Posts By: Geoff Gannon

Pendrell (PCOA): A Company with Cash, a Tax Asset, and Almost No Liabilities

Pendrell is essentially a non-operating company with two assets: cash and net operating loss carryforwards. The cash appears on the balance sheet. The net operating loss carryforwards do not.

The most recent balance sheet is dated December 31^st, 2017. It is found in the 10-K. Total liabilities are $9 million while accounts receivable are $17 million. Since accounts receivable alone can cover all liabilities – I’ll assume that all cash is surplus cash.

Cash is $184 million. The company has 242,769 shares outstanding (there are both “A” and “B” shares). That means cash is about $758 a share. Let’s call it $750 a share in cash. As I write this, the stock is trading at $645 a share. So, let’s call that $650 a share.

Let’s try to simplify the situation.

The stock price is about $650. The net cash is about $750 a share. So, if you buy the stock you are more than 100% covered by cash. Liabilities are almost nothing. And there’s no cash burn. So, you’re getting more in cash than you’re putting into the stock. That’s your downside protection.

Where’s the upside?

The company’s net operating loss carryforwards are not listed on the balance sheet. There is a legitimate accounting reason for this. However, the accounting treatment doesn’t reflect economic reality. Let me explain.

Pendrell presents a table (in a note in its 10-K) that shows the net operating loss carryforwards would be $625 million (this includes California) but then shows a “valuation allowance” for the full amount. This means the company has this tax asset on the books for zero dollars.

Why?

The company is taking an allowance for the full amount, because there is nothing in its past history or current operations that would suggest it can use these net operating loss carryforwards. Here’s the quote:

“For all years presented, the Company has considered all available evidence, including the history of tax losses and the uncertainty around future taxable income.  Based on the weight of the evidence available at December 31, 2017, a valuation allowance has been recorded to reduce the value of the Company’s deferred tax assets, including the deferred tax assets associated with the NOLs, to an amount that is more likely than not to be realized.”

That amount is essentially zero.

And that’s the right way to account for the net operating loss carryforwards. However, it’s not the right way for an investor to look at their value. How should we look at their value?

Pendrell has federal and state (California) net operating loss carryforwards.

 

California Net Operating Loss Carryforwards

The state net operating loss carryforwards are for past losses of $1.3 billion suffered in California. They begin to expire in 2028. I’ll just assume these state net operating loss carryforwards are worthless.

 

Federal Net Operating Loss Carryforwards

These net operating loss carryforwards begin to expire in 2025 with “a significant portion” expiring in 2032. Pendrell has $2.5 billion in federal net operating loss …

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Booking Holdings (BKNG): A Fast Growing Industry Leader Built on Network Effects and a Strong Brand

 

Write-up by Mister Compounder

 

Summary

 

• Asset light business model, with infinite return on capital, that requires little capital to grow enabling the use of cash flow for other purposes.
• Booking is currently trading at a free cash flow yield of 3.6%, before acquisitions and including adjustments for dilution of 1%
• The risks involve pricey valuation, overpaying for acquisitions in M&A deals, young industry and risks of increasing competition due to the attractive economics of the industry.

 

Overview

 

Booking Holdings (formerly Priceline) was founded in 1997 by Jay Walker and was listed in 1999. He later left the company in 2000. Since its inception, Booking has not split their stock, so the company today trades at more than $2,000 dollars a share. It wasn´t until recently that the company changed the name to Booking Holdings.

 

According to the current CEO, Glen Fogel, the reason was:

“We want to have a name aligned with all the different things that we do. We are now doing things that enable people to book hotels, homes, apartments, rental cars, flights, dinner reservations. Booking Holdings unifies all of these different things.”

The easiest way to think about Booking is to think of it as a distributor of inventory of hotels and airlines. Through acquisitions of meta search sites like Kayak and Momondo, they have developed into something like an online travel retailer. These acquisitions were a consequence of the emergence of the meta search sites. Meta search sites are price comparison websites, matching prices of different OTAs (Online Travel Agencies) and in this way challenged the business models of the traditional OTAs. Today, the international online travel market is really considered a travel duopoly, dominated by Booking Holdings and Expedia. These two companies are really holding companies for owning other brands.

