Kimly – Missed opportunity, lesson and alerts

As an update to a previous post on Kimly being a potential investment opportunity at S$0.42 and below, its been about 2 weeks since Kimly’s listing. Of course I knew there was no way it would trade anywhere near the IPO price of S$0.25 that day. It surged more than 100% at the opening bell before closing at S$0.44 on the day of the listing. As at 31 March 2017, the stock price was S$0.48.

The only time the stock price reached S$0.42 and below – prices at a margin of safety I was comfortable buying at – was in the morning and early afternoon of 21 March 2017. Unfortunately, I wasn’t able to get my hands on the shares. I was attending a prayer session held for my late grandmother during that time and my usual brokerage’s (Standard Chartered) trading platform was accessible only via a desktop/laptop.

By the time I got to a computer, the opportunity had vanished as the price had climbed back up. The price closed at S$0.46 that day.

I could make all these excuses but the fact was that I wasn’t there to pull the trigger when the opportunity presented itself. While the Standard Chartered platform did not allow trades to be done through a phone app or a mobile site, I could have utilised another brokerage although the fees were higher. I could have put a good-till-cancelled trade through other brokerages days prior even though Standard Chartered didn’t allow it. I could have gotten a close friend who would have been behind a desk at that time to login with my details to Standard Chartered and put through the trade.

The lesson I’ve learnt is this. When I’ve got the conviction to buy at a certain price once I’ve done up the necessary research, it makes sense to be well prepared in the event the trigger needs to be pulled. If there are restrictions, apply a little creativity to seek workarounds.

I’ve set an alert via the SGX app I downloaded. I’ll get a notification on my phone if the price falls to $0.42 and below. This will free me from having to check the stock price and in taking action only when the occasion arises. I also found a useful feature that the app is equipped with. It has a feature that alerts me to specific companies’ announcements when they are released. Instead of the usual ‘pulling’ of announcements as and when I decide to check, they are now ‘pushed’, which makes it more timely than before.

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Reflections on Value Walk’s interview with Greenhaven Road’s Scott Miller

I came across an interesting interview with Scott Miller of Greenhaven Road Capital a couple of days ago, conducted by Value Walk.

Without replicating the entire interview in full, I thought it would be useful to extract some key points which I found to resonate with me and which led me to reflect on experiences and thoughts. As such, I also typed out in italics some notes to accompany the extracted points.

 

On your brain being suitably wired for successful investing

As a person who can usually find an angle and has a contrarian streak, investing held great attraction. As for the value discipline, I think it is how my brain is wired. Not only do I have trouble paying retail, I enjoy items bought on sale markedly more than those for which I paid full price. Value is all that makes sense to me.

My notes: Similarly, I try my best to avoid paying full price for items or try to seek cheaper alternatives as much as possible. When I do have to buy clothes, gadgets or books, my first pit stop is always the internet to find the best deals. To save a couple of bucks, people are increasingly doing the same so that habit isn’t much to shout out about.

What I can say could be a little more unique is that when I am out in town after midnight when most normal buses and trains have stopped operations, I think nothing of taking a 10 minutes walk to a bus stop which has a late-night bus service operating, then waiting for another 30 minutes for the bus to arrive so that I can hop on for a 40 minutes long-winding ride back home. If I had hopped on to a cab, it would take much less than half the time to get home but at six times the cost. I find it hard too fish that kind of money out of my pocket, especially if I am not in a rush to get home. That said, I recognise the time cost involved. That is why I almost always bring a physical book or my iPad (loaded up with books) with me when I head out so that I can do some productive reading while travelling on public transport – money saving and good for the mind.

 

Juggling a day job and managing a fund

There was a ten plus year period where I was working a full-time job building in an operating business and investing on nights and weekends. Given my concentrated portfolio of approximately 15 companies and low turnover, I am only looking for one investment idea a quarter. Most days I don’t buy or sell anything. I am not trading news flow, so my investment style is conducive to investing in off hours.

 

For the first four years of the fund, I continued investing “on the side” one or two days a week with a near full-time, other job. I honestly think having other non-investing responsibilities did not hurt performance at all.

