FRMO Corp. (FRMO)

So I read a book, make a post about it and all sorts of ideas start coming out.  This is another thread that comes out of that and I am going to pull it to see where it goes (thanks to the person who mentioned this in the comment section in the other post).  I don't think there is anything imminently actionable here on FRMO itself, but I spent some time at their website and went through their annual reports and annual meeting transcripts and found it totally fascinating.

Here are the relevant websites:

http://www.frmocorp.com/
http://www.horizonkinetics.com/

FRMO is a strange entity, but basically it owns a stake in Horizon Kinetics (asset manager), has cash and investment assets, revenue sharing stream and things like that.  More on that later.

Horizon Kinetics is an asset manager run by Murray Stahl and Steven Bregman.   Murray Stahl sounds like an outsider's outsider.  Or maybe that's outsider^2.  He loves owner-operator businesses which is similar to the outsider CEOs and he himself is a manager (of funds, FRMO and Horizon Kinetics) who thinks like an outsider.

Check out how "outside" he is in his thinking.  This is a snip from a recent conference call transcript (on the website:  FRMO might have the best investor website ever.  Even better than Berkshire Hathaway and Leucadia; it has the simplicity of each of them, but includes conference call and annual meeting transcripts!)

 

Value Investor Insight (May 31, 2013)
Anyway, at the website there is a great interview with him from Value Investor Insight (May 31, 2013). 
Here are some notes from that interview:

• Stahl quote: "Every perspective I have will sooner or later go stale...  I'm constantly looking for how successful people do things differently."
• Horizon Kinetics manages $8.1 billion; the large cap strategy has returned +11.5%/year net versus 7.6%/year for the S&P 500 index since January 1996.
• Likes owner-operated businesses.  Warren Buffett and John Malone are examples. 
• Leucadia is also an example.  Handler looks good so still owns Leucadia.
• Sears is another example and the story there is not over yet.
• Valuation methodology:  estimate earnings in four or five years, apply reasonable multiple and then discount back at 20%.  If implied discount rate is greater than 20%, will look at closely.

These are some names discussed in detail:

• Brookfield Asset Management (BAM); has owned for a long time, trading below liquidation value, spin-off opportunities 
• Dreamworks (DWA): market not giving credit to film library; market tends to price stock based on most recent movie (hit or not).
• Ascent Capital (ASCMA):  Malone spinoff.  Burglar alarms, fragmented industry, opportunity for accretive acquisitions etc.  Amortization obscures core profitability (at $73.50) trading at 7-8x forward free cash.
• Likes Oaktree Capital Group (OAK): Run by Howard Marks.  Look at PIMCO (AUM $2 trillion) for potential upside of DoubleLine (AUM $60 billion).
• Dundee Corp:  Canadian owner-operator.  Analogous to Brookfield and Leucadia.   Run by Ned Goodwin.  Sum of the parts play.
• Onex Corp:  Listed private equity firm in Canada.  Trading at value of investments; market giving no value to management company (fee revenues streams).

Anyway, you will notice that this manager seems right up my alley.  He likes the same sort of companies that I do for similar reasons.


Owner-Operators
Since we are on an outsider CEO kick now, this is really on-topic to what I've been looking at recently (and another reason why I'm making this post).

Check out the holdings of the Kinetics Paradigm funds.  With $1.2 billion in AUM, I guess it's one of the main funds that Horizon advises:

So check this out.  It is a pretty focused fund (compared to other mutual funds) and there are a bunch of owner-operator and spin-off/special situations stuff.  I'm surprised more people don't talk about Murray Stahl / Horizon.

How has this fund done over the years?

 

All of this and more is available at the Kinetics Mutual Funds website.

So even if you don't invest in mutual funds, at the very least, checking out the holdings here is not a bad idea.

But anyway, back to the topic of owner-operators. 

Stahl talks a lot about the problems of indexing in the annual reports, annual meeting and conference calls.  So I think in an act against this trend, he has created his own index.  He decided to create an index based on owner-operated businesses instead of creating a fund or ETF.  You can read about all the reasons why in his literature, but at the end of the day, he just decided that that's the best way to go; it can be objective (third party to calculate / manage the index) and the cost of creating an index is very low (pencil, paper and a calculator).  Revenues that accrue from licensing will therefore have high returns.

Anyway, this lead to the Wealth Index.

Horizon-Kinetics ISE Wealth Index
This index is based on Stahl's idea that owner-operated businesses tend to outperform over time.  Again, I really recommend people to go read all of the annual reports and read the annual meeting transcpripts at the FRMO website.  He offers investment ideas and things like that too (at the annual meeting).  And it won't take long.  It's not like reading the 10-K of J.P. Morgan for the last ten years or anything like that at all.  In fact, you can read all of that stuff in less time it takes to read a JPM 10-K for a single year.

Anyway, the index is composed of companies run by wealthy people in control positions.

Here is how it has done over time:

Not bad at all for a mechanical index. 

So let's take a look at the inside of this thing.  Here is just a sample list:

So look at that.  Some of our favorite names are in there.  Berkshire Hathaway, Colfax (subject of a recent post), Loews, Liberty Media, Greenlight, Google, Vornado, Sears etc...

If you had an algorithm to pick stocks, you can do worse than this. 

Going off on a tangent for a second; how about taking this index as a basket and then applying the Magic Formula to it, or 'value'-weighting it as Greenblatt suggests?  Then you might get some insane returns. But then again, some of those metrics may not work for the above names.

At the annual meeting (according to the transcript), they said they have a new wealth index for the Japanese market and they are also developing a similar idea based on spin-offs.

There's a whole lot more and I may post more about what I find later.  There is still a bunch of stuff on the website (like research) that I haven't dug into, but from what I've read so far, I bet they would be well worth any serious value investor's time.

FRMO Corp
OK, so finally I get to FRMO.

I'm not going to go through the history here.  Stahl explains it well in the documentation at the website. If I attempt to summarize it, I will probably bungle it and confuse everyone.  So let's just say that all sorts of things happened at FRMO over time, and now the structure may be a little more stable going forward.

I think in the past it used to be really tricky to value this because FRMO had an ownership stake in a private entity (Horizon Kinetics) that didn't disclose much information.  If someone owns 1% of something and you don't know what that something is in terms of financials, you can't value it.

That's still sort of the case, even though we know a little more.  I think Stahl said that more will become public over time.  For example, the revenue share stream became clear starting in the first quarter of the new year because the non-investment related revenue will be pretty much the revenue share from Horizon-Kinetics (they get 4.199% of Horizon's revenues).

They also own 4.95% of Horizon Kinetics itself.   So we have two problems; what is the Horizon revenue sharing stream going to look like, and what is Horizon-Kinetics worth?

I have some ideas about that and I may post something at a later date.

But for now, I have a cheap copout on this.  Since they just did the deal where FRMO's ownership of Horizon Kinetics went up 4.09% to 4.95% we can use that as a valuation benchmark.  The deal was done on May 2013 so it's still fresh, or maybe five months old at most.

[ By the way, I found a typo on page 12 of the 2012 year-end financial statements.  At the bottom of the page, the dates May 31, 2012 and May 31, 2013 should be reversed; Investment in Horizon Kinetics LLC is marked at $10,973,940 as of May 31, 2012 instead of May 31, 2013. ]

Valuation
I don't think there was any mention at the 2013 annual meeting of the valuation of the deal in May when FRMO acquired 4.09% of Horizon-Kinetics, but I think they did it at what they consider fair value.  The last time they did a similar deal (mentioned in the 2012 annual meeting), Stahl said that they priced the deal using other asset managers as comps to avoid a conflict (as Stahl runs both FRMO and Horizon).  I think he said they used 6.3x EBITDA for the earlier deal excluding some stuff on the balance sheet.  That was when AUM and valuations were depressed in the sector, he said.

Assuming they did the same this time in May, then the $11 million valuation on the balance sheet for the Horizon Kinetics stake might not be too far off.  I have no idea what the balance sheet capital is at Horizon Kinetics so this is probably low (in the earlier deal, the balance sheet assets were not included in the valuation so FRMO got it for free).  But if they did the transaction at a fair price using asset manager comps, then the May 31, 2013 valuation might not be a bad benchmark going forward.

