Tobias Carlisle 1:19
Last time I was on I had Vonage, which has fallen pretty significantly over the quarter, which was a short of mine. So I think the time before that, I had Netflix. So I have a–I have this theme of shorts that I’m going to continue with today. My short is i3 verticals. Probably not a company that a lot of people have heard of. The ticker is I-I-I-V. It’s a payment processor. What it does is it takes various different payment options and turns them into cash for, for different companies. It does it across three lines: education, public sector, and nonprofit. Not a huge company, so it’s a $780 million market cap. The enterprise value is closer to a billion, so it’s about $200 million in, in net debt sitting on the balance sheet; really expensive. It’s close to 10 times book value. EV EBIT (*inaudible*), my favorite metric, 153 times. By any measure, it’s got these huge multiples because it’s a software; it’s a service business. And anything that software as a service is now worth an infinite amount of money according to the public markets because they have an infinite total addressable market, and they can scale there at zero cost. That’s not actually true. That’s, that’s not, that’s not the case, but that’s the perception of every software as a service business. I think they’ve got a little cash squeeze coming. So there are cash to debt ratio is .1, at the moment. So it’s possible that they need to do something in the not too distant future. They got narrow kind of interest coverage that EBITDA is 5.5 times, which is what you would expect to see in a leveraged buyout, straight after the acquisition, and they would be trying to pay that down like their hair was on fire. So the way that I put my shorts on that site, I have them on for about a quarter, and then I reassess. So this one is a newish one for us. I’d be short this for about a quarter, and I would look at it again in the end of March, April.

Preston Pysh 3:21
I’m looking at this, and in the last 71 days, this thing has gone up 50%. So I’m kind of curious, what was driving that factor for it to explode up in price? Because I mean, fundamentally, this thing looks like a disaster. But the price action is kind of scary. Taking a short and seeing it go up 50% in the last 70 days.

Tobias Carlisle 3:44
If you have a–if you cast your eye back to about the 70 days before that till you see it, it takes a dip of about half.

Preston Pysh 3:51
Yeah. Oh, yeah. No, let me major that real fast, so I can tell the audience what I’m talking about. So, yeah. 70 days prior to that it dropped 40 percent. So I mean, it’s it’s extremely volatile. I guess what I’m saying is, so how do we know this time it’s gonna drop back down like it did 140 days ago?

Tobias Carlisle 4:12
I think it’s got some near term liquidity issues that they’re gonna need. I think that that’s a rant because they need to raise a little bit of capital, so that they’re planning on–they’re gonna do a capital raise. And I think that that’ll be the thing that waters the stock. So just another thing I always short these things very small in the portfolio. There’s a shorter to less than 1% for the most part.

Stig Brodersen 4:31
So you know, whenever I’m looking at this peak here, Toby, you know, this is, this is a rapidly growing company. Back in 2016, revenue 200,000,017; 263, then the year after, 324; and now, around 376. So this is a company that’s growing pretty fast. It is also grown fueled by debt. So the debt to EBITDAS 3.25, and I read through the documents of the company, and currently they put a restraint on their self, not going more than four times that. So you might be right in terms of they might be liquidity squeeze. Bearing interest rates 5.5% at the moment, obviously that would likely go up if they continued to make acquisitions. And I kind of want to talk about that. If we look here in the fiscal 2019, they completed nine acquisitions, and this is a strategic focus for them. That, you know, they want to pick up new business with new payment systems. I think, one of the most noticeable was the utility payment system that just picked up. And so, whenever I’m looking at this, it’s not necessarily that I disagree with you that it looks expensive, but it’s really hard to make conventional valuation based on this in the first place, which I sort of the don’t really like is. This looks like a company that’s on a buying spree. It keeps on reporting, you know, high growth rates, you know? By definition, almost. And as you said before, you know, the market just continues to, to value that really, really well. So I’m thinking, yes, we can say that the market might be overestimating the impact and the revenue potential or the net income potential. But as long as a company like that can continue to fuel that growth with close to–well, I wouldn’t call it zero cost. But like money is very, very cheap right now, and being rewarded. I guess, for me, it seems to be if I’m going to put a short on, I probably would like to, to buy that put. And then, you know, just pay the premium. Definitely, don’t want to ride the put. I guess that’s some of the concerns that, that I have. I guess to me, it doesn’t look like the obvious short.

Preston Pysh 6:45
So Toby, I completely agree with Stig on this. I don’t understand why it’s a high probability short. I mean, I wouldn’t be surprised if it went down by 50% in the coming quarter. But what assurance or key metric do we have that makes us think the market is going to start pricing that abrupt change into the price?

Tobias Carlisle 7:03
I have a bias against that kind of manufactured growth from roll ups, so that’s part of my dislike for something like this.

