor. Joel Greenblatt wrote about it in “You Can Be A Stock Market Genius”, where he described it as a tool that “has many of the risk/reward characteristics of an investment in the leveraged equity of a recapitalised company”. I recommend reading his bit on LEAPS, starting on page 213, as Greenblatt himself can show its pros and cons much better than I ever could. But, the strategy is basically buying stock options that expire 2 years down the road. Stock options are usually not attractive for long-term investors as they don’t allow sufficient time for a larger repricing, and are dependant on a short-term catalyst. However, as you can own LEAPS up till two years, chances are a stock that is severely and obviously mispriced will reach (or get close to) its fair value during your holding period.

Since, LEAPS are basically long-term options, how do options work? You can buy put options and call options, but in this case we will just look at calls, which is basically the right, but not the obligation, to buy a stock at a specified price within a specified time. For instance, let’s say you purchase a call option on shares of GameStop (GME) with a strike price of $16 and an expiration date of August 10th 2018. This option contract would give you the right to purchase 100 shares of GameStop at a price of $16 on August 10th, but as this right is only valuable if GameStop is trading above $16 on the expiration date, you risk expiring the option valueless. Right now, you can buy one call option on GameStop for August 10th for $0.50, which represents 100 underlying shares of stock, so the cost of a trade of 100 call options will be $5,000 (($0.50 x 100) x 100 shares. If by August 10th, GameStop trades at $17, the buyer could use the option to purchase those shares at $16, then immediately sell them for $17. Therefore, the option will sell for $1 on August 10th, and as each option represents 100 underlying shares, and our hypothetical trader bought 100 options, this will all total a sell price of $10,000. Because the trader bought this option for $5,000, the net profit equals $5,000 – comparably, a common stock buyer would have had to invested $160,000 to make the same profit from the same trade.

If, however, GameStop stock trades for $16.50 at the expiration date, …

Andrew Kuhn June 9, 2018

Hamilton Beach Brands Holding Co: HBB

Hamilton Beach Brands Holding Co should not be a completely new stock to Focused Compounding members – but, for those who may be new I will provide a bit of a background. Hamilton Beach Brands Holding is the stock that was spun off from NACCO Industries (NC) last year, which of course NC is the stock that Geoff put 50% of his portfolio in. Hamilton Beach Brands Holding Co opened up post spin at $32.86 and quickly ran to $41.00 per share, only to fall back down to a low of $20.97. With HBB currently sitting at $28.20 about 8 months after the spinoff took place, we felt like it was worth another look.

Hamilton Beach Holdings is an operating holding company that has two business segments: Hamilton Beach Brands (HBB) and Kitchen Collection (KC). HBB sells small electric household and specialty houseware appliances to brick and mortar and through e-commerce channels in about 50 different categories. They sell through Walmart, Target, Kohls, and Amazon. If you’ve ever been down a Walmart blender aisle I’m pretty confident you have come across their products. They make blenders, toaster ovens, coffee makers, indoor grills, etc. HBB’s business model is asset light because they outsource all of their manufacturing to 3^rd parties in China which allows them to earn a high ROC (total CapEx for 2018 is only expected to be $10.5m, or about 1.7% of revenue). If you think about the staying power of the products that they sell it’s pretty safe to say we will still be using blenders, crockpots, and toasters 10 years into the future.

Kitchen Collection is the problem child in the business that is a specialty retailer of kitchenware in outlet and traditional malls throughout the United States. Management talked about their challenges in their last quarterly conference call, which they’re handling those challenges prudently. Their revenues fell $4.6m in the first quarter (their revenue comes from selling specialty kitchenware items in their retail stores) and management said in the conference call that they expect 70% of their leases to be one year or less by the end of 2018. Although KC is in decline mode with no favorable happy ending in sight, management is being proactive by not investing much capital into the business. Total CapEx for KC is expected to be only $500k for 2018.

For the investment case, I factored in zero value for KC.

Revenue breakdown from HBB’s most recent 10k:

What’s it worth?