As for the revenue share stream, it is also booked at around $10 million.  This is also a 'fresh' mark, so even if it's at cost, it hit the book recently from a fresh valuation.  This value was "determined by an independent valuation" so it may not be as good as the 4.95% ownership stake.

If I recall correctly, I think Stahl said that in the first quarter of this year (no conference call transcript of 1Q14) we will see the revenue stream; basically what is not investment related revenues should be the revenue sharing revenues.   If that is correct, then the revenue stream is $680,000 in the first quarter which annualizes to $2.7 million.   Using a 10% discount rate gets you a value of $27 million for this stream.  Using a 6% discount will get you to $45 million.  Either way, it's a lot larger than $10 million on the book.  This is pretax, but from an earlier post about asset managers, I am comfortable with 10x pretax earnings as a valuation for asset management earnings streams.

As for equity income from the 4.95% ownership, I thought Stahl said that we would see that itemized in the 1Q earnings report, but it looks like the income is clumped together with the investment partnerships as "Income from investment partnerships and limited liability companies".   They have $19 million or so of investment partnerships interests on the balance sheet so we don't know how much of this income is from the investment partnerships and what is from Horizon Kinetics.

So unless I am missing something, we still don't have enough information to get a value for Horizon Kinetics; the best guess is still where they did the transaction in May ($11 million).

What is curious is that both the 4.95% equity stake and 4.199% gross revenue sharing agreement are marked at a very similar level of $10-11 million.  As they mentioned before, a gross revenue sharing agreement is worth more than an equity interest as revenues don't come with costs attached (where an equity holder will get less than revenues due to expenses).

So my tentative conclusion is, let's say the 4.95% equity stake in Horizon is worth what it's on the books for ($11 million) and the revenue sharing agreement is worth much more.  From the above (if the assumption is correct that "Consultancy and advisory fees" is all from this agreement), then it may be worth $17 - $35 million more than the $10 million it's stated at on the balance sheet.   With 43 million shares outstanding, that comes to $0.40- $0.80 per share more than stated book value. 

The rest of book value is cash and investments, which are all marked to market.

So with shareholders equity at $1.93/share as of the end of August 2013, and an additional value of a possible $0.40 - $0.80, that's an adjusted value of $2.33 - $2.73.   But using my 10x pretax value for the revenue share stream, it may be closer to $2.33  (But keep in mind that this revenue stream can grow alot from here).

That makes the current stock price a bit high at $6.90/share.

Let's say that the equity value of Horizon Kinetics is actually very understated, even if they did the May transaction at what they themselves (Stahl) felt was fair value.  As a sanity check, let's assume that the 1Q revenue share income annualized of $2.7 million is more or less normal and they have (now or eventually) 50% operating margins (TROW, PZN and other equity and alternative managers have margins in that area). 

But with the revenue sharing agreement, the operating margin would be 46% (they have to pay out 4% of revenues so 50% - 4%).  Horizon would have annualized revenues of $64 million and at 46% operating margin gets you pretax earnings of $30 million, and 10x that is $300 million.  4.95% of that is $14.9 million, or another $0.09 on the balance sheet ($11 million is already on the balance sheet).  That would give us a total range of $2.42 - $2.82/share as the fair value of FRMO.  There are other adjustments to be made, but this is just a big picture guestimate.

Anyway, this back-of-the-napkin Horizon Kinetics value is probably way off as we don't know what the fee structure details are.  As I mentioned before I'm not a big fan of percentage of AUM as a valuation measure either as that really depends on the underlying assets (equities versus bonds versus liquidity funds), structure (mutual fund-like fixed management fee, institutional/retail, advisory / subadvisory,  hedge fund-type fee with incentives etc...) and other factors.  10x pretax earnings seemed to work well the last time I looked; valuations are probably higher now.

But!
If you read the annual reports and conference calls, you will notice that they have a lot of new projects planned, many with very low marginal cost (hedge funds, more indices and services with swaps which is very interesting to me as I have been involved with derivatives before (I assume they just get the licensing fee and not have anything to do with any actual swap)).  There can be a lot of potential there.  We don't know what the margins are at Horizon, but if new projects stick, they can probably get some pretty good operating leverage that is not reflected in the valuations above.  Licensing fees literally just fall straight to the bottom line and there won't be any AUM associated with that either.

They also said that AUM growth is accelerating (or at least the Horizon revenue growth).

Either way, this stock isn't currently trading at below any "readily ascertainable asset value" but who knows.  I look forward to following this going forward.

By the way, the structure of FRMO has been evolving and equity base is getting bigger so this may not be indicative of future potential, but check out the history of growth in per share value of FRMO over the years from their 2011 letter to shareholders (per share tangible BPS was $1.39 and $1.93 for 2012 and 2013):

Colfax Corporation (CFX)

OK, so this is another extension of the footnote to the book post.  Someone mentioned in the comment section that Colfax (CFX) is the younger analog to Danahar (DHR) and it is owned by some Tiger cubs and BDT Capital, a firm run by Byron Trott (Buffett's investment banker).

Here's the 2013 ownership section from the 2013 proxy:



Of course, what is interesting is that BDT Capital owns such a large percentage.  They did sell some shares in a public offering earlier this year but still own a large stake (or at least they didn't sell their entire position on the offering).  Probably the most important owner is Steven M. Rales; this is the Rales that founded Danahar (DHR).

Blue Ridge Capital, of course, is run by the Tiger cub John Griffin.  Tiger Global and other Tiger cubs own shares too.

Maybe interesting to the Buffett followers (other than Trott's involvement) is that Tom Gayner of Markel has been a board member of CFX since 2008 and Markel has owned a million shares or so since early 2012 (when CFX bought Charter, no not Malone's Charter, the Irish welding company... I know, this can get confusing).  Markel paid $23.04/share and BDT Capital got a bunch of shares at that price too in January 2012, related to the Charter acquisition.

Markel still owns it, and it looks like it's 2% or so of their equity portfolio.

Anyway, let's look at the chart:



CFX IPO'ed at $18/share back in 2008.  That was just when the world was falling apart and it shows in the stock price.  But over time, it has done incredibly well.   By the way, the red line is the S&P 500 index and the green line is Berkshire Hathaway.

History
Anyway, I have never heard of CFX until someone mentioned it the other day here.  CFX was originally started back in the mid 1990s with the backing of the Rales brothers.  As I was looking around the SEC filings, I found an S-1 filing for CFX from back in 1998.   I guess they filed an S-1 and never did the IPO. 

So here's a cut and paste from the August 1998 S-1 filing on the start of CFX:

Philip W. Knisely, with the support of the other Principal Stockholders,
embarked in 1995 to acquire, manage and grow world class industrial
manufacturing companies in the fluid handling and industrial positioning
industries. These industries were targeted due to their size, highly fragmented
nature and the Principal Stockholders' belief that these industries provided
the opportunity for accelerated growth and for improvements in operating
margins.

The Principal Stockholders have significant experience in acquiring and
leading multinational industrial manufacturing companies. Mr. Knisely, the
Company's President and Chief Executive Officer, has experience in managing
global industrial manufacturing operations for more than 15 years, including as
a group president of Emerson Electric Company and president of AMF Industries.
The Rales, who will serve as directors of the Company, are also directors and
principal stockholders of Danaher Corporation ("Danaher"), a New York Stock
Exchange ("NYSE") listed company and a leading manufacturer of tools,
components and process/environmental controls with a market capitalization of
approximately $5.6 billion as of July 31, 1998.

