SYTE - Enterprise Diversified

[Grafter]

 

Let me give an example from our onboarding audit earlier in the year:

 

We were needing to give documentation of our historic revenue. Fine. I get that. You want to verify stuff. I support that, and think it’s a good thing.

 

We gave our quickbooks/appfolio records for documentation... Not enough.

 

We then gave our bank deposit slips... Not enough- they needed to see a breakdown of every property’s rent, on the deposit slips.

 

We then referenced the quickbooks/appfolio files, that had both the rent amounts, and the serial numbers on the money orders... Not enough.

 

We reconciled these records to ensure that they MATCHED THE DEPOSIT SLIPS. Not enough.

 

I offered my tax returns, you know, because me lying about revenue on there, would do a good job of getting me in jail. SURELY, that, with the records we had (keep in mind SERIAL NUMBERS OF EVERY MONEY ORDER, and documentation where all those numbers reconciled with our bank deposit slips...

 

Nope.

 

We had to get our bank to go through THEIR deposit records, and print off a photo copy of EVERY rent money order (I stopped taking checks years ago because of them bouncing) that we had received during the period being audited... I had to call in a favor to get it done under the time that we had to get it done in. When I picked the copies of what I am guessing was in the thousands of money order photocopies, I hugged my banker because he’d done us such a solid.

 

This occurred... I want to say within the last 5 days of our deadline for the audit to be finalized, and 2 of those days were on the weekend. That monday may have been a holiday too. Can’t remember. What I do remember is this: It was stressful as hell, Jenn worked literally til 3 AM several times, Marie (her assistant) was booked like crazy, and there were others that were helping as well. I was pissed off because of the absurdity of it, and we almost didn’t get a clean audit opinion because of something that was pretty stupid in my mind. That said, I get it. People need to have faith in the capital markets.

 

_______

 

And no, the manager doesn’t have to do all the work that we did in terms of bookkeeping. They literally send a statement. It could consist of whatever they want it to, and be pretty simple. When audited, that’s pretty cut and dry for corporate. The auditors don’t go through and audit the records of your property manager... what could take them 15 minutes to do could have taken us an hour, just to cover all our bases.

 

Monthly reporting for corporate also becomes easier with a manager. Re-read what I said about the cutoff dates in our software. If a tenant made a payment on their late rent, that could really throw things off, and would require adjustments to be made, and took time to figure out exactly where problems were happening.

 

This was not insignificant...

 

Also, a lot of the various entries that were so time consuming were from the FIX UP operations. NOT the rental ones. At one point, we had more than 30 active house renovations going on. Once our stuff was rented, our maintenance expenses were generally pretty low because of how we went about fixing the houses.

 

As Steve and I said, this make so much more sense in the way that it will be, going forward. Both in terms of the public entity, and me doing stuff privately. A fund setup makes sense as well.

 

Mr. Moore, 

 

It does sound like there was a substantial burden with the documentation of prior history (most likely with showing historic information; though I haven't gone and looked).  But, after that beginning burden, and with the use of some scanning software going forward, I would imagine that you would be good to go (but that is past history). 

 

The more pressing point to me, is some of the comments made about turning over the rentals to a 3rd party management company.  It sounds that the company is turning over most of the day to day running of the business unit to a 3rd party manager and that you are relying on them for various financial information.  So, you are basically farming out management and accounting to them and then in turn, relying on them for information that the company will use in its financial reporting. 

 

If that is the case, I don't think it is as simple as you are presenting of "The auditors don’t go through and audit the records of your property manager".  It will very much depend on the terms of the relationship and who is doing what (especially if they are managing cash or the revenue cycle of the rentals for the company), but the company may very well end up needing a service auditor's report on the manager (such as a SOC 1 report; which is basically an audit of the service organization's controls) for your external auditors to feel comfortable with their work.  And I really doubt that many rental management companies have such an audit done (given that it is a considerable expense).  Given the the company is public, and some of the issues with meeting prior audit deadlines, I would strongly suggest that you communicate with your external auditor (and potentially your legal team) about the terms and conditions of the contract with the 3rd party manager sooner rather than latter, and how it could potentially impact your regulatory burden.