Management has long-term objectives (which excludes KC) of $750m – $1B in sales with an EBIT profit margin of 9%, which would translate into an EBITDA margin of 10%. We can use this as a base in our minds, but to start let’s run through a few different scenarios to see what HBB could be worth. In the examples below, I grew revenue first by 2% for the next 5 years in addition to growing EBITDA margins to their target …

Andrew Kuhn May 25, 2018

Pandora A/S (CPH: PNDORA)

Member Write-up by Luke Elliot

Note: Sponsored ¼ share ADRs also trade under “PANDY” in U.S. Dollars

Pandora A/S is the largest jewelry maker in the world

Overview Pandora is a vertically integrated jewelry maker that has rapidly grown from a local Danish Jeweler’s shop to the world’s largest jewelry manufacturer, producing more than 100 million pieces of jewelry in 2017. The original jeweler’s shop in Copenhagen, Denmark, was opened by goldsmith Per Enevoldsen and his wife Winnie in 1982. The company quickly transformed from a local shop, to a wholesale retailer, to a fully integrated global behemoth that designs, manufactures, directly distributes (in most markets), and retails its own jewelry. The company now sells in more than 100 countries through 7,800 points of sale. If you’ve ever been to a grade-A mall during Christmas or Valentine’s Day, you’ve probably witnessed the crazy lines snaking out of their small glass stores. Jewelry makers are segmented by price: Affordable (less than 1,500 USD), Luxury (1,500-10,000 USD) and High-End (greater than 10,000 USD). Pandora is in the affordable category by price but claims to have an ‘affordable-luxury’ brand. The company gets a little less than half (48%) its sales from EMEA (with 71% coming from UK, Italy, France, and Germany), about one-third (31%) from Americas (with 74% from US) and one-fifth (21%) from APAC (with 43% from Australia and 28% from China). The company’s sales are geographically diverse and in mature markets. To make it easy, let’s break down Pandora’s business model into two main retail formats:

1) Concept Stores (about one-third owned and operated by the company and two-thirds franchised): Concept stores are full-blown branded Pandora stores which only carry Pandora products and displays.

2) Other: other points of sale consist of “shop-in-shops” which are clearly defined spaces in other stores (think a little kiosk in an airport Duty-free) that only carry Pandora products and 3rd party distributors which can be either multi-branded retailers or non-branded retailers.

Pandora currently gets 66% of its sales from Concept Stores (plus online) and 34% from “other.”

We’ve discussed where the company sells and how they sell……..but What do they sell?

Pandora is the world leader in charms and charm bracelets. It’s their bread and butter. It’s estimated they own about 30% of the charm market and 75% of their revenues are generated from this category. Estimates are that charms and charm bracelets make up only 6% of the total jewelry market. In essence, Pandora sells you a bracelet for somewhere between $80-150 and then you fill the bracelet up with charms that are $50-150 each. Pandora sells 73 million charms per year (200,000 per day) and 14.5 million bracelets per year (40,000 per day). Pandora’s brand and leadership position in the charm niche is by far its most important asset.

Durability

The most prevalent risks to the durability of the company are a decline in the popularity of charm bracelets or a

Andrew Kuhn November 27, 2017

Quick Summary of 2 Businesses I’ve Studied Recently

CARS- Cars.com recently completed the spinoff from their parent company Tegna Inc, and started trading as its own publicly traded company on June 1^st. Geoff and I did some research on the company a little over a month ago and we have been watching from the sidelines ever since. Cars.com is a very capital-light, cash flow generative company with a solid brand and one I would say is not going to “go-away” within the next 10 years. This all being said, they operate and compete in a very crowded space and their competitors are spending much more of a % of revenue on marketing than Cars.com is. Geoff and I thought a lot about this and we couldn’t exactly figure out why.

Their Main Competitors Are..

Truecar
CarGurus
Autotrader

From looking at the other competing company websites I would say that Truecar and Cars.com is the best-looking website out of the group. Here is a quick breakdown of their financials where you will see the % of revenue spent on marketing.

	Cars.com	TrueCar	CarGuru

Sales	309.8	157.6	143.3
Cost of sales	-4.7	-13.5	-7.7
Marketing	-109.5	-89.1	-104.6

EBIT	56.2	-13.6	12.2

Marketing % of sales	35%	57%	73%
EBIT Margin	18%	-9%	9%

Management is forecasting revenue to finish down -1% in 2017, which obviously is not too appealing to many investors. This being said, CFO Sheehan has said in an earnings call that they expect the business to grow in 2018. After the spinoff, Cars.com opened at $25.34 and now currently trades at $24.47. The stock probably has not performed well since the spinoff due to the parting gift to Tegna of $650m. But, due to the companies cash flow generative nature, I don’t believe this will be an issue going forward. Also, I believe the stock currently is priced as a “no growth going forward” type of stock. If they can resume to top line growth and continue to produce significant free cash flow, I think if the stock falls back down to the $20 per share area it can make for an interesting investment over the next 2-5 years. This company is on my watch list of a company I would like to own at a future price if given the chance by Mr. Market.

