Geoff Gannon October 30, 2019 Gannon on Investing 0 Comments

Daily Journal (DJCO): A Stock Portfolio, Some Real Estate, Some Dying Newspapers, and a Growing Tech Company with Minimal Disclosures

This was going to be one of my initial interest posts. Then, I started reading Daily Journal’s SEC filings for myself. At that point, I realized there just isn’t enough information being put out by Daily Journal to possibly value the company. There just isn’t enough information to even gauge my initial interest in the stock. I’ll still try at the end of this post. But, my look at Daily Journal will be a quicker glance than most.

Daily Journal is a Los Angeles based company (it’s incorporated in South Carolina, however) with 4 parts.

Part one is a stock portfolio consisting mainly of – we’re sure of this part – Wells Fargo (WFC) and Bank of America (BAC) shares. The third part of the portfolio is probably (my guess) mostly shares of the South Korean steelmaker POSCO. Yes, Daily Journal does put out a 13F – this is where sites like GuruFocus, Dataroma, etc. are getting the “Charlie Munger” portfolio to show you. However, the way that kind of filing works is that it would entirely omit certain securities. For example, it’d include POSCO shares held as ADRs in the U.S. (which is probably a small number) while not counting any POSCO shares held in Korea (which is probably a bigger number). Daily Journal does have a disclosure about foreign currency that includes discussion of the Korean Won. We can also see by looking at the 13F for periods that are very close to the balance sheet date on some Daily Journal 10-Qs that the actual amount of securities held by Daily Journal is greater than the amount shown in the 13F. There would be other differences too. For example, we know Daily Journal sold some bonds at a gain. Those bonds would not be included in the table filed with the SEC that websites use to tell you what Charlie Munger owns. Everyone can agree on the two big stock positions though. Daily Journal has a lot invested in Wells Fargo and Bank of America shares.

The value of these stakes are offset to some extent by two items.

One, Daily Journal would be liable to pay taxes if it sold shares of these companies. As long as Charlie Munger is Chairman of the company (he’s 95 now, though) I don’t expect Daily Journal to ever sell its shares of these banks. Therefore, I don’t expect a tax to be paid. If a tax was to be paid – you should, perhaps, trim the value of these stakes by over 15%. A very big part of the holdings are simply capital gains. If a stock has increased in value by 4 times while a corporation has held the shares – then, the final amount of taxes paid will seem very large relative to the size of the stake. This is because most of the stake is capital gains that would be taxed on a sale.

The other offset is margin borrowing. Daily Journal borrows using a margin account. The company doesn’t borrow to amplify returns. It borrows against its shares in companies like Bank of America, Wells Fargo, and (presumably) POSCO to buy technology companies that can help the company grow in a new direction. That direction is providing services to governments – basically courts and other justice related government agencies (like the traffic ticket payment processing part of a city government, for example) – using software. This is what drew me to write about the company. I read an interview in Columbia Business School’s “Graham and Doddsville” newsletter that talked about Daily Journal. The investor being interviewed had some very interesting things to say about how Daily Journal recognized revenue and things like that. We’ll discuss this when I get to the “Journal Technologies” part of Daily Journal. For now, we just need to know that Daily Journal borrows in a margin account against stocks like Wells Fargo and Bank of America to fund the acquisition of legal software companies serving governments in the U.S. and abroad. Margin borrowing is a cheap form of borrowing. There are a lot of reasons to like it. The margin loans are done at Fed Funds Rate plus a premium. They never mature. Daily Journal just has to keep sufficient collateral to protect the loans adequately. That’s not difficult considering I expect Daily Journal has no intention of ever selling these stocks anyway while Charlie Munger is in charge. The margin loans are also – at least for now – at rates well below the expected returns in the stocks they are collateralizing. So, to fund an acquisition by selling Wells Fargo stock, you’d trigger a major tax. Instead, you avoid triggering the tax. You keep compounding at 8% or 10% or whatever in Wells. You pay 3% or whatever (actually, the Fed Funds Rate has declined since the reports I’m using to write about Daily Journal here and so has the margin loan rate). This means shareholder wealth is still compounding nicely at 5% to 7% (instead of 8-10%) on the portion of the stock that you otherwise would have sold but now just borrow against. The tax continues to be deferred. Daily Journal gets to make an acquisition. It works out well for shareholders from both a tax and return perspective. And it uses leverage that is both low cost and doesn’t come with solvency risk involving when it matures. It does – of course – come with the market risk that a huge decline in Bank of America, Wells Fargo, etc. stock would require Daily Journal to post more collateral, sell stock, etc. Given the amounts involved here – the amount borrowed versus the other assets Daily Journal has – I think the risk is low. I think Daily Journal is very smart to borrow in a margin account against its shares instead of resorting to more traditional bank loans.

