Posts In: Idea Exchange

A-Mark Precious Metals (AMRK): A Dealer and Lender in Physical Gold

A-Mark Precious Metals (AMRK) has been written up twice at Value Investor’s Club. The most recent time was this year. You can read those write-ups over there. It was this most recent write-up at Value Investor’s Club that got me interested in the stock. However, it was for different reasons than that write-up itself lays out as the case for buying the stock. The VIC write-up focuses on how low volatility in the price of gold (and silver and other precious metals) in recent years means that A-Mark has under-earned in each of the last 5 years or so. Having looked at the company now – I’d say that’s possibly true. A-Mark says many times in its SEC filings that it benefits from increased volatility in the physical markets for precious metals. The company also says that the price of gold – rather than how much that price bounces around – doesn’t much matter to the company’s results. I’m less sure of this second point. There is one activity that the company engages in where I feel high (and continually rising) gold prices would be a benefit and low (and continually falling) gold prices would harm the company. Since I mentioned “activities” – let’s talk about what acts A-Mark actually engages in.

The best way I can describe this company is as an investment bank (really, a “trading house”) focused on physical precious metals. That word “physical” is important. We are talking about the buying, selling, storing, shipping, minting, lending, and many other things of actual physical bars and coins of gold, silver, etc. The business is almost completely U.S. It seems 90% of profits probably come from the U.S. I say “seems” and “probably” because of some difficulty in using traditional accounting measures when looking at a company like this. A-Mark is a financial company. It really is a highly leveraged and fully hedged – or as near as fully hedged as it can get – trader in a market. As a result, an accounting line like “revenue” is meaningless. The company reports revenue. But, revenue doesn’t matter. The first line on the income statement that is worth paying attention to is “gross profit”. Gross profit at A-Mark is always less than 1% of revenue. Usually it’s quite a bit less than 1%. This makes typical SEC requirements to disclose revenue stuff useless. For example, does A-Mark have high customer concentration? We don’t know from the 10-K, 10-Q, etc. There’s a line in the 10-Q that says about 50% of revenue comes from two companies: HSBC and Mitsubishi. However, this is just hedging activity. Because of how A-Mark’s accounting works, you could list big “customers” as just entities they are making sales to in the form of hedging activity that will never be settled with physical gold and will never result in any gross cash profits for A-Mark (on their own). So, it may be that around half of the revenue line you are seeing is hedging done with …

GrafTech: Contracted Cash Flows Covering 60% of the Market Cap

Recent events with increase demand for lithium-ion batteries from EVs, the steel and the graphite electrode industry, have put this company in a position to be able to sell 65% of their 5-year cumulative capacity on take-or-pay contracts, thus almost guaranteeing the company a fixed source of free cash flow 5 years into the future. I believe the supply and demand imbalance will probably we present fro the next 5 years. This report will look into why that may be the case. 

Ardent Leisure Group Ltd (ASX:ALG): Initial Interest Post and Request for Scuttlebutt

Posted by: Warwick Bagnall

ALG consists of two main parts; the Dreamworld/White Water World theme park in Queensland, Australia and the Main Event chain of family entertainment centres in the US.  I’m interested in ALG mainly to try and understand why it is the largest position (>20% and growing) of a value/activist LIC (Ariadne Australia Ltd, ASX:ARA) which I hold.  ALG is cheap compared to its past share price and on a (depressed) P/S basis but it has been loss making since 201. Hence this write-up is part of a reverse-engineering exercise.

ALG’s financials take a lot of work to understand.  By that I mean that the reporting is complete and efforts have been made to attribute costs and revenue clearly.  However the company has recently sold business segments, changed from a stapled structure to a simple company, is dealing with a major safety incident (below) and has opening new stores.  There’s a lot going on in the accounts.

When ARA went activist they published a plan for realising the value in ALG.  The plan addressed ALG’s management and operational shortcomings and suggested a final valuation of at least AUD 3.58 versus the current share price of AUD 1.05.  That’s fine as a start but it doesn’t address the main things I want to understand – who visits ALG’s businesses, why do they visit, how robust is the business model and will there be any worthwhile growth?