Preston Pysh 7:10
Hmm, that’s interesting. I’ve never thought of using something like that as a metric. So that’s, that’s pretty interesting. All right, so if you guys don’t have anything else, I’m gonna go ahead and pitch mine. I was going through our intrinsic value or TIP value filter. And as I’m going through it, there’s just so many financial companies that are coming up in the screener. And I personally believe that we’ve got a major issue with fiat currencies. I think we have a major issue with bond markets globally. And based on that global macro opinion that I have, I’m very hesitant to invest in financial companies at this point. So in the filter, I was going through, and I was trying to find companies that were, you know, great value picks, but not part of the financial services industry. And I came up with a company called Biogen and the ticker is B-I-I-B. This company has a ton of intellectual property. Their annual top line is around 13.4 billion. And that was for the 2018 number. They’re flush with cash. They have a very large profit margin, so for instance, their bottom line was $4.4 billion. And so, when you compare that to a top line of 13.4, you can see that they are, they’re really kicking off some high margin business. And that’s after tax, 4.4 billion. Not highly leveraged at all, which I really like. When I crunch the numbers on this, and I’m trying to figure out the intrinsic value, I do it through an IRR calculation. And so the IRR that I got for, for Biogen was around 10%. What I really like about the company is that they have a great track record of mergers and onboarding their acquisitions through the years. What I find a lot of the time with companies is you, you have management that are making acquisitions. And sometimes as acquisitions are more based on ego because they’re just trying to grow the top line, and to make the company bigger. But they’re doing it at the expense of the shareholders because they’re not bringing on margin, whenever they’re doing those mergers and expansion. This company, I think, has demonstrated for multiple decades that that’s not necessarily the case. They’re very strategic in the way that they are bringing companies on or they’re acquiring assets. They’re acquiring intellectual property that is very strategic and advantageous as they combine it with their other product lines. And that’s something that I really like based on the numbers that I’m seeing. The company was founded back in 1978 by some PhDs, very smart individuals. They do a lot of research in neuroscience; they do a lot of drugs; they’re, they’re working on one right now for Alzheimer’s. In fact, back in March of 2019, they were gonna launch a new drug, specifically for Alzheimer’s. And here the–there was an issue with the launch. The–once the, this became public knowledge, the stock price got crushed back in the march timeframe, but then in October they, they got some type of amendment, and it looks like the drug is now going to market, so I think that that’s a very good sign for that new asset. That’s one of many in their, in their list of assets that bring in all the the bottom line margin and profit that we’re seeing in the numbers. In general, I’m really–I’m very comfortable with the, the cash flow that the company’s kicking off. I think that those are going to continue to persist into the future. I think if based on where we’re at in the credit cycle and the craziness that we’re seeing with central banking action, I think this is a company that’s gonna outperform the S&P 500. And so that’s why I’m making it as my recommendation today. So with that, I’m kind of curious what you guys all think.

Tobias Carlisle 11:22
I hold it in the acquirers fund (*inaudible) to CIG. And I like the position.

Stig Brodersen 11:27
Yeah, I, I like the position also. I think whenever I looked at the numbers, it looked really good. It has a lot of the characteristics that I really like: the growing top line, you know; it doesn’t really have any capex; great margins as we, you know, see with, with pharmaceutical stocks, so it looks good. And then, I, you know, I’ll obviously had to ask myself, you know: “Why is the market pricing this so attractively, I guess, in comparison to so many other things out there right now?” And I think you brought up like a very interesting point there before, Preston, in terms of how the stock price is fluctuating. It’s very interesting looking at these companies, whenever you look at the stock price, you know? We have these steep climbs and these steep drops, which is just, you know, hundred percent correlated to, you know, announcements of late state’s products because it’s just always interesting. It’s a very difficult game to play. And, you know, I’ve–I pitched the stock before United Therapeutics, here on the show, and, and Toby pitched Gillette before, and you know? Some of the numbers looks really, really good. It’s just–I guess for me, I’m not smart with picks like this. It’s kind of, it’s hard for me to grasp everything that’s going on with patents and the value of these various patents. So let me just give you one example and–of something that I am concerned about, whenever we look at the–that stable, nice revenue growth. The blockbuster drug that they’ve been making so much of the revenue on. So last year 42% came from Tecfidera, which is a drug also for Alzheimer’s, and it can be challenged now. So, you know, no surprise when, whenever a patent can be challenged, you know? You see declining margins, and, and they don’t see as much revenue from that. So that’s something that I guess I’m a bit concerned about for a company. And this is, I just want to say for the record, I, I like the numbers. This is also to find hair in the soup, but say that the buyback yield is what 4, 6% like very, very nice also because of the current valuation; don’t really give into dividend. I don’t think they have a history of giving dividend, which is something for a lot of stocks, I would like to see right now, given the macro picture that Preston talked about before. And all of that money; the remaining money is really plugged back into like acquiring and developing new drugs. So I think that you can get decent returns; high single digits, probably, even though it’s probably going to be a sort of a bumpy ride as it is with these companies. So I think holding it like Toby is doing like in a portfolio with so many other stocks; more based on…more based on the metrics itself more than necessarily, this is the winner, you know? This is the winner in the industry. I think, I think a portfolio size more than 1-2% is probably a bit too aggressive for me.

Preston Pysh 14:16
Yeah, I pretty much agree with everything you just said. Hari, I’m curious what you think.

Hari Ramachandra 14:21
Yeah, I just had a question. I was reading up about their company, and I found that they’re under investigation for their treatment of Dementia and Alzheimer’s disease. Are you aware of this investigation? And how critical is it for them?

Preston Pysh 14:37
I tell you how I would go about it as I would go, and I would look at how much the settlement is for. I’d look at the probability for past settlements for this industry. And like, how much of that gets adjudicated, and then, I would just compare that to the bottom line and what kind of impact that might have for future revenues or impairment of the intangible asset. That’s how I would go about doing it.

Tobias Carlisle 14:57
Yeah, I would just say for something like this, so optically, it’s really cheap. And everybody would say, “Well, why is it really cheap?” Thing is that the stock is down; hasn’t gone anywhere for five years. And the reason for that is very simple. Five years ago, it was a very, very expensive company. It was trading on, say 40 times enterprise value free cash flow. Now, you look at it, it’s trading on something like eight and a half times enterprise value to free cash flow. So what it’s done is it’s grown pretty consistently for the last five years, but the stock hasn’t gone anywhere ’cause it’s been working off this massive over valuation. Now, when the stocks cheap, it’s easy to find all the problems with it. That things don’t get cheap without a reason. But my view is that many of these things just turn out to be temporary; that the investigation’s temporary. I just think a little bit of this in the portfolio. These sort of positions tend to work themselves out. I feel pretty good about something like this.

Preston Pysh 15:50
You know, it’s funny you say that, Toby, ’cause I’m looking back at the price, and it peaked in 2015; like right at the start of 2015, and this thing has gone sideways and kind of down in price ever since. But when you look at the fundamentals, they just kept on getting stronger throughout that whole period of time. Something else that I really like about this. On our momentum tool, the annual volatility on this thing is around 21% annually. It just broke out and turned green on our momentum tool, which I also think is a great indicator. So not only do we have fundamentals, we also have the price of the momentum changing outside of its statistical volatility range for a long term annual position. In general, I like it. I’m, I’m with Stig. I think the valuation from an IRR standpoint…if you think you’re gonna get more than like 9 or 10%, you’re probably overestimating future cash flows in my personal opinion. But I think that that’s probably, where this would lie for me as far as valuation.

