Geoff Gannon – Page 13 – Focused Compounding

Geoff Gannon May 8, 2018

An Illiquid Lunch

To Focused Compounding members:
There are a couple sayings every modern investor and econ student has had drummed into him over and over again. One is: “there’s no such thing as a free lunch.” It sounds like the kind of thing an economist would come up with. Though it’s not. In the 1970s, an economics writer (Milton Friedman) took the saying from a science fiction writer (Robert Heinlein) who had – in the 1960s – simply transplanted an old 1940s saying to the moon. The actual marketing ploy of giving a free lunch dates back to 1800s America. Some bars in the U.S. offered a free lunch to new customers as a loss leader to drive sales of booze. The marketing ploy has long been forgotten. But, modern economists have embraced the saying, with Gregory Mankiw – in a textbook that has, no doubt, earned him tens of millions of dollars in royalties – describing the principle as: “To get one thing that we like, we usually have to give up another thing that we like. Making decisions requires trading off one goal against another.” That’s not as catchy as saying “there’s no such thing as a free lunch.” But, it’s a lot more honest. Because, there is – of course – such a thing as a free lunch. It’s called trade. Two centuries back, David Ricardo explained comparative advantage, a concept which basically boils down to the maxim that: “if two parties can trade with each other, it’s best for each party to focus on the thing they themselves do best.” The thing you should train yourself to get best at is learning to hold illiquid stocks. I know of no simpler way to improve your lifetime rate of compounding than to accept lower liquidity in exchange for higher returns. Lucky for you, there’s always someone willing to take the other side of that trade. In a 1990s episode of a series in the Star Trek franchise, a character from a very capitalistic species of alien traders explains his people’s belief that:

“…there are millions upon millions of worlds in the universe, each one filled with too much of one thing and not enough of another. And the Great Continuum flows through them all, like a mighty river, from ‘have’ to ‘want’ and back again. And if we navigate the Continuum with skill and grace, our ship will be filled with everything our hearts desire.”

Well, there are millions upon millions of traders out there looking to buy and sell many of the same stocks you are looking to buy and sell. And the one thing they all want – and you’ve got – is liquidity. Like the case for trade, the case for investing in illiquid stocks is backed up by the historical record. Those of you who follow me on Twitter (@GeoffGannon) saw me retweet a table of historical returns from the 1970s through today which showed that even within each market cap size – …

Geoff Gannon May 6, 2018

The Urgent and the Important

Tuesday, May 1st – North American Energy Partners by Alex Middleton
Wednesday, May 2nd – Entercom Communications by Vetle Forsland
To Focused Compounding members:
This is the time of year when value investors flock to Omaha and come the closest to being a religious sect. It’s a good time to think about both what value investors preach and what value investors practice. The day-to-day practical work of investing that becomes habitual to you is what matters most. This is what you should care most about shaping. And yet it is the thing that is least likely to become memetic.

What spreads – copied from one person’s mind to another’s to another’s – are things like quotes. I use quotes in this memo each week. And Warren Buffett certainly quotes others a lot when presenting a concept. It’s a lot easier to spread a quote around – online or offline – than to spread around a habit. I’ve talked before about the importance of reading a 10-K a day. It is important. But, I don’t know how to make that concept something that is easy to spread. A soundbite is easy to spread.
This is the time of year when value investing ideas spread fast. You now have video of Warren Buffett and Charlie Munger at the annual meeting. You have video of Warren Buffett on CNBC. You have transcripts. You have soundbites. And you have those transcripts and soundbites broken down into quotes the length of a tweet that can be re-tweeted again and again. We’ve had all that before. What’s new this year?

CNBC’s “Warren Buffett Archive”. CNBC describes this archive as:
• 25 annual meetings, going back to 1994, with a highlight reel for each year
• 130 hours of searchable video, synchronized to 2,600 pages of transcripts
• 500 video clips covering scores of subjects

Now, there is a lot to learn from Warren Buffett. But, I recently recorded an interview with Andrew where I said that although I often call “You Can Be a Stock Market Genius” the best investing book out there – there is a second contender. And that second contender is the “book” made up of the chapters of Alice Schroeder’s biography of Warren Buffett, “The Snowball”, that discuss Buffett’s investing life in the 1950s, 1960s, and 1970s. And as I listened to Buffett’s annual meeting preamble where he talked about how he and Charlie Munger would probably get a lot of questions about current events instead of the truly long view – I started to think about whether I really thought someone’s time would be better spent watching that annual meeting Q&A or re-reading those chapters of “The Snowball”.