 

Granted, this is coming from a outside by-stander (no ownership) and offered free of charge, so make of it what you will.  As well as I'm aware that you probably can't respond/outline the structure at this time either.

[matts]

Thank you Grafter!

 

Seriously, I was about to give up since everyone is talking about this like they have never been audited and assuming the same about everyone else. And actually, Jeff is not one of those people. His post was very informative. But I had the same response as you did.

 

1) I own a company that is regularly audited under IFRS, so pretty much the same standard as a US public co so I know what is required. Was it painful the first year like Jeff described? Hell YES. I don't think Jeff even did it justice. It was awful and I can totally see where he is coming from. But then you learn that going forward you have to photocopy and scan each money order before you take it to the bank. This applies to a lot of the painful aspects of an audit. The next year it's a lot better.

 

2) not sure what Jeff meant by "And no, the manager doesn’t have to do all the work that we did in terms of bookkeeping. They literally send a statement."  Maybe ENDI won't see it because they will just get an invoice but the manager HAS to do all that bookkeeping for their own tax purposes, especially if they manage 100+ homes. There might be a slight saving because the standard is not as high as an audit but I'm guessing it's 80-90% of the accounting workload (assuming again, that we are comparing a private 100 house manager vs a public one in the steady state, not in their first audit year). Any of that benefit will be eaten up by the profit the external manager will demand, and then some.

 

Listen, I now understand the situation from Jeff's point of view and if I was him I'd bail too. That sounds like a nightmare compared to how he used to run things. But ENDI presenting this as a way of lowering costs, and keeping the high quality of product and service by going external is almost insulting. The management of these properties will now cost more (all-in economic costs), not less, and they will be managed worse, not better. Shareholders will pay a price for making ENDI management's life simpler and easier.

 

 

 

 

 

[Spekulatius]

This is basically a FoF as a C-Corp instead of an LLC/S.

 

I guess the thesis is if you invest you only get your return after fees.  Whereas if you invest in the top level entity you get most of your return because some of the fee revenue is paid back as income.

 

 

I guess this could make sense if they had a lot of funds.  Asset managers are extremely valuable, look at the big ones, Fidelity, BlackRock etc. But you need a lot of scale.

 

And the mediocre ones go for almost nothing like MN, BEN....

[Guest roark33]

Yes, corporate-level taxation and public company G&A costs.  Both of those things are completely unnecessary (LLC and private company).  Kiel should, if questioned directly, respond why Willow Oak (or the other two failed investments) make sense in the structure they are.  He won't because there is no answer.  Additionally, the fact that the structure is a really bad way to make these investments make you question the investment acumen of the management.  That sounds harsh, but it is basically what happened with Jeff's situation and sooner or later it will happen with Willow Oak. 

[fishwithwings]

Yes, corporate-level taxation and public company G&A costs.  Both of those things are completely unnecessary (LLC and private company).  Kiel should, if questioned directly, respond why Willow Oak (or the other two failed investments) make sense in the structure they are.  He won't because there is no answer.  Additionally, the fact that the structure is a really bad way to make these investments make you question the investment acumen of the management.  That sounds harsh, but it is basically what happened with Jeff's situation and sooner or later it will happen with Willow Oak.

 

I wouldn't criticize their acumen.  Rather, it could their incentives.  Biglari Holdings v. 2.0? [move]Just Kidding![/move]

[valueyoda]

The fund managers are highly competent, but the SG&A at SYTE for running a public company and the relatively small size of the funds will make growing its book value or sum-of-the-parts valuation over time highly difficult. Plus the share price had already risen far beyond a fair valuation for the company before all of this chaos unfolded. It is hard to see a fair value beyond $5 for the stock (even if you don't take huge writedown hits on the real estate; the internet business is a melting ice-cube that deserves an extremely low multiple; the value of off balance sheet fund rev. sharing agreements are fairly insignificant at this point). The huge premium of the stock above that $5 is essentially the call option premium that investors are willing to pay for value growth beyond the status quo with regard to AUM and performance fees with both funds and optionality that management will add value in new areas in the future.