Stig Brodersen 16:47
Can I ask you, Toby, ’cause you hold this in CIG, so how many positions do you hold? I’d assume you have some sort of mechanical way of determining position size or something like that. But could you please elaborate a bit more on that?

Tobias Carlisle 17:01
We hold 30 positions long; 30 positions short. The longs 4.3 times the size of the shorts. And the longs tend to be around 4.3%; the shorts are 1% at inception. I don’t spend too much time trying to work out which opportunity is better than the other because our universe is 1500 large. We’re taking 30 positions, which is, you know, one fifth of a decile, so we’re already very concentrated. And then, I think it’s hard to sort of differentiate between opportunities in there. What we’re trying to do is capture that deep value movement of the market–which anybody who’s been following along closely–that got out to historic wits bottomed on August 27, and it’s been outperforming the market since then. So that value, however, you measure value has been doing better through September, October, November, and into September. So I, I feel really good about value at the moment. So I like these kind of positions that are cash rich; generating cash flow; trading on very low multiples. And the, the idea is that you buy it with the possibility that the Alzheimer’s drug gets approved or something happens, and then you get this massive pop to the upside, but in the interim, it’s unlikely to lose much money.

Stig Brodersen 18:08
So does it mean that whenever you rebalance, it’s equal weight rebalancing?

Tobias Carlisle 18:13
We rebalance back to equal weight (*inaudible*). The stocks run pretty well, so we’ve been in it for a little while. So I think this is one of our bigger positions at the moment. We are just about to rebalance. I’d say that by the time this comes out, we’ll have rebalanced, but it’s 4.86% as of December 15, when we’re recording.

Stig Brodersen 18:30
Anyone else have any comments for Preston’s pick?

Preston Pysh 18:34
Seems like everybody liked it.

Tobias Carlisle 18:36
That’s the kiss of death. That’s the kiss of death.

Stig Brodersen 18:40
Okay. I can go next, guys, if you don’t mind. My pick is Allstate. I guess a lot of you guys are familiar with Allstate. It owns and operates 19 companies around the United States, United Kingdom, Canada and India. Revenue of $40 billion, so it’s one of the hundred biggest companies in the US based on revenue. So this is not your odd value pick. It’s not your exciting ten-bagger, anything like that. It’s a stable stock. It’s a stable compounder in these times with a relative load yield. And there’s basically two reasons why that first came on my radar. So we have our own filter, where you have something called the TIP multiple, which looks at the EBIT to enterprise value. And we weighed that primarily towards the last three years, and it has just had a very–the most was 10.1, which is for a large-cap stock is relatively low. And Preston talked about it a month before. We also have a green momentum, and even so, we have a little inside of buying, too. So on the surface, it looked pretty well. So if we dig a little deeper; if you look at some of the performance over the past five years, you know? It’s, it’s gone from 68, 69 and today’s trading 110 near a 52-week high, and it’s similar to what the S&P 500 has been doing. So my take is that there’s still value to gain even here in the 52 high. It sounds so, so much unlike me. I’m usually looking at these stocks as a 52-week low. So I’m trying the other way around here. Also, this is the largest publicly traded property casualty insurance company in the US. So they have insurance products; they have wealth transfer and financial products. But 85% of revenue comes from property liability insurance, and 50% of total revenue is from auto insurance alone, which might be sort of a negative, but we can talk more about that later. Insurance is a very simple business. The company underwriting insurance, and basically what they do is that they’d make money on expectedly paying less back to the policyholders and the charge. Then, they take that cash and they hold it for the customers, and then they invested in different assets. So it’s not too unlike, you know, Berkshire Hathaway that we talked so much about here in the show before. So, you know, they were both have an underwriting income, but they also have a net investment income. And if you look at how they are positioned, generally, insurance is a very fragmented industry. You don’t have a lot of big players. You have, you know, State Farm is the biggest. They have like 9.6%. Allstate is number five in the States having two little less than 5% market share. So it’s not like you have these two awfully or anything close to that. Because it is a no moat type of business, you know? That there’s very few people who are, who just want this insurance company because it’s so much better than than all the others, you know? Price is very, very important here. So if you look at some of the negatives for Allstate, and I think it just might just put it out there. We might be at the top of the market cycle. You know, what the reason why I’m saying this is that, as mentioned before, 52% of the revenue, underwriting revenue comes from all insurance. If I had to–if you asked me, I would say that we probably at the top of the cycle right now, which might not be as attractive. But all that being said, it’s a business that I really like; not a lot of capex; generates lots of free cash flow; buybacks are high, 6.7%; trading 12 months; nice yield to almost 2%. Let’s talk about some of the assumption going into the valuation. I’ll go to here. So as you guys know, Preston and I usually like to look at stocks with in three different scenarios. Like a positive base scenario and then negative scenario. And what it did was to set there was a 25% probability of a 5% growth; 50% that’s my base case of minus two primarily because of the exposure to the auto insurance, and then 25% for a minus 10 growth in future cash flow. And I come up with a return of 10.2%, so, so that’s my pick, guys. And since I’ve been so nasty with your other guys’ picks, please bring the bats, and let me–tell me why I’m wrong, guys.

Preston Pysh 23:04
Toby, you want to beat him first? Or do you want me to beat him?

Tobias Carlisle 23:07
The thing is, it’s, it’s another one that I hold in the fund. So I like it. I’ve held it for a little while now. It’s, it’s worked really well. I like it for all of the reasons that Stig has identified. It’s one of those things that, you know, I get nervous when they work as easily as this one has worked. It’s still pretty cheap. That’s free cash flow yield, sort of. It’s on eight times multiple free of cash flow yield. It’s getting, you know, on my preferred metric acquirers (*inaudible*) multiple. It’s about 11, but I bought it a little bit cheaper. It’s just–I had to sell them. When they’re cheap like this has been as high as 13 just over the last couple of years, so I don’t, I don’t think it’s expensive. It’s still performing. I, I think it’s a really good pick. Nice work, Stig!