My notes: I realised that too much idle time available can be a doubled edged sword in investing. A couple of years ago, when I had a fair bit of time on my hand away from my day job, returns in my personal portfolio started going downhill.

With idle time, I turned over more stones and seek out new, undervalued opportunities. On the other hand, it affected my mind, in that I became increasingly worried about my positions and returns. I felt that I needed to safeguard those returns achieved by turning over the portfolio to lock in gains. I also fell prey to the sunk-cost fallacy. Having done research on a number of different opportunities, I felt cornered to put capital to work even though the ideas were not the most compelling ones and checked the stock prices of my portfolio a lot more often than I should. This fed into the loop of being nervous about returns.

That period was one of the formative periods in my investing journey. I am glad that over time, those demons have been suppressed. Through that episode, I learnt that having too much idle time on hand can be very damaging for one’s portfolio if the mind has not been properly disciplined. 

 

Fund structure and choosing aligned investors 

Greenhaven Road is modeled after the early Buffett partnerships. I don’t take a management fee. I do earn an incentive fee of 25% on returns above 6% with a high water mark. I like to say that I make money with my investors, not off of them. In a year where I am up less than 6%, not only do I not make money off of my investors, in fact, I incur some costs. I only get compensated if I provide returns to investors.

 

In August when the world was blowing up, many funds were holding hands of their LP’s convincing them that everything would be alright. My situation was far more positive. The only email I got from an investor was asking if he could nearly triple his investment in the fund. I was able to look for opportunities, not worry about redemptions. So from a structural perspective – small size, terms that are aligned with a long investment horizon, and a like-minded investor base are a great foundation.

My notes: It looks like other than Monish Prabai, Scott Miller is one of those other few managers who has tapped on the original Buffet partnerships to structure their funds. If I do ever set up a fund, it will likely be of a similar structure.

My opinion is that the typical 2/20 structure of funds will end up incentivising most managers to become asset gathers instead of being motivated to generate real after-fees alpha for investors. Even for those well-meaning managers who do have the initial aim of doing good for their investors, I suspect that those structural chains of incentives to move towards asset gathering will eventually be too hard for the managers to break. It is thus important to set up the structure to be aligned right from the start.

In times of market stress, the opportunities are probably the greatest, while existing positions if bought at reasonable valuations should continue to do well over the long-term if there aren’t any permanent impairment to the business. It is precisely during this time that capital should not be pulled out. Having came across a number of horror stories of investors who do not have the right temperament pull out of funds at the worst possible time when a manager should be investing heavily, Scott Miller’s words of being selective of clients and having like-minded clients is an important reminder of what to do and what not to do.

 

On idea generation

Like most investment managers, I spend a lot of time reading. In particular, I love fund managers’ investor letters. If there is ever a time for a fund manager to put a good foot forward and present their best ideas, it is in their fund letters. Some of my favorites are Jake Rosser at Coho Capital and Eric Gomberg at Dane Capital [interview coming soon]. Voss Capital, Arlington Value, are great as well. The Value Walk daily email is also a very helpful source of letters. I scan it every day. Another place I go every day is Value Investor Club. The discussion and quality is the best I have seen on the internet.

My notes: Other than Arlington Value, I have not heard of the rest of the other funds. Will definitely be checking them out. A few months ago, I set up a bi-weekly calendar reminder on my phone to visit Value Investor Club to read through the high quality investment ideas for 2 reasons. The first is in hope of finding interesting actionable opportunities. The second is to improve my craft by reading and understanding the thought processes of analysis done by investors who are way better than I am.

 

Evaluating opportunities and being selective

I have a couple of checklists that I run through that date back to my private equity experience. In particular looking closely at the product, market, team, and execution risk – really just getting comfortable with how good a business it is.

 

This process of making a decision can take a day or a month, but I have a very good sense if a company is a very likely or very unlikely investment in under 30 minutes. Given I only make a few investments a year, I end up with a huge, “too hard” pile – which is for opportunities that could be good – but I just cannot get there.

My notes: A good reminder to walk away from non-compelling opportunities. If the opportunity does not jump off the page, is way outside of my circle of competence and/or has elements that makes me very uncomfortable, such as excessive debt load and/or governance issues, I should dump them into the ‘too hard’ pile. The pain of errors of commission will be greater than errors of ommission.

