Tobias Carlisle (00:02:41):
Danish krone to the US dollar?

Stig Brodersen (00:02:43):
Yes.

Tobias Carlisle (00:02:46):
So, this is like a $30 million US?

Stig Brodersen (00:02:47):
Oh, sorry, no. The marcap was $200 million, and so, just to give you an idea… It’s probably 220, but the other numbers I’m going to give you would be in the local currencies just instead of converting 20, 50 different numbers. But good question, and in case anyone is worried about currency risks and saying, “Hey, I’m not based in Denmark.” The Danish krone is pegged to the euro, so you can just consider it like you would be buying a stock in euro, and has been pegged for an eternity now.

Stig Brodersen (00:03:17):
Everything else equal, it’s probably a stronger currency than the euro if it were to break the peg, which I don’t see is realistic at this point in time. Full disclaimer, I do not own a stock, but it has become a little more interesting here lately due to the recent… I was about to say bear market. At least it was whenever I started preparing for this, but with the bounce and all, who knows?

Stig Brodersen (00:03:41):
This is an ugly stock. It’s what Warren Buffett back in the day would call a cigar butt investing. This obscure small stock that’s drowning in cash, making a bit of money. Anyway, I wanted to bring this pickup for a few different reasons. I actually list four reasons down.

Stig Brodersen (00:04:00):
It has a large stock portfolio compared to the marcap of the companies, around 40%. It has a declining legacy business from the industrial world that’s spinning off a lot of cash, but it’s declining and it’s cyclically declining and it also has a growing tech business.

Stig Brodersen (00:04:19):
So, what is North Media? You can think about North Media as three different businesses in one. The first one, that’s the legacy business I was talking about before. It’s Denmark’s leading distributor of leaflets and local newspapers to consumers, and they also have a digital side as well.

Stig Brodersen (00:04:38):
In addition, FK Distribution provides package services for Danish customers and for Deutsche Post, which is the main German distributor of mail and parcels. It accounts for 84% of operating revenue and has an EBIT margin of 22.7%. If you look at some of the historical data, last year was quite unusual, it was 28. This is probably more what you can expect.

Stig Brodersen (00:05:04):
You have 66% of Danish households who are receiving leaflets. That’s a negative change of 2%, and you can probably expect that to continue. And what’s interesting about this business is that it doesn’t require a lot of manpower. It used to require a lot of manpower. They now have a new fully automated logistics and distribution setup.

Stig Brodersen (00:05:26):
The second part of the business is what we will call the tech business, which is the remaining 16% of revenue. If you look at the EBIT margin, it says 2.1% for 2021, but there’s a lot of adjustments in those numbers that you have to make. In reality, it’s much higher.

Stig Brodersen (00:05:44):
The numbers from the first half of 2022 just came out today. It says 10.2%, which is more accurate, but the reality is still higher, and we are going to talk more about normalizing that later. Digital services consists of three units, and then they have a 50% interest in another company, in a fintech company.

Stig Brodersen (00:06:03):
The largest unit is a rental housing platform. That’s the clear leader in Denmark, which has networking effects, and it’s building a similar platform in Sweden. I’m pretty bullish on the Danish version, probably not so much on the Swedish. And it just more comes from me being a bit pessimistic because if you present the argument that you have strong networking effects in your own country, why do you expect that you can just go to another country that already has strong networking effect with another platform and say that, “Oh, we can just do the same.” But that is the most interesting of those three.

Stig Brodersen (00:06:40):
The second biggest business unit for the business services is a job-seeking portal. This is a segment that grew sharply during COVID, and it’s growing. It has a 15% EBIT margin. The platform is the fifth-ish biggest job platform in Denmark depending on how you measured it, and so, it’s been monetized through online advertising for employers and have some other services too.

Stig Brodersen (00:07:03):
I don’t see them as having a distinct mode whenever it comes to this unit. Just doing a small detour, I don’t know, have you ever watched, Toby, the video with Peter Thiel? It’s called Competition is for Losers.

Tobias Carlisle (00:07:21):
I have, a long time ago.

Stig Brodersen (00:07:23):
Right, and he talks about the companies who have a monopoly, they go through lengths of saying, “Oh, oh, look at poor me. We don’t have a monopoly at all. We’re Amazon, we are global retail. We have no market share.” Then you have the other companies who are like, “Look at all this monopoly power we have,” and that’s typically because they don’t.

Stig Brodersen (00:07:47):
Anyways, so this is a market they have grown a lot here recently. It’s the seventh consecutive quarter where they have double or triple-digit growth. They are making some interesting investments, bought a small Danish company for 12 million in the local currency, four million to the founders, and they put eight million in.

Stig Brodersen (00:08:08):
So, the third unit, just please stay with me here, the third unit. And the second, digital services was the second unit if you want. It’s called Bekey and it supplies and maintains digital access solutions to customers. So, easy access, locked door, encrypted keys.

Stig Brodersen (00:08:27):
It’s only 2.5% of the overall revenue, and if you look at the numbers, it looks really ugly. Partly it’s because it is ugly, but you also have a lot of write-offs for some IT structure. It’s been written off, they have their operations in Ukraine and have been… They haven’t really changed the operation itself, but the IT development team is based there and had to be relocated due to everything that’s happening.

Stig Brodersen (00:08:49):
If you adjust the EBIT for digital services, it would probably be at least 50% higher if you remove Bekey and the investments that they are making there. And then they also have 50% in a company called Karman Connect, which is a fintech business that’s growing relatively fast. Michelin and revenue accounts for 3% of the consolidated EBIT.

Stig Brodersen (00:09:11):
The third leg in this business is the securities portfolio. If you look at the latest numbers that we have, they have 643 million. Again, this is local currency, but 643 million, and the marcap is 1634. So, if you look at the latest numbers, 39% of the business is in equities. 18 stocks-ish. Last time I counted tech, healthcare, other industries. Mainly Danish and American equity. The Americans are generally in tech.

Tobias Carlisle (00:09:45):
I’m going to derail, but why do they have equity portfolios?

