Why I’ve Passed on Keweenaw Land Association (so far)

Trey had a good question in response to my Keweenaw Land Association article:

“Are you willing to share your reason for not investing at this time?

My first pass analysis leads me to also not choose to invest at this time. For me, it’s a matter of opportunity cost. Simply beating the S&P500 is insufficient. Since the S&P500 is projected to return much lower than its historic rates of return, my current opportunity set is much better.

That’s really always been my hesitation with owning something like timberland. I’ve been interested for diversification reasons, but in order to achieve double digit returns over long periods of time, you have to really buy at a large discount.

While I agree with the analysis that downside looks limited here, I struggle to come up with a scenario where a long-term owner (10+ years) could earn 10%+ returns. I understand though, that if the company is sold in a shorter amount of time for a premium, you could earn that hurdle rate over a shorter period of time. With that said, I think purchasing below $75-80 per share would offer the additional 2%/year return that I need for a 10 year holding period.

Sure. So, it’s easy to imagine a scenario where a long-term holder of timberland makes 10% plus returns. All you need is high inflation. Timberland’s long-term returns should be driven by: the cash flow produced by the annual harvest, the biological growth, the rate of inflation, and then also there tends to be some return – at least historically this has been true as countries develop – of competing uses for the land. This last factor is not important in Upper Michigan. But, there are places in the U.S. where it is. There’s nothing nominal about any of the factors driving returns in timberland. All the factors driving returns are real factors. So, if you had 6% inflation or higher – it’s likely timberland would return 10% or more a year for as long as that situation continued. You can check the historical record for periods of high inflation in the U.S. and see how timberland performed versus stocks, bonds, commodities, etc. during that period. The answer is good.

Over periods as short as 5-10 years, the factors driving timberlands returns would really just be the purchase price you were getting in at (if you’re buying a timber stock – this means both where we are in terms of timberland pricing and where the share price is versus the appraisal value of its timberland) and then whether demand for housing increases while you hold the timber stock. There are other uses for timber, but the most cyclical use for the more profitable trees is housing. So, when you see a low projected return for the S&P 500 versus a high projected return for timberland over the next 5 or 10 years, what the forecaster is really saying is: stocks are relatively more expensive than timberland right now, home construction …

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Keweenaw Land Association: Buy Timberland at Appraisal Value – Get a Proxy Battle for Free

Keweenaw Land Association (KEWL) is an illiquid, unlisted stock. It trades something like $15,000 to $20,000 worth of stock on an average day. The company does not file with the SEC. However, you can find plenty of information – including investor presentations, annual reports, quarterly reports, and other news – at the “company reports” section of Keweenaw’s website. You can also find news about the company – including press releases from a 26% shareholder who is trying to take control of the  board – at Keweenaw’s OTCMarket.com “News” page.

Keweenaw Land Association owns timberland in Upper Michigan. It has 185,750 acres of timberland and 401,841 acres of mineral rights. The difference between those numbers – 216,091 acres of mineral rights – is “severed” mineral rights where Keweenaw sold timberland without selling the mineral rights on that land.

The company has 1.3 million shares outstanding. So, each shares of Keweenaw Land Association is essentially made up of 0.14 acres of timberland, 0.31 acres of mineral rights, some cash, some marketable securities, and some debt. Of those assets and liabilities – it’s the 0.14 acres of timberland that matters most. Unlike many of the big, publicly traded timber companies, Keweenaw Land Association is not a REIT. However, the current board has said they plan to convert to a REIT for tax year 2018.

 

First Let’s Deal with the Catalysts: 3 Weeks till a Contested Proxy Vote, REIT Conversion, Copper, etc.

I say “current board”, because Keweenaw is in the middle of a proxy battle that will decide board control at the April 12^th vote. So, there is a catalyst here. Control of the board might flip 3 weeks from today. The party contesting the election is Cornwall Capital. Cornwall has 2 of 8 board seats right now. They are contesting 3 board seats at the April 12^th election. If they win all 3 board seats, they will have a majority (5 of 8) board seats. Cornwall Capital is a long-term holder of the stock. I believe they have held Keweenaw shares for about 10 years. The firm is run by Jamie Mai (who already sits on Keweenaw’s board). Cornwall Capital owns 26% of Keweenaw’s shares outstanding. Jamie Mai was mentioned in Michael Lewis’s “The Big Short”. The Paul Sonkin that Cornwall is running on their ticket for the April 12^th vote is the nano-cap/micro-cap investor who used to run Hummingbird Value, works at Gabelli, and co-wrote one of Bruce Greenwald’s value investing books. I don’t have much of an opinion on this board vote, the nominees, etc. I just thought it was worth mentioning that if you – as a value investor – are thinking the names Jamie Mai and Paul Sonkin sound familiar, it’s likely because you read “The Big Short” and “Value Investing: From Graham to Buffett and Beyond”.

