Chaos: Making a New Science by James Gleick

This book review is a little different than the others on this blog. I tend to write up interesting books related to investing but, as you may have surmised from the title, this one is not directly an investing/business book per se. But I hope that you will indulge me and follow along.

It’s been almost a year since I wrote up a book review on the blog. I’ve read some pretty decent books between this and the last write up, but nothing I felt overly compelled to write about. Plus, between portfolio company write ups and busy personal & professional lives, I’ve not had a ton of time for a book review post or a lot of recreational reading, frankly. Luckily, my family and I spent a few days on vacation recently so I had the opportunity to catch up on some reading. I find that when I am laying by a body of water, I prefer to read something that’s not directly business related. So, I took along an old book that I picked up for $1 at a local library liquidation – Chaos: Making a New Science by James Gleick. I can’t say exactly why I picked up this book to being with – I don’t know anything about science or physics beyond basic high school/undergrad classes and anecdotal readings – but the price was right and “chaos theory” has always seemed like a seductive sci-fi phrase that peaked my interest.

I would bet if you are reading this post you, like me, suffer from the paradox (affliction?) in which your brain tries to relate anything you read/hear/discuss back to investing/markets/business. I am a big fan of the Value: After Hours podcast (highly suggest it if you have not listened before – the content is pretty unstructured and tends to be more of a conversation than a formal discussion). One of the hosts on the show, Jake Taylor, regularly presents a segment where he discusses observations from a wide range of fields of study (like biology, power generation, gardening, etc.) and relates those to various investing concepts. I suppose this is a nod to the modern “mental models” fascination that seems to be popular with hard core philosopher-investors. Anyway, I bring this up to say that I’m blatantly stealing this schtick for this post. As I read through Chaos, I couldn’t help but see parallels to investing all over the place, so I’ve collected a few of the more memorable passages and put together some quick thoughts around each.

Before we get started, a very brief background on the subject matter: Chaos (as in “Chaos Theory”) is this fascinating intersection of science and mathematics. From this outsider’s perspective it seems most closely akin to physics, but has seen contributions from practitioners and academics across mathematics, meteorology, biology and many other branches of science. The book is quite dated at this point (published 1988) and it seems to me that “dynamical systems” is the more professional and widely accepted term for what began as chaos theory. And to be honest that seems more descriptive of what “chaos” actually is – the study of complex non-linear systems. At it’s core, the work is about finding order in what appears to be randomness. As it turns out, that makes it widely applicable across a great number of disciplines (including some attempts at applying it to economics and financial markets). The book points out that one of the major accomplishments of chaos was the reversal of the trend toward increasing specialization within scientific fields, which seems to be pushing forward innovations faster as a result of more collaboration across disciplines. The book follows the birth and growth of chaos as a legitimate field of study and includes a colorful cast of personalities accompanied by easy to follow explanations of core concepts. Overall, it was a very easy and interesting read for me and if you’ve ever had any sort of inclination toward physics/mathematics I would imagine it would be interesting to you as well.

With no further ado, here are a few of my favorite selections:

Chaos breaks across the lines that separate scientific disciplines. Because it is a science of the global nature of systems, it has brought together thinkers from fields that had been widely separated. “Fifteen years ago, science was heading for a crisis of increasing specialization,” a Navy official in charge of scientific financing remarked to an audience of mathematicians, biologists, physicists, and medical doctors. “Dramatically, that specialization has reversed because of chaos.” Chaos poses problems that defy accepted ways of working in science. It makes strong claims about the universal behavior of complexity. The first chaos theorists, the scientists who set the discipline in motion, shared certain sensibilities. They had an eye for pattern especially pattern that appeared on different scales at the same time. They had a taste for randomness and complexity, for jagged edges and sudden leaps. Believers in chaos – and they sometimes called themselves believers, or converts, or evangelists – speculate about the determinism and free will, about evolution, about the nature of conscious intelligence. They feel that they are turning back a trend in science toward reductionism, the analysts of systems in terms of their constituent parts: quarks, chromosomes, or neurons. They believe that they are looking for the whole.

This excerpt captures the core tenant of much of the book. I look at this and think about how investing has also trended toward specialization over time – sell side coverage on specific industries, hedge fund pods that execute some extremely specific arbitrage, etc. On the other hand I don’t think specialization in the world of investing is nearly as dramatic as it seems to be in academia/sciences. Maybe that’s because in the world of investing even the most niche strategies are impacted by tangential factors and market events. Nonetheless, I think it’s an interesting parallel with the idea that there is some value in being a generalist in markets and having a wider perspective than any one specific niche.