	Market Cap ($Mil)	EV/EBITDA	P/S	EBITDA MARGIN
Cars.com	$1,755	10.1x	1.17	37%
TrueCar	$1,180	N/A	3.43	-5.70%
CarGurus	$2,266	99.4x	10	10.40%
Auto Trader	$4,210	16.3x	10.57	67.80%

Papa John’s

PZZA – I started to get interested in learning more about Papa John’s business because first, I love pizza (who doesn’t?) and second, because I saw in the news that Papa John’s was blaming the NFL on slowing pizza sales, which caused sort of a media frenzy. Although I don’t know if Papa John’s blaming the NFL on slowing pizza sales is a valid claim or an excuse, I’m not exactly sure if the stock is exactly cheap. In addition, Domino’s Pizza is definitely a far …

Andrew Kuhn November 17, 2017

Becoming a Better Investor: Reading One 10k After Another

I’m a big process guy. I believe if you have the correct processes in place and develop the right habits over time, you will succeed in whatever it is that you want to accomplish. Geoff and I get asked all the time a variation of: How do I become a better investor? The answer is simple, but not easy. I would say it really boils down to reading. A lot. Okay okay yes, I know if you are a Buffett / Munger fan you probably already know that. But, what should you read to get better? I believe people waste their time reading too many books on theory, when really, they can become a better investor overtime by reading one 10k after another. Geoff said it best in one of his blog posts when he said: if you’re reading more books than 10ks, you’re doing it all wrong. Truth be told, I once fell into this category. I felt like If I read more investing theory books it would help me overall as an investor. While this is true, I feel like once you have the basics down and a solid rational way of thinking about stocks and the market, from there on out all you will need to do is read and learn about different businesses and practice valuing them. If someone came to me today and asked me how to get started in investing, I would point them in this direction:

While reading books of course is beneficial and fun, I believe if you want to get better as an investor the 6 things I just listed above is all you need to know fundamentally speaking. From there you can proceed to reading 10k’s, which is the main activity that will make you better. As you may or may not know, Geoff and I meet 1-2 times a week. This topic of “how to get better” and “focus” is one that we talk about often and is one of great interest to me. Here is some tough love on how to get better. Stop being so lazy. If you want to get better, then get better. The opportunity is 100% there. I always say we are living in the luckiest time in life because of the technology that’s available to us that allows us to get access to whatever it is we want to learn about. Think about how much that has changed within the last 15-20 years. Being in Dallas, I could have a package shipped to China tomorrow if I wanted to. Technology has changed and gotten better, so we must adapt to get better. Think …

Andrew Kuhn November 10, 2017

Green Brick Partners Q3 Earnings: It’s still cheap…

Green Brick Partners reported earnings this past week on November 6^th. For those of you who don’t know much about the company, here is a summary that Geoff wrote about the company back in September:

“Green Brick Partners is a homebuilder that is split close to evenly between Dallas Fort-Worth (it builds homes in places like Frisco, which is right by where I live in Plano) and Atlanta. I don’t know the Atlanta housing market. But, I do know the Dallas housing market. The stock trades at about 1.1 times book value. However, in the homebuilding industry, land is usually held for 2-5 years from the time a homebuilder buys it to the time they sell the finished house on that land. Land prices in Dallas Fort-Worth have risen, so the fair value of their holdings would actually somewhat exceed 110% of book value – meaning, the market value of the company’s assets is slightly greater than the market cap of the company. They have enough net operating loss carryforwards to not pay taxes for another 3-5 years depending on how much they grow earnings. The decision maker (Jim Brickman) is a good homebuilding guy and has a meaningful personal stake in the company. Together with David Einhorn’s Greenlight capital (about a 50% owner) and Dan Loeb’s Third Point (about a 17% owner) people who are insiders/long-term investors of some kind hold about 75% of Green Brick Partners. So, the float is probably no more than $125 million. The stock was, in recent memory, a speculative ethanol type company that was used as the public entity to take this Einhorn/Brickman homebuilding entity public. In investors’ minds, the company is probably not “seasoned” as much as it’s going to get in the sense that if I say “Green Brick Partners” today – you may not have recognized the name and if you did you may not have immediately remembered it’s a homebuilder and even if you did remember that you still might not have remembered where it builds home (Dallas and Atlanta). It’s underrecognized. If you buy the stock in 2017 and plan to sell it in 2022, you’ll probably be selling a bigger, more recognized stock with a higher price-to-book multiple that is then starting to pay taxes.