The annual meeting seems more important because it is more urgent. It is happening now. It’s news.
But how important is news to investors? Over time, I’ve come to believe news isn’t something that investors should seek out. Not because news isn’t important. But because news will be served up to you on …

Geoff Gannon May 2, 2018

Entercom Communcations (ETM): The Second Largest Radio Station Owner in the U.S. Trades at a Lower EV/EBITDA Than its Debt Laden Peers

Member write-up by Vetle Forsland

Introduction

Entercom Communications (ETM) is an American radio company founded in 1968 by the Chairman Emeritus Joseph Field. He alone represents 21.8% of the total voting power, while his son, CEO David Field, represents an additional 6.2% of the voting power. For years, Entercom operated as a top five radio broadcaster. In the fall of 2017, when they acquired the much larger CBS Radio through a Reverse Morris Trust merger, ETM became the second largest radio broadcasting company in the US.

A special situation always interests me, and this particular merger was interesting primarily for one reason: the former CBS shareholders would own 72% of the new ETM stock. Since the former CBS shareholder never actively sought out a position in Entercom, many shareholders would be pressured to sell their stock, which explains why ETM has dropped from about $12.20 per share to $10.50 today. In my opinion, the stock trades at a significant discount to its fair value, as the market believes the recent struggles of several radio companies have been caused by a bleak radio industry, although the real reason has been over-leverage and poor management.

Business overview – is radio dying?

Entercom operates 235 stations in the mid-and-top tier cities of the US. They reach over 100 million monthly listeners, and generate revenue from the sale of broadcast time to advertisers. They sell ad time to local, regional and national advertisers. The largest portion of revenues comes from local, in which each station’s local staff generate ad sales, while the rest is handled on a national basis. Radio is a capital-light business, which is mirrored in their 5-year average EBITDA margin of 25.1%. It is also very asset-light, as 75% of their assets come in form of licenses and goodwill. Furthermore, the company is the second largest podcaster in the market, owns Radio.com (a website for music news) and generates revenue from organizing festivals, concerts and other live events.

Since they get almost all of their revenues from radio broadcasting, the prime concern is whether or not radio will stay intact over the next decades. At a first glance, it might sound like a dying medium in a world of Spotify and YouTube, but research completed by reputable firms shows the opposite. For instance, research conducted by Nielsen, a company with 44,000 employees, show that radio reaches more Americans each week than any other platform. Radio reaches well over 90% of the US population, compared to just ~85% for smartphones and the same for television. Furthermore, the amount of weekly listeners has increased over the past three years and ten years.

Radio also offers a high return on capital for advertisers, as compared to other mediums. Procter & Gamble recently stated that they are spending “more and more” on radio advertising and declared a $100 million investment in digital ads “largely ineffective”. It wouldn’t surprise me if other major companies will mirror the actions of Procter, which …

Geoff Gannon April 29, 2018

The Second Side of Focus

To Focused Compounding members:
Back in 1991, Warren Buffett and Bill Gates were asked the same question. What one word described
how they became successful. Both men said “focus”. Most investors I talk to understand the importance
of focus. But, they understand it wrong. They think that Buffett and Gates mean they applied
themselves longer, harder, and in a more disciplined way to a particular task. This is the focus means
more school of thought. It’s half the story. There is a second side to focus.

Warren Buffett’s biographer, Alice Schroeder said this of Buffett: “…he expends a lot of energy checking
out details and ferreting out nuggets of information, way beyond the balance sheet. He would go back
and look at the company’s history in depth for decades. He used to pay people to attend shareholder
meetings and ask questions for him. He checked out the personal lives of people who ran companies he
invested in. He wanted to know about their financial status, their personal habits, what motivated them.
He behaves like an investigative journalist. All this stuff about flipping through Moody’s Manuals picking
stocks, it was a screen for him – but he didn’t stop there.” That’s the kind of focus investors imagine.
Hard work. But, there is another way to look at what Alice Schroeder said there. Focus means doing
more about less. But, focus also means doing less about more. Alice Schroeder did a Reddit interview
where she talked about Buffett’s approach to time management: “Warren is a master of time
management. He knows how to ease people off the phone without making them feel dismissed. He is
great at saying no…he manages his energy, reading when it’s optimal, talking on the phone when he’s
got the right energy for that and so forth… he does not multitask through his day.”