 

Running a successful holding company structure is very difficult when you are the size of SYTE. In my experience, it tends to work better when the size of the holding company gets above $75mln, because your fixed expenses relative to the size of the company and investments are more manageable. I wouldn't be amazed if the stock would trade below adjusted book value in the future once a true reset kicks in.

[andgroup]

 

At the end of the day, you still have three big horses pulling this wagon. 

 

Steven Kiel, Dave Waters, and Keith Smith.

 

Everyone makes mistakes, the point when you do, is no thumb sucking, admitting it and getting back to your circle of competence.

 

Compounding can overcome quite alot, especially when combined with visibility, and even more so when combined with stable forms of leverage.  Who knows what the future holds.

 

In terms of structure, Buffett did the same thing with Berkshire, so the question is not whether it is PERFECT, the question is whether or not you can find anything better.  If you can, then go there. 

 

I'll take the long view.  I think these guys are smart enough to have wonderful futures ahead.

 

http://basehitinvesting.com/buffetts-underrated-investment-attribute/

 

Thanks,

John

 

 

 

[matts]

 

At the end of the day, you still have three big horses pulling this wagon. 

 

Steven Kiel, Dave Waters, and Keith Smith.

 

Everyone makes mistakes, the point when you do, is no thumb sucking, admitting it and getting back to your circle of competence.

 

Compounding can overcome quite alot, especially when combined with visibility, and even more so when combined with stable forms of leverage.  Who knows what the future holds.

 

In terms of structure, Buffett did the same thing with Berkshire, so the question is not whether it is PERFECT, the question is whether or not you can find anything better.  If you can, then go there. 

 

I'll take the long view.  I think these guys are smart enough to have wonderful futures ahead.

 

http://basehitinvesting.com/buffetts-underrated-investment-attribute/

 

Thanks,

John

 

Curious to hear what makes you call each one a "big horse".

[andgroup]

Track records.  I think these guys will compound money.  That will attract capital. 

 

 

[Spekulatius]

The fund managers are highly competent, but the SG&A at SYTE for running a public company and the relatively small size of the funds will make growing its book value or sum-of-the-parts valuation over time highly difficult. Plus the share price had already risen far beyond a fair valuation for the company before all of this chaos unfolded. It is hard to see a fair value beyond $5 for the stock (even if you don't take huge writedown hits on the real estate; the internet business is a melting ice-cube that deserves an extremely low multiple; the value of off balance sheet fund rev. sharing agreements are fairly insignificant at this point). The huge premium of the stock above that $5 is essentially the call option premium that investors are willing to pay for value growth beyond the status quo with regard to AUM and performance fees with both funds and optionality that management will add value in new areas in the future.

 

Running a successful holding company structure is very difficult when you are the size of SYTE. In my experience, it tends to work better when the size of the holding company gets above $75mln, because your fixed expenses relative to the size of the company and investments are more manageable. I wouldn't be amazed if the stock would trade below adjusted book value in the future once a true reset kicks in.

 

The holding structure does not work well at a small scale like SYTE or PDH, the overhead is just too much. I think SYTE has like $600k overheard. That’s a very high hurdle  when you are of a $10M scale. People talk about the BRK, but they forget that when BRK became public via the Berkshire takeover, their size was much larger, especially considering these were 1970’s $.

[Guest roark33]

 

At the end of the day, you still have three big horses pulling this wagon. 

 

Steven Kiel, Dave Waters, and Keith Smith.

 

Everyone makes mistakes, the point when you do, is no thumb sucking, admitting it and getting back to your circle of competence.