Exiting Ebix

I sold the last of my stock position in Ebix on 1 December 2016 at US$58.45. In this post, I look back on the journey and the lessons drawn.

The backstory as to how I first came across the investment idea was reading it off the September 2013 issue of Value Investor Insight. I subsequently jotted down my thoughts in a write-up on 14 March 2014

Before I continue with the rest of the backstory, I thought it would be good to bring the lessons learnt in point-form upfront for my easy future reference:

  • It is important to look for behaviourial clues beyond financials such as the manner in which a deal is structured. To consider who benefits from the deal. Incentives matter
  • Sell in stages rather than everything at one go. This leaves room to capture further upside, especially when the market starts to get really in love with the stock – reverse dollar cost averaging. Similarly, and in converse, take advantage of the market’s pessimism to buy and dollar cost average down when prices start to decline for no good reason
  • Even if the price has marched upwards by a large amount, if fundamentals remain sound and earnings have kept pace such that valuations remain compelling, the right move is to buy rather than anchoring on the initial purchase price

At that time, Ebix received some really bad press, in particular, a short seller report by Gotham Capital alleged that Ebix was laundering money, evading taxes and had a host of accounting issues. Needless to say, the stock took a beating and was among the most shorted stock in the US.

At the initial stages, my thesis was that an investment in Ebix was going to be a binary outcome. It was either a giant fraud and will go to zero or it is an extremely misunderstood opportunity whereby the potential returns are going to be pretty great. I thought it was more likely that Ebix was misunderstood than it being a fraud. If it was a fraud, my investment was going to zero no matter what instruments I use. However, if I am right about Ebix, I wanted my returns to be asymmetrically skewed towards the sky. As such, I structured the investment accordingly by purchasing options in November 2013 at US$2.80 with a strike price of US$11.00, expiring in June 2014. At that point in time, the stock price was US$11.87. I then sold the 6-month option about 5 months later in April 2014 for US$6.01 for a 115% gain to lock in profits and as there was a relatively short duration left before expiry. I would have gladly bought LEAPs to let the investment stretch out over a longer period of time but as it was a small cap company then, there were no LEAPs available.

As I dug deeper into Ebix, I realised that the investment case was not as binary as I initially thought it to be. Beyond my thoughts jotted down in my write-up on 14 March 2014, I realised there was a quirk in the buy-out deal Ebix made with Goldman Sachs that was most interesting and gave me the confidence to then plough the proceeds generated from the sale of the Ebix options into the stock. Despite the negative news swirling around Ebix, Goldman Sachs continued on with the due diligence and came out saying they would proceed. That proved short lived. While the deal eventually fell apart, it appeared to be mainly due to mounting public pressure and embarrassment by association rather than any tangible business negativity they found in Ebix.

The interesting quirk that I mentioned was the fact that the going-private deal had a provision which enabled Ebix’s CEO to increase his stake rather significantly in Ebix AFTER it has gone private. Why would the architect of Ebix who allegedly perpetuated money laundering, tax fraud and cooked the books increase his stake in a sinking ship? That did not make sense to me. I would have thought the CEO, Robin Raina, would have been very keen to sell out his entire stake if there was any truth in the allegations. However, the market did not seem to take much notice of it. Along with the strength of Ebix’s financials and business, and with this important bit of information, I took the contrarian view and started purchasing the stock.

Over the past few years, I added to the position at different stages with the price ranging from US$16.10 all the way up to US$28.70. The stock price went way beyond my initial conservative price target of US$21.10 but the business remains sound and earnings, along with the price multiple outgrew what I initially assessed it to do.

As the price kept marching upwards, I assessed the valuation and grew increasingly nervous. I started selling the stock in May 2016 till December 2016 between the price range of US$45.84 to US$61.10. I felt that the FCF/EV yield was getting stretched and at a trailing-12-months yield of 3.3% given the stock price of US$59.70, I thought the stock price has gone way ahead of its fair value and it was time to completely sell-out for reinvestment into areas where the risk-reward ratio are more attractive.