There are some differences in the business models, though, where Expedia is more exposed to flight tickets and the merchant model, while Booking is more exposed to hotel rooms and the agency model. I’ll touch more on this topic later in the article, but if you want a nice, brief introduction to the business model, I can recommend this article on Business Insider.

 

Even though Booking Holdings consists of several brands, the company today is really all about Booking.com which is close to 90% of gross profit. In addition, Booking also has brands like Kayak, Rental Cars, OpenTable and Momondo (which they acquired last year). Booking in total has more than 1.5 million properties in more than 220 countries. Today, Booking Holdings as a company generates more than $12 billion in sales and $10 billion in gross profit. Approximately $9 billion of that gross profit is generated from Booking.com.

 

Booking has three types of revenue sources:

 

• agency revenues at approximately 76% of revenues
• merchant revenues at 17% of revenues
• advertising and other revenues at close to 7% of revenues

 

Agency revenues consists of the commission rate that Booking can take in bookings …

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General Electric (GE): Step Zero – Will We Ever Be Able to Value This Thing?

I apologize in advance for the disorganized and inconclusive nature of this write-up. By this point, I’ve read a little about GE. It’s a stock many of you have said you’d like to hear about. And yet, I’m not sure I have anything worthwhile to say about it quite yet. This piece is the best I can do for now.

So, this isn’t even an “initial interest” post. This isn’t step one of my analysis of GE. This is step zero. The company is that difficult to understand, value, and analyze. I’m writing this piece about GE now to sort of lay out what I would need to know later to be able to start analyzing this thing.

In preparation for this piece: I read GE’s shareholder letter, 10-K, the most recent earnings call transcript, and an investor presentation.

Of those: the shareholder letter is the easiest read. So, I recommend you read it now.

 

GE’s Letter to Shareholders

I’m going to walk you through the notes I took while reading this letter.

“While most of our businesses delivered solid – and in the case of Aviation and Healthcare, world-class – performances, our cash flow was challenging.”

This is our first hint that I’m not going to be able to value this thing. As an investor, I tend to limit myself to free cash flow generating businesses. It’s not real clear GE generates a lot of free cash flow. And the difference between free cash flow and reported earnings in some of the businesses GE is in – like power, aviation, and transportation – can be big. Power and aviation are two of GE’s biggest businesses and they involve the sale (usually financed) of extremely long-lived equipment. I’m ignorant of most of the businesses GE competes in. But, I have researched a couple companies related to GE’s power business: the combined Babcock & Wilcox (see the “report” section of Focused Compounding) and Aggreko. Aggreko is a stock I’ve never written about. But, I have researched it. As part of my research into Aggreko, I actually looked at a competitor that was renting out GE turbines as a source of temporary, mobile power. I don’t mean to suggest these businesses are true peers. For example, the core competency at Babcock was working with steam. GE’s power business is like 95% not steam. But, there are some similarities. And the point I’m trying to get to here is that the cash profitability of these customer relationships can be really uneven in terms of timing. You can make nothing upfront and then have very high cash profits on maintenance work you do many years later. The important figure to focus on is the lifetime value of the customer in terms of something like a DCF. Whether GE is focusing on that or not is kind of tough to tell from the 10-K. And it’s extra complicated in the case of GE, because there’s sometimes also the involvement of GE Capital. The …

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j2 Global (JCOM): Half Cloud, Half Digital Media and All About Acquisitions

Guest write-up by Jayden Preston

 

 

Introduction

 

j2 Global brands itself as an Internet service company. At its core, the company’s goal is to participate in the monetization of the shift from analog to digital. They do so in two business segments: 1) Business Cloud Services and 2) Digital Media.

