Tintin

Having been on my 'To Do' list for a long time, I finally got around to reading the Nomad Partnership letters over the weekend. Wow! I cannot remember the last time I derived so much value from something relative to the time required to read it. They can only be described as 'essential reading' for any investor with a long-term outlook. The concept of 'scale economics shared' is wonderfully intuitive, and has gotten my juices flowing again for ideas. I'd be grateful for any pointers on micro or mid-cap companies in any geography that are currently employing this business model. I feel the urge to start digging into some 10Ks! Thanks.

I've spent the past month going quite deep into BABA (and yes, it was Munger that sent me there). My take is as follows; I believe that there's an inordinate amount of irrational fear regarding Chinese regulators and the VIE structure that has pushed the stock price down. China has no incentive to permanently handicap one of its greatest companies, and the relatively lenient SAMR fine is pretty compelling proof to that. Yes, there's still plenty more talk of further regulation in the pipeline, but it appears to be little more than noise. I think the worries over US delisting of the ADRs are off the table for the moment too - an utterly pointless move anyway given that the ADRs are fungible. US Shareholders will simply move their holdings to Hong Kong and with very minimal cost involved. With regards to the VIE structure, I think it's obvious to anyone who does a little reading on the subject that the whole arrangement is completely illegal under Chinese law! It's a useful tool that probably allows the CCP to hang the sword of Damocles over smaller fish, but there is no way they are going to rule against BABA or any of the other major companies that have ADR holders. China is desperate for foreign capital inflows, so I see the chances of a Chinese court coming in and ruling against the VIE structure as being somewhere within the probabilistic realm of 0% to 0.1%. And for the same reason, I don't think we'll be seeing Jack, Joe, or Simon trying to steal the company from the shareholders as was the case with Ant. Oh the times they are a changin' - if they tried to pull a similar stunt this time, I think there's no doubt that they really would go missing. Anything that threatens China's current ability to attract foreign capital is simply not going to be tolerated. If you hold the ADRs, you can rest easy. But there's a lot of things I see that aren't so palatable for BABA shareholders, which can pretty much be summed in one word - accounting. The complexity of the Company's structure, the baffling array of shells and holding vehicles, the related party transactions, the sheer number of investments that it has in 3rd parties. That almost made me want to put it in the 'too hard' pile straight away. But I persisted nonetheless. I'll have to credit a guy called Stephen Clapham for much of what follows as I found his insights to be very interesting. In a nutshell, he has raised very legitimate concerns about the value of BABA's Balance Sheet investments and goodwill. Notwithstanding the fact that GAAP rather stupidly obliges companies to record changes in the carrying values of their investments as either profits or losses on their Income Statements, it is not credible to argue that the changes BABA records almost always only go one way - up. Given that the company is essentially providing VC seed funding to so many different ventures, it's absurd not to see far higher levels of impairment to these assets. There just isn't that high enough of a success rate when bankrolling start-ups. And as for the related-party transactions... the audit fees are very much on the low side. So who was going through all these transactions in detail to make sure the shareholders weren't getting stitched up? I'm trying to get my head around Munger's way of thinking as I do not believe that he would have missed this stuff. My belief is that these accounting irregularities might not be quite as black and white as westerners would recognise them. I cannot comment on Chinese culture or business practices as I am completely ignorant on them, but as Munger has a far greater understanding of such practices, it is possible that he recognises that a little bit of hokey-pokey is accepted as pretty standard in Chinese accounts, and the fact that it goes on does not necessarily translate into saying the company is a complete sham. Were any US companies engaged in such practices then I think he'd be running a mile, but perhaps his close relationship with Li Lu has helped him to view the matter through a more nuanced prism? One other thing that I am struggling with - BABA's financing cash flows. I believe that Ben Graham said words to the effect of "Always look in the Cash Flows from Financing. That's where the ghosts are hidden." Over the past 6 years, BABA's figures have shown that its Operating Cash Flows have been more than enough to finance its CapEx, acquisitions, and investments in third parties. This being the case, why has it had positive inflows from financing in almost every year? And the amounts aren't even small! It just does not sit right that so much debt has been taken on and so much dilution has taken place if the company is generating that level of operating cash flow. I recently started reading Duncan Moore's book on Jack Ma, and there's a quote in the book about Ma always wanting to have a nice big war-chest available for M&A situations, and always wanting to get capital flowing in when he didn't need it because the worst time to seek it is when you actually do need it! And I guess that's a fair point, but I still just can't reconcile the need for all this financing cash if the operating businesses are doing so well. In conclusion - at the risk of stating the obvious, I am not on the same level as Munger, not even close. The fact that he's sat on his hands for over a decade doing nothing and then suddenly pulls the trigger on this... I think we'd be very foolish not to pay a great amount of attention to that. I don't know of many other people whom I would entrust more with fiduciary responsibility than him, and it's obvious that he is not going to just take a bet on something with DJC's shareholders' money. He wears that responsibility very heavily. But I am struggling to get conviction on this to the point where I could 'own' the decision myself. But it's Charlie!! I think the compromise is to shamelessly clone a smallish position. Granted, if Charlie is not around for much longer then it becomes very hard to have an exit strategy from a shameless clone. But at that point, I think the focus then turns to Pabrai. Charlie has clearly shared his secrets with him.