I continue to love Ebix’s highly recurring revenue business model of charging its customers on a per transaction scheme rather than the conventional systems set-up model. While I doubt the valuation will ever come back to levels reached in 2013, if valuation starts moving towards a FCF/EV yield of 6% or better, I will definitely start to be interested again.

Between the first purchase of the option when the price was at US$11.87 till the highest price I sold the stock at US$61.10, it moved upwards by 415%. While the number is not entirely representative of the total returns generated as I bought and sold along the way, the 3 years journey culminates in probably the best percentage and absolute returns generated on my portfolio thus far on an overall basis. I highly doubt I’ll ever be able to see one of my positions move upwards in such a dramatic manner. The conditions at the point of purchase that set up this successful investment were unique and unlikely to be repeated in the exact same way again. However, the lessons drawn from this episode certainly are valuable and it would benefit me to keep them close to heart.

Trumped

The day before the presidential elections when Trump was declared President-elect of the USA, I went through an internal struggle on whether to hedge my portfolio. A significant portion of my portfolio is denominated in US Dollars (“USD”) and the stocks are listed in the country. I believe that for most of the people residing outside of the US, they would have hoped for Clinton to win the elections. The prevailing view appeared ot be that a Clinton administration would bring about stability to the global markets.

However, hoping versus reality are 2 very different matters, as I found out for myself when Brexit happened. I didn’t think the UK would leave the European Union but it didn’t matter what I thought. The votes spoke for themselves and the British did vote to leave, never mind the current on-going twists and turns with the British government and the courts’ fight over bringing the ‘Leave’ decision to the parliament. Given that I had a fair percentage of investments denominated in British Pounds (“GBP”), I was caught with my pants down when the value of the GBP dropped against other major currencies. Needless to say, I did not hedge my positions prior to Brexit and had to watch my stock positions in the UK and my excess cash held in GBP, crumble. The good news was that my largest GBP-denominated position was YouGov. As a large portion of YouGov’s business were derived from outside of the UK, coupled with good financial results during the subsequent quarter, the rise in its stock price more made up the currency devaluation over time. This was definitely attributable to good luck, with zero skill involved.

This time around with the potential prospect of Trump being the 45th President of the United States, I converted my remaining excess cash denominated in USD into my local currency to avoid the same from happening again. I hedged a portion of my USD and US stock exposure by buying a gold instrument. This is the first time I have ever bought anything that is closely related to gold, largely because I am in Warren Buffett’s camp – in that he says gold by itself doesn’t produce cash flow and doesn’t have intrinsic merit. I agree with him that over the long-term, gold can’t compound value the way businesses can. I very much doubt he owns gold or its derivatives. However, where I take different approach and depart from this, is that I believe gold can be a good protector of constant value over the short-to-medium-term, particularly in times of uncertainty, such as these Brexit and Trump-entering-the-White-House events. As such, I will only utilise gold in my portfolio very sparingly an in rare occasions.

Anyhow, the US market (both stock and currency) did not react as violent as I or most other people thought. In fact, the S&P ended up a 1.11% higher on 9 Nov 2016 and most of my US-listed stocks turned out OK. The very next day, Asia markets rebounded strongly, with the largest gain coming from Japan, where the Nikkei 225 rose 6.72% and Nippon Paint (a stock I own) jumping 8.73%. To be fair, the Nikkei 225 was also among the largest losers the previous day. Thus, the strong rebound was pretty much a catch-up. With gold price coming off in the past day, I am a couple of percentage points down on my hedge while on a portfolio basis, the cost is less than half a percentage point. I still think the insurance was absolutely necessary. Although it ultimately wasn’t necessary in the end, it served its purpose well and helped me get through the day with much less worries.

As to why the markets reacted the way it did, I think a friend summed it up well:

“I think there is a difference between Brexit and US elections, and hence a difference in market reaction. Brexit is directly an economic event (Britain leaving an economic bloc).

US elections is largely a political event, although it can have economic consequences (which are still unknown as of now)”

Pricing power – The rocket fuel to any investment thesis

“If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.” – Warren Buffett

I added a column within the Google Spreadsheet Watchlist for “Pricing power”, with the ranking system of 1 to 5 – 1 being weakest and 5 being strongest. This provides an important reminder for myself when evaluating companies, that sufficient pricing power itself can be a margin of safety and may invite unexpected upside.