The question then is why others don’t do what Buffett has done. Why don’t they focus as much? Is it the
first side of focus: the hard work, the deep dive into one specific subject? Or is it the second side of
focus: denying yourself the possibility of knowing a lot of subjects superficially. This comes up whenever
I talk about specializing in some specific type of stocks. Recently, I gave this advice to two different
people. I said here is a list of categories of stocks that “work”. They tend to get overlooked. So, instead
of sifting through all the public companies out there – start by limiting yourself to stocks that are spinoffs
or have spun something off, that are OTC stocks, that are illiquid, that have just come out of
bankruptcy, etc. The reaction from both people was: “Eh. Why restrict myself? Maybe I’ll have a great
idea that doesn’t fit into any of these arbitrary boxes.” And they probably will. Odds are that the very
best investment opportunity out there right now isn’t in any of those arbitrary little boxes. But, you
don’t need the very best investment idea out …

Geoff Gannon April 22, 2018

Patience as a Process

Friday, April 20th – Vestas Wind Systems by Kevin Wilde
To Focused Compounding members:
Andrew and I recorded four podcast episodes this past Friday. One of them was a Q&A podcast where the question was about patience: “Would love to hear your general thoughts about what I consider the greatest investment virtue of them all: patience. How do you think about it and how do you approach it practically? Can it be cultivated?” We didn’t give this question the time I think it deserved on the podcast. So, I’d like to give it a little extra time here in the Sunday morning memo.

Patience is a process. Warren Buffett has a quote he cites so frequently that some people think he’s the originator of the phrase: “The chains of habit are too light to be felt until they are too heavy to be broken.” Each day – as you are using your phone and your computer – you are re-wiring your brain. You are forming the habits of exactly how (and how often) you check your stock quotes and place your trades. You are forming reading habits. When online: do you read things word-for-word or do you skim? Do you decide what to read ahead of time, or do you let reading material come to you throughout the day? None of these things are sins. But they are all habits that must be unlearned if you ever – even just once – want to force yourself to do the exact opposite. If you spend every day of your online life skimming paragraphs, it will take you extra effort to read a 10-K word for word compared to someone whose brain has been wired – through daily training – to read every word of every paragraph he encounters. He won’t feel an urge to skim. You will. It takes a lot of willpower to regularly resist an urge. So, don’t. Don’t resist urges. Instead use what precious little willpower you have to shift your habits from unhelpful ones to helpful ones.

A habit is just a process you practice every day. To change your habits, change your process. Stop using an online broker. Stop placing your own trades. I call an actual human being on the phone and place all my trades that way. This one change will cause a dramatic drop-off in your turnover rate. Trading today is so cheap and easy that it seems costless. The cost is patience. In an earlier era, there were big costs and big inconveniences in trading stocks. A desire to avoid those visible costs inadvertently caused investors to avoid the invisible cost: a habitual erosion of their patience. Every trade you place makes you more likely to place another trade in the future. Cultivating patience is about cultivating inaction. It’s about building up intellectual inertia. An impatient investor acts quickly based on a small amount of analysis that supports a barely decisive conclusion. A patient investor acts slowly based on a large amount …

Geoff Gannon April 15, 2018

Fear, Greed, and Boredom

Sunday, April 15th – Computer Services, Inc. (CSVI) by Jayden Preston
Sunday, April 15th – AutoNation (AN) by Dave Rottman
To Focused Compounding members:
In a recent interview, I said: “Stocks bounce around due to fear, greed, and boredom. You can make a lot of money being greedy when others are fearful. But, you can make at least as much money being bored when others refuse to be bored. There are a lot of boring stocks in the OTC market. They’re not cheap because people are afraid of them. They’re cheap because the people who own them are tired of them always being cheap…In listed stocks, you get bargains when people are scared. In OTC stocks, you get bargains when people are bored.” There are, of course, even some listed stocks that investors get bored with. Andrew and I just did a podcast about one such stock: Tandy Leather Factory (TLF). Tandy is a microcap. But, it’s not so illiquid as to be “uninvestable” for most individuals. An individual who decides not to invest in Tandy can’t really make the argument that illiquidity is the culprit. So, what is? For most people, I think it’s boredom. Some stocks just bore people even when they’re good businesses selling at a good price. Tandy is one example. It dominates leathercrafting retail in the U.S. It has a professional investment manager as its Chairman (Jeff Gramm’s Bandera Partners owns 31% of the stock) and it has a deal with a bank to borrow quite a bit of money to buy back quite a bit of its stock should the board decide to do so. So, Tandy checks the Warren Buffett boxes of wide moat and rational capital allocation. And yet it trades at maybe 1.2 times book value, maybe 1.5 times net current assets, and maybe 5 to 6 times EBITDA. Those levels aren’t quite cheap enough to attract deep value investors. But, the company’s competitive position is far stronger than any stock a deep value investor would get the chance to buy. Breeze-Eastern (this is the helicopter rescue hoist maker Andrew and I did a “post-mortem” episode about) falls into this same “boring” hidden champion group. No one I mentioned the idea to ever thought it was a bad stock to buy. But, I also never heard anyone say it was their favorite idea. It was a solid idea they weren’t in any great hurry to go out and buy. It was boring. Boring stocks do remarkably well. The best screens I can create for small, illiquid, consistently profitable stocks always have the same pattern in their back tests: as the screen’s alpha rises, its beta falls. You’ll find that a good, solid screen – like a low price relative to net current assets and a long history of profitability (in other words, something that picks stocks like Tandy) – will tend to have both less volatility and higher returns than a screen that focuses on even cheaper, even more exciting (that …

