Blog – Page 20 – Focused Compounding

Geoff Gannon May 13, 2018

Goodness vs. Soundness

Tuesday, May 8th, Industrial Logistics Properties Trust (ILPT) by George Baxter
To Focused Compounding members:
Ben Graham wrote: “Confronted with a…challenge to distill the secret of sound investment into three words, we venture the motto, MARGIN OF SAFETY…all experienced investors recognize that the margin of safety concept is essential to the choice of sound bonds.”

Note the word I bolded: “sound”. As I sat down to write this memo, I thought immediately of chess. Can a good chess move be an unsound chess move? Can you win a game because you made a move that actually gives you a negative margin of safety? We know you can. After playing a game of online chess, humans often have a computer chess engine analyze their game. At each point along the way, the computer evaluates the position and states the advantage for black or white in terms of hundredths of a pawn. The computer can also suggest “lines” – or series of moves – where the game would have worked out differently. So, a computer can tell you what move your opponent should have made and whether or not you had a real advantage under “best play”. A move that wins against a human with limited time to think but would fail against a computer with infinite time to think may not be a bad move – but, it is a speculative move. The English word speculation comes from a Latin word – a language Graham knew well – that basically means “to look out for”. A speculation is future focused. It depends on stuff you have to look out for. In chess, to judge whether or not your speculative move was a good one you can look at the result of your game. However, to judge whether or not your speculative move was a sound one you have to sit down – perhaps with a computer, but certainly with a lot of time – and analyze what would have happened had a different move been played in response. Perhaps Graham’s most important quote on the topic of margin of safety is this one:
“The function of margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.”
A sound move is one that works well enough whatever your opponent plays. A sound investment is one that works well enough whatever the future holds. But, just as some “unsound” chess moves work more often than not when playing against a human – some speculations have awfully good odds.

This brings us to Entercom (ETM). Last week, this minnow that swallowed the whale called CBS Radio was the subject of an excellent write-up by Vetle Forsland. A lot of members have asked for my comments on the stock. And a lot of members are clearly excited by the opportunity. Here’s the thing: If I had to come up with one and only one “line” that is most likely to be played out over the next few years, it …

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 – …

George Baxter May 8, 2018

Industrial Logistics Properties Trust (ILPT)

Industrial Logistics Properties Trust (Nasdaq: ILPT)

Summary: ILPT is a busted REIT spin/IPO with high-quality assets trading at a 35% discount to NAV. As a recent spin, ILPT has limited coverage and buy-side recognition. The company’s assets, which are located in Hawaii and the Mainland US, are 99.9% leased with an average lease duration of 11.2 years, and contractual rent-resets provide a clear pathway for modest organic growth. ILPT’s leverage of 2.6x net debt/EBITDA is less than half the peer median of 5.3x, and it’s 6.4% dividend is double the peer set median and conservatively covered by cash flow. ILPT is cheap on a nominal and relative basis, trading at only 12.3x 2018E FFO vs an industrial REIT average of 22.4x, as well as a deep discount to NAV. At the current price you’re essentially buying the Hawaiian assets at a fair price and getting the Mainland logistics assets for free. We believe the stock will return 44% over the next 12 months in our base case, with nearly 100% upside in our bull case based on the recent PLD/DCT transaction, and 15% downside in our bear case.

Price: 21.30

Total Diluted Shares 65MM

Market Cap: 1.38BN

Cash: 20MM

Debt: 351MM

EV: $1.711 BN

2018E, 2019E, 2020E FFO Per Share: 1.68 12.3X, 1.75 11.8X, 1.77 11.6X

2018E, 2019E, 2020E EBITDA & EV/EBITDA: $123MM 13.2X, $137MM 12.2X, $148MM 11.3X

Background

Industrial Logistics Properties Trust (ILPT) is an industrial/logistics REIT that spun-out/IPO’d on January 12^th, 2018. ILPT owns two sets of assets: Hawaiian and Mainland US. The company has owned the HI assets since 2003, and occupancy at those properties has never dropped below 98% during that time. The mainland assets were primarily purchased in 2015 and are 100% leased with Amazon as the largest customer. The company’s assets were formerly owned by Select Income REIT (SIR), who continues to own 69% of ILPT common stock. As many of you likely know, SIR and ILPT are RMR managed REITs, not exactly a compliment in the REIT world. The RMR family of REITs is managed by the Portnoy family, who had a very pubic and nasty fight with Corvex and Related over Commonwealth REIT. The rub on the Portnoy family of REITs was that they were vehicles to enrich the family while not doing much for outside shareholders. We believe the risk of this happening at ILPT is largely mitigated by the company’s compensation structure, which only really pays off for management if ILPT outperforms the REIT index by a significant margin. The idea behind the ILPT spin was the high-quality Hawaiian and Mainland assets would get a premium valuation compared to the legacy SIR office assets. With little in the way of leverage, management could continue to acquire high-quality mainland logistic assets at ILPT. As the company acquires mainland logistics assets, coupled with contractual rate increases at the legacy properties, NOI and the dividend will grow over time.

The ILPT IPO could not have come at a worse time, which …

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 …

Kevin Wilde April 20, 2018

Vestas Wind Systems A/S (OCSE:VWS)

Opportunity Summary:

Vestas holds the top position among wind turbine manufacturers.
The industry has attractive economics (high ROIC) and long-term growth prospects; wind as an energy source has crossed the threshold of being able to compete with fossil fuels without the aid of subsidies.
Vestas (>16% market share in cumulative capacity & new builds), Siemens Gamesa (~15% market share), and GE (~12% market share) are the dominant players.
Due to scale advantages and cost cutting initiatives started in 2011, Vestas has the best EBIT margin (>10-% vs. 5-8% for GE & Siemens and <5% for most other competitors).
Vestas’ stock is down 50% in the past few months based on concerns on how well wind energy can fair against other energy sources without government subsidies and competitive industry pricing that was predicated on the industry’s move to an auction system. My research suggests these risks are overblown considering the already cost competitive nature of wind and Vestas’ competitive position / profitability.
Management has done a great job of running the company over the last few years, having reduced fixed and variable costs by streamlining the business and by growing the highly profitable / fast growing / sticky services business.
My first pass at a valuation suggests that the stock could do well as a long-term holding.

NOTE: I first became aware of the opportunity via VIC. See link for detailed write-up:

https://valueinvestorsclub.com/idea/Vestas_Wind_Systems/141645

I would love to hear your thoughts if you have some industry insight or have looked at the opportunity. Send me a reply here in the thread, or directly at [email protected].

Cheers,

Kevin

…

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.…