Stig Brodersen (00:09:49):
I think it comes from a few different reasons. The main thing is that the founder… We’ve got to talk more about the ownership structure, but the founder who owns 56% I want to say of the company, he’s 82 and he’s still… So, he’s no longer chairman, but I would expect that he still has a say. What they’re saying is that they want to take advantage of great opportunities if that happens. And they also have a strategy in place where they’re going to spend up to 200 million from 2021 to 2024, they haven’t spent a lot of that money, into acquisitions.

Stig Brodersen (00:10:22):
But even if they did, giving the free cash flow they’re doing, they’re probably going to do short of 200 million this year. It doesn’t really make sense. As an investor, especially in this time of business, you probably want them to pay out the cash. The owner who, again, he doesn’t have any kind of operational role, he’s no longer chairman of the board, but he is still running their equity portfolio. I would imagine it’s because of those reasons, and perhaps it’s better for him to run the portfolio from inside that company that he wholly controls.

Stig Brodersen (00:10:58):
If he had to do that privately, of course, he could transfer to another company, but if he has to do that privately, he would have to pay 56-ish percent in taxes first. So, there are probably different reasons why that happens, but it’s like that will be more going to local tax laws and all.

Stig Brodersen (00:11:16):
But anyways, I can understand why it sounds odd, and this, as an investor, you probably would like to see a different type of asset allocation. So, we would probably want as investors to go in and analyze those 18 stocks. If I had to do an assessment without going to every one of the 18 stocks, but they’re quite familiar names, I would probably say they might be slightly overvalued. Last year, they were definitely overvalued, but if you put me on the spot today and the fair value right now is 643 as of 31st of July, it might be a little lower.

Stig Brodersen (00:11:53):
Also, keep in mind, this is generally very liquid stocks, so that’s kept stocks and mega kept stocks, primarily invest in Denmark and the US, which is among the most expensive stock markets in the world. So, if you just use that as an indicator, we probably are slightly overvalued.

Stig Brodersen (00:12:10):
But I wouldn’t say if you look at the intrinsic value, I had a chance to look at them. I wouldn’t say it’s more than 10-15%-ish. It’s not outrageous, the type of evaluation you see in the portfolio. To your point there about why they hold equities, they have this idea, which is also true. Of course, that it’s better to have them in equities in the long term rather than in cash.

Stig Brodersen (00:12:36):
Of course, then you can make the augment as an investor. You might be even better if it’s in your pockets instead, but it is what it is. The company has no debt. They have three mortgages spread across five properties with a long-term fixed rate. The properties are carried at 244 million, the mortgage is 117.

Stig Brodersen (00:12:57):
I’m not going to use this in any ways in my valuation, it’s just more the way it has been operated. I feel it would be too aggressive to add any of that equity into the valuation. At least I choose not to, and the company has 140 million in cash too.

Stig Brodersen (00:13:14):
I’m going to walk you through the math at the very end because I know I’m throwing a lot of numbers at you right now. But anyways, you’re basically looking at a company with securities and cash close to 750 million, and the market cap was 16… it’s just called at 1650.

Stig Brodersen (00:13:32):
So, you are paying 900 million for assets producing around 200 million free cash flow. If we look at the buybacks, just talking a bit more about the cap’s allocation, generally, I think the founder has done a decent job. I always like to look back and say when have he sold and bought in the past, and does that make sense with the intrinsic value I have in mind too?

Stig Brodersen (00:14:02):
It hasn’t been crazy numbers. There was a buyback yield of 4% in 2019-2020, and he sold a bit back in 2021. It’s only very little though, but he sold whenever the stock was clearly overvalued, which you don’t see a lot of founders do. It’s very much like either-or, so they would continue to buy back stocks even though it doesn’t make sense, and they would issue shares at the wrong time.

Stig Brodersen (00:14:25):
It seems like the founder has a pretty good idea of what he’s doing. The dividend is five Danish kroner, which is equivalent to a yield of 6.25% at the moment, and the intention is to maintain the dividend until 2024 and then reevaluate. And the company went ex-dividend in 28 of March, and it was paid out 30 of March, so just keep that in mind.

Stig Brodersen (00:14:50):
So, talking about the ownership structure, I think I mentioned the founder owns 56% of the company. No other investors hold more than 5%, which you by local laws are forced to disclose. Aside from North Media itself, it owns 8.12% of the treasury shares. Those shares are mainly used in terms of compensation. It still meets the Warren Buffett rule of not giving out more than 1% in terms of dilution to reward management.

Stig Brodersen (00:15:19):
The chairman of the board has recently made open market acquisitions at a price of 72 and 92 Danish kroner, and the stock is trading today at 80 Danish kroner. We also have seen some insider selling, but as we talked about on this show before, there are always many more reasons for selling than buying. There are stock options, there are tech considerations, someone is buying a vacation home, diversification reasons. There’s typically only one reason why someone wants to buy, but there are a bunch of reasons why you want to sell as an insider.

Stig Brodersen (00:15:54):
Let’s talk about… I mean I feel I make all of this sound good. Lots of bad stuff too, so let me talk about some of the bad stuff. Two things I’m really on the lookout for here. One of them is that by definition, in this country, you get leaflets sent to your door unless you say no.

Stig Brodersen (00:16:18):
A long time ago, there was some jitter that, “Oh, should we change that?” So, generally, you won’t get sent all kinds of leaflets and pamphlets and advertising to your door unless you say yes. And it’s always been the other way around, which is just very, very powerful.

Stig Brodersen (00:16:34):
My wife and I, we actually don’t want that product, and so, we had to go in and cancel it because we moved a year ago. And whenever you move, it doesn’t follow, and it’s actually really annoying. The process is quite a few ways for you to stop you, to make it difficult for you basically so you’ll continue to get those leaflets. So, that’s a major risk since most of the money comes from FK Distribution, which is the legacy business. If that piece of legislation would change, major risk.