  The Company intends to expand its operations through internal growth and
acquisitions. The Company believes that there is a significant opportunity to
increase the internal growth of the Acquired Companies and of
future acquisitions by implementing the Colfax Business System ("CBS"), a
disciplined strategic planning and execution methodology designed to achieve
world class excellence in customer satisfaction. CBS is a customization of a
system which has its roots in the world-recognized Toyota Production System. A
similar system has been successfully deployed at Danaher for more than 10
years. Management has begun implementing CBS in each of the Acquired Companies
and believes that it has resulted in cost savings that have contributed to an
improvement in the Company's pro forma results of operations, as shown in the
following table:

<TABLE>
<CAPTION>
                                                         UNAUDITED PRO FORMA
                                                           SIX MONTHS ENDED
                                                      JUNE 30, 1997 JULY 3, 1998
                                                      ------------- ------------
                                                        (DOLLARS IN THOUSANDS)
   <S>                                                <C>           <C>
   Net sales.........................................   $272,006      $277,201
   Adjusted operating income(a) .....................     22,155        33,364
   Adjusted operating income margin..................        8.1%         12.0%

And like the other outsider companies, the main growth strategy is:

GROWTH STRATEGY

. INTERNAL GROWTH

  The Company believes that there is significant potential to increase the
  internal growth of the Acquired Companies and of future acquisitions.
  Through the implementation of CBS, the Company will seek to grow internally
  by focusing on customer needs and striving to improve product quality,
  delivery and cost. Specific actions to accomplish these goals include: (i)
  leveraging its established distribution channels; (ii) introducing
  innovative new products and applications; (iii) increasing asset
  utilization; (iv) using advanced information technology; (v) increasing
  sales and marketing efforts; (vi) expanding and diversifying the customer
  segments served; and (vii) expanding the geographic markets served.

. ACQUISITION GROWTH

  The Company believes that the fragmented nature of the industries in which
  it participates presents substantial consolidation and growth opportunities
  for companies with access to capital and the management ability to execute
  a disciplined acquisition and integration program. The Company's
  acquisition growth strategy is to acquire companies in the segments in
  which it participates that (i) have leading brands and strong market
  positions; (ii) will expand its product lines; (iii) have reputations for
  producing high quality products; and (iv) complement or enhance the
  Company's existing worldwide sales and distribution networks. The Company
  also believes that the extensive experience of its management team and the
  Principal Stockholders in acquiring and effectively integrating acquisition
  targets should enable the Company to capitalize on these opportunities. The
  Company intends to take a proactive approach to acquisitions and has
  currently identified approximately 50 potential acquisition targets in each
  of its two business segments located both in and outside the United States,
  although it does not currently have any agreements or understandings with
  respect to the acquisition of any such potential targets.

Their growth strategy is more detailed than this in their 2008 prospectus.  But the above pretty much shows you what the original intent was.

I don't know what happened since 1995 until the late 2000s when we get more information through the public filings.  Knisely no longer runs CFX; at some point it seems he went to work for Danahar (executive VP), retired and now is an advisor to Clayton, Dubilier and Rice (private equity shop).

Anyway, the Rales are still involved as owners and Chairman (like DHR) and that's the important thing.  We are looking for another DHR, right? 

By the way, here's the current CEO.  He's a DHR guy:

Steven E. Simms has been President and Chief Executive Officer since April 2012. He has served as a Director of Colfax since July 2011. Mr. Simms also served as Chairman of the Board of Directors of Apex Tools and is a former Executive Vice President of Danaher Corporation.  Mr. Simms held a variety of leadership roles during his 11-year career at Danaher. He became Executive Vice President in 2000 and served in that role through his retirement in 2007, during which time he was instrumental in Danaher’s international growth and success. He previously served as Vice President–Group Executive from 1998 to 2000 and as an executive in Danaher’s tools and components business from 1996 to 1998. Prior to joining Danaher, Mr. Simms held roles of increasing authority at Black& Decker Corporation, most notably President–European Operations and President–Worldwide Accessories.  Mr. Simms started his career at the Quaker Oats Company where he held a number of brand management roles. He currently serves as a member of the Board of Trustees of The Boys’ Latin School of Maryland and is actively involved in a number of other educational and charitable organizations in the Baltimore area.

He's only been on the job for a little more than a year. 

Anyway, let's take a look at how CFX has done over the years.  I'm too lazy to make a table so I'll just snip stuff from the annuals so you can get a sense of how they've done:

This is from their 2008 annual report; the first annual after their IPO.  Things looked fine.  Sales are up, margins are going up etc.  Adjusted EPS is $1.22, so the IPO was priced at around 15x the current year EPS.  Their margins were going up thanks to CBS (Colfax Business System), and was up to 15.0%.  Hold that thought because we'll need it.  By the way, DHR has operating margins north of 15% (17.3% in 2012).

 

And things sort of start falling apart along with the economy.  This is from the 2009 annual report:

And finally this is the five year financial summary from the 2012 10-K:

So it wasn't smooth sailing through the great recession like some of the other outsider companies.  But look what happened in 2012.  In January, they did a huge deal, obviously.  I guess we can call that a tranformational acquisition since it's so big. That's the Charter acquisition that brought in Markel and BDT.

Now look closely at the operating margin.  Even excluding all that acquisition-related and restructuring charges, operating margin is really low.

Remember, how is CFX going to grow?  Through acquisitions and CBS (Toyota-like improvement system), right?  Yes, organic growth too.  But acquisitions and margin expansion are two big drivers.  So for CFX to make such a huge acquisition and for BDT, Markel and others to support it by providing equity funding for the deal, there must be some huge operational improvement potential at Charter, right? 

So that's the story right there.  Of course, the main, full-time story is that CFX will grow like DHR did and like other outsider companies.  But the story now is this huge deal that they did, and I think it's obvious that they know Charter's business well enough to have confidence that they can really get their margins up. 

Valuation
So let's get to the interesting part.  Yahoo finance says that CFX is trading at 60x ttm P/E and 22x next year's estimate EPS.  CFX is guiding $2.00 or so for December 2013-end full year EPS.  At $56, that's 28x P/E.   I notice that there are people calling to short this overvalued stock based on this P/E.

But with shareholders like the above, we know this can't be right.   We have to look beyond the headline metric to see what is actually going on.

So check this out. This is from their June 2013 investor presention:

So the model for the top line is to outdo GDP by 1-2% on an organic basis and then add to that via acquisitions; something that the Rales have sort of been good at doing historically.

And here's the key for my current back-of-the-napkin analysis:  Margins.  They target mid-teens operating margins.  Let's call that 15%.  This was once achieved by CFX (see above 2008 annual report) and is currently done by DHR, so there is no reason why it can't be done here.  In recent years, there was the financial crisis and then this huge megadeal.  But when they work through this huge deal, there's no reason why they can't get up to 15% operating margins.  Well, yes, things can go wrong.  The economy can fall apart etc.   

Also, like DHR, they will get free cash flow above net income.  There's no reason why they can't do that either. 

By the way, here's what the big deal did to their revenues:

They have higher exposure now to higher growth markets.   This may have backfired in the short term as it seems like former high growth markets are having problems (China, Brazil etc...).  But that's probably a short term cyclical problem, and over time, the growth markets will tend to grow faster than the mature markets.

So let's get to the fun part.  This is going to be really rough work so don't take it too seriously.  I am just going to play with the numbers to get sort of a reality check on valuing CFX. 

What if CFX gets operating margins back to 15%?  What would earnings look like then? 

Here's the 2013 guidance from their 3Q earnings slide:

 



 

You will see that on the low end, they are guiding revenues of $4.1 billion, adjusted net income of $223 million and adjusted EPS of $1.98/share. 

Now let's just adjust the above to a 15% operating margin instead of 10%.  Then the above table would look like this:

Revenues:                              $4,120
Adjusted operating profit:        $618
Interest:                                    ($76)
Taxes  (@27%):                     ($146)
Noncontrolling interest:           ($31)       
                                                 $365

I'll just use 115 million shares (102 million shares outstanding plus 13 million dilutive shares) and we get $3.20 in adjusted EPS.   That's 17.5x P/E ratio if, all else equal, operating margin was 15%.

Wait, but there's more.  CFX seeks to have free cash flow exceed net income.  DHR had free cash above net income for 21 years in a row.  If the Rales are focused, they can get that done here too.  Why not? 

For a quick guestimate, I just looked at depreciation and amortization against capex.  For the first nine months of 2013, D&A was $102 million versus capex of $51 million.  So cash earnings were $51 million higher than net earnings so far this year.  Annualize that and you get around $70 million.