 

Business Cloud Services (BCS)

 

The main business here is providing businesses of all sizes with cloud services that meet their communication, messaging, security, data backup, hosting, customer relationship management and other needs. At the moment, the biggest value drivers are their fax and voice products, including eFax, an online fax services that enable users to receive and send faxes over the Internet; and eVoice, which provides their customers a virtue phone system. These are the original businesses of the Company and are called number-based businesses.

 

In more recent years, j2 has also built up their non-number-based businesses within their BCS portfolio. This group includes KeepItSale, a cloud backup solution; FuseMail, which provides email encryption solutions; and CampaignerCRM, a customer relationship management tool.

 

The above group of service offerings all have a subscription business model, where the lion’s share of revenue is derived from “fixed” subscription fee from basic customer subscription, with the rest from “variable” usage fees generated from actual usage of services by customers.

 

j2 Global also generates revenue from licensing their intellectual properties to third parties. However, historically this revenue source has been minimal, around 1% to 2% of segment revenue from BCS. We will thus neglect this in our following discussion.

 

Digital Media (DM)

 

Their DM segment consists of the web properties and business operations of Ziff Davis, the physical-magazine-turned-digital publisher that j2 Global purchased in 2012 for $167 million. j2 Global bought the company from private equity firm, Great Hill Partners, with the intention of providing more capital so that Ziff Davis can continue to execute its business plan of building a multi-vertical online publisher that earns revenue from video ads affiliate links, demand generation and data licensing. This is exactly what happened in the subsequent 5 years.

 

Since the acquisition, Ziff Davis has gone on an acquisition spree, spending nearly $1 billion to expand their web property portfolio. Major properties now include PCMag.com, IGN.com, Speedtest.net, AskMen.com, Everyday Health and Mashable. Revenue of Ziff Davis increased from around $50 million in 2012 to $539 million in 2017, with revenue sources from advertising and sponsorships, subscription and usage fees, performance marketing and licensing fees.

 

During 2016, their DM web properties attracted 5 billion of visits and 18.1 billion page views, up from 345 million visits and 1.1 billion page views in 2012.

 

 

Durability

 

Business Cloud Services

 

Durability of the BCS segment mainly rests on whether eFax will still be needed in the future. In 2016, fax-to-email revenue constituted 35% of the Company’s consolidated revenue, or 54% of the Business Cloud segment.

 

The modern fax machine was introduced in the US in 1964. Since …

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U.S. Lime (USLM): A High Longevity Stock in a Low Competition Industry

This is the second article in my new approach to writing for Focused Compounding each week. I will give you a look into my initial thoughts on a stock that I may then research further. At the end of this article, I will tell you my interest level (0% means there’s no chance I will follow-up with additional research on this stock; 100% means it’s already at the top of my research pipeline). This is my first article on U.S. Lime & Minerals (USLM). So, the question I have to answer here is not “should I buy the stock”, “what is the stock worth”, etc. Right now, the question is simply: should I research USLM further.

Charlie Munger is a fan of flipping how you frame a problem by “inverting”. If everyone is looking at a problem the same way – maybe looking at it upside down will give you a different but equally correct way of seeing things. Today, I’m going to “invert” the problem of finding a company with a high return on capital. Actually, what matters for us investors is a company’s incremental return on capital while we own it. What the stock earned on its capital before we invested in it and what it earns after we sell the stock isn’t what we care about. We care about the return on money put to work while we own the stock.

That’s a more difficult question to answer, though. So, let’s just start by asking if we think U.S. Lime will can earn an adequate unleveraged return on equity for a long-time into the future. Here, I am focusing on the “long-time into the future” part.

First, a confession. I personally don’t think in terms of return on equity when making my own investing decisions. Instead, I always “invert” ROE. I think of capital not as something you earn a return on but something which is a bit of a “tax” on growth. The reason I wrote about a stock like NIC (EGOV) is that if it does grow – that growth will have a very low owner’s equity tax. Maybe the stock will grow and maybe it won’t. But, if it does grow, it isn’t going to need to retain earnings to do it.