A homebuilder is not the kind of stock I’d usually buy. Green Brick isn’t a capital light pure homebuilder like NVR (NVR). Nor is it more of a marketing machine like LGI Homes (LGIH). It’s something that buys up land, holds it for up to five years, puts a house on it, and then sells the land plus the house. There’s no cash flow that doesn’t go back into buying up more land. Everything it does is tied to residential land values where it operates. So, this is purely an investment in residential land in Dallas and Atlanta. However, the combination of UNTAXED (for now) cash flow from homebuilding activities going back into buying additional land plus the annual appreciation …

Andrew Kuhn October 9, 2017

A Few Thoughts on Hostess Brands

“Your premium brand had better be delivering something special, or it’s not going to get the business”

-Warren Buffett

For the past few weeks I have been studying and doing research on Hostess Brands, the maker of the classic chocolate cupcake with the squiggly white frosting line and of course the iconic, golden, cream-filled Twinkie. At first glance, the company passed almost all my filters on my investment checklist for a company I would want to be involved with. They claim to have a 90% brand awareness among people in the United States, they benefit and profit on the nostalgia that their products create within people, they are growing internally at a decent rate and they are run by a very capable management team. Before we can dive into the investment case, let’s go back through the history of the company to better understand how we got to the present.

Hostess 1.0

The first Hostess cupcake was introduced to the public in 1919, followed by the formation of Interstate Baking company and the introduction of Twinkie in 1930. The company progressed with their normal course of business only to later file for Chapter 11 bankruptcy protection in 2004. For those who don’t know, Chapter 11 bankruptcy gives a company time to re-organize their debts and pay them off without having to “go out of business”. Chapter 7 bankruptcy on the other hand, is when a company or individual must sell off their assets to repay debts; in other words, liquidate. In most events the shareholders get wiped out, but I just wanted everyone to know the difference. Although that sounds terrible at first glance, Interstate Bakeries filing for bankruptcy protection was never due to failure of their brand. It was the result of union issues, zero efficiency within the company (stay with me here, I will go into more detail in a bit), high fixed costs and an excessive amount of debt…. A true recipe for disaster within any company. During this time, the company employed a Direct to Store Distribution Model which meant they needed a high number of employees (more than 33,000), tons of trucks to deliver their products frequently due to a 28-day self-life and 57 bakeries around the country to produce fresh products close enough to the stores that they deliver to. All of this compounded together created a company that, although had great products that people loved, had a structure that economically did not make sense. Their operating and labor costs where through the roof which led them to begin the bankruptcy process.

Hostess 2.0

Interstate Bakeries emerged from bankruptcy in 2009 and changes its name to Hostess Brands. The company gets back to its normal course of business to only again file for bankruptcy in 2012. This time, the company files for Chapter 7 and begins of the process of liquidation. Yet again, the result of them filing for bankruptcy was never due to lack of consumer consumption of their products, but more …

Andrew Kuhn October 3, 2017

Psychological Tendencies to Guard Against In Investing

“The first principle is that you must not fool yourself and you are the easiest person to fool”

-Richard Feynman

Do Something Bias, Social Proof and Confirmation Bias… Let’s walk through a theoretical situation where these three powerful Biases can destroy someone in the field of investing:

A new Investment Manager named Benjamin just signed-on a new client for his investment firm and is very excited about it. The new client, let’s call him “Thomas”, rolled over his IRA account of $500,000 and assured Benjamin that there will be more capital behind it if Benjamin performs well. Benjamin automatically feels a sense of pressure to find some ideas to put the cash to work because he does not want to disappoint Thomas, and he also wants to show performance so he can acquire his other assets as well. Benjamin naturally starts to scroll through Twitter, Value Investors Club, Seeking Alpha and wale wisdom – scouring for potential ideas from other “smart investors”. He finds an interesting idea through Value Investors Club and then proceeds to type the ticker into Seeking Alpha to see what other people think about the particular stock. There are a ton of write-ups and almost every single post along with the comments on the thread seem favorable and promising. Benjamin starts to get excited. To compound this feeling of confidence, he also learns that a very well known, astute hedge fund manager has a very large long position in the company. What could go wrong with this investment? He decides to further his “research” and reads the investment presentation that the hedge fund giant created for the company, talking about how wonderful the business is and even comparing it to being the next Berkshire Hathaway. By now, Benjamin feels so confident in the business that he buys a 20% position at $150 per share and rationalizes it to himself that the other smart investors had to have done more research than he ever could do to understand the company, so if they feel confident, than it must be a good investment.

As time goes on, this company continues to roar on and is now at the high price of $250 per share! Benjamin looks like a hero, his clients love him and he feels like he has found a true compounder. October 21 comes along and an investment research firm puts out a very negative piece about Benjamin’s beloved company and compares it to being the next Enron. There is no slight sense of positivity that can come out of a statement like that, and Benjamin deep down knows that. Frozen, he does not know what to do. After all, he realizes he does not know much about the company at all and was only riding the coattails of other smart investors in this investment. The company that he has loved and that has made so much money is now falling by 51% in a single day. Not knowing what to do, he waits …

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