Add the $70 million to the above $365 million and you get $435 million in free cash.   That comes to around $3.80/share.   With a $56 stock price, that's 14.7x cash earnings, or free cash per share.  That's a 6.8% free cash yield.

So think about that.  And as they get their margins up there, sales will probably continue to grow and some of the softer emerging markets will start to come back.  So even without any sales growth, just by doing their Toyota thing, they can get almost a 7% free cash yield...  and then add to that the GDP plus 1-2% growth organically and maybe some potential acquisitions and more margin improvements there and you are talking about some serious potential compounding.

Oh yeah, on the earnings calls, they sort of talk about margins for their segments.  Segment margins and overall company operating margin will differ; segment margins don't include corporate overhead.  

I would think that CFX should get company level operating margins up to 15% at some point, but let's say that they only get their segment margins up to 15%.  In that case, we will have to lop off around $50 million for corporate SGA from the above $365 million.  This would make the above figures around 14% lower. 

Conclusion
I don't know why I keep writing 'conclusion' on these posts when I don't often have one.   I just wanted to take a look at this company as there seemed to be so many reasons why I should;

• it's an outsider-type company with a similar strategy
• and it's actually run by the Rales who have done it before with DHR (or at least Chairman'ed by them)
• has a distinguished shareholder list even though BDT seems to be selling.  Blue Ridge seems to have gotten in in the past year or so, so it's still fresh.  Markel still owns it.

Anyway, my analysis above is admittedly very rough, but I don't think it's a stretch to imagine that CFX can keep improving the operations and get their margins up.   This is what they do and what they are good at.  If they do so and they keep sales growing organically and through further acquisitions, I would not be surprised at all if CFX stock does really well.

Having said that, I've only spent a day or two on this so even though I like a lot of what I see, I can't say I am comfortable with it enough to own the stock (or at least own a big position in it).  Maybe I'll get more comfortable after looking more closely at DHR (and get familiar with the way the Rales operate) and following it in real time for a little.

 

Is the Next Teledyne the Old Teledyne?

OK, so I've known about Henry Singleton and Teledyne for a long time.  Buffett has said that he was the greatest capital allocator of all time.   Since I read the outsider CEOs book I got to thinking about Teledyne again.  I am embarassed to say that I have the book, Distant Force: A Memoir of the Teledyne Corporation and the Man Who Created It, by George A. Roberts (published in 2007), but haven't read it yet.  There are a lot of great books in my pile that I haven't gotten to.

Anyway, having read the outsider book, I obviously needed to bring that book up to the front of the queue.  And in the back of the book, there is a CD included with all the annual reports from 1969-1995.  This got me really excited, but unfortunately, I don't know what that stuff is since the 'annual reports' don't seem to include any financials or 'letter to shareholders' or anything like that.   They are scientific articles, basically.  (By the way, here's a business idea:  I would pay for a century worth of annual reports of companies, wouldn't you?   Say, like, all the Coca-Cola annual reports from 1900 - 2012 or something like that.  That would be fascinating to me. Even complete sets of companies that no longer exist would be interesting!)

So I surfed around the internet and duh, I realize that Teledyne (TDY) is still a listed company.   I figured TDY didn't exist on it's own and they were parts of other large corporations by now.  But TDY merged with someone in 1996 but was spun out again in 1999 as Teledyne (along with other parts of the old Teledyne, Water Pik (PIK) and Alleghany Technologies (ATI).  Water Pik was bought out by private equity and ATI is still listed (now I see why Joel Greenblatt was on the board of ATI; it must have been spin-off related).   All of this stuff is in the book, by the way (the merger and the spinoff, and the chapter "Teledyne Renaissance" written by the then (at spin) and current CEO Dr. Robert Mehrabian).

But then again, who cares, right?  TDY was a Henry Singleton story.  Singleton is no longer around so who cares about TDY?

I was surprised, though, at how well it has done since the spinoff.

Danaher (DHR) preview
Before I go on, though, someone in the comments section in my other post about the outsiders book mentioned that Thorndike wanted to do one more chapter but the management didn't want to talk (the guess was Leucadia which I agree is a good candidate).  Well, someone else mentioned in another comment some companies that were run by outsiders and one of them was Danaher (DHR).   DHR is a name that comes up when you talk about industrial conglomerates that are really good allocators of capital and I have looked at them in the past; shame on me for not owning any!

Check this out:

This is the stock price performance of DHR since 1990 or so.  The red line is Berkshire Hathaway, and the green line is the S&P 500 index.  This is just nuts, isn't it?

Yahoo Finance data only goes back to 1987.  According to that, DHR stock has appreciated 21.7%/year over the past 26 years.  That compares to 8.1%/year for the S&P 500 index (excluding dividends).  21.7% versus 8.1%.  That's mindboggling.

So wait a second.  How does this compare to the other outsider CEOs?  I will cut and paste from my original post and see how DHR compares:


1.  Tom Murphy (Capital Cities Broadcasting):
    +19.9%/year over 29 years versus +10.1%/year for the S&P 500 index
2.  Henry Singleton (Teledyne):
    +20.3%/year over 27 years versus +8.0%/year for the S&P 500 index
3.  Bill Anders (General Dynamics)
    +23.3%/year over 17 years versus +8.9%/year for the S&P 500 index
4.  John Malone (TCI)
    +30.3%/year over 25 years (up to ATT acquisition) versus +14.3%/year for the S&P 500 index
5.  Katharine Graham (The Washington Post)
    +22.3%/year over 22 years (since IPO) versus 7.4%/year for the S&P 500 index
6.  Bill Stiritz (Ralston Purina)
    +20.0%/year over 19 years versus +14.7%/year for the S&P 500 index
7.  Dick Smith (General Cinema)
    +16.1%/year over 43 years versus +9%/year for the S&P 500 index
8.  Warren Buffett (Berkshire Hathaway)
    +20.7%/year over 46 years (through 2011) versus 9.3% for the S&P 500 index

9.  The Rales Brothers (Danaher)
    +21.7%/year over 26 years versus +8.1%/year for the S&P 500 index (excluding dividends)

Hmm... Seems to fit right in.  

OK, so anyway, DHR is a great company too.  Not completely unknown.  I will look at it in a later post but for now I would point out that they may look expensive at first glance due to the high P/E ratio (well, high for us bottom feeders) but I think the key is that they are earning a lot of free cash; their free cash to net income was 130% last year and has been consistently over net income in recent years.  So from that point of view, the raw P/E ratio may not be the best way to look at this.

Back to Teledyne
OK, so let's get back to TDY.  It's still listed and it has been doing quite well.   As Buffett would say, here lookit:

Again, like the other chart, the red line is Berkshire Hathaway (I'm not picking on Buffett; he's just a very good benchmark!), and the green line is the S&P 500 index.  This looks pretty good too, even though it would have been quite a rough ride over the years.  But you know, we are not supposed to care about price volatility as long as intrinsic value keeps going up.  I haven't followed TDY over the years so I don't have a strong sense of what these years were like for them.

That's a 18.1%/year return for the stock compared to +1.6%/year for the S&P 500 index (excluding dividends).  That's not bad either, and may be worthy of outsider status.  14 years might be a little short compared to the others (but General Dynamics was 17 years, so).

Anyway, who'da thunk TDY did so well post-Singleton?

August 2013 Investor Presentation
TDY too has a great investor relations website so let's snip some stuff from there:

Similar to Transdigm, they focus on highly engineered products.  From looking at the annual reports over the years, it seems like they started focusing more on transitioning over time.

 

This high SGA margin is an area they see as potential for improvement (and margin expansion). 

 

This EPS growth looks pretty good.  But some will argue that the $0.21 might be abnormally low so the CAGR over time is front-weighted.  So let's just look at different time periods:

EPS growth rates from the above graph were:

5 year:       +8.1%
10 year:  +17.3%

So not so bad even starting in 2003.  Of course, we have to keep in mind that the five year growth rate includes the great recession.

Again, if we focus just on P/E ratio, we might miss the more important free cash flow; raw P/E might make this look more expensive than it is.  A lot of opportunities arise when people are misled by 'headline' metrics.  Maybe this is one of those situations.