Stig Brodersen (00:17:07):
The other thing, and I want to say this in a political correct way. I’ll pause to see if I can say that. People who use this service are dying, but I want this to come off-

Tobias Carlisle (00:17:24):
I’m glad it was the politically correct version.

Stig Brodersen (00:17:27):
I don’t think it was the political correct version, but the reason why I’m saying that. Obviously, I’m joking as I’m saying this is that you can track generally it is so that the older generation wants this, and the young generation do not want this. They can get it digitally or they don’t want it, or they go directly to the store that they want to shop in because they have their own apps.

Stig Brodersen (00:17:47):
And so, that’s also one of the many reasons why you see that… We have some graphs here. I can link to one of the reports and we can just see year after year that it’s just slowly declining, the number of people who want to receive these. And right now, it’s 66%. In 10 years, it’s going to be significantly less.

Stig Brodersen (00:18:06):
Then you have other costs. They are a distribution, so the price of oil, that going up, that has been a bit of a pain. The price of paper has skyrocketed, which has been bad too. North Media are not buying the paper themselves, but the customers are buying the paper, but it has a spillover effect in terms of managing their cost in advertising.

Stig Brodersen (00:18:27):
So, that’s like those are the major… At least for the legacy business, that’s the major risk that I’m looking at. Could they lose the modeling precision delivering these? Probably not. That’s not the way it looks right now. Also, the interesting thing about having this type of legacy business is that you don’t get a lot of competitors because it’s a dying business.

Stig Brodersen (00:18:56):
So, it’s something to consider, but it is a business that, of course, has some sort of competition. You have the former national monopoly who also delivers, but they do slightly different things.

Tobias Carlisle (00:19:10):
When you were doing your valuation for this, do you model decline in this part of the business? Did you model that in? What are your assumptions there? Continue to dock the client 2% a year or-

Stig Brodersen (00:19:22):
Whenever I look back over the past three to five years, it’s generally been low to mid-single digits decline for the legacy business. Of course, all this depends on, do you measure in the currency? Do you measure in the volume?

Stig Brodersen (00:19:40):
Whenever you look at the strategy they outlined going until 2024, they talk about a stable turnover. I would say that’s probably a bit ambitious. In any case, it would be nominal numbers whenever they talk about the stable turnover, and with inflation at 8’%, you have to consider that too.

Stig Brodersen (00:19:59):
Then you have, again, if you look at the strategy, the growth in the digital services versus around 16% of revenue now, and probably would have different margins whenever they mature and they stop investing as much. You’d probably see around 20% annual growth. Right now, they are almost offsetting each other, and that is the strategy because they actually call FK Distribution, that company, they actually call it the last mile in the report, and it’s probably for good reason.

Stig Brodersen (00:20:27):
They also have a business relationship with Deutsche Post, which is the main German distributor, but they only package that because they have the fully automated system, and they do that for 1.9 million households in Northern Germany. They do not distribute them and whenever that was announced, they didn’t make any changes to the guidance.

Stig Brodersen (00:20:48):
And so, it’s not disclosed how much money they’re making, and they say that it’s a focus. I guess it’s about survival and manage this slow decline more than anything. As great as it sounds that, “Oh, now we’re teaming up with a much bigger market,” that’s not where the money is, is my best guess for North Media.

Stig Brodersen (00:21:09):
The other thing that could be a bit concerning is that whenever you want to acquire companies to grow, I’m not saying that it can’t be done. Of course, it can. It’s just very, very difficult. It’s a lot easier if you’re really good at something and you grow that business. Whenever I say that, if we take out cash and we take out this curious… and it’s trading at four-and-a-half times EBIT or free cash flow.

Stig Brodersen (00:21:34):
EBIT and free cash flow generally follow each other which they don’t do for all businesses, but it also shows what type of business it is. It is spinning off a lot of cash. It’s cheap. It’s also cheap for a reason, but it’s definitely not an expensive share compared to the intrinsic value right now.

Stig Brodersen (00:21:50):
If we talk about potential catalysts, one thing that we as value investors have seen over the years or companies who are profitable and the stock price seems to go nowhere, and you keep on… Even if it’s also because they’re spinning off cash, it seems like it’s not really going anywhere because it’s just sitting there.

Stig Brodersen (00:22:11):
So, I have a potential catalyst, and it’s also not political correct. That’s going to be my disclaimer going into this. The founder is 82 years old and he’s the one managing the portfolio. I don’t know how much longer he’s going to do that. Hopefully, and I want this to come across the right way, hopefully for many years. I don’t know him. I have nothing against him.

Stig Brodersen (00:22:37):
Sometimes what we see whenever the owner is not there, for whatever reason, the new shareholders change the strategy and want to do something else. And so, what I said there between the lines and I’m going to say here now is that perhaps the new owners want to liquidate the portfolio. Perhaps they want to increase the dividend payments.

Stig Brodersen (00:22:58):
Like I mentioned before, I mean we’re talking about a 40% market cap that’s securities and cash, and we have a 6+% dividend yield. It’s real cash that could be distributed. It was announced back in February 2021 that the founder and his wife has decided to give their shares to a foundation. They would retain the current long-term strategic direction of the company.

Stig Brodersen (00:23:24):
I’m not completely sure what to make out of that, but everything else equal, I would imagine that the pressure for paying out some of that cash would probably increase whenever he’s not managing that portfolio for whatever reason.

Stig Brodersen (00:23:40):
I have a disclaimer here on the end, but I feel like it’s probably been one of the longest pitches I’ve done here of all our mastermind groups. I wanted to make sure that I made a proper disclaimer. I am a little uneasy whenever I present a small stock like this that’s bought over the counter. The listeners can potentially move the market.

Stig Brodersen (00:24:04):
I remember whenever our friend Jake Taylor was on, and he pitched this very small… I think it was Fairfax Africa, this very small stock. It could be a complete coincidence, but whenever we release the episode, which we did over the weekend, Monday morning it just went up, and it’s such a thinly traded stock.