Daily Journal’s financial strategy is interesting. It’s very unusual. This brings me to part two. After you figure out how much the stock portfolio should be valued at – subtracting whatever amounts for margin loans, taxes, etc. you think is appropriate – you then can move on to real estate. Daily Journal owns several buildings it occupies. In fact, the company recently switched from leasing to owning one of its buildings. It owns property it uses in Los Angeles as well. The “properties” section of the 10-K gives exact details on years when buildings were built or bought, square footage, what the buildings are used for, etc. A next step would be to look for more accurate appraisals of the value of these properties. Is this a meaningful part of the value of Daily Journal?

Maybe.

I don’t think it’s worth writing a lot about real estate here. But, it is an unusually large number relative to things like market cap and enterprise value compared to what percent of value real estate makes up at most operating businesses. Here, again, Daily Journal is borrowing. Borrowing against real estate – like borrowing against stocks – can be a smart move for creating shareholder value. You don’t want a company tying up money in both acquiring tech companies and in holding its own real estate, stock portfolio, etc. You’d rather that shareholder money only be put to uses that are likely to compound. The equity left above a real estate loan is likely to compound fine. The stock net of a margin loan is very, very likely to compound fine. And the purchases of tech companies is a necessary part of Daily Journal’s long-term term strategy. So, here – in the real estate part of Daily Journal – we’d just want to get a better appraisal of the real estate and then subtract out the real estate loans. That would be my next step here on returning to analyze the company in detail.

As I’ve hinted earlier though – I don’t have plans to revisit Daily Journal in-depth. The reason is that, so far, I’ve been unable to find information that would help me value some of the most important parts of Daily Journal. I’ll get to that in a second. Let’s now deal with – what is, to me – the least important part of Daily Journal.

Part 3 of Daily Journal’s value comes in the form of the “Legacy Business” which is also known as “The Daily Journals” (and some other related publications). These are old, originally print only newspapers (they now also have websites) that charge annual subscriptions to those getting the paper delivered to their home, office, etc. and that also charge advertisers to run ads in the papers. The papers are targeted at lawyers, judges, etc. Historically, the company had run a lot of public notice advertising. These are things like foreclosure notices that have to be run – they’re required by state law – in a newspaper of record in some particular county, town, etc. by such and such a date or for so long to meet some legal requirements. In the past, more popular newspapers – the kind average people read for enjoyment, not because they are lawyers or judges – did not run much of this kind of advertising. One risk here is that bigger papers will run those kinds of ads. Big papers have lost some of their most valuable forms of advertising – like classified ads – to things like Google, Facebook, and Craigslist. They are failing. And they may eventually accept any kinds of ads that pay much of anything. I suppose Daily Journal would still have advantages in being able to charge less, having a history of running these kinds of ads (so better known by the advertisers), and also through ownership of an agency that specializes in placing these kinds of ads – usually in non-Daily Journal owned newspapers – while taking a 15-25% commission. Still, as an industry shrinks – once protected niches may get generalized. This legacy business has some costs that might not get slashed fast enough. It could produce some cash profits for a while. But, the offset in terms of value would be any period where the legacy business is burning cash and yet hasn’t been shut down. The 10-K includes some language that makes it sound like Daily Journal sees some of its reporting as a duty here beyond just a profit seeking motive. Once they are actually burning meaningful amounts of cash in this business – they may be willing to forget about that duty. It’s never said in the 10-K that the duty extends to running money losing papers. It’s just mentioned that they pursue objective reporting even in cases where that might not be the ideal profit maximizing decision. Still, that kind of language and focus on service to the local communities instead of just to shareholders is always worrying when it is being used to describe a business that will soon be in need of permanent shutting down. I’d value this business at nothing. It might be worth slightly more than nothing. But, it could – if the company refuses to shut things down fast enough – also have a real negative value for shareholders here. So, I don’t think valuing it at nothing is as conservative as it seems.