Geoff Gannon April 15, 2018

AutoNation (AN)

I’m creating this thread to start discussion of AutoNation (AN). The stock was written up by Dave Rottman here:

https://focusedcompounding.com/autonation-an-a-cheap-cannibal-with-minimal-downside/

It’s a nearly 6,000 word article. So, I wanted to focus in on one specific point (mentioned in the title). AutoNation is a “cannibal” as Charlie Munger would say. It eats its own shares up. I thought a table might help.

Shares Outstanding

1998: 471 million

2003: 287 million

2008: 178 million

2013: 123 million

Today: 92 million

Anyway, this is the place to ask Dave questions about AutoNation, to discuss the stock amongst yourselves, etc. Please do so below.…

Geoff Gannon April 15, 2018

Computer Services Inc., “CSI” (CSVI)

This is the core processor stock that was just written up by Jayden Preston:

https://focusedcompounding.com/computer-services-inc-csvi-an-unlisted-but-super-predictable-company-trading-at-an-unleveraged-p-e-of-15-times-next-years-earnings/

I also spent the better part of today’s Sunday Morning Memo on CSVI. You can find that memo entitled “Fear, Greed, and Boredom” here:

https://focusedcompounding.com/memos/

Since CSVI doesn’t file with the SEC, it’s not on EDGAR. For that reason, I thought I should include links to the specific pages where you can find “EDGAR-like” information on the company.

The company’s “Disclosures” page over at OTCMarkets.com has annual reports going as far back as 2006 (filed in 2007, covering the year 2006):

https://www.otcmarkets.com/stock/CSVI/disclosure

CSI always includes a “Selected Financial Data” table in the annual report that goes back a full 10 years. So, the 2006 annual report has data going back to 1996.

The company also has an investor relations page that includes financial data in other summary forms:

https://www.csiweb.com/investor-relations

I don’t know if I’ve mentioned this before, but I always read a company’s Glassdoor page as well. This is a site that includes employee reviews. CSI has a lot of reviews on its Glassdoor page. So, you might want to check it out in this case. I usually read the reviews more to get a sense of what the company actually does day-to-day, what incentives are like for lower-level employees especially those that deal with customers, etc. than because I prefer companies with higher reviews from employees or something like that.

I’ll summarize the reviews in general here by saying this company doesn’t have very high base pay, it does have benefits, it doesn’t have very high employee churn, and management cares about hitting profit targets (and probably the stock price). Employees also mentioned something that had been disclosed in a press release:

“..non-executive full-time employees with the company more than 12 months will receive a one-time $1,300 cash bonus in March. Part-time and other employees with the company less than 12 months will receive a one-time cash bonus of $650 also in March. The company also stated that all eligible employees will receive an additional one-time contribution to their retirement plan.”

This is due to the tax savings that Jayden mentioned in his article.

Anyway, this is the thread to use to ask me questions about CSI, to ask Jayden questions about CSI, to give your thoughts, etc. Please do so below.…

Geoff Gannon April 15, 2018

AutoNation (AN): A Cheap Cannibal with Minimal Downside

Member write-up by Dave Rottman

Introduction and Overview

AutoNation (AN) is the largest automotive retailer of new and used vehicles in the United States. As of the end of 2017, they owned and operated 360 new vehicle franchises with 33 different new vehicle brands through 253 dealership locations concentrated in major metropolitan areas primarily in the southern Sunbelt region. AutoNation also owned and operated 76 collision centers scattered throughout the continental US.

Prior to 1999, AutoNation was named Republic Industries and was involved in waste management and then later electronic security services, vehicle rentals, and automotive retailing. Since the turn of the century, AutoNation has been focused exclusively on the automotive retail business.