I've been looking into FB more deeply over the past few weeks and am attracted to the stock's continued earnings potential moving forward. But in trying to calculate a margin of safety, one of the headwinds seems to stem from the regulatory risk that the company might be broken up. I'm nowhere near smart enough to put a probability on that outcome, so would rather be conservative and just assume there's a 50% chance it will happen anyway. So if WhatsApp and Instagram were forcibly spun off, would it be the case that existing FB shareholders would automatically receive shares in the new spinoffs? Or would existing shareholders have to buy into them, just like everyone else would in an IPO? I am unfamiliar with the process of what would happen to existing shareholders in a scenario involving a forced regulatory spinoff. The way I look at it - if existing shareholders were indeed to receive 'free' shares in the spinoffs then it becomes far less of a concern in calculating an initial margin of safety on the FB stock today, because the owners get free shares in 2 great businesses with good runways ahead of them. But if FB shareholders aren't entitled to free stock in the new companies, then the margin of safety needs to be higher now. Is this a fair way of looking at the problem? Thanks.

Thanks for the reply! I know Bruce Greenwald has an interesting take on calculating the amount of 'growth' CapEx within a company, but for a business like semiconductor manufacturing that framework just doesn't appear to work. As for MU returning value to shareholders... given that they won't be paying dividends any time soon, paying off debt is probably their most likely course of action in 2021 as they generate more FCF on the upside of the cycle. I wouldn't totally write off the prospect of further share buybacks from happening in 2021, but that would be dependent upon a macroeconomic or geopolitical event driving the price down, e.g. a severe escalation in tensions between China and Taiwan might create a buying opportunity.

I've been going deep on MU over the past few weeks, and am now trying to construct a suitable framework to estimate their Owner Earnings - which isn't as easy as it looks. The way I see things, semiconductor manufacturing is an interesting business in that virtually all capital expenditure has to be classified as 'maintenance' rather than 'growth'. Although companies are continuously spending huge sums on 'new' product and process technologies in order to lower per gigabit production costs, do they really have a choice in the matter? I would say that they don't. If they don't continuously innovate by creating better products at lower costs, they get left behind sitting on a bunch of inventory that nobody wants next year. So if innovations in 'new' production processes are a fundamental prerequisite to simply maintain their existing sales volumes, how can we view such CapEx as a form of 'growth'? I have therefore come to the conclusion that for a business such as Micron, their free cash flows and owner earnings are essentially the same number. Is this a fair assessment or have I missed something obvious?

Agree that the preferreds would be an interesting play. Here is my take on them - SRG cannot redeem them until December 2022, and even if real estate retail values tanked (which would lead to the preferreds trading well below par value beyond that date) the likelihood of near zero interest rates beyond 2022 would almost certainly lead SRG to redeem them. Why continue to pay at 7% if you might be able to borrow for half that rate? On this basis would it be fair to assume that preferred share holders almost certainly get their $25 back in December 2022?

I'm very open-minded on Seritage, so would be grateful if somebody who's bullish could help me place a missing link in my analysis. When viewed as a 'cigar-butt' investment, I can see a liquidation value margin of safety at $10 or lower after the debt's been repaid. But where I am having more trouble is making the link between where SRG is today, and the belief that it could become a multi-bagger 10 to 20 years down the road. I respect and admire a lot of the 'guru' investors who have recently ploughed into the stock, and am particularly curious about the fact that Guy Spier added to his position in Q2. Spier by his own admission is far more risk-averse than Pabrai, and yet he added a significant tranche to his position. So I am still on a journey to try and make the link as to how this stock becomes a long-term compounder before I file it in the 'too hard' box. Phil Town recently commented that the stock has the potential upside of reaching $140 a share long-term. I have reverse-engineered this figure as follows; $140 * 55.9m shares = $7.8bn Add $1.6bn of existing debt for an EV of $9.4bn Assume a more optimistic long-term cap rate on well developed properties at around 6%, and we get approx $550m NOI, which can be achieved if we optimistically assume $25 rents per sq foot on 22m sq ft of GLA (this also assumes that SRG sells another 7m sq ft of GLA in the coming years). Even if we assume that these reasonably optimistic assumptions play out, here is the missing link I just can't piece together right now... In the latest 10Q dated June 30th, SRG states that out a total GLA of approx 29.3m sq ft (including their share of JV properties), approx 18.8m sq ft is either being redeveloped or is available for lease. As described above, if we assume that 7m sq ft gets sold off, that still leaves 11.8m sq ft of GLA that needs significant redevelopment expenditure in order to achieve a rental figure of $25 per sq ft. Assuming a 15% yield on CapEx redevelopment, SRG would have to spend $166 per sq ft in order to achieve rental income of $25. That's almost an additional $2bn that needs to be spent on the remaining 11.8m sq ft of GLA that is currently not generating any income for Seritage. Some of this figure is clearly going to be covered by the sale of further properties, but nowhere near enough to cover the full sum. And that's before we even factor in the cash burn they are going through right now (although Berkshire's leeway on interest payments should cash levels fall too low will clearly give them breathing space, particularly as the rate of cash burn declined a lot in Q2). Therefore, when I look at a cautious investor such as Guy Spier adding to his position, I cannot bridge the link between the 'cigar-butt' outcome, which I can see a lot more clearly, and the 'multi-bagger' outcome, which I am struggling with. Have I made erroneous assumptions regarding the redevelopment build costs? Is it actually the case that a substantial number of the remaining properties are already in much better condition than I am envisaging, thereby requiring significantly less average redevelopment costs of $166 per sq ft? I don't want to throw in the towel on this just yet so would appreciate any insights into where you might think I am going wrong. Thank you.