 

Compounding can overcome quite alot, especially when combined with visibility, and even more so when combined with stable forms of leverage.  Who knows what the future holds.

 

In terms of structure, Buffett did the same thing with Berkshire, so the question is not whether it is PERFECT, the question is whether or not you can find anything better.  If you can, then go there. 

 

I'll take the long view.  I think these guys are smart enough to have wonderful futures ahead.

 

http://basehitinvesting.com/buffetts-underrated-investment-attribute/

 

Thanks,

John

 

The real ironic thing about this post is you cite a great author/investor, John Huber.  You answer your own question, you can find something better than SYTE--invest directly with John, no double-taxation issue and no corporate drag. 

[oddballstocks]

 

At the end of the day, you still have three big horses pulling this wagon. 

 

Steven Kiel, Dave Waters, and Keith Smith.

 

Everyone makes mistakes, the point when you do, is no thumb sucking, admitting it and getting back to your circle of competence.

 

Compounding can overcome quite alot, especially when combined with visibility, and even more so when combined with stable forms of leverage.  Who knows what the future holds.

 

In terms of structure, Buffett did the same thing with Berkshire, so the question is not whether it is PERFECT, the question is whether or not you can find anything better.  If you can, then go there. 

 

I'll take the long view.  I think these guys are smart enough to have wonderful futures ahead.

 

http://basehitinvesting.com/buffetts-underrated-investment-attribute/

 

Thanks,

John

 

The real ironic thing about this post is you cite a great author/investor, John Huber.  You answer your own question, you can find something better than SYTE--invest directly with John, no double-taxation issue and no corporate drag.

 

I think the advantage of SYTE is you can invest $100 with SYTE. What's John's minimum, $50k? $100k? Plus you need to be a qualified investor.  The public listing of these things means you can get some exposure even if you're not qualified.

 

If you are qualified then I 100% agree, invest directly, not in the entity.  But for anyone who isn't they don't have that choice.

 

[iambagman]

There seems to be some confusion about the actual business SYTE is in with Willow Oak.  As I understand it, a fund like Bonhoeffer has a general partner and limited partners.  The limited partners are the investors.  The General Partner is in charge of the partnership and receives a management fee and an incentive fee (share of profits).  The economics of a general partnership are very favorable if a fund can achieve scale (AUM).  That is why the Forbes 400 is littered with Hedge Fund managers - as they are the General Partners for very large funds.  Willow Oak / Sytestar owns a portion of the General Partnerships for the Willow Oak funds.  With low AUM and poor returns - these GP stakes do not generate real revenue yet.  They are call options in my opinion, but interesting call options as these GP stakes require zero additional capital to grow and they do not show up in the book value of the firm. 

 

If you think Alluvial or Bonhoeffer can raise real dollars and generate real returns - it can get interesting quickly.  Management fees vary by funds as do the incentive fees and the Willow Oak ownership.  There will also likely be additional funds in the future - so using a generic/hypothetical example - if in a few years, Willow Oak has a fund that has $200M in AUM with a 1% management fee and a 20% incentive fee of which they own 20% of the fund - in a year where the underlying fund generates 20% returns - the Willow Oak portion would be in round numbers $400K in management fees (20% of 1% of $200M)  and $8M in incentive fees (20% of 20% of $40M).  Now the number of funds that reach $200M is small and in a flat or down year the economics are far worse - my point here is they are building call options in Willow Oak that are very asymetric.  Depending on your opinion of the magnitude of success of the underlying funds - may make the current $30M market cap seem quaint or not.

[Hielko]

SYTE is not only a general partner in the funds, but has also been providing seed money for the funds. Think they put $10 million in the Alluvial Capital fund as limited partners, right? I bet that stake is a order of magnitude more valuable than the GP interest.