Despite changing conditions in the coming years with the advent of online automotive retailers, autonomous vehicles, increased ride sharing, and electric vehicles, AutoNation offers investors several attractive characteristics.

First, as the largest automotive retailer in the United States, AutoNation enjoys benefits of scale both in terms of lower general and administrative overhead and in volume discounts when purchasing parts for the repair business and even inventory from manufacturers. As the automotive retail industry continues to undergo consolidation into a less fragmented market, these benefits are likely to amplify and strengthen the competition position of those players with scale, like AutoNation.

Next, the business generates a large and noncyclical stream of cash flow related to its parts and service business that has increasingly become a larger portion of earnings. While new and used car sales and the associated finance and insurance revenues are cyclical, parts and service earnings have provided a stable base of cash flow. In addition to stabilizing the cash flow of the overall business, this has also allowed AutoNation to consistently funnel cash into stock buybacks when shares prices are attractive, leading to a 5, 10, and 15 year growth rates of approximately 10% in earnings per share. This is impressive considering that the sales volume of actual new and used vehicles has essentially been flat over the course of the cycle.

Further, AutoNation holds a large amount of attractive real estate that provides a meaningful asset-based value that can be sold as a next-best use that supports valuations if earnings power were to become impaired or if/when AutoNation decides to decrease its physical presence.

Finally, and more speculatively, in late 2017 AutoNation announced a partnership with Waymo – Google’s autonomous vehicle company – where AutoNation will maintain and repair Waymo’s autonomous fleets. While the actual value this will provide to AutoNation is extremely uncertain at this point, it does serve as an offsetting factor to the risks posed by increased use of autonomous vehicles and ride sharing by hitching AutoNation up to the dominant player in autonomous vehicles in the nascent stages of this development.

The Business

There are four parts to AutoNation’s business: new vehicle sales, used vehicle sales, parts and service (P&S), and finance and insurance (F&I).

New and used vehicle sales are straightforward: generally speaking AutoNation purchases new vehicles from …

Geoff Gannon April 15, 2018

Computer Services Inc. (CSVI): An Unlisted, But Super Predictable Company Trading at an Unleveraged P/E of 15 times Next Year’s Earnings

Member write-up by Jayden Preston

Introduction

Computer Services Inc (often called “CSI”, the ticker is CSVI) is an unlisted stock in the US. It does not file with the SEC. But it does trade over the counter. The Company also publishes annual reports and quarterly earnings reports. You can find more information about the Company on OTCmarket.com.

As you would expect from an unlisted company, their annual report is not as extensive as you would find in a 10K. However, there are financial figures of the Company going back to 1996. There are also three main comparable companies that are listed. So, you can gather enough information to make an educated judgement on the Company.

CSI provides service and information technology solutions to meet the business needs of financial institutions and corporate entities. Their main clients include community banks, regional banks, multi-bank holding companies and a variety of other enterprises. They emphasize that their services are tailor-made to the clients’ needs.

The Company categories their revenue sources into two major parts: 1) core processing and 2) integrated banking solutions. Below I quote from the annual report on the range of services they offer:

“We derive our revenues from processing services, maintenance, and support fees; software licensing and installation fees; professional services; and equipment and supply sales. In addition to core processing, our integrated banking solutions include digital banking; check imaging; cash management; branch and merchant capture; print and mail, and electronic document delivery services; corporate intranets; secure web hosting; e-messaging; teller and platform services; ATM and debit card services and support; payments solutions; risk assessment; network management; cloud-based managed services; and compliance software and services for regulatory compliance, homeland security, anti-money laundering, and fraud prevention.”

As you can see, their solutions cover a very wide range of operational needs of financial institutions. They are almost like an outsourced IT department for financial institutions, with many functions they provide being highly critical.

Within the bank core processing industry, CSI is a distant fourth player, with a market share of 6.6% in 2017. The biggest player is Fiserv, with 37.1% of the market. The next two players are Jack Henry and FIS, with market share at 17.6% and 16.6% respectively.

Durability

For the business of core processing and other bank IT services to be durable, two key conditions are needed: 1) Financial institutions, such as banks and credit unions, remain durable and 2) Outsourced solutions continue to be an option.

Historically, banks are some of the most durable businesses. Now, with cryptocurrencies being all the rage, there are people who will question whether banks will remain durable. That is too big a topic to discuss in full here. But in short, my personal thought is it is too speculative to believe bitcoins will take over the whole banking industry. A more reasonable scenario to me is the blockchain technology will be incorporated within the current banking system instead.

As …

Posts By: Geoff Gannon