The theme park segment of the business is loss-making due to a fall in visitor numbers and per-capita spend following an incident involving one of the rides in 2016 in which several people died.  The inquest into the incident concluded last year (2018) but the final report hasn’t been released yet. ARA gained control of the board in 2017 and significant improvements in safety, operations and per-capita spend have since been made.  

The park has a similar catchment size and scale to a typical Six Flags park but has more competition in the form of a nearby Warner Bros. Movie World and Sea World plus some smaller attractions. Fortunately, the area where the park is located attracts a lot of tourists year-round and there are few, if any, comparable parks left in Australia.  People travel to the area from other states to holiday so the number of potential customers is likely higher than what the surrounding population catchment would indicate. Now that per-capita spend has increased, if park attendance returns to 2016 levels then the parks segment should be profitable. Even if this doesn’t happen the stock is valued such that the market seems to be pricing the parks segment at less than the value of the underlying land.

The Main Event chain is much more interesting.  Main Event is headquartered in Plano TX, has 42 sites and plans to open around five more each year.  An average store does USD 7.4 MM in revenue at an EBITDA margin of 33% and ALG claim the first-year ROI on new stores is around 41% …

A Different view on Fannie Mae (FNMA) and Freddie Mac (FMCC) “Optionality has value”!

A Different view on  Fannie Mae (FNMA) and Freddie Mac (FMCC), an issue is rather complex. 
Here I may refer to both institutions as “government-sponsored entities” or (“GSEs”).

But YOU as an investor should focus on what’s knowable and controllable.
Here is what the market is missing an my variant perspective: “Optionality has value”!

Here is my invitation to you investor: see Fannie Mae and Freddie Mac at current price as an option, that could go to $0 or to $17.55 each. You would really be paying for the optionality.
You just bought an option, but not only that, this one doesn’t expire. 

how much would that option be worth?
for a “know nothing about the company” kind of investor using a Black an Scholes kind of formula works pretty well. Even though we don’t want to use it for prolonged periods of time, since the formula stops working basically.

Charlie Munger on Black Scholes Option Pricing Model (2003) –  https://www.youtube.com/watch?v=Fd4lfVNJljk

we need some assumptions: – http://www.iotafinance.com/en/Black-Scholes-Option-Calculator.html

Calculation results

That means you are getting $2.77 for free in the a $3.2 stock.

Now all of the reading, research, news, video calls, etc etc any work that you may put into understanding GSE’s will only affect the size of your position, due to your level of confidence (I use Kelly criterion calculator in binomial situations like this, where I think the value is either $38 or 0, I take about this later)

Let me summarize a very complex issue like this the best I can:

• Under current conditions shareholders there WILL NOT be profits for shareholders ever, but shareholders have been pushing back with very good arguments, and now they are winning slowly.
• Congress is almost 79.9% owner of the institutions though warrants 
• Is in everybody’s interest to raise the price of the stock (remember the US holds a lot of warrants and needs to sell them)
• GSE’s are out of riskier practices that caused their collapse and started making a lot of money.
• GSE’s will make more income, because insurance for new loans are higher as time passes and old loans disappear.
• Trump wants to capitalize the GSE before a recession.

The problem:

• We don’t know how lawmakers are going to capitalize GSE again. In some hypothetical scenarios there could be significant dilution of current shareholders or even worst, that would mean you stock goes to $0 so fast that you won’t be able to exit your positions.

So what started moving the stock now?

Trump just came out with a plan to capitalize the company. And a lawsuit in favor of shareholders to put everything back on track. 
You see the Government has already been paid what they lend …

How Does Warren Buffett Apply His Margin of Safety?

March 26, 2011

Someone who reads the blog sent me this email.

Geoff,

In a previous email to me you explained how Warren Buffett values a company.  The text that your wrote was:

“He wants his investment to increase 15% in value. For every $1 of capital he lays out today he wants a day one return of 15 cents. That means a 15% free cash flow yield or buying a bank with an ROE of 15% at 1 times book or buying something for less than a 15% initial yield as long as it is growing.”