With a commodity like lime, it’s possible that the “inflation” part of any growth won’t require much capital investment. If you already own plenty of lime deposits, then it shouldn’t cost you much more to produce the same tons of lime each year – and yet, if the dollar gets 3% less valuable each year, you may be able to charge 3% more for your same quantity of lime produced.

This is the aspect of a commodity producer that’s attractive. There are other less attractive aspects to commodity producers that often make me shy away from them. But, maybe we’ll learn lime doesn’t share those qualities.

My interest in U.S. Lime is a little odd. On the one hand – as …

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Babcock & Wilcox Enterprises (BW): A Risky Stock Getting Activist Attention

I’m trying something different this week. In an effort to share more ideas with members, I’ve decided I’ll write about whatever stock I’m looking at – even if I don’t like what I see. This will give you some insight into my stock selection process at the earliest stages. It will also let me give you more regular, stock-specific content. The downside, of course, is that it’s risky. I’m risking getting you interested in a stock you shouldn’t be interested in. So, I’ll rate the initial stock ideas I write up here with an interest level (from zero to ten) at the end of the article.

This week I’m writing about Babcock & Wilcox Enterprises (BW). I once owned this stock, because I bought the pre spin-off Babcock & Wilcox and kept my shares of BWX Technologies (BWXT) through to today. I sold my shares of Babcock & Wilcox Enterprises about 11 months ago at $15.48 a share.

Where is the stock today?

It’s at $5.80 a share.

Your first step in researching Babcock & Wilcox Enterprises should be to read the old report on Babcock & Wilcox in the “reports” section of this website. That report describes what would become BWXT and BW in great detail. I’m not going to spend time here discussing what it is that Babcock does, because you have a report available to you that describes that in greater detail than probably any public information on Babcock that’s out there.

However, that report describes what those businesses looked like as of about two and a half years ago.

Some things have changed since then with BW.

Let’s start with the recent news items that might get a value investor interested in the stock. The company has attracted two major investors.

One is Vintage Capital Management. It owns 14.9% of the company and now has two board seats. You can read Babcock’s announcement of the deal with Vintage here. You can also visit Vintage’s website for yourself and see what other companies are in their portfolio.

The second – and more recent – investor in Babcock is one you’re more likely to have heard of: Steel Partners.

The details I’m going to give you now come from Steel Partners’ 13D on Babcock filed February 5^th. Steel Partners owns 11.8% of Babcock & Wilcox shares. These shares were bought between January 26^th and February 5^th at prices between $5.99 and $6.58. The stock now trades at $5.80. So, you can get your shares a bit cheaper than Steel Partners got their shares. That’s one reason for writing this up obviously.

Another reason is that the stock trades at $5.80 a share and Steel Partners apparently wanted to buy all of Babcock for $6 a share. This quote is from the 13D:

“On December 15, 2017, Steel Holdings made a proposal to the Issuer to acquire all of the Shares not owned by Steel Holdings or its subsidiaries for $6.00 …

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NIC (EGOV): Loses Its Biggest Customer (Texas) – Stock Drops 20% Instantly

As I write this, NIC (EGOV) stock is down 20% for the day. For potential buyers of the stock, there have been two developments in the last 24 hours. One, EGOV announced it lost the Texas dot org portal. It is still in the running for payment processing on behalf of the state. Texas, as a whole, accounted for 20% of EGOV’s revenue. It may have accounted for even more than 20% of the company’s profits. Two, shares of EGOV are now down 20% in price. EGOV has no debt and has some net cash. So, a 20% decline in the stock price is equivalent to a 20% re-pricing of the entire business’s value. Right now, I can’t say that one of these events is clearly outsized versus the other. So, I can’t say that the news of the last day should make you much more or much less inclined to buy the stock. That’s because the loss of Texas is a big loss for the business. However, we already knew: 1) That any business EGOV has could be lost and 2) That any re-bid for something like Texas could be done at a lower level. So, the expected probability of losing Texas wasn’t 0% before yesterday. And yet the stock dropped by almost 20% when the company announced it has lost revenue of about 20% of the total company. You see how the similar scale of the two items – the loss of a profitable business and the reduction in the stock’s price – make it difficult to say whether the stock has become a lot more or a lot less attractive.