Another potential catalyst is that Keweenaw could convert to a REIT. The board had previously said this was a bad idea. Now, they say they’ll do …

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Fairfax Financial Holdings: Large Upside Potential with Minimal Downside

Member write-up by: Alex Middleton

 

Introduction

 In the past 10 years Fairfax Financial has achieved what can easily be considered sub part returns, however I believe that the company will outperform the S&P significantly in the next 10 years as a result of the improved rate of return on their investment portfolio and a multiple expansion on their stock.  One of the main reasons that their stock is undervalued today is because people are anticipating that Fairfax’s growth will underperform in the future as it has in the recent past.  Fairfax’s entire history however tells a different story.  From 1985 to 2017 Fairfax achieved a compound annual growth rate of 19.5% on their book value (Source: 2018 Annual Report).  This is a tremendous achievement over the span of 3+ decades which many people seem to forget.  Fairfax has (until recently) been heavily hedged against equities, at a time the S&P continued to grow to unprecedented levels year after year and this underperformance is still very fresh in people’s memories.

The hedging has always been justified by Fairfax management by reiterating their goal of protecting shareholders capital against (what they perceived) as a major risk of deflation in the global economy, which was not entirely unreasonable given how much money the Federal Reserve injected into the economy post 2008.   Over the course of the past 10 years Fairfax has been quietly building their set of tools to take advantage of the next big opportunity that the market offers them. From 2008 to 2017 they have managed to compound their investments per share by 2.4% and compound their book value by 5.4% per year. At today’s price you are paying approximately 1.1x book for the business.   In this article I will summarize why I believe Fairfax is a very good investment opportunity for investors today.

 

Investment Portfolio

Fairfax’s current investment portfolio is comprised of a combination of book value, debt and insurance liabilities (float) and is worth $39.2 billion as of Q4 2017  (Source: 2018 Annual Report).  This amount currently works out to $1412 per common share ($1250 per common share less debt and goodwill) where about $819 per common share is made up of their insurance float (Source: 2018 Annual Report).  When a value investor finds opportunities to put this amount of money to work at a decent return, the relative impact on shareholders’ equity can be dramatic.  Recently Fairfax has  removed a considerable amount of their equity hedges from their portfolio and is now sitting with about 50% of their investments in cash.  As with many other value investors who are expecting the next big opportunity in stocks to come in the near future, this sort of “war chest” is exactly what they need in order to surpass their previous 10 years investment performance.

In this year’s shareholders letter Prem Watsa had indicated that buying back shares would be done more aggressively in the future than in the past.  At today’s stock price of $495 or 1.1x book value and …

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Summerset (SUM): A New Zealand Retirement Village Developer with “Float”

Member write-up by: André Kostolany

Investment Horizon: 5+ years	Market Cap: 1,494MM NZD
Type: Compounder	Net Debt: 348 NZDMM
Target Upside: 150% (ability to compound 20%+ p.a.)	Price/Net Tangible Assets: 1.95x
Country: New Zealand	Price/Underlying TTM EPS: 18.0x
Industry: Senior Living	Price/IFRS TTM EPS: 6.8x

 

• Summerset (SUM) is a retirement village developer and operator. It has created 20% CAGR in shareholder value since its IPO in 2011 and is just entering an accelerating growth period
• Summerset’s operating model is that it operates its retirement villages and provides care to residents at very thin margins of 3-5%. In return residents are inherently selling Summerset a free call option on real estate/entry fee appreciation as well as providing Summerset with interest-free float
• Summerset is currently trading at around 1.95X Price/net tangible assets, 6.8x NTM IFRS EPS and 18.0x NTM Underlying EPS while generating a 14.3% ROE, providing a wide margin of safety to its intrinsic value. Summerset will grow at a minimum of 18% p.a. to leverage demographic tailwinds. There is some downside protection through the highly conservative assumptions CBRE uses for appraising Summerset’s real estate

Key Thesis Points

1. Call Option on Real Estate/Entry Fee Appreciation
2. Float: The business model inherently generates a large amount of float, which finances the majority of development costs for new retirement villages and provides leverage to the above-mentioned call option
3. Demographic Tailwinds: New Zealand is now entering a demographic sweet spot for Summerset, brought about by accelerating aging trends
4. Understated Book Value: Accounting conventions, coupled with CBRE’s highly conservative valuation depress book value but also “bake in” rapid future book value appreciation

Industry

• Summerset is a New Zealand based retirement village operators

Source: Ryman Investor Presentation 2017

• As shown above, there are five other large retirement village operators in New Zealand (Ryman, Metlifecare, Bupa, Oceania and Arvida). The top six operators have around 65% market share and are continuing to grow their market share at the expense of smaller operators at about 2% p.a. This report focuses on Summerset due to the combination of inexpensive valuation, quality and scale
• Operators face a tradeoff between focusing on independent living and senior care. Summerset falls more heavily on the independent care end of the spectrum, a business that more closely resembles that of a hybrid real estate developer plus property manager
• Ryman is the largest and highest quality operator with about 18.5% market share of the retirements units market in New Zealand whereas Summerset has a market share of 11%.
• Summerset eventually plans to expand into Australia. Australia has a larger number of smaller competitors including publicly listed Japara Healthcare, Regis Healthcare, Ingenia Communities, Stockland and Aveo
• Over time, the New Zealand retirement village industry has tended to consolidate. I believe the same will happen in Australia due to the advantage that large float and cheap access to capital markets confer upon larger players

Source: Metlifecare Presentation

• Summerset sells three types of apartments: Villas, independent living units and serviced and memory care apartments. Villas require a higher

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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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