Stig Brodersen (00:24:24):
I don’t know. I’m not saying that’s the case, but I checked the numbers here before, and they might not be updated, but I checked it two-thirds into the trading day. There was 14,000 shares traded, and they’re trading in dollars, they’re trading around $11.

Stig Brodersen (00:24:43):
And so, it’s not a huge volume. We’re closing in on 100 million downloads here on the feed, and we have let’s say 200,000 people that eventually listen to this episode. So, if that’s the volume of the day, it doesn’t take a lot to move that price.

Stig Brodersen (00:25:00):
So, what we’ve done as hosts is that we all signed this pledge that we won’t take position in the stocks that we mention on our episodes after 30 days after it’s been published unless we have a really clear disclaimer of, “Oh, we want to buy it at this price.” We want to be very upfront with it because it probably wouldn’t make any difference if we’re talking about Apple, I’m pretty sure, but now we’re talking about this obscure stock.

Stig Brodersen (00:25:24):
And even more important, this was something William got in, which I really like. It said the Warren Buffett rule is not to do anything that you wouldn’t see on the front page on the newspaper the next day. And so, that is the guiding principle.

Stig Brodersen (00:25:38):
With that, with this long disclaimer, I want to say that I do not expect to take a precision through this after this has been published. If it was trading lower at around 60 Danish kroner from now until it’s been published, I probably am going to take a position. Right now, it’s trading at 80, but just so everyone know, unless there’s some sort of opportunity cost and other stocks are more appealing, I might not buy at 60 Danish kroner. But it would be very, very appealing around that price.

Stig Brodersen (00:26:07):
So, if I have any excess cash and there’s not something else that looks fantastic, it would be something I would be looking for. Toby, that was a long pitch there. Let me throw it over to you. I’m curious to hear any thoughts you have about the stock.

Tobias Carlisle (00:26:24):
I like these sort of positions because the downside is fairly capped. The question is, how do you realize the value? And I guess with a 56% owner who’s 82, with any luck, he’s got years and years and years. So, there’s no immediate catalyst.

Tobias Carlisle (00:26:45):
Having said that, 6% dividend is pretty material, particularly in this market. And you’ve got the found value of 40% of the market capping in equities [inaudible 00:26:58] business, even though it’s in decline, it’s an interesting business. It’s going to throw off a lot of money. They’ve got some competition that they can probably raise their prices as they go along because that last mile is pretty attractive there.

Tobias Carlisle (00:27:12):
They do have a little bit of pricing power there, and then, I don’t know, I missed slightly how big the digital services part of the business was relative to the… At what point do you think that that grows sufficiently to offset the decline in the other business?

Stig Brodersen (00:27:30):
To answer the first question first, it’s 16% of revenue. The reported EBIT is 10%, whereas it was around just call it 20. I think it was 22 for the last mile. But in reality, the digital services EBIT is much higher. Bekey accounting-wise are losing a bunch of cash because of write-offs, but also because the reinvesting is probably not my favorite business either.

Stig Brodersen (00:27:58):
But if you would normalize the EBIT on that, I would say it would be higher than 20%, so it’s something to consider. The ambition is to grow 20% a year, and I think year over year, I think the growth is 16%, I want to say. Just if anyone is going to report afterwards and like, “Ah, that number is slightly off,” we have new numbers coming out like… I watched the presentation six hours ago, so some of the numbers are very, very new.

Stig Brodersen (00:28:27):
If you look at year over year for the last reported quarter, which I want to say it was around 16%. I’m scrolling through my notes, but it’s in that range. And so, whenever you hear them say, “Well, we’re going to allocate up to 200 million for acquisitions, and those acquisitions would be in the digital services.”

Stig Brodersen (00:28:45):
If they spend all that money, it will grow a lot faster. If they don’t spend any of that, it will take a lot longer. It is quite tricky, and it’s going to be one of those… Remember in school, when you had one of those like the train is leaving from this city and it runs back 40 miles an hour. Then they have this other city and it’s when do they cross?

Stig Brodersen (00:29:05):
Yeah, so it’s one of those. You might say, “You have to… There’s 84% of revenue. Let’s just use revenue, and it’s going to decline. As close as 4% a year.” When you have the other thing that’s 16% that’s going to grow over 20% a year or whatever number you think is reasonable.

Stig Brodersen (00:29:24):
My head is spinning right now. There’s probably someone in the eighth grade who are listening to this already solved it, but that’s the way it is. In terms of allocation, they are, as you can probably tell, taking that cash to reinvest. Of course, also to pay out this dividend, but to reinvest into the service businesses because they know that’s the way it’s going, and the rest. They just put in equities. So, it is an interesting way of thinking about this.

Tobias Carlisle (00:29:50):
What’s the payout ratio? How much are they paying out?

Stig Brodersen (00:29:53):
Yeah, so it’s a bit tricky whenever you talk about the payout ratio because the payout ratio are typically measured on the net profit. But we have this change in gap rules or IFRS rules as it would be in Europe.

Stig Brodersen (00:30:09):
And so, whenever you look at those numbers, they are all over the place because it’s mark to market. And so, whenever you see the market decline, as you’ve seen, it’s going to look really, really ugly, and then last year, it looked fantastic. I want to say it’s less than 50%. Let me see if I can find the exact number here.

Stig Brodersen (00:30:28):
Yeah, I would expect that because I would expect the free cash flow to be around 200 million. The 20 million shares, the pay five. So, yeah, around 50% right now would be the payout ratio give and take.

Tobias Carlisle (00:30:41):
So, the way that I would think about this is you have… It’s a $200 million US market cap. 40% of it is in equities, which let’s say they’re worth roughly what they’re worth, there might be some good stuff in it that’s going to grow, but let’s just treat that as cash for the moment.

Tobias Carlisle (00:30:58):
So, it’s $120 million in market cap. Sorry, $120 million in enterprise value paying out $12 million in dividend on the 200 million, 24, and then another $12 million next year because the 6% is fixed. Sorry, 6%, that dividend is fixed, so that’s 12 and then 24.