I understand that no problem whatsoever.  However, I am just curious.  How does he apply a margin of safety (for example 50%) to this fcf yield valuation?  Thanks for the help.

Chad

He doesn’t.

Buffett has said that with something like Union Street Railway – bought back in the 1950s – he saw the margin of safety was that it was selling for much, much less than its net cash. For Coca-Cola the margin of safety was the confidence he had in future drinking habits around the world.

Buffett felt sure people would drink Coca-Cola in larger and larger amounts per person per day in countries where Coke had been introduced more recently than in the United States. History was on his side. Per capita consumption of Coke had been rising everywhere for years. In contrast, history was not on the side of Union Street Railway.

Passengers – Union Street Railway

1946: 27,002,614

1947: 26,149,937

1948: 24,224,391

1949: 21,209,982

1950: 19,823,933

1951: 18,736,420

Bad trend.

But Union Street Railway had $73 in cash and investments – not a single penny of which was needed to run the actual business. The stock traded between $25 and $42 during 1951. So, even at its high for the year, Union Street Railway’s stock was trading for more than a 40% discount to its net cash.

At its low, the company’s cash covered its stock price almost 3 times.

Union Street Railway had a big margin of safety.

But so did Coke.

Buffett believed both Union Street Railway and Coca-Cola had an adequate margin of safety when he bought them.

With Coca-Cola it came from human drinking habits. With Union Street Railway it came from the cash and investments on the balance sheet.

Buffett was as confident in Coca-Cola as in Union Street Railway.

It’s just that his margin of safety in one case was people’s buying habits and in the other case it was the cash on the balance sheet.

Buffett doesn’t apply some standard 50% margin of safety to an intrinsic value estimate.

He just looks for situations where he’s confident his investment will earn an adequate return from day one far into the future.

And he wants to pay less than the stock is worth.

But that doesn’t mean it’s necessary to do an actual intrinsic value calculation and then slap on some percentage discount to that value.

It just means seeing the …

Kingstone: A simple New York homeowners insurer

Kingstone Insurance

Kingstone Insurance (KINS) is a multi-line provider of personal and commercial insurance. The company distributes predominately through independent brokers and agencies with a high touch model. The vast majority of premiums underwritten today have been in the state of NY in home property insurance. More recently, the company has begun branching out into neighboring states such as Pennsylvania, Rhode Island and New Jersey.

What is unique about Kingstone is their willingness to operate with smaller rural agencies. While most insurance companies require significant minimum premium volumes for an insurance agent to qualify for commissions, Kingstone’s minimum for agents is 50k. This gives Kingstone a sticky and loyal base of independent insurance agents who originate new business for them year after year.

Kingstone transitioned from a mutual into its current form in 2009 and has since been growing premiums at 25% a year while producing a return on equity of 15-16% in years without hurricanes. When hurricane Sandy hit the New York area in 2012, they experienced mild losses but were still able to maintain a return of equity of 4%.

This streak continued up until the first quarter of 2019, when Kingstone had to restate reserves in its commercial lines business, where it was writing property insurance for small businesses. While commercial lines formed a minor part of their business, Kingstone clearly mispriced the risks here and had to restate its reserves, taking substantial losses. Fortunately, Kingstone has acknowledged its past mistakes, reorganized its claims management department and pulled back on new commercial business. The market however has reacted as if Kingstone’s business model is fundamentally broken. Over the next several quarters Kingstone should show that their core home property insurance business is just as profitable as it used to be and that it can continue its history of profitable growth by growing into adjacent states.

Underwriting

Kingstone has for a long time maintained a mix of roughly 80% personal and 20% commercial policies. As they have experienced reserving issues in the commercial segment, Kingstone will stop growing commercial policies and instead focus on its core homeowner and dwelling coverage business. Approximately half of their policies are written in Long Island / Westchester, with another 43% written in NYC. Long Island / Westchester is a particularly interesting market for Kingstone as major insurers pulled out of the market in the wake of Superstorm Sandy.