Anyway, TDY is certainly worth a look.  I haven't spent much time on this; this is just one of those tangents that came from reading that book. That's what's so great about reading!  And then I posted about it and I got other leads from the comments section so thanks to those who do post comments.

Oh, and one more quick thing.  Who is TDY run by? 

Who is Dr. Mehrabian?  
He is 71 years old as of the most recent proxy, so that's an issue; who knows how long he intends to stay on the job here (and what the succession plans are).  I haven't listened to any conference calls or anything like that so there is still a lot I don't know.

But anyway, here's a snip from the proxy:

As I said before, he wrote a section at the end of the Teledyne book; a chapter called "A Teledyne Renaissance".

Dr. George A. Roberts (President of Teledyne during the Singleton era and author of the Teledyne book) in the book says of Mehrabian (page 252; From Merger to Spin-off):

Among those included as new members of the combined companies was a highly competent individual well known to both Dick Simmons and myself, Dr. Robert Mehrabian, who now heads Teledyne Technologies, Inc.  He had been president of Carnegie Mellon University for seven years, and also served there as a professor of materials sciences and engineering.  He was an internationally known authority on advanced technologies, and after joining the board in 1996 he retired from the presidency of Carnegie in June 1997.  Alleghany Teledyne Chairman Richard Simmons offered him the position of senior vice president and segment executive to run the new company's Aerospace and Electronics segment.  A year later he was placed in charge of all Alleghany Teledyne companies other than the specialty metals operations...

So anyway, there you have it.  There is TDY doing wonderfully long after the passing of Henry Singleton. 

This is not a recommendation to go out and buy TDY, of course.  I haven't done any serious work on this yet.  But yes, it's certainly one that belongs on a watch list. 

 

TransDigm Group (TDG)

So this is sort of a footnote to the previous post about a really great book. 
  (The Outsiders:  Eight Unconventional CEOs and Their Radically Rational Blueprint for Success. )

In chapter one (page 34), Thorndike mentions the TransDigm Group (TDG) as a contemporary analog for Capital Cities.  TDG has grown  cash flow at 25%/year since 1993 through internal growth and acquisitions (which Thorndike calls an "exceptionally effective acquisition program").   The approach is similar to Capital Cities in that they focus on businesses with exceptional economic characteristics.

The CEO responsible for this nice record, Nick Howley, is still the Chairman and CEO and is 60 years old (as of the 2013 proxy) so the story may still be intact; maybe it's worth a look.

TDG Performance versus S&P 500 Index Since IPO

That's a 33%/year performance since 2006.  Pretty nice and consistent with the performance of other outsider CEOs.  The book says TDG grew free cash flow +25/year since 1993. 

Here are some figures for the last five years:

                                             2007             2012        CAGR
Sales   ($mn):                       593               1,700       +23.5%              
Operating income ($mn):     234                  700       +24.5%
Adjusted EPS:                     $2.01               $6.67     +27.1%
EBITDA:                            $275                $809       +24.1%

These are pretty decent growth rates and the period includes the great recession.

What would one pay for a business that grew adjusted EPS at +27%/year in the past five years?  The midpoint of the company guidance for 2013 is $6.80.  With the current stock price trading at $143/share, that's a P/E ratio of 21x.  This may not be Graham and Dodd cheap, but with historical EPS growth of +27%/year and a company goal of growing 15-20%/year (in equity value), 21x may not be expensive at all, not to mention that free cash flow is much higher than adjusted earnings.  If we use 55% of current year expected EBITDA as free cash flow (see later slide), we would get $8.93/share in free cash flow per share and a multiple of 16x free cash; not bad for a company growing so quickly.

Some of the components included (or excluded) in the "adjusted" earnings and EBITDA may be debatable, but I'm not trying to pinpoint an exact valuation here; just getting a general sense of the company.

Unlike the many outsider companies, TDG has a great investor relations website with some interesting slides (see here).

By the way, one thing we have to look at later is that current year adjusted EPS guidance is $6.80 (at midpoint) versus $6.67 in 2012. I haven't dug into this to see if the growth period for TDG is over, or if it's a short term thing (EPS was also flat in 2010, so this may be lumpier than your typical 'growth' stock).

Ownership
Management/directors own just over 10% of the shares, but Howley doesn't own much except for what he gets from options (which only vest with performance).  Howley owned just under 5% at the time of the IPO but hasn't owned much since except for the options.

Berkshire Fund VII (Private equity, not the Buffett entity!) owns 7.6%,  and Lone Pine Capital owns 6.7% (as of the 2013 proxy).  It looks like they sold some shares but still own 2.6 million shares as of the August 13F.   Lone Pine Capital is run by the highly successful Stephen Mandel, a Tiger cub (ex-Tiger Management).  Tiger cubs are known to do a lot of work (analysis) on their holdings.

Also, I noticed that Tiger Global, also a high performing Tiger cub bought some shares this year which indicates that TDG might still represent some value.  Tiger Global owned a large stake for a while but didn't own any shares (according to the 13F) earlier this year until some shares showed up on the 13F in August.  It's only 530,000 shares or so compared to their 4.5 million shares they owned back in 2008.  TDG didn't show up in the 13F as far back as late 2011, so maybe this is seller's remorse.  In any case, it's a datapoint for whatever it's worth.  Tiger cubs are generally very fundamentally based investors who focus a lot on management so it's a good sign that they are shareholders.


Anyway, let's take a look at some slides.

First I'll snip some stuff out of the 2012 Analyst Day presentation:

TDG makes and sells aftermarket products for the aerospace industry.  It is apparently a high-moat business since not just anyone can make stuff and sell it to people who put them in planes.  They are highly engineered and government approved (for safety etc...), which usually takes time and money to do.

The private equity-like business model is their dependence on acquisitions for part of their growth.  They typically pay 9-11x EBITDA and through efficiencies,  get the effective EBITDA multiple down by more than 50%.

Here's a very long term view of their results, going back to their founding in 1993 (actually, the following two charts are from the September 2013 investor presentation as they have updated figures):

 

It's good to know that TDG continued to grow even after EBITDA margins got into the 40s in the early-to-mid 2000s.   So EBITDA margin improvement from 20% in 1993 to 47% in 2013 is not the whole story; TDG has grown substantially even since 2004 when margins hit 46%.

They operate in a growing industry, so this is not rolling up local yellow pages or anything like that:

I think there is no doubt that the aviation industry is growing over the long term:

High moat businesses:

Big Market:

Sole source means they are the only ones that can replace a part.

Kind of Berkshire-like (or outsider-like) localization:

Performance based pay:

Clearly defined objective:

...and way to achieve it:

Plenty of room for more acquisitions:

As Munger says, what you don't do is just as important (or more important) than what you do:

And of course, what's the point without free cash?

Conclusion
Well, this is just a quick first look but it is certainly pretty interesting.  It's trading at 21x current adjusted P/E and 16x free cash flow (assuming free cash is 55% of EBITDA this year), which is not a bad valuation if they continue to grow in their target range of 15-20%.

I have yet to dig into the filings, conference call transcripts and annual reports going back, but there is plenty of interesting things here to make this worth at least a closer look.  I haven't followed this company at all so I don't have a comfort level with this as much as the other companies I post about, but the fact that it came out of the outsider book and has Tiger cub shareholders (even though one of them may be on their way out) gives me more comfort than a random idea I read about on the internet.

The immediate concern, I suppose, would be to get a sense of why things are slowing so much in 2013; a year that doesn't look so bad. 

Earnings for the FY 2013 (which ended in September) should be out soon and maybe we can get some more clarity on the outlook for next year.

Other concerns are obviously how long Howley will stay on, how size may become a problem going forward etc.

As usual, if I find anything interesting to add, I will make a followup post to this.

 

A Really Great Book: The Outsiders

This is old news as this book was recommended by Warren Buffett in Berkshire Hathaway's 2012 annual report.  I knew it was going to be a great book, but it was sitting in my big pile all year until this past weekend.  Once I started reading it, I couldn't put it down.  Not surprisingly, it is a really, really good book.