The beauty of true pricing power acts in such a way that a company can raise its prices (revenue) without a corresponding increase in its cost base (expenses). In other words, the extra boost in revenue falls directly to the bottomline and provides a magical boost to profits without lifting much of a finger. As a simplified example, a company that makes $100 in revenue by selling widgets currently has a cost base of $95. This translate to a net profit of $5. Assuming that it has a significant amount of pricing power so much so that it is able to raise the price of its widget by 20% without losing a single customer, its revenue is now $120 for the same volume of products sold. The cost of manufacturing its widgets and other miscellaneous costs continue to be $95. Instead of earning a net profit of $5, the company now earns $25 ($120 – $95). This effectively means that profits multiplied by 400% (from $5 to $25) even though revenue only increased by 20%.

Imagine now that the company is publicly-listed and was trading at a P/E multiple of 10 times. When it initially earned $5 in net profit, the stock price was $50 ($5 x 10). After flexing its pricing power muscle and assuming its P/E multiple remained at 10 times, its net profit of $25 now translates to a stock price of $250 or a 4 times gain if you sell the stock at this point. If the market decides that it previously overlooked the “hidden” pricing power the company has, that perhaps a 10 times multiple is too low for such a strong business, and that a 15 times P/E multiple is probably more fitting (multiple re-rating), the stock price goes up to $375. From the initial stock price of $50 to $375, one would have made 6.5 times his money from the benefit of a company’s pricing power and the market’s recognition of it.

In the real world of course, the perfect situation of a company as described above is probably rarer than a unicorn, given that most people would have easily recognised the strength of such a business, so much so that the multiple would be way higher than 10 times. Even though it is an extreme example, I hope it clearly illustrates the extra rocket fuel an investment can provide if the underlying business has sufficient pricing power, and given the skewed positive returns it can provide, paying up for quality businesses even at higher multiples can sometimes be very worth it.

The most recent types of businesses or more specifically, a company that has been in the limelight for all the wrong reasons by taking pricing power to the extreme is none other than the pharmaceutical company, Valeant. It worked well for awhile before it all came crashing down when enough people decided Valeant had gone too far in raising its products’ prices. The underlying lesson is that to build a sustainable business, a company that is able to raise its prices above the rate of inflation with such ease without losing a single unit volume, should probably use this privilege sparingly to avoid alienating its customers and risk damaging its long-term viability.

Alice Schroeder’s Reddit Ask Me Anything thread

I had the good fortune of stumbling upon Old School Value’s Facebook post on Alice Schroeder’s Reddit Ask Me Anything (AMA) thread. For the uninitiated, Alice Schroeder is the author of the wonderful book – The Snowball – on Warren Buffett.

Though the thread is more than 2 years old, it doesn’t discount the fact that it is a treasure trove of insights from the woman who spent many years understanding his methods and profiling him. It’s probably the next best thing to hearing from the man himself.

Culled some interesting points from the thread for future reference.

  • On how Buffett does his famous back of envelope calculations:
  • Schroeder on a cheap opportunity being a catalyst by itself and on her mistake of anchoring her desired buy price:
  • On Schroeder’s book recommendations:
  • Schroeder on not tying oneself to a single investment approach:
  • On looking forward to life:
  • Schroeder on how to get ideas to start a business (in relation to having understanding disruption and having a sense of how the future looks):
  • Schroeder on assessing B2B businesses’ competitive advantages:
  • On the differences between how Buffett filters opportunities then and now:

Picks and shovels in Virtual Reality (VR) and other industries

Just the other day, I was at a friend’s place trying out his new big-boy-toy, the HTC Vive. For the uninitiated, it’s one of the hottest gadgets in the market currently to get the VR experience. I’ve tried the Samsung Gear which I thought was pretty cool. But the HTC Vive, a collaboration between the Valve – the gaming giant – and HTC – an ailing mobile phone maker – is unlike anything I have experienced before.