In fluid systems and mechanical systems, the non-linear terms tend to be the features that people want to leave out when they try to get a good, simple understanding. Friction, for example. Without friction a simple linear equation expresses the amount of energy you need to accelerate a hockey puck. With friction the relationship gets complicated, because the amount of energy changes depending on how fast the puck is already moving. Nonlinearity means that the act of playing the game has a way of changing the rules. You cannot assign a constant importance to friction, because its importance depends on speed. Speed, in turn, depends on friction. That twisted changeability makes nonlinearity hard to calculate, but it also creates rich kinds of behavior that never occur in linear systems. In fluid dynamics, everything boils down to one canonical equation, the Navier-Stokes equation. It is a miracle of brevity, relating to fluid’s velocity, pressure, density, and viscosity, but it happens to be nonlinear. So the nature of those relationships often becomes impossible to pin down. Analyzing the behavior of a nonlinear equation like the Navier-Stokes equation is like walking through a maze whose walls rearrange themselves with each step you take. As [world renown mathematician John] Von Neumann himself put it: “The character of the equation […] changes simultaneously in all relevant respects: Both order and degree change. Hence, bad mathematical difficulties must be expected.” The world would be a different place – and science would not need chaos – if only the Navier-Stokes equation did not contain the demon of nonlinearity.

Lot of things to like here. First off, the “demon of nonlinearity” is  a great turn of phrase – love it. And I don’t know if I’ve ever heard a better allegory to financial markets than: it’s “like walking through a maze whose walls rearrange themselves with every step you take.” Nonlinearity is probably not so novel for those of us in the investing world given that financial instruments exhibit that sort of behavior all the time but I thought the hockey puck example was illustrative. This is just a glimpse at the broader discussion of nonlinearity that the book covers, but throughout I couldn’t help but think how we try to pave over nonlinear relationships with linear ones in markets. One of the core building blocks of professional portfolio management (CAPM) is a hilariously oversimplified linear model for an unbelievably complex (chaotic?) system, attempting to bypass the “demon of nonlinearity.”

Chaos should be taught, he argued. It was time to recognize that the standard education of a scientist gave the wrong impression. No matter how elaborate linear mathematics could get, with its Fourier transforms, its orthogonal functions, its regression techniques, may argued that it inevitably mislead scientists about their overwhelmingly non-linear world. “The mathematical intuition so developed ill equips the student to confront the bizarre behaviour exhibited by the simplest of discrete nonlinear systems,” he wrote.

Along the same lines as the previous passage, this one reinforces the sentiment more directly. Just replace “scientist” with “investor” in this paragraph and it could be in a modern white paper or Institutional Investor article.

How can we calculate how quickly a cup of coffee will cool? If the coffee is just warm, its heat will dissipate without any hydrodynamic motion at all. The coffee remains in a steady state. But if it is hot enough, a convective overturning will bring hot coffee from the bottom of the cup to the cooler surface. Convection in coffee becomes plainly visible when a little cream is dribbled into the cup. The swirls can be complicated. But the long-term density of such a system is obvious. Because the heat dissipates, and because friction slows a moving fluid, the motion must come to an inevitable stop. Lorenz drily told a gathering of scientists, “We might have trouble forecasting the temperature of the coffee one minute in advance, but we should have little difficulty in forecasting it an hour ahead.

The “Lorenz” referenced here is Edward Lorenz, a highly influential mathematician (and meteorologist) who’s early ground-breaking research established many of the core principles of chaos. This quote from Lorenz reminds me of the old Ben Graham quote: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.” As a value-oriented investor myself, I like to think we can have more confidence about outcomes over an appropriately long time frame while the shorter term is noisey and less predictable.

It was just a vacuum tube, really, investigated in the twenties by a Dutch electrical engineer named Balthasar van der Pol. A modern physics student would explore the behavior of such an oscillator by looking at the line traced on the screen of an oscilloscope. Van der Pol did not have an oscilloscope, so he had to monitor his circuit by listening to changing tones in a telephone handset. He was pleased to discover regularities in the behavior as he changed the current that fed it. The tone would leap from frequency to frequency as if climbing a staircase, leaving one frequency and then locking solidly onto the next. Yet once in awhile van der Pol noted something strange. The behavior sounded irregular, in a way that he could not explain. Under the circumstances he was not worried. “Often an irregular noise is heard in the telephone receivers before the frequency jumps to the next lower value,” he wrote in a letter to Nature. “However, this is a subsidiary phenomenon.” He was one of many scientists who got a glimpse of chaos but had no language to understand it. For people trying to build vacuum tubes, the frequency-locking was important. But for people trying to understand the nature of complexity, the truly interesting behavior would turn out to be the “irregular noise” created by the conflicting pulls of a higher and lower frequency.