Stig Brodersen 23:45
Wow. Oh, Toby you’re–oh, after all the bashing I gave your pick. Come on! Haha! I expected so much more from you, Toby!

Tobias Carlisle 23:54
Nobody likes the short, guys. Nobody likes the shorts.

Hari Ramachandra 23:57
I have a question on, on this one. And specifically, for insurance companies, not just for Allstate. In the low and negative interest rate environment we are in and looks like we are going to be in this for a long time, how does it impact insurance companies’ earning power, and in general their health? That’s number one. Number two, given a choice between Berkshire and Allstate, which would you want?

Stig Brodersen 24:23
Okay, so two great questions. The first one, how does influence the earnings power, whenever you have like a, a very low yield environment. If we look specifically at All State, you know, 68% isn’t fixed income, which is not that interesting. And there has to be, you know, there was something that’s called “matching” because they need to be able to prove to the authorities that they actually can repay that to the policyholders. If something goes wrong, a lot of that would have to be in a fixed income, so you can’t really get away with that. It’s not that interesting. Just last year, 2012 month, they have an investment portfolio, $81 billion. The return on that portfolio was 0.8%, which is not uncommon. For instance, Markel. I know you–especially, we mentioned Berkshire, but if you look at Markel, who was very often top of the class, they were negative last year. So, it is a–it is tricky. The other part or the other side of the coin, whenever you have something like very low yield is that you typically have a–you typically have a higher under rating income, so it goes in these cycles. So whenever you can expect to make a return on the money you’re holding for the policyholders, you need to make the money on something else. And what you do is you underwrite insurance in the different ways. You would have what is referred to as a combined ratio. That would be relatively lower. So if you have a combined ratio of 92%, that means for every a hundred dollars that comes into your company, you would expect to pay 92% out. That’s the other side of it. So if we imagine that you would have a very high yield environment; imagine that you will have, you know, 6% risk-free rate. So the ten-year treasury, that’s what I’m referring to, whenever I say risk-free rate. You’d be a lot more aggressive in terms of writing those policies because then you know, you can make those 6%. And what I would recommend for everyone to, to do if they want to understand this even more, I don’t know if I give the best explanation to this, is to read the Berkshire Hathaway’s or Warren Buffett’s letters to his shareholders. Max Olsen did a great write-up, and it’s been updated. And you can find it on Amazon. It’s not too expensive, unless you buy the entire book, which is a lot of pages. And he explains that Warren Buffett also makes that comparison of the cycles, and whenever you had a high guaranteed rate, and that low guaranteed rate, which you’re seeing right now, and what that has done to the combined ratio. That’s kind of like the first question–I want to make that recommendation. Then, you were asking, which company would I prefer to own: Berkshire Hathaway or Allstate? So the way I want to respond to this is in the very value investing type of way. It depends. What’s the valuation right now? If you ask me how is Berkshire Hathaway priced? I think the BCS across around 220, 225 right now. It’s probably priced relatively fair. Can it be expected, can Berkshire Hathaway expect it to outperform the market? Probably, probably a little. I would imagine even this price level, then we look at something like Allstate. Can they expect to outperform the market? Yes, I think their price is relatively more attractive, but I don’t, I don’t expect it to be more than, I don’t know, 10%. And if you ask me, what kind of return would I expect if I bought Berkshire this share price? So not necessarily the share price that I insert, but at this share price? Probably say, 8%, 9%. Whenever you ask me and I would say 8-9% for Berkshire, and I was like, “Oh, my, you know, Excel sheet says 10% for Allstate.” You know, that’s the same. You know, that’s not that much of a difference. This is approximately the same.

Hari Ramachandra 27:53
The reason I was asking about Berkshire at this current price and Allstate is last time in 2008 during the Great Recession, Allstate’s earning dropped by almost 80% from peak to trough. And it took them quite a bit of time to really reach profitability. And whereas, Berkshire you get the downside protection in terms of they being conservative, solid balance sheet; diversified businesses; and Buffett. At this point of the cycle is what I am asking because how protected is the downside with Allstate. If I have it in my size–sizable position in my portfolio versus just having Berkshire, which gives me the insurance exposure anyway.

Stig Brodersen 28:39
Earnings are little tricky. And you could say the same thing for the free cash flow, whenever you do value insurance companies. They don’t follow the same that common standards as, you know, Coca-Cola or Johnson and Johnson. You know, there’s also a lot to be said about the investment income. It’s just like taking a beating. And that is the very nature of insurance companies because that’s how they deploy the money. So I think you have a good point, Hari. I think had a really good point in terms of the downside protection because Berkshire is–they have a different structure than Allstate. They are (an) insurance company, but there’s so many other things. So you might say the downside is lower. I would also argue that at least at this price level, the upside is also lower for a company like Berkshire Hathaway. And I just want to say for the record that I both own stock in Berkshire and Markel, and not on Allstate at the time of recording.

Preston Pysh 29:28
Hey, Stig, my only comment on this one, I completely agree with everything that’s been said. I liked Hari’s highlight there with comparing downside risk being probably a lot different than the downside on this one. If we would go into a, you know, credit contracting type event. The thing that I would probably be paying really close attention for ownership on this is I’m using our momentum tool. So it’s, it’s coming up with a 17% annual volatility based on the current price of $110 a share. It’s saying that the stop would be set at $93 is when you’d be getting out of that volatility that the normal volatility range of the price action. So–is I would own this, my expectation moving forward is that it’s gonna continue to make money; it’s gonna continue to do pretty well. But for me, I would keep adjusting that stop because historically, as I look at this over the last 10 years, this thing’s been green on our momentum pool for almost all that period of time. There’s been a few instances, where it stepped out of it, but so I’d be watching the, the momentum, when the volatility steps out of that 17% range to the downside is whenever I’d probably liquidate position to try to minimize that downside risk that Hari is talking about.