Tobias Carlisle (00:31:21):
So, you’re getting a lot of your capital back, and then inside, you have a business that’s still throwing off a lot of money plus these two others that are growing pretty rapidly. It’s reasonable risk-adjusted then for where it is, and with the 6% dividend you’re getting paid to hold it, downside is minimal. Upside is… at some point, it gets taken care of. That’s the kind of position I like.

Stig Brodersen (00:31:46):
Yeah, if I were Toby Carlisle with the basket approach, I would like this type of company in my portfolio. As of yesterday, I bought a new stock yesterday, we probably don’t have time to talk about it today, but we can always do it next time. With that, I have four individual stocks.

Stig Brodersen (00:32:05):
I tend to run a pretty concentrated portfolio. I also have other type of investments, but for my individual stock picks-

Tobias Carlisle (00:32:11):
What do you hold? What’s in your portfolio?

Stig Brodersen (00:32:15):
I have Berkshire, I have Alibaba, Google or Alphabet. And keep in mind, whenever you listen to all of this, one thing is what it’s trading at now, another thing is the price you bought it at. Not that I did well on Alibaba. I actually just added to my appreciation today at $89, so whenever this comes out, who knows? Who knows how much it has laid since. And yesterday, I bought Prosus.

Tobias Carlisle (00:32:40):
South African company that has a chunk of Tencent.

Stig Brodersen (00:32:45):
Sort of. So, they did this swap, that was because they want to unlock the value, so they made their… And incorporated then Prosus. The control is still with Naspers, but the values of the business is with Prosus. And if this sounds complicated, it’s because it is.

Stig Brodersen (00:33:03):
So, I bought a small position. I bought enough to pay attention, but not so much if I am completely off in what I’m doing that really affects me. I do that just to make sure that I keep up and then double down if I realize that there is something there.

Stig Brodersen (00:33:21):
If it’s not, I typically tend to sell it. I really like to have very few equities I focus on at a time. What Prosus is doing right now, it’s just interesting now that we are talking about it. I bought that, just for full disclosure, I bought it at 63.90 euros. I did it while the net asset value was 101 euro per share.

Stig Brodersen (00:33:47):
And so, what’s interesting about it because they did decide to unlock the value, and I think this was announced probably in late June. I can’t remember exactly, but they own a lot of Tencent. It used to be 45%, but now it’s significantly less. I want to say off the top of my head, 27% whatnot. I looked at it this morning, but I wanted to have it in front of me.

Stig Brodersen (00:34:09):
All right, so they have numbers that they actually update on the databases, which is very, very nice. The net asset per share right now in euros is 100.50 euros. The net asset value in billions of euros is 142.7, and that’s not at all what it’s trading at right now.

Stig Brodersen (00:34:33):
And so, if you just look at Tencent itself, what it has now is $107 billion. So, what they do right now is they are selling Tencent shares even though that’s, for all intents and purposes, undervalued. They sell that to buy back Prosus in the market. So, the way to think about this is, using generic numbers, they are selling a dollar for 60 cents to buy back at 40 cents.

Tobias Carlisle (00:35:01):
Selling a dollar for 60 cents to buy back at 40 cents to narrow the gap between the two. Is that the idea? That’s what they’re trying to achieve.

Stig Brodersen (00:35:12):
Yeah, right now, if you bought the share, you actually get more Tencent stock in fair value that you’re buying it for. Plus, you get all the other businesses for free. I know it sounds odd. A lot of times something is trading below net asset value, but in this case, it’s primarily marketable securities.

Stig Brodersen (00:35:32):
Not all of it. Of the listed assets, they have 112.7 billion euros, and they have 31.3 in unlisted assets. That comes from analyst consensus and post-money valuations. It’s difficult for me, whenever I read up on the portfolio, it’s difficult for me to say it’s worth 31.3, but I’m pretty sure it’s worth more than zero euros.

Stig Brodersen (00:35:58):
And so, that’s the first part of the thesis. Whenever I look at Tencent too, which is like I know I’m derailing the conversation completely, Tencent looks really cheap to me. And so, I’m buying something that’s probably already discounted through a vertical that’s already discounted.

Stig Brodersen (00:36:17):
Plus, I’m getting, what is that? Almost a third of that in extra free businesses if you want, from their unlisted assets. It is what it is. I know I’m throwing a lot of numbers at people, but I’ll make sure to link to some resources and everyone can check it out for themselves. Have you seen something like this before, Toby?

Tobias Carlisle (00:36:41):
Oh, yeah. Yeah. That’s bread and butter for Deep Value. It’s good stuff.

Stig Brodersen (00:36:47):
Right. Are you looking at something like this right now?

Tobias Carlisle (00:36:51):
My pitch is something different, but we’ll get to that when we get to that.

Stig Brodersen (00:36:57):
Right, right. Can I ask? Because whenever I saw yours like, “Huh, this is interesting.” Do you have anything in your portfolio? I know I’m really putting you on the spot here, but is that a part of your strategy or are you using different metrics to find the companies?

Tobias Carlisle (00:37:11):
I’m looking for operating businesses. My main focus in the funds is operating businesses that are throwing off free cash flow and are using it to make material buybacks. For the most part, that’s the kind of stuff that I like.

Tobias Carlisle (00:37:25):
I like them when they’re growing by themselves, but I like to see management exercising some discipline around… I think the stock that I’m going to pitch is a good example of that.

Stig Brodersen (00:37:34):
All right, let’s do it, Toby.

Tobias Carlisle (00:37:37):
So, the one that I’m pitching is First American Financial. It’s a $6 billion market cap, $7 billion in enterprise value, so it’s about a billion dollars in debt. Dividend yield is 3.5%. Over the last say five or six years, return on invested capital has varied from about 12.6%, which is about run of the mill for listed companies, to as much as 21% last year. But that was probably flattered by the property market.