This anecdote is followed by some discussion of information theory (which ties into the “irregular noise” phenomenon) but I like this section because I think about how, when it comes to stocks or markets or whatever, we find what we are looking for. That means that a slightly different perspective or frame of reference can lead to dramatically different findings. My mind immediately connected this to Greenblatt’s example of Marriott’s good co/ bad co spinoff in the You Can Be a Stock Market Genius book where most investors were focused on the franchise operations (good co) and ignoring the debt laden, real estate rich bad co. Every investor in good co had to know about bad co, but it wasn’t what they were focused on and wasn’t what they were looking for, which left an opportunity for shrewd investors like Greenblatt.

A few dozen yards upstream from a waterfall, a smooth flowing stream seems to intuit the coming drop. The water begins to speed and shudder. Individual rivulets stand out like coarse, throbbing veins. Mitchell Feigenbaum stands at streamside. He is sweating slightly in sports coat and corduroys and puffing on a cigarette. He has been walking with friends, but they have gone on ahead to the quieter pools upstream. Suddenly, in what might be a demented high-speed parody of a tennis speculator, he starts turning his head from side to side. “You can focus on something, a bit of foam or something. If you move your head fast enough, you can all of a sudden discern the whole structure of the surface, and you can feel it in your stomach.” He draws in more smoke from his cigarette. “But for anyone with a mathematical background, if you look at this stuff, or you see clouds with all their puffs on top of puffs, or you stand at a sea wall in a storm, you know that you really don’t know anything.

I like this passage for two reasons. First, despite this book being largely exposition, I do think Gleick is a pretty solid writer and I think this shows off some of his true writing prowess. Second, I really love the ending quote from Feigenbaum (highly influential physicist in his own right) – particularly the visual of standing at the sea wall in a storm. I like to imagine this metaphor applied to finance undergrads and EMH academics trying to make sense of meme stocks and crypto in 2021.

The question was so deep that almost no one had thought to ask it before: Does a climate exist? That is, does the earth’s weather have a long term average? Most meteorologists, then as now, took the answer for granted. Surely any measurable behavior, no matter how it fluctuates, must have an average. Yet on reflection, it is far from obvious. As Lorenz pointed out, the average weather for the last 12,000 years has been notably different than the average for the previous 12,000, when most of North America was covered by ice. Was there one climate that changed to another for some physical reason? Or is there an even longer-term climate within which those periods were just fluctuations? Or is it possible that a system like the weather may never converge to an average?

I love this paragraph because it is so directly applicable to investing. I feel like I hear this conversation non-stop in the quant and institutional research communities. There’s a mountain of white papers and journal articles that contemplate this exact same problem but reference factors, valuations, econometrics, etc. rather than climates. I also like this because it re-raised for me the idea that maybe averages/medians/(insert your favorite summary statistic here) just don’t matter. If you assume there’s no real equilibrium state (i.e. markets have a “chaotic” quality about them) then you’re just chasing phantoms by trying to time any portfolio decisions based on irrelevant historical data.

That’s all the quotes I’ve got for you. If this peaked your interest at all, I highly recommend reading the book. There’s obviously much more detail than I could cover here in a single blog post, but I found it to be an easy and interesting read – hopefully you will too.

Anyway, if you’ve made it this far thanks so much for reading. If you aren’t already, feel free to follow me on Twitter and/or subscribe to get email updates whenever a new post goes up on the blog (see the top right hand side of this page to enter your email).