Stig Brodersen 30:40
Very interesting point you bring up, Preston. And I also want to say in terms of position size, you would probably do something similar to what Toby is doing like have them like a minor position in the, in the last portfolio. And I would be happy to do that with a company like Allstate. It’s not the best insurance company. I think its priced well, but it’s not the best. I think they’re doing a good job with capital allocations, but it’s not a–it’s more an insurance company than they are a capital allocation company. And, and the way–the reason why I say this is if you look at their, their total asset on the management, you know? 9% of that is in equities right now. If you look at a company like Markel, also very often referred to as a baby Berkshire, you have 29%, which is more or less all that company like Markel is allowed to put into equities. And no surprise, you have Tom Gaynor, you know? With such a smart guy, who’s handling that; who’s allocating into Markel ventures; who was, who’s like reinvesting into stocks; and he has a very good approach. He’s sort of like a podcast series himself. How’s he doing that? So it’s more like, it’s not the top of the class, but what is the valuation you are getting right now? And for that reason, I wouldn’t put it like as a (*inaudible*) much more than 2 or 3% in my portfolio.

Preston Pysh 31:58
All right, Hari. Let’s here it, man!

Hari Ramachandra 32:01
Okay, I’m ready. So this time my pick is GrafTech. The reason this caught my attention was due to Pabrai. GrafTechis a manufacturer for graphite electrodes, which are essentially a key ingredient in electric arc furnaces for manufacturing steel. This company was originally founded back in 1886. And the name was National Carbon Company, and they were acquired by Union Carbide in 1917. Then in 1995, they were again brought out as a public company, and back in 2015, I believe, Brookfield took to private. And then, it lately in 2018–April 2018, Brookfield spun it off as a IPO as a public offering. And Brookfield still holds 80% stake, I believe in the company. The couple of things to kind of keep in mind is this company has a history of innovation, especially in this–manufacturing steel. And they were the first to come up with the UHP type of graphite electrodes. They were the first to come up with that. And they also are well known for high quality graphite electrodes in the industry. And in fact, they’re the leading manufacturers of graphite electrodes. They also in 2010 acquired, Seadrift, which is a top manufacturer of needle coke, which is a raw material or key ingredient of–for making graphite electrodes. Needle coke is absolutely essential. And there are only a few companies at the scale of Seadrift. The other one is Phillips 66. So needle Coke is either number two or number three. The rest are either in China or Japan in terms of manufacturing capacity. So the reason Brookfield took them private was that they were struggling; aren’t efficient. So obviously, Brookfield Management, if you know them, they basically have a good track record of acquiring esoteric businesses like this, including a nuclear power plant that they’re operating today. And in two and a half years, they’ve basically, successfully restructured and repositioned GrafTech by selling of non core assets like NeoGraf Division. And then, they started focusing more on the core electrode businesses. And they achieved quite a good increase in the productivity by saving almost $100 million in cost per year. So when they acquired GrafTech, back in 2015, it was generating around 45 million of EBITDA, and the revenue of 530 million. But now in 2018, when they took it public, it was generating a EBITDA of 1.2 billion, and a revenue of 1.9 billion. So that’s what–and in fact, Brookfield was awarded for this in the private equity international trade group. So that’s kind of the background. I’ll go into why the stock currently is trading low. But before that, let me talk about some of the positives of GrafTech. Number one is that it’s, it’s a leading producer of high quality graphite electrodes. In fact, in the top three. The second is it has established itself as a reliable high quality producer with its vendor. Those (*inaudible*) has good pricing power because total cost of producing steel through electrical arc furnace of which graphite electrode constitute or constitutes only 1-5% of the cost, so they do have pricing power from that perspective. And the other part is that after acquiring Seadrift–so one of the major problem for graphite electrode manufacturers is the stable, reliable, and low costs of play (*inaudible*) of needle coke, which is the key ingredient. And needle coke is actually made out of what is known as decant oil, but because of Seadrift’s capability to supply almost 70% of their product line; and Seadrift supplies 100% of its products to GrafTech because they’re a 100% subsidary, GrafTech has a stable source of needle coke, and also, at low cost. So 70% of their product line can be sourced through low cost. That protects them from fluctuation of the price of needle coke, which is a big factor in this industry. And the other source of volatility in this industry is the price of graphite electrodes themselves. If you look at the variation in the price back in 2016, it hit a low, as low as 2000, $1500-2,000 per ton of graphite electrode to a high of around 13-15,000 in 2018. After Brookfield acquired GrafTech, one of the ingenious thing(s) they have done is to sign this three to five-year contract of take or pay agreements with their major vendors. In fact, 65% of their production capacity is now covered under take or pay through 2022, which gives them at a fixed price of around 9700 per metric ton, which is higher than what the point price today for graphite electrodes. And because of that, that gives them price stability and input side. So input side is needle coke. Because of Seadrift they have supplies (*inaudible*) back. And because of this take or pay, they have stabilized the output price. And people are not aware of this take or pay contract. It’s basically, customers sign a contract, where they will say that they will buy a fixed amount of graphite electrodes from GrafTech through 2022. But if they don’t any year, they’re gonna pay 100% of what they would have paid anyways without taking the, the delivery, and some percentage 60 or more percentage for the next period till 2022. So that gives GrafTech a reliable source of revenue. And then, Brookfield still holds 80% stake, so that gives some stability ever after (*inaudible*) for the investor, who’s with you. So that’s the positives. Under risks, I think like anything else in the manufacturing sector, the risk is China. And that’s one of the reasons, market is a bit spooked about this company because the Chinese had a crackdown on their graphite electrode manufacturing because of pollution concerns. However, China’s embracing electric arc furnace rapidly, so there is a concern that China can ramp up the production. Chinese companies are in the top five, and they can undersell everybody else, so that’s number one. Number two, the reason graphite electrode companies were suffering–many of them, the competitors of GrafTech is that needle coke supply was quite constrained because of that recent adoption of needle coke in lithium ion battery. And that gave an advantage to graphite electrode in the past couple of years. However, whenever the price of needle co(ke) goes higher, both companies tend to shift to alternatives like natural graphite or graphene, which will again belies the needle coke prices and bring it down. Then again, the other risk is its fate is tied to the steel manufacturers. It all depends on the demand from the steel manufacturers. And in fact, right now, the reason the stock is done is it’s going through that cycle. The graphite electro prices hit the high in late 2017 and early 2018. Now it’s trending lower. It’s not a ticket, the 2016 lows, but it’s going there. So those are the concerns. And that’s–the one of the reason why the stock is down. But I believe I can–Pabrai, when he took a stake, there are some catalysts that might cause this investment to do good. And that’s number one is the thesis that the China will disrupt this industry and disrupt graphite tech specifically, might not be well formed because if you look into the details of the Chinese manufacturing sector, they are not into high quality electrodes yet. And it will take them some time to really manufacture high quality graphite electrodes. That means tested with less than 600 mm in diameter. They are not there yet. So that’s number one. Number two, the rising production of steel, and iron, and aluminum, which all needs graphite electrodes in China. It’s growing at a very fast pace. In the last 10 years, it has been growing at a gather of almost 7%. Same in India, so their internal demand is sufficient for their production. So it’s probably not going to interfere GrefTech’s customer demand. And finally, GrafTech already has protected majority of its revenue stream with the take or pay contracts. So at least for the next couple of years or till 22, the downside is somewhat protected because stock (*inaudible*) today is paying a dividend of 2.7%, so that’s the kicker on top of this. Their balance sheet is not that bad. When I was looking into this, I was remembering Pabrai’s stake in Horsehead, which didn’t go really well. So I was a little skeptical, when I saw he took a stake in this. But this seems to be a different story and Brookfield being a 80% owner in this company gives me another level of confidence because they’re are very mature, astute investors. Then, at the same time, they will also sell their stake over a period of time. So there will be dilution. But I’m, I’m assuming and hoping that they will be rational about it, and the way they sell off their stake. So in terms of valuation, I think I would want to hear from you. What do you guys think about the valuation and its prospects? Thanks.