Tobias Carlisle (00:38:05):
So, First American Financial, what they are, they’re a title insurer. That’s not a business that many people will be familiar with, but the idea is that in the US, there’s no centralized government depository or record of who owns real estate. So, when you buy real estate, you’re always running the risk that the person that you’re buying it from doesn’t have a clear title. And that’s a catastrophe if you buy something and somebody else owns the property or there’s some encumbrance against the property where somebody else can come interfere with your clear title to the house that you live in. You don’t want that.

Tobias Carlisle (00:38:48):
So, there are a number of these companies around, and First American Financial is the biggest that have these very extensive comprehensive databases of title chains, so you can see that you are getting a clear title to the property. As the purchaser of a house, you buy title insurance, and it just guarantees that if there’s any issue, then you’re going to be made whole to the extent that you can be on your house acquisition.

Tobias Carlisle (00:39:19):
And so, it’s mandatory, but it’s a no-brainer for somebody buying a house to go and get title insurance because it’s such a small amount of money relative to the cost of the house and you protect it. So, the suppliers for the seller of insurance. It’s a good business for them too because it’s not like personal and P&C. It’s not property and casualty. It’s nothing like that where there’s big payouts. It’s not balance sheet intensive.

Tobias Carlisle (00:39:47):
What it is, it’s like a due diligence process. As long as their systems are good and they’ve tracked it, it’s very unlikely that they’re ever going to need to make a payout. It’s just part of the diligence process of buying a house.

Tobias Carlisle (00:40:02):
The business itself, it’s very profitable, it’s very dependable. The issue, of course, is that it varies along with the property market. When there are more property transactions, they make more money. When there are fewer property transactions, they make less money.

Tobias Carlisle (00:40:17):
You need it for a refi, and you need it for a sale or purchase. You make more money from a sale or purchase than you do from a refi. That’s about two-and-a-half times as much for a sale or purchase versus a refi. First American makes about… Well, they made $9 billion last year, so it’s a great business.

Tobias Carlisle (00:40:35):
That resulted in about $618 million in free cash flow on a $7 billion enterprise value, so it’s like a 9% free cash flow yield. Over the last, say six or seven years, that’s varied from as little as $12 million, $18 million, to 600 being the best. Average is about 200 over that period of time.

Tobias Carlisle (00:40:59):
The reason that it’s cheap is that we’re likely going into housing markets collapsing a little bit over here. There are some statistics today that I saw that the housing… In California, which tends to be more boom/bust than any other state it looks like we’re going through a 2007 or 2020 type… There are as few transactions going through as those two periods, so it’s possible they’re not going to have great years for the next few years.

Tobias Carlisle (00:41:27):
But the business is… It’s just it’s so hard to compete with something like this if you don’t have that database to start off with. There’s a handful of competitors. These guys are very good at buying in local markets. They’ve got 550 offices, they’ve got 20-something thousand employees, so it’s a business that requires some… It is a little bit hands-on, and they buy these little title insurance companies in specific markets where they don’t have coverage.

Tobias Carlisle (00:41:59):
Otherwise, the presentation on the website is very good. It shows you what they do with their cash flow. They’ve been very good at buying back stock, pay a dividend that’s about 3.5% yield at the moment. So, that’s what I like to see. They do a great job buying back stock, and they pay out the cash flow to the extent that they can. It’s a great-looking capital structure, and it’s a simple business. It’s readily understandable.

Tobias Carlisle (00:42:25):
So, I think the business consistently earns more than its cost of capital, which means that it definitely has very chunky value and it’s hard to compete with it, so it’s the sort of business that I really like. Small, simple, clear, people need it, and the cost to them is minimal compared to the larger transaction that occurs when they buy it. So, that’s it.

Stig Brodersen (00:42:46):
I love your pick as always, Toby. The big question mark is, how bad is this going to be with the interest rate going up, the recession coming? At least the bond market is telling us that a recession is coming. I had a chance to look at the most recent slide deck. I’ll make sure to link to this, but if you look at page seven in that deck, it goes all the way back to 2000 and what happened after the burst of the dot-com bubble.

Stig Brodersen (00:43:18):
You could just see how with the refinancing even though it was primarily located in tech, at least that’s how we think back at it, you saw a lot less refinancing and origination as well. Pretax margins at the time was around 5%, and then you saw the peak. It turned profitable soon after…

Stig Brodersen (00:43:41):
It was already profitable, but a lot more profitable. And then you had the 2008 great financial crisis, and then you saw negative pretax margins for some time. Since then, it’s only going up and it’s now around 17-18% pretax margins. You can see that they estimate slower sales, and who knows how bad it’s going to be like?

Stig Brodersen (00:44:04):
I’ve been burned by picks like… I wouldn’t say like these because I think this is more solid, but I’ve been burned by some old stocks in the past and you know how it is with cyclical stocks. At least you learn after you’ve been burned with cyclical stocks that it typically tends to look really appealing whenever they trade at really low multiple, and the rest of the market knows that something bad is going to happen, which is why it trades at a very low multiple.

Stig Brodersen (00:44:30):
And then the profit just disappears, and the multiple seems not to matter at all because it’s, what is minus times infinity whenever you do the math? And so, I guess that’s my main concern with a company like this. I don’t know how bad it’s going to get. I just don’t know the market well enough. We’ve seen whenever we had recession in the past, that’s not going to go well. The question is how high is the interest rate going to go?

Tobias Carlisle (00:44:56):
Well, we’re into the fall in property market. That’s going on right now. So, the data that I saw today says that the number of transactions going through in California is comparable to 2020 and to 2007, which are the two quietest periods in the last whatever it is, 20 years or something like that.

Tobias Carlisle (00:45:19):
The business has been around for quite a while. You can see the data in that slide deck that goes all the way to 2000. It has good years, and it has bad years, but it is reasonably consistent. Even if we go through this period of time where there aren’t as many transactions, people will still buy and sell property, and there will still be refinances going on.

Tobias Carlisle (00:45:40):
From that perspective, it’s not like an oil and gas business where they don’t know what the price of the commodity is going to be in 12 months’ time. Negative numbers are possible it turns out. I didn’t realize that was a possibility in oil and gas, but it is evidently, and then also very high priced. It’s nowhere near as cyclical as that.