I'm sure many of you have already read it, but if not, stop what you're doing right now.  Go to the library and get this, or you can order it here:  The Outsiders: Eight Unconventional CEOs and Their Radically Rational Blueprint for Success (by William M. Thorndike, Jr.)

Here is the list of the unconventional CEOs (and how they did versus the S&P 500 index):

1.  Tom Murphy (Capital Cities Broadcasting):
    +19.9%/year over 29 years versus +10.1%/year for the S&P 500 index
2.  Henry Singleton (Teledyne):
    +20.3%/year over 27 years versus +8.0%/year for the S&P 500 index
3.  Bill Anders (General Dynamics)
    +23.3%/year over 17 years versus +8.9%/year for the S&P 500 index
4.  John Malone (TCI)
    +30.3%/year over 25 years (up to ATT acquisition) versus +14.3%/year for the S&P 500 index
5.  Katharine Graham (The Washington Post)
    +22.3%/year over 22 years (since IPO) versus 7.4%/year for the S&P 500 index
6.  Bill Stiritz (Ralston Purina)
    +20.0%/year over 19 years versus +14.7%/year for the S&P 500 index
7.  Dick Smith (General Cinema)
    +16.1%/year over 43 years versus +9%/year for the S&P 500 index
8.  Warren Buffett (Berkshire Hathaway)
    +20.7%/year over 46 years (through 2011) versus 9.3% for the S&P 500 index

These are amazing figures.  We financial people tend to focus on fund managers and people like Warren Buffett, but there are tremendous value creators in the business world too. 

And this lead to another thought that connects to what I always try to tell people.   If you own a business with good, rational managers, then you shouldn't worry too much about what is going on in the stock market; they will do what makes sense and increase value (without shareholders having to get in and out based on all sorts of indicators and prognostications). 

Instead of worrying about what will happen to the stock market or the economy going forward, the more rational question would be, "which companies have a lot of cash flow and can take advantage of any volatility in the market or economy going forward?  Who is going to survive and come through the other end stronger?".  If this question is taken care of, then one needn't worry about much else (except for maybe how much volatility you can stomach).

This leads to the question who the "outsiders" are today.  So far, most of the businesses that I have mentioned on this blog I would consider "outsiders".  They are very focused on shareholder value.  While the "outsiders" in the book focused on cash flow, I have tended to write about financials so the focus has been on earnings and book value per share.  But still, they tend to focus not on accounting profits and losses but on increasing intrinsic value per share.

Thorndike mentions Transdigm as a "contemporary analog for Capital Cities" and mentions Exxon Mobile as a current example of a company similar to the above list (emphasis on rational capital allocation with a 20% return hurdle).

If you asked Buffett right now which company he feels fits the bill of an outsider, he would probably tell you IBM (well, and all of the other companies he owns).   Analysts sounded pretty upset in the recent conference call and the stock took a dive.  Are the analysts too impatient? Will IBM pull through?  If IBM's problems are short term as management claims, then IBM can be a great buy today.  We have to keep in mind that analysts are under tremendous pressure.  If they like a stock and recommend it to clients, they take a lot of heat if the company doesn't perform.   When analysts are frustrated, it may be a good time to buy the stock.

Eight Years in the Making
This book took eight years to write.  They spent one year studying each CEO in detail (the author with the help of Harvard Business School students).    One semester was devoted to researching financial details of the companies (and peers) including financial reports, books, magazine articles and videos and the other was spent interviewing  analysts, employees, investors, bankers etc.

So think about that.  Eight years of hard, detailed work summed up in a single book for $27.00 (list price, which nobody pays anymore).  That's a bargain.

Anyway, I don't really do book reviews here too much but I felt compelled to write this post since this book really is that good.  This belongs on every investor's bookshelf, right next to The Intelligent Investor (The Intelligent Investor will tell you how to think about the markets, and maybe this book will tell you how to think about businesses).  I feel it's really important to understand how value is created at the business level.  The more people understand how business works and how good ones can create value, the less they will worry about the stock market or the stock price.  If people can really think about the stock they own as part of a business, then I think they will tend to do better.

Some Other Books
OK, so some other books I just finished reading:

Cable Cowboy: John Malone and the Rise of the Modern Cable Business
This books is just what it says; a business biography of John Malone and the cable business.  It's very timely to read now with the recent Charter Communications deal.  We know something is brewing here, and Malone is getting back into the business that got him started.  It's also a good read because Malone is one of the "outsiders" from the above book.  This book goes into much more detail, obviously, than the single chapter in the "Outsider" book.

Anyway, from reading this you will see how immensely rational Malone is.  It's a fun read too.  

King of Capital: The Remarkable Rise, Fall, and Rise Again of Steve Schwarzman and Blackstone
This was also a pretty good read.  I don't have any problem with the private equity industry.  I know they are not very popular (and Buffett / Munger often takes shots at them too), but I've never really had a problem.  

Anyway, this is not just the history of Blackstone and Schwarzman, but does cover the history of the industry so it was very interesting.

Schwarzman has some issues, I suppose, with his tremendous ego and things like that, but what you realize is just how good Schwarzman really is.  You may not like the guy and may not ever want to work for him, but he is really good. 

I've spent time looking at Blackstone over the past few years and I always thought that.  Go look at the Blackstone investor presentations at their website.  They are really well done.  The earnings slides are really good too.  And when you listen to the conference calls, Schwarzman is there taking questions and answering them.  If I recall correctly, they didn't just shut down the call after an hour.

Some may say that's just Schwarzman loving the sound of his own voice or whatever, but who cares.  He is there answering questions.  It's actually a good thing for investors (and the public) when the CEO likes to talk; we can learn a lot from listening (even if you are not a Blackstone or private equity fund investor).

So anyway, I am really impressed with Schwarzman and Blackstone but don't own any stock.  Why?  I was going to make a post about that (and still might eventually), but the short answer is that I just think they are getting too big for my taste.

I know that is a common criticism and Schwarzman addresses it in the presentations; they have continued to do well despite their size. Too, they grow by adding strategies and products so it's not like their private equity business is ever expanding.

A lot of the growth is from new business lines, like real estate and hedge funds (or fund of funds).  

But still, when you look at the presentations of the big, listed private equity firms, their AUMs are just exploding to the upside.  It makes you wonder how they will make high returns with so much capital sloshing around in the industry (even if they are across different strategies).

I do understand that allocations to alternative investments are rising for a reason, and this may not be a fad but a permanent reallocation similar to what happened when institutions shifted allocations into equities decades ago (the reallocation to equities was permanent and not a one-time event).

But still, when I see the trajectory of the AUM trends in ALL of these alternative managers, it makes me nervous. 

Anyway, again, maybe that's a topic for another post.  But for now, I just wanted to say that I enjoyed this book.  I think there is something to learn from these guys for any serious investor.

Liberty Media Investor Day 2013

So Liberty Media (LMCA) had their investor day last week.  I wasn't there but the investor day webcast is available with a slide presentation at the LMCA website.   

There was some fun stuff in the beginning (with a disturbing slide of Greg Maffei doing some sort of dance) and then Maffei (LMCA), Meyer (Sirius XM), Rutledge (Charter) and Rapino (Live Nation) did presentations on their businesses.

Anyway, I will cut and paste a whole bunch of stuff from the presentation as it's easier to do that than to type stuff up myself.

This will be sort of a summary, but not a complete summary.  This is sort of a note to myself so I will add thoughts along the way.  Maybe it will be helpful for people who don't want to sit down for two hours to listen to the webcast. 

Those interested in LMCA should at least go look at the slides (much of them are here, but many more in the original presentation) and if you have time, listen to the presentations.  They are really well done, and the Q&A afterwards is very interesting. 

John Malone is one of the legendary people in business and he is always worth listening to.  You can learn a lot about many things by listening to him.  Just like you learn a lot about banking by listening to Jamie Dimon and learn a lot about everything from listening to Buffett, you learn a lot about cable, media / entertainment from listening to Malone.

Anyway, here is one of the 'fun' section slides from the presentation:

Non-New Yorkers might not recognize the buildings in this photo, but that's the Time Warner Center in New York City.  Maffei was talking about a fictional radio station on Sirius XM (called Malone's Melodies).  The tune playing is "Time Is On My Side", so you know they really want to do this deal.