Preston Pysh 42:21
So Hari, my first problem with this, and it might be just the data source that I’m looking at, is it seems like the numbers are kind of all over the place. Fundamentally, that the numbers are all over the place. Like I’m seeing large growth and then, the balance sheet I–it’s kind of hard for me to even find some of the balance sheet numbers that are reliable because as I’m going from one source of data analytics to the other, I’m getting different numbers, which is kind of strange for me. When I’m looking just purely at the price, this thing’s volatility on an annual basis is 60%, right? So like, that’s like, that’s like cryptocurrency-type size volatility. I am having a hard time with it because, you know, I, I think one of the most important things about Buffett’s style of investing–if we’re using him as kind of a benchmark on valuation–is he likes numbers that have a very trend-like look to them. So like the top line is growing, and there’s, there’s not a lot of variance in those fundamental numbers. When you’re looking at the cash flows, they’re really predictable, and they’re trending in a certain direction. Or maybe there was just bad news that came out, and the market is super emotional. And they give you that big opportunity to step in and take a position, and it’s, it’ll give you that 10% return or, or whatever, right? With this. I mean, the numbers are so lumpy. You go from one year of not even having free cash flow to having like this total wave of free cash flow. And then, like, there’s just nothing that I can kind of wrap my hands on. If this was a bond, and I was trying to figure out my coupon payments, so that I could figure out the valuation, it would be like, you know, just a total swag as to what those coupon payments are going to be. You have no idea from one half of the year to the next half the year what you’re going to receive in the mail for your coupon. So for that reason alone, because it lacks this stability characteristic, I just can’t even come up with a valuation; let alone go any further to try to understand anything about it. Like I would, when I would look at this, I would not even attempt to go any further just because the numbers are so lumpy, and so unreliable for me to even spend time qualitatively trying to understand it.

Hari Ramachandra 44:39
If you look into their history, you will know why; the reason being Brookfield acquired them two and a half years back. So I think we should look at it is that it’s more like a new IPO, rather than a company that has been operating for a while because what Brookfield did is they had a lot of diversified product portfolio and they had almost six, I think, manufacturing setups. In the last 2 1/2 years, they already was at from six to three. And they made a lot of good productivity gains, but more importantly, they improved their relationship with the customers in terms of the contracts. So it’s really hard to look at them like a company that’s operating for many years. It’s basically like a IPO; new company that IPOed in 2018. So, yes, there is not much history into that. I think Toby had something to say.

Tobias Carlisle 45:33
It’s one of the stocks that comes into the Acquirer’s Multiple screens. It’s been there for a little while. I think that Pabrai secretly uses my screens, too, at night. I don’t really–I’m joking about that. But we have a lot of overlap. There’s a lot of their stocks at my screen that end up in his portfolio. Just for coincidence, I’m sure. Probably it’s, it’s a similar investment style. He doesn’t mind a little bit of volatility. Look, it’s as cheap as it’s ever been. It’s trading at like a five times multiple. That’s a gigantic yield. Revenues have been pretty good. They’re buying back stock this. I like a lot of things about this company. I think that the volatility doesn’t really bother me. But that’s one of those things that it could be volatile to the upside, too. And I think you can lose much on it. And I think you–it’s that nice asymmetric position. It’s been around in my screens for a little while. That’s the only thing I’d say it’s sort of been bumping around four or five times on an Acquirer’s Multiple bases, which is cheaper that might be appropriate for a commodity stock. But when these things catch fire, they run, so I like it.