Tobias Carlisle (00:45:56):
And it’s not like they’re investing into that market, they participate along with transaction volume. And so, what I think will happen is what we’re seeing now is the slowdown in transaction volume, and that’s why the stock is cheap. And that’s probably why you can look at the valuation, it does look like it’s the cheapest valuation in 10 years.

Tobias Carlisle (00:46:14):
But as you point out, that’s likely a little bit misleading because it will be on peak numbers when we’re going through the bust right now. But I think that if you look at further, if you think out three, five, 10 years, this business is still going to be there.

Stig Brodersen (00:46:27):
Oh, yeah.

Tobias Carlisle (00:46:27):
The business is still going to be going. The normalized run rate for this business is it could be a half to a third where it is now. But the downside I think is very limited. The downside is virtually non-existent. It’s hard for this to be a zero. It’s hard for this to fall much more. I think…

Tobias Carlisle (00:46:49):
This is not the stock price that I’m talking about here, this is the business itself. I think it’s hard for the business to slow down much more than they’re currently enduring, which will probably come out in the next few quarters. You’ll see how bad it is.

Tobias Carlisle (00:47:01):
But even in that scenario, I don’t think it’s that bad because it throws off lots of free cash flow, it’s conservatively capitalized, and it’s just hard to compete with. Nobody’s going to be coming in and competing with this business. It does have other competitors, but these guys have got… They’re like 23% of the market share, something like that. Very solid.

Stig Brodersen (00:47:22):
That is very solid.

Tobias Carlisle (00:47:24):
I just think it’s a… The upside may not be huge, but the downside is very limited, and it should earn a reasonable return from here.

Stig Brodersen (00:47:32):
I completely agree with everything you said, Toby. I think that the downside for sure is very, very low. They talk about how 25 basis points on the year Fed funds rate adds up to another 15 to 20 million a year. So, part of that is, of course, a hedge. If you had to do the apples-to-apples comparison, just of course consider how much the investment income is compared to how much cash flow they’re doing.

Stig Brodersen (00:47:59):
But just to give you some numbers, so the marcap is six billion, the price to free cash flow is 8.2 today as I’m recording, and what’s interesting about their investment portfolio, they have 6% in equities of their $9.5 billion consolidated portfolio.

Stig Brodersen (00:48:21):
Might sound crazy to you if you compare it to a company like Berkshire, but most companies are not like Berkshire or like Geico. They are managed by other asset managers. The bond yield right now is 1.8%, average rating is AA, and the duration is 4.3 years. And so, there is something I guess a hedge offsetting there.

Stig Brodersen (00:48:47):
Whenever I see stocks like this with First American, and whenever I see the one with North Media, I am thinking, “Oh, let’s have 30 stocks like that. Let’s not be super concentrated and have three or four stocks and let them just throw off that cash and let’s make [inaudible 00:49:09] do its magic.”

Stig Brodersen (00:49:12):
Is that where you’re at right now in terms of constructing a portfolio? Or let me ask you another way because who would that type of investing be right for?

Tobias Carlisle (00:49:23):
So, that’s how I invest. I like to buy a portfolio because I’ve seen people get too concentrated into individual names and blow themselves up. I don’t think that you’re going to have any problem with the names that you have, but I have seen people get caught. Everybody’s looking at the upside, everybody forgets about the downside.

Tobias Carlisle (00:49:43):
The downside is the place I would start with. I want to make sure that none of them can blow up. I want to make sure that they can model through even in bad markets for their businesses. And then I also like to see management that in the event that you do go through something like what these guys are probably facing, that has a track record of buying stocks because that creates that antifragile quality where they take advantage of the undervaluation.

Tobias Carlisle (00:50:15):
All else being equal, as a shareholder, you want the prices lower because that means that you are going to be concentrating faster into the business as they buy back stock. So, my portfolio is filled with these companies that throw off lots of free cash flow. They grow reasonably but might be a little bit more cyclical. The cyclicality is something that management can take advantage of and buy back stock so that over time, you own more and more of the underlying business.

Tobias Carlisle (00:50:48):
That’s essentially the strategy. I don’t have to be as deep in the weeds in any given name because as long as most of the pieces fit in a portfolio of 30 or 100 names depending on how big… The small and micro portfolio is much more diversified for the simple reason that they are less high-quality businesses, and they are much more subject to the other things that go on around them in the economy. So, they are very sensitive to the [inaudible 00:51:18].

Tobias Carlisle (00:51:20):
I think that it’s hard to lose too much on these, and it’s probably likely that they deliver reasonable returns for the capital investor. That’s basically the way I’m thinking about it.

Stig Brodersen (00:51:32):
Interesting. I guess two points to that. The first one, in case everyone is like, “So, Stig then invested 40% in Berkshire, and 30% in Google, and 30% in Alibaba, and then just bought one share of Prosus.” My three shares are now four shares, but Prosus is very, very little. That’s 20% of my portfolio, so just before, Toby, you get concerned and like, “Something is going on there.” It is what it is, but it’s the small portfolio I have with individual stock names.

Stig Brodersen (00:52:07):
To your point about First American, I love what they’re doing right now with the buybacks. It’s interesting tracking what they’ve done in the past on that. Since the beginning of the year, they repurchased approximately 6% of the shares. It’s a lot, and this is a company that’s trading at eight times free cash flow, so things are going fast.

Stig Brodersen (00:52:27):
And like Charlie Munger’s saying, “Beware of the cannibals,” and this surely is one. I don’t think this is going to go out of business. I also just want to clarify that. It was incorporated in 1889, and even though that’s no guarantee that it will continue, a lot of saddle makers were also incorporated around that time I’m sure, it doesn’t seem like this company is going anywhere. So, I just wanted to clarify that. Do you have anything you wanted to add to North Media, to First American Financial, anything?