Thanks to an Ambest upgrade to A- in 2017, Kingstone is well prepared to continue its growth as this allows Kingstone to access a greater number of insurance agents to sell its home insurance product through (many insurance agents limit their insurance writing with companies that are rated A- or better). Kingstone has been growing premium at 25% per annum for the last several years and is likely to continue to grow premium by at least 20% per annum through a combination of growth in New York and Long Island / Westchester as well as expanding its agent base in upstate New York, Connecticut, …

Highly Cash Generative Aquarium Operator

Citigroup Capital Securities XIII – a high yield trust preferred from Citi

This is a writeup for Citigroup Capital Securities XIII, or Citi N’s. Citi N’s are trust preferred obligations of Citigroup. Why write up a pref instead of a stock? This one has some interesting special features.

A trust preferred is basically a subordinated debt obligation of the issuer. It ranks above common equity, above preferred shares but below senior in the capital structure. Coupons on subordinated debt are deferrable for up to five years but cumulative, meaning that if Citi cannot pay the coupon on Citi N’s in any given year, this does not constitute an event of default. If Citi does not pay a coupon for five years, this does constitute an event default. As coupons are cumulative any coupons that were skipped at one point have to be repaid later on. Here, I am simply explaining the structure of the security. Citi has never skipped a coupon on Citi N’s and is unlikely to do so in the future.

Citi N’s pay a coupon of Libor + 637, which means the current coupon is 9.1205%. It is a $25 face security currently trading at 27.70, so the current yield is about 8.2%. 8.2% is a very high yield for a high quality credit like Citigroup. For comparison, JP Morgan and Bank of America Preferred Shares currently yield 5.6%, Morgan Stanley Preferreds yield 5.7% and Goldman Sachs Preferreds yield 5.8%. Trust Preferreds are higher in the capital structure than preferred shares, yet Citi N’s have a significantly higher current yield.

Citi N’s have a final maturity of 2040, but are immediately callable today. If Citigroup decided to call Citi N’s tomorrow, they would fall from 27.70 to something closer to par + accrued, so around 25.50. Citi could call Citi N’s tomorrow and issue new preferred shares with a coupon around 5.6%-5.7%. Why has this not happened yet?

To understand this we have to go back to the financial crisis. On January 15^th 2009 Citigroup entered into a loss-sharing arrangement with Treasury, the Federal Deposit Insurance Corporation (the “FDIC”) and the Board of Governors of the Federal Reserve System related to a pool of $301 billion of assets. Citigroup issued to Treasury $4.034 billion of its perpetual preferred stock as consideration for the loss-sharing protection provided by Treasury and $3.025 billion of its perpetual preferred stock to the FDIC as consideration for the loss-sharing protection provided by the FDIC. Treasury’s and the FDIC’s perpetual preferred stock was exchanged for capital securities issued by Citigroup Capital XXXIII on July 30, 2009. On December 23, 2009, as part of an agreement to end the loss-sharing protection, Treasury cancelled $1.8 billion of the $4.034 billion Capital XXXIII Capital Securities it held, and the FDIC agreed to transfer an additional $800 million of its remaining Capital XXXIII Capital Securities to Treasury upon the maturity of Citigroup debt issued under the FDIC’s Temporary Liquidity Guarantee Program. On September 29, 2010, Citigroup modified Citigroup Capital Trust XXXIII by redeeming $2.234 billion of those securities …

Gaia (GAIA): A Strange Value Investment in a Strange Streaming Service

Gaia operates a streaming service like Netflix, but for yoga, meditation, and weird conspiracy videos. They have many great titles, like “The Baltic Sea Anomaly; A Crashed UFO Or Natural Rock Formation?” or “Cannabis Spirituality: Using Plant Medicine as a Sacred Tool”. The company is run by its founder, Jirka Rysavy, who owns over 32% of the company’s stock. Rysavy is an experienced entrepreneur who founded Corporate Express, which became a Fortune 500 company before merging into Staples. Gaia is growing extremely fast, but has been losing money along the way. I believe the net losses are a result of investments for growth that will dramatically decrease over the next few years.