Preston Pysh 46:26
I have a confession to make. The…let me start by saying that earlier this year, I took a significant position in GrafTech; actually put around 8% of my portfolio into, into the company. So I should have something to say about this. I really like the company, and it’s sort of like a trigger thing. I, I think it’s important, and you know, Preston and I have been very upfront with that here on the podcast. And, and you could say the same thing for Toby or Hari–like we also want to, to eat our own cooking. And then, you have on like the flip side, you know, for some stock picks you–this is something that whenever I first started listening to you know Guy Spear and reading his book, and then, one is Pabrai. They talk about this bias of going on record for things because then you can’t–and you feel like you can change your mind was sort of like can be a tricky thing, and I kind of in all fairness, it was not because Hari sent an email before I actually said that to the group, when I was pitching. I just felt I liked this pick so much that I don’t want to anchor myself too much before…I guess, I, I know this sounds weird before I know learn more about the company. So there’s this weird thing whenever you do investing, and guys say welcome to grab tickets some part in time, but there’s this weird thing that obviously you do a lot of research before you invest in a company, but in a way you don’t really learn about the company before you own it. I know that sounds sort of silly, especially if you take a significant position in it. And I’m sure that a lot of investors would know what I mean. You definitely spend countless hours before. That being said, you learn in a different way, whenever you have money in that business. I like to stock for the same reasons as, as Hari. What I like is that…to me, I know this might sound odd, whenever you look at ten-year key ratios or whatnot. Keep in mind what Hari said before about this is sort of a new company in many ways. There’s actually a lot of stability to this company, which might sound super odd, when, whenever you like you see the volatility, and when you see what everything that’s been going on. And, and what I mean about that is not only, it’s not only what Hari already talked about in terms of how much that’s been locked in until 2022. It’s also that it’s been locked in with a 70% gross margin, which in itself is interesting. It’s very difficult to add supply into this. It takes around seven years to build supply and right now there is no added supply added into this industry. Whereas, Hari said before *Brought Heavy is one of the key players. So you have a demand. We can talk more about the demand later. You have a rising demand that is already secured 65%. I think it was a number of you brought up 65 or plus percent. It’s already been locked in and really, really nice margins. And then, you don’t have any supply coming in anytime soon. Now, so, for me, there was a big difference between uncertainty and risk. And you’re definitely right, Hari, that there are some uncertainties. China being one of them. You were right. It would take a long time for them to have that high quality, but it is like risk. How much capacity are they going to throw into it eventually? But you don’t have a lot of risk because for the near future that won’t change. They just can’t happen. So it’s one of those things, where I’m like, “Heads, I win. Tails, I don’t lose much,” as Mohnish Pabrai would say because I probably would just get my money back. You know, if everything goes south, and you know, China calls in tomorrow and says that they got to wrap everything up. And I’m like, “I’ll probably just get my money back.” But I think that their–the upside is really huge. So I’m not just talking about, you know, for instance, in terms of steel, and we talked about cyclicality of that. But you see a huge influx right now because the demand will in the future also be driven by electric vehicles. Projections is probably that the demand for needle coke will be almost double of what it is right now; in 2025. And, and it might be even more than that. If we say that in 2025, the sales of electric cars would be 10-11%, ten times what the demand will be today. So I wont ever say that. I’m talking about what’s, what’s demand for that specific part; juice for electric cars. And then, whenever I–then, I said double. I mean, what is the needle coke demand now, which will be double in 2025? So it’s two different numbers. So I never say ten times double. It’s not, it’s not the same. It’s ten times for something that’s very low, but it’s expected to go up in the future. And I think, steel aside, we can talk more about that. I think we can all agree that the demand for electric cars is probably bound to go up. It’s very, it’s a key ingredient in the, in the lithium batteries. So I’m pretty bull. You can expect to see a lot more buybacks, also. The return to shareholders probably going to be like 50-60% of these. That is what the management targets. Sorry for the long spiel, guys, but that is sort of some of the reasons why I’m so bull on the stocks. That was the confession for the day, I guess.

Hari Ramachandra 51:33
I’m glad you came out of the closet.

Tobias Carlisle 51:38
It’s funny how owning a stock changes your view of that stock doesn’t it? You’re gonna get a reputation for just changing your mind all the time. That’s what I’m trying to develop. Someone says, “What do you–weren’t you like pitching that stock like a week ago?” Yeah, I changed my mind.

Stig Brodersen 51:50
That’s a good point. You know, it’s, it, it is sort of a tricky thing, right? Going on record saying, “This is the most amazing stock,” and then, you kind of feel guilty if you end up selling it afterwards. You kind of feel like a fraud because then, you said that to someone, “I really like this.” So it is just one of those situations. But now that since Hari brought it up, I don’t think I can stay in the closet as you might say any longer.

Hari Ramachandra 52:14
The question I have for you guys is the way I see this one, this is like a three to five-year play at max. This is not a stock that I would hold for a long time because there is a catalyst, but eventually there are some uncertainties if it plays out like the China production; if they get down to the value chain higher up, it might disrupt graphite at some point because of graphite is like a single trick pony. There is no other product. So I wanted to get your opinion. Toby, how are you planning to manage this in your portfolio? Is it like a medium-term hold?

Tobias Carlisle 52:50
I don’t hold GrafTech. It’s just in my screens. Sorry, if I wasn’t clear about that. It’s… of the, of the three that we’ve discussed today, it’s plan ten of…(*inaudible*). Out of the four we’ve discussed, this one I don’t have a position in. I actually really like it though. I want to take a closer look at it, but it’s, it’s just in my screener. It’s on the acquirersmultiple.com website.

Hari Ramachandra 53:09
How would you, Stig? Thanks

Stig Brodersen 53:12
Yeah, I agree with you. I mean, it’s one of those where…not to repeat myself too much, I feel that if we see a lot of supply coming in, which you know for commoditize business, we don’t want to see you. If we see a lot of supply coming in, I would probably be very–for said reasons that will probably won’t happen anytime soon. Anything else for GrafTech, guys? So before we, we wrap up, Hari, last time, we talked about Berkshire Hathaway and Toby you,

Tobias Carlisle 53:40
I’ll be there.

Stig Brodersen 53:40
You are going to the Berkshire Hathaway then? Preston and I will of course be there. Hari, you said 90% last time. Where is the…where are we now?

Hari Ramachandra 53:48
Ours has increased. In fact, I’m planning to get my son to hopefully his first visit.

Stig Brodersen 53:53
Okay guys, so if anyone else is interested in joining the Mastermind Group, we will make sure to link in the show notes. We have already have an itinerary of what we plan to do. We’re gonna have some casual events. All of that will, of course, be completely free. And if anyone wants to join us, they can join us by signing up to contact at theinvestorspodcast.com, and you speak to member of our team, and she will set you up with the Whatsapp Group that we have for people going. Guys, thank you so much for taking the time to come on the show. Toby, Hari, could you please give a hand off for the audience, where they can learn more about you guys?