Tobias Carlisle (00:52:58):
I like these positions. I like North Media as a pick. I think that you will see The Investor’s Podcast bump when this goes public.

Stig Brodersen (00:53:07):
Yeah, I’ll make sure to-

Tobias Carlisle (00:53:08):
I won’t touch it, just to be clear.

Stig Brodersen (00:53:10):
Okay, great. Yeah.

Tobias Carlisle (00:53:13):
Not because I don’t like it, but because I think that there will be a bump.

Stig Brodersen (00:53:16):
All right, okay. Yeah, let’s see. It will actually be interesting to see what’s going to happen. Hey, Toby, before I let you go, as always, please, give the audience an opportunity to… Where can they learn more about you, your funds, what you do?

Tobias Carlisle (00:53:32):
My funds are the Acquirers Fund, the ticker ZIG. It’s 30 names domestic US following along the same strategy that I just outlined before. And I have a smaller microcap fund. The ticker is DEEP, D-E-E-P, and I have a website acquirersmultiple.com. I’m on Twitter @Greenbackd, G-R-E-E-N-B-A-C-K-D.

Tobias Carlisle (00:53:56):
I have some books out there as well to articulate the strategy in more detail if you’re interested in that. The most recent one was The Acquirer’s Multiple which came out in 2017. It’s on Amazon along with everything else. All the links are on Acquirers Funds, Acquirer’s Multiple, and the two funds have their own sites as well. Always fun being on, Stig. Thanks for having me.

Stig Brodersen (00:54:22):
Yeah, always fun chatting. I look forward to next quarter already. As you can tell, I already prepared my pick, Prosus. Anything that’s on your mind? Not that you can’t go back on your word, but any stocks you’re looking at right now?

Tobias Carlisle (00:54:38):
Well, I think that we’re… I don’t see anything that’s screamingly cheap given this little run-up that we’ve had since mid-June, but I do see a lot of… The operating margin for the S&P 500 has come back from 13% which was at its peak, which was extremely high. It’s 10%, which is still high, and I think that that trajectory is true for many businesses I have seen.

Tobias Carlisle (00:55:06):
And who knows whether it was because 2020 and 2021 were unusually good years, or if there is some real slowing in the economy. I do think that it’s the latter because you can see that in other figures like housing is slowing, all those other things.

Tobias Carlisle (00:55:20):
I think that you’re seeing that in businesses, so I don’t see anything that’s growing so rapidly and likely to continue to do so that you can justify a big premium for the business. I have this thought that we’re probably likely to go through… I think we’re midway through probably an extensive bear market. I don’t know, but that’s my gut feeling.

Tobias Carlisle (00:55:43):
When I look at where all the multiples are for the market itself and when I look at the underlying trajectory of the earnings, I feel like we haven’t cleared the decks yet, so I suspect that we will. I’m hopeful that when we come to do another mastermind there will be some screamingly cheap stuff probably that will mean that we’re well into another bust.

Tobias Carlisle (00:56:04):
And I would say to people out there who… I’ve been through two now. I’ve been through the 2000 bust and the 2007, 8, 9 bust. 2020 was a flash crash and there was a bust in 2018 towards the end of the year, and there was a bust in 2016 as well. I think that people have now been conditioned to expect that these things recover really quickly.

Tobias Carlisle (00:56:28):
This is not as deep as 2020, but it’s been much more extended in terms of time. This is what real bear markets look like. It’s not so much the collapse that kills you, it’s the rallies being sold to lower lows that just wears you down over time. I would just mentally prepare potentially for another… It could be another year to 18 months of this before we see the real bottom.

Tobias Carlisle (00:56:54):
I’m saying this with the market within kissing distance of its all-time high, so I don’t know when this will come out. It could be clear that’s already happened by the time this comes out. I’m not nervous about the market. I just think that you should be mentally prepared for more carnage as we go along.

Stig Brodersen (00:57:13):
You have these small rallies, and you feel like now you are out of the weeds, especially if you haven’t experienced the markets for a long time. What happens is that they’re selling to a new low as you were mentioning, and it just exhausts you to a point where a lot of people just lose faith. That’s when everythings get ugly.

Stig Brodersen (00:57:32):
I want to say too, so please correct me if I’m wrong, but last time we had one of these conversations, you said that in the first two-third of a bear market, you lost a third of value. You’re nodding, so you know where I’m going with this, and the last third, you’re losing two-thirds of the value.

Tobias Carlisle (00:57:49):
Yeah, it’s the first two-thirds in time leads to one-third of the loss. And then the last third in time is two-thirds of the loss. That’s a Ken Fisher line, but I’ve heard that also from the British quality investor. What’s that gentleman’s name? It’s just escaping me at the moment.

Tobias Carlisle (00:58:14):
In any case, average bear markets are 18 months to two years, and the bulk of the selling occurs at the end. It’s that final spasm of selling that indicates the end of it setting up a… The 2007-2009 crash started in June 2007. By June 2008 it had almost rallied back to all-time highs. It didn’t quite get there, but then all of the selling happened from June 2008 in Q4 2008 and Q1 2009. So, it was quite drawn out.

Tobias Carlisle (00:58:50):
And so, I don’t know what the equivalent is now, but we could be… And the other odd thing is the ARK complex, the profitless tech that started selling off in February 2021. So, that’s now well and truly 18 months of selling. The market itself didn’t sell off until the start of this year, but that’s what happened in 2000 as well.

Tobias Carlisle (00:59:10):
It was all a little bit delayed, and so, the whole thing was quite delayed. And so, I think it’s impossible to predict where the market goes. I should say that first off. The reason I say this is just you need to be mentally prepared for, and I’m mentally prepared for another 18 months of carnage here.

Stig Brodersen (00:59:29):
Let them be the last words. Mentally prepared for 18 months of carnage. Hey, Toby, fantastic as always. Always good fun speaking with you. Thank you so much.

Tobias Carlisle (00:59:40):
My pleasure, Stig. Thanks for having me. Good to see you again.

Outro (00:59:44):
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Outro (01:00:01):
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