So, I would caution those who say this clearly is a buying opportunity or this clearly is the moment to bail out on the stock – right now, I don’t see this moment being either of those things.

What do I see?

There were some other points discussed in the earnings release and the earnings call transcript. You can read the full transcript at Seeking Alpha.

1. Same-state revenue growth in interactive government services continues to be excellent and management continues to expect it to keep being excellent. Interactive government services – these exclude driver history records – were up 11% for all of 2017. As discussed a little in the article I wrote on EGOV and even more in the comments to that article, a fast rate of growth in same-state interactive government services means EGOV will be less reliant on car related revenue and may even be able to grow its overall business even if it can’t win more state contracts and keeps losing some contracts.
2. The information (really “guidance”) provided on taxes was also excellent. In 2018, the company expects its tax rate – “before any discrete items” – to be in the range of 24% to 25%. Historically, EGOV’s tax rate had been in the high 30s. It was between 35% and 40% in something like 13 of the last 15 years. So,

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Carrols Restaurant Group (TAST): America’s Biggest Burger King Franchisee Comes with “Rights of First Refusal”

Guest write-up by Vetle Forsland

 

Overview

 

Carrols Restaurant Group (TAST) is the largest Burger King franchisee in the US. They are currently operating 753 Burger King restaurants on the east coast of North America, in 16 different states. That accounts for about 10.2 % of all Burger King locations in the USA.

 

Carrols was founded in 1960. At the time, they were operating an independent burger chain. In 1976, they started converting those stores to Burger King locations, and they became a franchisee. In the 1990s they were already one of the nation’s largest Burger King franchisees. Later, Carrols bought the Pollo Tropical and Taco Cabana brands, which accounted for about 50 % of the company’s revenue in the 2000s. In 2012, Carrols spun off the two latter businesses to Fiesta Restaurant Group, and Fiesta’s market cap is currently around $520 million vs Carrols’ $450 million. The spin-off took place shortly after 3G capital took control of Burger King’s owner, Restaurant Brands International (QSR). A part of 3G’s plan was to give more power to franchisees, as these businesses in the past were capped to a certain amount of Burger King locations, leaving BK restaurants fragmented and underperforming, as a result of little to no economies of scale.

 

Since the spin-off, Carrols has put significantly more focus on expanding their business and acquiring other Burger King locations. Most notably, they acquired 278 restaurants from QSR in 2012. Sales have increased 23 % annually on average since the spin-off, versus a 1 % decrease a year from 2000-2011. Additionally, the number of restaurants has increased around 24 % since 2012, compared to a 1.4 % decrease in locations in the 11-year period before the spin-off (Carrols had an IPO in 2004, so store counts before 2000 are non-existent/very difficult to find).

 

The 2012 acquisition of nearly 300 restaurants from QSR was financed through debt and preferred stock issued to QSR. So, Burger King’s owner basically bought a 21 % equity stake in Carrols. Executive officers and directors also own 5 % of the company, so 26 % of Carrols is owned by insiders. The 2012 deal included a preapproval by Burger King for Carrols to expand to 1,000 restaurants in “Rights of First Refusal” states, and the ability to expand beyond this region with Burger King’s approval. Carrols therefore has Rights of First Refusal in 20 states on the East Coast, paving the way for more acquisitions in the near future. 21 % of Carrols’ restaurants today are in North Carolina, 17 % of them are in New York, and 31 % are in Indiana, Ohio and Michigan. So, 69 % of their restaurants are in 5 states, diversifying their revenue but at the same time making the company vulnerable to potential economic downtrends on the east coast.

 

Durability

 

Restaurants have been around for hundreds of years, and serves as an important part of modern culture and our society today. There is no need to analyze …

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