Then we get to “part 4”. This is “Journal Technologies”. Here, the Daily Journal acts as a competitor and peer of sorts to publicly traded companies like Tyler Technologies (TYL) and NIC (EGOV). This is the part of Daily Journal that originally attracted me. It’s also the part I’ll be spending the least time on now. The disclosures in this section are inadequate. There is no way to value the business. We know the CEO (79 and recently suffered a stroke) who runs almost all aspects of this business is entitled to a percentage of the pre-tax income of this business unit. However, at present, the business unit has no pre-tax income. We can also see that Daily Journal’s accounting is very, very conservative. For example, they don’t recognize a lot of the revenue till the system they installed has gone live and the customer is satisfied. They’re able to do this – which results in massive mis-matching of revenue and expenses, so very anti-GAAP in spirit – by not invoicing the customer till the system goes live. Without an invoice, they can claim that the revenue is not certain enough in amount, whether it will be paid, etc. Still, this creates a huge problem for any analyst.

It’s possible that – as the Graham and Doddsville interview suggests – Daily Journal’s Journal Technologies business will grow into a free cash flow juggernaut within a decade or so. Maybe. But, I have no way to gauge the size or profitability of this business. The revenues shown understate the amount of billing the company is likely to do in the future. However…

There are two problems that make this one nearly impossible for me to analyze. I’m not even sure if Journal Technologies will or won’t create a ton of value in the future. One is that in many years the company has been growing its salaries and benefits line as fast as its revenue line. Now, if the amount of revenue the company will EVENTUALLY book is running ahead of revenue in percentage terms each year – that’s fine. Basically, if you are growing expenses by 10% a year and revenue by 11% a year, but you’re actually growing the eventually invoice-able amount of future billings expected by 16% a year, you have a good business. Since I can’t know whether revenues are or aren’t a good proxy for growth in Journal Technologies’ future business value, it’s hard for me to see if there’s going to be future business value here. You could say it’s necessary to trust the business judgment of the CEO here, of Charlie Munger (the chairman), J.P. Guerin (Vice Chairman and big shareholder), etc. and just accept the idea that they wouldn’t allow operating expenses at Journal Technologies to grow as fast or faster than what they expect to eventually bill. But, if you aren’t willing to make that assumption – I’m not yet seeing percentage growth in revenue exceeding percentage expense growth by enough to get me interested. If this was a growth company without Charlie Munger’s name attached – I’d pass on it.

Finally, Journal Technologies remains free cash flow negative. It doesn’t have meaningful cap-ex (at all). And it does – or did, I think it’ll be just about done with this when you’re reading this part – amortize a lot of intangibles that depress earnings. So, it wouldn’t be hard for Journal Technologies to very soon flip into a free cash flow generator. But, in past years, the segment has consumed cash flow in its operations. I can’t remember the last time I invested in a company that had negative cash flow from operations. This could change soon. And a big period of investment of cash followed by years of FCF generation may be the right way to run a growing software business as it gets to scale.

But, again, it’s a pass for me.

Even with Charlie Munger’s name attached to this one – my interest level is low. I don’t think it’s a bad stock. Some information in how it accounts for things combined with that interview I read does suggest that Daily Journal could be more of a growth company than it appears. But, it’s not the kind of investment for me. There’s just too little disclosure of the stuff I need to see to value a company.

In this case: too little information leads to a low interest level.

Geoff’s initial interest level: 30%

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