At first glance, Gaia is exactly the kind of business that value investors would avoid. The company is selling for $160 million, and produced just $42 million of streaming revenues in 2018. This gives the stock a price to sales ratio of 3.8. The company’s losses have been growing, with a net loss of $33.8 million in 2018 and $23.3 million in 2017. At this point, most value investors would have lost interest and moved on to the next idea. However, there are some very interesting aspects of this business that deserve a closer look.

Gaia has a low amount of operating expenses, while most of their net loss comes from investments for growth. This provides the business the potential to earn very high returns on capital as the investment in growth spending slows. In the 2018 Q4 earnings call, management expressed that their plan was to reduce subscriber acquisition spend throughout 2019 as they attempt to head toward profitability.

What really excites me about Gaia is the low cost of content. This can be seen within the company’s gross margin. As the company grows, the gross margin continues to rise as well, from 80.7% in 2015 to the 87.2% Gaia had in the 4th quarter of 2018. Netflix, for comparison, has a gross margin of 36.9%. In addition, the gross margin doesn’t tell the whole story for Netflix, as their amortization of streaming content leads to cash flow being much worse than net income. The opposite is true for Gaia, as they reports better cash flow than net income. However, cash flow is still negative for Gaia for the time being. This low cost of content is achieved even considering that the vast majority of Gaia’s titles are either created by or exclusively for Gaia. About 90% of Gaia’s content is exclusively available for Gaia subscribers. For companies like Netflix or Gaia, the sole product is content. With such low costs of content, there is potential for abnormal profits eventually.

The net loss for Gaia can be attributed to the ‘Selling and Operating’ line on the Income Statement, as this is currently 156% of revenue. In 2018, this value was $68.3 million. Management discloses in the earnings calls the breakdown of what they consider operating expenses compared to subscriber acquisition costs. $52 million was spent on subscriber …

Inspira Financial (LND.V): Liquidation of Business Provides Low Risk Opportunity

*I own shares in this company, and it is a very illiquid stock

Inspira Financial trades under the ticker LND.V on the TSX Venture exchange in Canada, and trades OTC under the ticker LNDZF in the US. While the stock has more volume in Canada, LNDZF is very illiquid. For most of my purchases of LNDZF, my trades accounted for the entire trading volume that day of the stock.

Inspira Financial is selling for about $4.8 million USD, or $6.4 million CAD. The company reports in Canadian dollars, so for simplicity the rest of the information I write will be in CAD. This is a small business that used to lend money to medical offices. They also operate a small billing subsidiary. Management decided to get out of the lending business, so they are collecting on their loans and liquidating that business. They also put their billing subsidiary up for sale as well. This is a weird situation since the stock is basically in liquidation. I think the stock will either be bought out, or the company will use all the cash generated from the liquidation to acquire a new business.

The company is selling below the value of its cash in the bank minus all liabilities. The whole company is selling for $6.4 million, which is 30% below their $9.2 million in cash. Their total liabilities are $1.7 million, which is mostly made up of a provision for legal matters related to a billing competitor. Their other assets, not counting cash, come to $4 million. So let’s assume either their other assets can only be liquidated for less than half of their book value, or that the legal matter is understated, and they cancel each other out. That would still leave us with a company selling 30% below the level of cash in the bank. These other assets of $4 million are made up of $3.7 million of receivables and deposits, while the remainder is equipment. I think it would be conservative to assume the other assets offset the company’s total liabilities.

Inspira also has a billing subsidiary called Inspira Saas Billing Services that they are looking to sell. I am skeptical about this billing business, as I get the feeling they use Saas as a trendy buzzword. This business generated sales of $1.8 million in 2017, and has been growing slightly over the past year. If you extrapolate their latest quarter, the business would have $2.3 million of annualized sales. Last quarter, they reported that they only have two customers within this business, and that one customer makes up over 90% of sales. This quarter, they added 3 new customers bringing the total to 5. However, the main customer still makes up over 90% of sales. Total billing revenues did increase 5% in the quarter, but this is still a tiny business. I’m not sure what this business is worth, but if they could sell it for half of its level of sales, that would be $1.15 million. …