Blown away by VR
I shan’t go into the details of how the gaming experience on the device blew my mind. There are plenty of online videos and reviews for that. What I can say is that experience set me thinking about how VR seems likely to be the next big thing and can truly be transformative in terms of how we communicate with each other through games, videos, etc. More importantly and in direct relation to investing, is whether there are any potential investment opportunities in identifying which VR gear maker is going to come out on top. There are plenty of competition in the market. We have Oculus, HTC, Sony, Microsoft and plenty of others vying for a slice of the pie. Trying to pin down exactly which company is ultimately going to be the winner in the race to reign supreme in VR is tough, especially since the technology evolves very quickly. This almost guarantees obsolescence for those who are one step behind.

Asking the correct question
While in the midst of going through HTC’s financials (not exactly pretty given that revenue is in freefall) and cracking my head trying to solve the puzzle, I had a realisation that I was asking the wrong question. It wasn’t about who was going to win the VR gear race.

The correct question was – who is going to win no matter who wins the VR gear race? The inspiration came from the old investing story of the San Francisco gold rush of the mid-1800s. While a handful found fame and fortune, most miners failed had to head home with nothing more than rocks after failing in the quest to find gold. The ones that truly and consistently made money by the buckets were those who sold ‘picks and shovels’. In other words, those who sold tools to help others chase their pot of gold (pun intended) were the ones who ended up rich. Levi’s, the eponymous jeans maker, was one of the vestiges of the era. By selling rugged and durable jeans that were able to withstand the tough environment to gold miners, Levi’s made its own pot of gold.

Finding value in value chains
By the same token and in modern parlance, analysing the value chain of an industry can be a fruitful exercise, even though the economics of the main industry itself is in the dumps. In the field of VR, I came to the conclusion that the business selling modern-day picks and shovels were the graphic card makers. In this case, the largest maker is none other than Nvidia. VR gears require the vast processing power of a dedicated graphics card and the gear is required to be hooked up onto a rig which has the graphics card. Between Nvidia and it’s main rival, ATI, Nvidia had a much larger market share, greater economies of scale and a greater brand that people are willing to pay a premium for, even if the specifications of an Nvidia and ATI product are similar. It is pretty much like Intel vs AMD, in which Intel prevailed against AMD for a large part of their history in terms of well, everything. A little tidbit – ATI is actually owned by AMD.

While I have more than a fair deal of faith in Nvidia’s future, role in its industry and more importantly, it’s profitability, as any investor knows, a good investment isn’t just about whether a business is great. It’s also about whether the valuations are right to initiate investments in the stock. For the record, Nvidia is listed on NASDAQ in the US.

This post isn’t about the valuation on Nvidia. That’s another story for another time. It is more about the importance of applying a framework to dig deeper into an industry, looking into the value chain and finding out where the real value lies. It is about not expending energy in trying to read the tea leaves when a simpler answer lies in front of us.

Bright spots even in the worst of industries
Even in the worst of industries, there are invariably sub sectors that are cash spinners with deep moats. As an example and to close this post off, the air travel industry is a well known capital black hole. Very few airlines make money consistently, with the exception of a handful such as Southwest Airlines and Ryanair.

Move along the value chain and you start to realise there are some interesting sub sectors such as the engine makers (GE, Rolls Royce and Pratt & Whitney) which by the way, make pretty good money from their servicing contracts. Move further along and you find engine part makers. They make the parts that wear out real fast since engines burn at a high temperature and are utilised intensely. These parts form a small component of the overall cost of maintaining a plane but the parts are mission critical. A loose part may mean the certain deaths of a full load of passengers, not to mention the loss of an aircraft worth hundreds of millions and a huge dent to the airline’s reputation. In other words, if a new aircraft engine part upstart comes along and cut prices by 50%, you can be sure the airlines and engine makers aren’t about to make a snap decision to change engine part suppliers given the repercussions that may result from moving away from an established and reliable status quo.

In a similar way, engine part makers are also the modern day pick and shovel sellers, only that the industry in question is the airline industry. An additional investment tidbit – it is probably because of the dynamics of the sector and industry as discussed above that Warren Buffett, in his largest acquisition ever, bought Precision Castparts – the very producer of the said parts – for US$32 billion in 2015.

While the history of another San Francisco gold rush surely will not repeat, it does and will rhyme.