Hari Ramachandra 54:28
Okay, I’ll go first. Thanks, Stig! You can always reach me at my blog, bitsbusiness.com or my Twitter handle: @harirama.

Tobias Carlisle 54:38
I have first some free screeners up on acquirers multiple.com, and I run a firm acquirersfunds.com. You can find my fund the Acquirer’s Fund. It’s an ETF ticker, ZIG; has all the holdings up on the site. You can see performance data is probably best gonna Morningstar. But it’s been a good time for Valley, so it’s worth taking a look at it.

Stig Brodersen 55:00
Thank you, Toby. And thank you, Hari. We already look forward to the next Mastermind meeting next quarter. One thing I’d like to talk about is that if you do enjoy these Mastermind Group Meetings that we unfortunately only do once a quarter. Preston and I also do a monthly write-up of a stock that we find interesting. And everyone can get free access to that. Simply go to tipemail.com. That is tipemail.com, and we’ll make sure to send you a write-up of both a stock that we find interesting, but also the current market conditions. All right, so for this next segment of the show we’ll answer a question from the audience. And this question comes from Cody.

Hari Ramachandra 55:38
Hi, Preston and Stig. This is Cody from Finland. I have really enjoyed your show. Keep up the good work. My question is about the future projections about the company’s growth. When deciding percentage, the future scenario, how do you decide the likelihood? Are there any tricks to make better projections? Or is it just your best guesstimate?

Stig Brodersen 56:02
That’s a great, and also, a really hard question. It really makes me think of the quote, “It’s hard to make predictions, especially about the future.” And that is also true, whenever it comes to predicting growth rates. So before I talk about how you can estimate potential growth, I would like to highlight the word estimation here. We have different rule of thumbs in terms of doing that. But more than anything else is more art than science. There’s no really best practice of how to have an accurate prediction of a growth rate because in essence, you’re predicting, so a few different things that you can do. The first one is you can listen to the management on the earnings call. You also really need to understand that earnings calls are typically very biased in favor of the company. I would pay very close attention to the track record of the management’s early predictions about growth rates before I would potentially use that. Then, I would say that you also need to understand the business units. And you also need to read reports from third parties. So for instance, Google is making most of the money from online advertising. And it’s an industry that’s expected to grow 50% the next year. This is a number that I have from industry report. So if we assume that this is approximately correct, it’s really up to you to determine how much would be captured by Google; how much would be captured by Facebook; and other competitors like Amazon. Very often these industry reports will also have some of those estimates. But of course, it’s also up to you to determine, hmm, are they too favorable in Google’s favor or not, if that is the company in question. Now keep also in mind that most listed businesses, especially large-cap stocks have multiple business units. It’s important to understand where revenue and profit is coming from. For instance, we can really use the growth rates of Disney’s mall movies, even if we have the data because to predict the growth rates of Disney, we need to understand that the Marvel movies is just one piece of the puzzle to determine the total revenue. And even if you could, you also need to understand how profitable that business unit does. All that being said, there’s really no reason to make more complicated than it is. Now, what does your common sense tell you about this? Now one thing is what the management says, or what you can find in a report about the industry, or what you can learn in the ten case. But what do you think in it as an investor? You invested in the stock in the first place because you understood the industry and the business. And based on what you know about the company, make sure to filter out the noise, and then come up with your own growth predictions. And of course, I have to say this here at the very end of my response, regardless of which growth rate you come up with, make sure to be very conservative. I mean, growth is fantastic, but too many stocks have turned into unprofitable investments because the investors were just too optimistic about the future.

Preston Pysh 59:05
So I really like this question. And it reminds me of my days back in business school because I would make a bunch of professors really angry, whenever they would bring up this idea of calculating a value with a beta and looking at the historical price volatility as being your “risk.” And I would always raise my hand and ask the professor if they thought that maybe the underlying assets of the business and how they’re able to sustain their competitive advantage, moving into the future with all the other competitors in the marketplace, was the actual risk to the business. And I guess this was my way of kind of torqueing the whole debate as to how you calculate the intrinsic value of a business; what’s important that you’re actually looking at; and it goes right at the heart of what you’re asking, which is: How can I make a projection with any type of confidence that I’m just making it up, or that it’s, you know, just a total swag? And so what I would tell you is really dig into the assets and the liabilities of the business; understand what their competition is; understand how sta–how stable those future cash flows are going to be based on the asset lines that they have on their balance sheet. So let’s say you have a company. That company has one product, and it’s the total breadwinner of the company. And that product has been very stable for years on end, and they don’t have many competitors in the marketplace. Typically, that’s a good sign that they’re probably gonna have competitors in the marketplace moving forward, but that’s where your research comes into play. And if you suspect that that, that environment’s gonna change, or if you suspect that that environment’s gonna stay steady. Well, now you have a better idea as to how much variance and, and how wide those angles of your cash flow projections need to be. I always use the example of a hurricane. And whenever they’re trying to project where the Hurricane’s gonna hit seven days in advance, they have a cone of probability as to where the storm’s gonna hit. There’s a most likely course; there’s a left and a right limit. I look at future cash flows the exact same way I kind of have–I, I look at where the storm the “storm” has gone, right? Where have–where did the cash flows come from? Where did–what did they look like over the last tens years? And then, my projection is, is kind of interpolating off of that path moving into the future. But if you’re gonna really put a lot of money into a position, you got to think through what are those underlying assets? What are the liabilities of the company, what’s their competitive position, especially for their breadwinning product lines and service lines within that business? And then you got to base those, those estimates on those variables in my humble opinion. All right, Coltie. For asking such a great question, we’re gonna give you free access to our Intrinsic Value Course for anyone wanting to check out the course, go to tipintrinsicvalue.com. That’s tipintrinsicvalue.com. The course also comes with access to our TIP Finance Tool, which helps you find and filter undervalued stock picks. If anyone else wants to get a question played on the show, go to asktheinvestors.com, and you can record your question there. If it gets played on the show, you get a bunch of free and valuable stuff.

Stig Brodersen 1:02:37
But guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. We see each other again next week.

Outro 1:02:45
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