News

LMCA did a series of deals to raise some cash (that was used to pay down margin debt).  LMCA continues to repurchase shares.  As we'll see later, they have already bought back more than half the shares in the recent past.  The repurchase of 5.2% of LMCA from Comcast in a tax-free exchange was priced at $132/share.  LMCA still has $327 million in repurchase authorization after this deal (details of this deal are in the presentation slides).
The sale of SIRI shares back to SIRI also comes tax efficiently as this was some of the high basis stock that LMCA owns and effectively gets dividend treatment for tax purposes.   

The convertible bond deal is a tax efficient way to lock in some low funding rates for the long term (10 years).

As a result, LMCA has been able to pay down much of the margin debt they took on when they bought Charter.  Maffei used the term "reload the gun" to describe what these transactions did.  Those words should excite people who are looking for LMCA to do more deals.   Well, maybe they are getting ready for Time Warner Cable.

LMCA is very shareholder friendly (we already knew that), but this chart is incredible.  They've bought back more than half of their shares since 2008, and they still have plenty of liquidity (borrowing capacity, high basis SIRI shares etc...).

Stock Price Performance

LMCA share price performance has been amazing too, and recent performance is not just a recovery from the crisis lows.  The CAGR is +36%/year since 2006, so that includes the crisis.

Sirius XM (SIRI)
Jim Meyer made a presentation about SIRI which I thought was very interesting.  He addresses some of the questions that critics raise.

Of course, LMCA bought SIRI as a distressed situation and did very well with it, but Malone sees a lot more growth ahead for SIRI.

One of the issues is competition from internet radio, like Pandora and music services like Spotify.  Meyer points out that SIRI is not a music company.  SIRI does music, talk and sports:

Also, with respect to competition from internet streaming services, Meyer points out that the big competitor out there is still terrestrial radio:

The following charts show the superior earnings model versus the competition:

Growth
The following charts show subscriber, revenue and EBITDA growth:

Increasing Margins

Meyer said that SIRI can safely get to 40%+ EBITDA margins at maturity.  He said this is doable due to the scalability of the business.

But at the end of the day, what's really important is free cash:

and free cash per share:

He said he is asked what he values more; subscriber growth, revenue or EBITDA?  He said "yes" to all but free cash flow per share growth is most important.

Growth is linked to new auto sales, obviously, and here's the trend and forecast (auto industry forecast).  SIRI has been increasing share in new auto sales. 

What's interesting is that even if new auto sales flatten out, SIRI can still grow subscribers because every new auto sale is a potential new subscriber (assuming the new car buyer didn't have it before; otherwise I suppose a driver just replaces a car so subscriber count won't change).

Anyway, SIRI did some work on this and shows the growth potential based on projected new car sales:

Meyer said that they are very comfortable that they will reach more than 100 million enabled vehicles by 2018 (enabled vehicles is not the same as number of subscribers, but shows the potential).

Their balance sheet looks much better now than before at 2.7x leverage (versus 3.5x target):

The other big growth area is used cars.  The used car market is 3x larger than the new car market and this area has a lot of potential.  Also, connected vehicle services (telematics) is another area of growth potential that Meyer talked about. 

As Malone mentioned in the Q&A later, he sees a lot more growth to come at SIRI.

Charter Communications (CHTR) 
Tom Rutledge did a presentation on CHTR.  This is actually a pretty exciting situation, I think.  There is a lot more on the topic in the Q&A where Malone talks a lot about the history of cable and what he sees happening there going forward.

One of the reasons why I got interested in CHTR and LMCA (I have owned LMCA and DISCA in the past but haven't followed them too much recently until early this year) again is because I thought that the industry was coming to some big inflection point.  For many years, cable companies just kept growing by adding subscribers.  They were making so much money and growing so much that they didn't really care what they paid for content as the subscribers paid for them.  That's why I was always a fan of content; I've owned Disney and CBS in the past for that reason.  I figured content providers will always get paid regardless of what happens in the distribution world.  For all I care, the phone, cable and satellite companies can fight it out and destroy each other, but they will all still have to pay high fees to ESPN.  So as a Disney shareholder, I was indifferent to what happened in the pipe wars.  Who cares who won.  They will all just have to pay more to get more content to compete even more.

Then cable got saturated (well, it has been saturated for a while) and stopped growing and then phone companies came in with video offerings, and of course satellite companies continued to take share away from cable.  So, all of a sudden, with distributors unable to grow (due to saturation), and prices of content continuing to go up and customer cable bills rising, new alternatives pop up, like Netflix, Hulu, Youtube or whatever else.

Distribution companies start wondering why they are paying so much money to content providers when the same content can sometimes be viewed elsewhere for free.

In any case, I don't really understand the media business that much, but all of this stuff was the impression I was getting.  The industry seemed really ripe for a change.  Business as usual just wasn't going to work anymore.

And then LMCA takes a big stake in CHTR.  So for me, this deal coincided with my feeling that something is happening in the industry, or at least something is about to happen.  At first, I wasn't sure how the industry can change.  I thought, like everybody else, that cable was under pressure from phone companies and satellite providers, and increasingly from over-the-top TV.  I did understand that their ownership of the last mile into people's homes was a big asset but it wasn't really clear to me how the cable companies with their video package (which Malone himself said will be obsolete in five years or less) will compete with the over-the-top guys like Netflix.

Now I think I understand this a lot better what can happen.

Anyway, let's get back to the CHTR presentation where Rutledge explains why CHTR is such a great opportunity.

CHTR History
Rutledge started by explaining the history of CHTR.  It was founded by Paul Allen.  They assembled a big system by paying very high prices and spent a lot of money creating a state-of-the-art network.  Because of the high prices they paid and poor management, they went bankrupt.  They then had to cut cost where they shouldn't have leading to poor service etc.  As a result of this, CHTR has the lowest product penetration.

So a lot of the growth story here is just bringing things back up to where they should be in terms of product penetration.  Here is a slide that shows the potential for CHTR:



Also, FiOS competes in only 4% of CHTR's markets.  As for satellite competition, CHTR's edge is that they have two-way connectivity versus one-way for satellite.

Malone said a while ago in an interview that he thinks CHTR can get competitive high speed internet at a much lower cost than others (fiber optics etc.).  Here is a slide that shows how this can happen:

This is the other story for CHTR.  By going all digital, they free up a lot of broadband on their cables that will allow them to increase speed / capacity for high speed internet and other things.

Rutledge says that capex is high now due to spending related to going all digital, but once that is done capital intensity of the business should go down.  Along with increasing revenues, this should boost EBITDA going forward.

There are a lot more details in the presentation, but the CHTR story is pretty simple; reversing the years of undermanagement to boost revenues, going all digital, decreasing capex needs going forward and operating leverage from that.

Live Nation (LYV)
Frankly, Live Nation has never been on my radar.   I always thought of the concert industry has one that makes money from the occasional Rolling Stones fairwell tours, Kiss reunion tours and things like that.  I think for many years (not that I follow this stuff) the highest grossing concert tours tended to be these old, boomer-generation rock bands.  So Michael Rapino's presentation was an eye-opener for me.

Growth
First of all, I was wrong about the concert industry.  Who knew it was a growth business?  I don't go to concerts anymore, so I guess there would have been no way for me to know anyway.  But here it is:

And look at 2013 growth by region:

...and for ignorant people like me who think only U2 or the Stones can sell tickets, check this out:

I don't know if I should be proud or embarrassed to say that I have no idea who these people are.  OK, I know Fleetwood Mac, Depeche Mode, Kid Rock and Beyonce.  Not bad, I guess...

So why is it growing so much?  What's different now than before?  This is an interesting thing that Rapino said.  He explained that concerts these days are driven by fan demand.  In the past, concerts have been driven largely by record labels. It was the record distribution model that included concerts as promotional events to sell records. 

Now concert demand is driven by fans, and how this is done is very interesting:  It is done through social media like Youtube, Facebook etc.

Check out this slide:

So we see that only 17% of the Rihanna concerts take place in the world excluding North America and Western Europe, but 56% of her fans on Facebook and 40% on Youtube are from this area. 