 

I think you shouldn't put too much value on the general partner stakes they have. Alluvial Capital for example has now a bit more than $20M AUM, but half of that money is from SYTE itself. So really they have $10M of outside capital. That fund has a 1.5% management fee and 20% performance fee above a 6% hurdle. So in a 20% year you would make 30K in management fees and 200K in performance fees if they have a 20% stake in the GP (don't know what the deal exactly was?). Right now, even an excellent year barely produces anything meaningful.

 

Even if they grow the size of the fund to 100M of outside money (at which point it becomes questionable if their strategy works) you are still looking at 300K in management fees and 2 million in performance fees (for SYTE, assuming a 20% stake in GP). And that is at least a couple of years in the future, and probably more than a couple. And of course, that is if they ever reach it! And additionally, this is still a pretty good year even if they managed to reach that scale. So many things have to go right before a stake in a GP starts to become valuable. And then presumably overhead would be increasing as well. To come back to the Alluvial Capital example (which I follow because I do think Dave has a good nose for value), there is already an additional employee that was added this year. I would guess his salary is paid by the GP, and is thus eating into the amount of management en performance fees that are available for distribution as profit.

 

And then, when that stake does become valuable, how easy is it for SYTE to keep the managers on their platform? People invest in Alluvial Capital because they think Dave Waters is a good investor, not because "Enterprise Diversified" means anything to them. Especially the manager that is managing the fund that grows to $100M plus will presumably be becoming more of a star. If he (or she!) thinks "Enterprise Diversified" is getting a too big piece of the pie they might simply start their 100% own fund and take most of the clients with them.

 

And even if the fund manager is very loyal to "Enterprise Diversified" I think it's quite problematic that the real value would still be the fund manager. What happens if after 5 or 10 year the fund manager thinks, "Okay, I have had enough of this. I made plenty of money already, I can just as well focus on managing my own money, and quit." Would AUM be sticky? I doubt it. It's not like, that even if a fund reaches a good scale, that you can value it like it will exist into eternity.

[Spekulatius]

^ There is nothing to prevent a successful fund manager from jumping ship / starting a new fund without SYTE. If there is any moat, it is with the manager, not with SYTE.

[Hielko]

I'm not that pessimistic. The fund manager is important, but so is access to capital. If SYTE grows to have multiple funds, has a marketing department, has the relations with institutions and HNW individuals they would have a big part of what is important as well.

[NBL0303]

If he (or she!) thinks "Enterprise Diversified" is getting a too big piece of the pie they might simply start their 100% own fund and take most of the clients with them.

 

 

Good on you, Hielko.

[gfp]

And of course the general concept of Loyalty, Character, etc...

 

I'm not that pessimistic. The fund manager is important, but so is access to capital. If SYTE grows to have multiple funds, has a marketing department, has the relations with institutions and HNW individuals they would have a big part of what is important as well.

[Tim Eriksen]

And of course the general concept of Loyalty, Character, etc...

 

I'm not that pessimistic. The fund manager is important, but so is access to capital. If SYTE grows to have multiple funds, has a marketing department, has the relations with institutions and HNW individuals they would have a big part of what is important as well.

 

There are a few misunderstandings here and in some of the other recent posts:

 

1. Unless Sitestar did a stupid deal, it doesn't work this way.  Having sold part of my GP, my agreement clearly does not allow me to close the fund and re-open under a different name to eliminate the fee share. 

 

2. If the GP hires additional personnel it does not cut into the revenue earned by Sitestar.  Sitestar basically has a royalty. 

[Tim Eriksen]

There seems to be some confusion about the actual business SYTE is in with Willow Oak.  As I understand it, a fund like Bonhoeffer has a general partner and limited partners.  The limited partners are the investors.  The General Partner is in charge of the partnership and receives a management fee and an incentive fee (share of profits).  The economics of a general partnership are very favorable if a fund can achieve scale (AUM).  That is why the Forbes 400 is littered with Hedge Fund managers - as they are the General Partners for very large funds.  Willow Oak / Sytestar owns a portion of the General Partnerships for the Willow Oak funds.  With low AUM and poor returns - these GP stakes do not generate real revenue yet.  They are call options in my opinion, but interesting call options as these GP stakes require zero additional capital to grow and they do not show up in the book value of the firm. 