If you ever wonder who benefits or makes money from Youtube or Facebook, well, now we can think about LYV.

The live concert business is not a particularly high margin business.  So that may be another reason why I wasn't too interested in LYV before, but the LYV business model is actually to use the live concert business to drive the other high margin businesses:

They are also increasing business through mobile (another question people keep asking; how people make money off of mobile), and their secondary ticket sales business looks pretty interesting.  There is a bunch of stuff in the presentation that you should look at if you're interested.

But the bottom line is that all of this is leading to some interesting growth:

 

Anyway, I've never looked at LYV in detail so I don't know where all the above numbers lead in terms of valuation, but there seems to be no doubt that it is growing at a decent rate and there seems to be some more growth opportunities in the future.

So that's it on the business presentations. 

And then there was what many may consider the most interesting part of the day.

Q&A Session
Malone and Maffei took questions from investors and there were some interesting discussions on various topics.  Anyway, these are from my messy notes so not word-for-word or anything.

Why continue to keep owning SIRI? Why not spin it off?
They like SIRI.  LMCA has no big free cash generating assets.  SIRI is the only big one.  It's ability to generate capital for LMCA to use is interesting.

SIRI is also a work in progress.  They feel they can still help SIRI. 

Maffei mentioned that historically, LMCA has spun off assets when the value of an asset was not recognized by the market, or when a business has reached an apogee.  They think neither is the case at SIRI.  The value of SIRI is well recognized inside of LMCA now and there is much more they can do there.  There is still "a lot of upside".

Malone says CHTR will require capital (Time Warner?).  SIRI will give them the financial flexibility to "chase a few more rabbits".

Malone also said that there are still some synergies in the music business that hasn't been exploited (and LMCA can help SIRI with that).

Is there more tension between programmers and distributors now?  Relationship more complex, more aggression than in the past?  Is this a reason for consolidating?
Malone said that programmers and distributors have had good relations for years.  It was all about who could create economic value.   The over-the-top phenomena is creating unusual tension.  TV everywhere would create value for everyone.   Distributors and content providers still have huge monetization systems to defend.  They will eventually realize that.  Consolidation will make it easier.  Fewer rational players works better than more, but is is not the primary reason to consolidate.

Dilution at CHTR in case of Time Warner deal
LMCA would like to keep interest above 25% for future flexibility.  LMCA would purchase more CHTR to keep interest above that level to offset dilution, for governmental reasons.  He explained later that the Investment Company Act makes a 25%-owned asset a good asset, and one under 25% a bad asset.  I think he meant that under 25%, the ICA would deem it a passive investor interest or an investment security so would make LMCA an investment company, whereas owning more than 25% would make it an operating subsidiary (so wouldn't make LMCA an investment company).

Competition to Cable
Malone feels that the long term competitive position of cable is good.  Increasing digitization of video will free up bandwidth,and increase speed and capacity of internet delivery.  Cable has a marginal cost advantage (a tremendous advantage) for base network.

He mentioned that DT (Deutsch Telecom) put in a volume cap.  DT provided content is not included in the volume cap but non-DT content is.  The regulators are currently digesting this so don't know what will happen.

Malone mentioned that eventually terrestrial carriers will have to price traffic based on volume.  The current model is unsustainable as revenue and pricing won't reflect capital pressures of the providers.

Over-the-top content can be bundled with broadband and when that starts to happen, cable can clawback share from satellite.  Cable market share will grow because of services bundled.  (Somewhere he said that cable will get at or equal to fiberoptics in terms of speed).

Intrinsic Value versus Price of the Parts
Someone asked him how he viewed the prices of LMCA holdings versus intrinsic value.

Malone said that he has always been a leveraged free cash flow investor, so he discounts the free cash flow at whatever interest rate they can fund at.  If you lengthen the maturity and fund at current levels, he says that the "multiples look low to me".

Importance of Content?  Does CHTR need more content?  Comcast bought NBC
Malone said that the control of content is an important determinant of market share.  He then went on to explain the evolution of the cable business.

Cable in the early days was highly balkanized.  There was no ubiquity and they didn't compete with each other.  Back then, the opportunity for cooperation, scale and uqiquity was obvious.

TCI did one acquisition a week for ten years.

As an industry, they got together to cooperate.  They organized joint ventures.  For example, in technology they created the MPEG video compression, coaxial cable architecture etc...  In content, they created Discovery, BET, Telemundo etc...  The industry created 23 or 24 programming vehicles that the cable industry collectively invested in.

Ted Turner was an entrepreneur that got the support of the industry.  TCI was a founding investor in Fox News.

The industry solved the balkanization and scale problem by joint effort.  Malone says it can be done again.  Hulu can be syndicated, or something created from scratch.

He mentioned Comcast, as big as it is, can't buy national level content.  It's not big enough. You have to be pretty big to get content for TV everywhere.

So this cable industry inability to buy or create content has benefitted Netflix. They buy nationally, distribute ubiquitously and their local distribution is incrementally free.  This is not a situation that can persist indefinitely.

Cable industry is in the need of organizational development.

HBO transformed the cable industry and "made us all rich".  If there is an equivalent to that, of course they would be more enthusiastic in investing in the business.  M&A and industry cooperation go hand-in-hand. 

(At some point the Microsoft purchase of Comcast shares was mentioned, and Maffei was actually at Microsoft at the time and did the deal; so we know he knows the business)

Investment opportunities?  Which Liberty entity is the cheapest?
Malone said international (non-U.S.) is where the opportunity is now.  He said don't put all your eggs in the U.S. basket.  There are some rabbits outside of the U.S., but obviously he can't say what looks good.

Mobility?
75% of mobility is is wifi (and rising). The implication is that mobile traffic will end up on cable (wifi -> cable connection) and not cellular network.

With over-the-top and TV everywhere why do consumers need aggregation interface and pay economic rent?
Netflix, Hulu and other streaming models offer content without economic rent.
Malone said that the answer to that is that they don't need it.
Why did HBO come into existence?  Why didn't Hollywood sell directly to cable operators?  They couldn't work together.  This created opportunity for HBO to get scale.  Once they had scale, they didn't need all the studios so changed pricing power.

Over the top guys will get content through scale; original and unique content.  Netflix has enough scale to get exclusion and original content.

Netflix
Netflix started as a library of old content.  They built a business on low distribution cost (almost free); heavily subsidized U.S. Postal Service.  Netflix migrated to streaming service.  They have gained scale and ubiquity of presence.   The cable industry has been very slow and that gave a window of opportunity to the over-the-top guys.

With network neutrality (free incremental distribution cost) and scale, they have "quite a good business".

A year ago NFLX was written off by many, but it's good that NFLX survived.  If it was bought by someone with deep pockets it would've been more dangerous;  someone with infinite capacity to underwrite their strategy of buying exclusive content.

NFLX has scale and uniqueness to do well now   (but as he said before, this is not sustainable).

So that's about it.

My Thoughts
I do like LMCA and CHTR; I find them very interesting situations (SIRI and LYV don't look too bad either).  As far as valuation is concerned, it seems like most of LMCA value is driven by the large listed holdings.  The multiples look high, particularly on the big SIRI position, but the growth rates are pretty high too.   If they keep growing subscribers and their margins get up to over 40% (EBITDA margins) as they say, it can be pretty interesting.

On the other hand, for an entity like LMCA at this point in time, I tend to think the bigger question is what LMCA does with the liquidity offered by SIRI over time.

I would tend not to look at it like, "what is SIRI actually worth and how much per LMCA share is that?".  My question would be more like, as LMCA liquidates SIRI over time (via SIRI buybacks and maybe other transactions), what do they invest in next?

LMCA is obviously holding SIRI for the cash generation ability so more interesting to me is what they invest in with the cash from SIRI rather than what SIRI is worth.

This is not to say that it doesn't matter what SIRI is worth.   Malone said that SIRI gives them the flexibility to "chase a few more rabbits".  I'm sort of more interested in the "rabbits" than satellite radio.

Still, it's good to know that Malone thinks there is still a lot of upside there even as they use SIRI as a source of liquidity.