 

If you think Alluvial or Bonhoeffer can raise real dollars and generate real returns - it can get interesting quickly.  Management fees vary by funds as do the incentive fees and the Willow Oak ownership.  There will also likely be additional funds in the future - so using a generic/hypothetical example - if in a few years, Willow Oak has a fund that has $200M in AUM with a 1% management fee and a 20% incentive fee of which they own 20% of the fund - in a year where the underlying fund generates 20% returns - the Willow Oak portion would be in round numbers $400K in management fees (20% of 1% of $200M)  and $8M in incentive fees (20% of 20% of $40M).  Now the number of funds that reach $200M is small and in a flat or down year the economics are far worse - my point here is they are building call options in Willow Oak that are very asymetric.  Depending on your opinion of the magnitude of success of the underlying funds - may make the current $30M market cap seem quaint or not.

 

Under your scenario it would be $1.6 million not $8 million for incentive fees under the revenue share.  $8 million is gross.  $1.6 million would be 20% of the 20%. 

[Hielko]

And of course the general concept of Loyalty, Character, etc...

 

I'm not that pessimistic. The fund manager is important, but so is access to capital. If SYTE grows to have multiple funds, has a marketing department, has the relations with institutions and HNW individuals they would have a big part of what is important as well.

 

There are a few misunderstandings here and in some of the other recent posts:

 

1. Unless Sitestar did a stupid deal, it doesn't work this way.  Having sold part of my GP, my agreement clearly does not allow me to close the fund and re-open under a different name to eliminate the fee share. 

I of course don't know what's in the agreement, but it almost has to be possible in some way or another. Sure, closing the fund and re-opening another one next day, maybe not. But it's probably also not the case that if you want to quit and then you can never ever ever start a fund again for the rest of your life. Hope no-one signs something like that ;)

[Tim Eriksen]

And of course the general concept of Loyalty, Character, etc...

 

I'm not that pessimistic. The fund manager is important, but so is access to capital. If SYTE grows to have multiple funds, has a marketing department, has the relations with institutions and HNW individuals they would have a big part of what is important as well.

 

There are a few misunderstandings here and in some of the other recent posts:

 

1. Unless Sitestar did a stupid deal, it doesn't work this way.  Having sold part of my GP, my agreement clearly does not allow me to close the fund and re-open under a different name to eliminate the fee share. 

I of course don't know what's in the agreement, but it almost has to be possible in some way or another. Sure, closing the fund and re-opening another one next day, maybe not. But it's probably also not the case that if you want to quit and then you can never ever ever start a fund again for the rest of your life. Hope no-one signs something like that ;)

 

I have a five year restriction.  Not sure why you would hope no one signs something like that.  On a $10 million fund commitment, the manager gets a management fee of $100 k per year plus incentive fees (in addition to scale for a one person shop).  Not sure how that is a bad deal for a young manager.

 

In deals where the manager gets significant cash up front it is not unusual for inclusion of future earnings should for example, a manager close his/her small fund and be hired by a bigger fund.  It's a legal agreement both sides should protect themselves.

[Hielko]

Yeah, I agree that should make it pretty hard to just leave and setup something new on your own.

[gfp]

Q is filed

https://www.sec.gov/Archives/edgar/data/1096934/000143774918020863/syte20180930_10q.htm

[Foreign Tuffett]

Q is filed

https://www.sec.gov/Archives/edgar/data/1096934/000143774918020863/syte20180930_10q.htm

 

"Of the 194 units held for investment, 100 of the units are occupied or available to rent, 85 of the units are vacant units being prepared or to be prepared to market to tenants, and nine of the units are vacant lots."

 

Not hard to see why management was concerned about Mt Melrose: that's a lot of vacant houses!