IDT Corporation (IDT)

  • IDT is an ignored and undervalued collection of assets with an impressive track record of capital allocation and shareholder value creation
  • Unlike most SOTP situations, IDT catalyzes value recognition by spinning assets into standalone entities (a la IAC) or selling them outright
  • IDT is on the cusp of another spin with several other embedded attractive “options” at the remainco, a profitable core business, and a strong balance sheet

The Numbers:

Price: $22.20 (Sawbuckd cost basis $17.35-19.05)

Mkt Cap: $571M

EV: $455M


P/E (LTM): 13.4x

The Company:

IDT was founded in 1990 by Howard Jonas with the designed purpose of providing cheap international long distance telephone rates to U.S. consumers. After building a successful international telecom business through a series of savvy business moves and technical innovation, Jonas parlayed that momentum into a platform for significant shareholder value creation across a diversified array of industries using IDT as the incubator. IDT’s history of spinning off or otherwise successfully exiting businesses is impressive and extensive – here is an abbreviated timeline of IDT’s track record:

1996: IDT is publicly listed as an international long distance carrier and wholesale servicer to other telecoms

2000: IDT sells the original net2phone subsidiary (a leader in VoIP technology) to AT&T for $1B

2006: IDT sells its Russian Telecom business for $129M

2007: IDT sells IDT Entertainment to Liberty Media for $220M

2009: IDW Media Holdings (IDWM – a collection of comic book, television, board games, books, etc. IP) spun off to shareholders (market value subsequently stabilized around $30-40M, has been as high as ~$300M)

2011: Genie Energy subsidiary (GNE – electric and natural gas services) spun off (average market value over the past decade has been ~$200M)

2013: Straight Path Communications subsidiary is spun off to shareholders and would eventually be purchased by Verizon for $3B in 2018

2014: IDT sells Fabrix subsidiary (cloud storage and network delivery tech) to Ericsson for $69M

2016: Zedge subsidiary (ZDGE – mobile device content development) is spun off (market cap has been as low as $10M since the spin but currently sits at $125M)

2018: A number of real estate holdings and Rafael Holdings (early stage pharmaceuticals) subsidiary are combined  spun off (RFL – has grown from $60M to $600M in market cap since spin)

Today, IDT continues to execute the same playbook they have been since 1996. The legacy telecom business produces consistent cash flow that is deployed into new lines of business that are incubated and monetized in one way or another. The company currently divides itself into 3 operating groups: fintech, Net2Phone, and traditional communications. The “fintech” segment includes a payments/money transfer business and a point of sale (POS) terminal network. Net2Phone is a comprehensive cloud based communication service for domestic and international commercial customers. The “traditional communications” segment includes the legacy telecom lines of business: a consumer-focused international calling service, a consumer-focused mobile “top-up” offering, as well as a carrier/platform services offering that caters to cable providers and telecoms.

One interesting thing I noticed about the current collection of businesses that compose IDT is that while each of the business lines might appear fairly incongruous with one another, they all build on a core strength of the legacy business. IDT’s legacy telecom services in the consumer space were aimed directly at immigrant communities, who have an obvious need for long distance international calling service. IDT’s current portfolio is a group of offshoot businesses that dovetail with that existing customer base or utilize some of IDT’s existing internal infrastructure. The money transfer service is a natural need for existing long distance calling customers that want to send money abroad (the payments business even carries the same branding as their legacy calling service) while the POS network is marketed primarily to independent convenience and liquor stores that typically serve immigrant communities. Even the Net2Phone business line carries certain synergies with the legacy telecom operations and give them reach into a number of foreign markets. I will note, however, that IDT is no one trick pony; this sort of tangential relation to their core business is not a necessity. As I listed in the timeline above, IDT’s spinoffs include a media company (IDWM), an electric/gas services company (GNE), a pharma company (RFL), and a mobile phone content business (ZDGE).

The Good:

Any discussion of IDT must begin with the company’s founder and visionary, Howard Jonas. Joe Boskovich of Old West Investment Management did an entire podcast about Jonas on Bobby Kraft’s Planet Microcap Podcast, which I found to be an extremely valuable resource (and what ultimately lead me to look at IDT in the first place). My conclusion, much like Joe’s in that podcast, is that Jonas is a highly capable leader with a fierce business acumen and the track record at IDT to prove it.  I hope that the timeline included above, which cumulatively reaches into the billions of dollars worth of shareholder value created over multiple decades, speaks for itself. Beyond merely the impressive historic record, the Jonas family itself is aligned with shareholders. Each of Howard’s nine children (including one of Howard’s sons who is the acting CEO) hold shares via trust with the family collectively controlling about 33% of the shares in IDT (and ~75% of the voting power).

Before I get into some of the nuts and bolts valuation, I want to say a little about why I think this opportunity exists. Despite the aforementioned insider alignment and strong track record, IDT continues to be (unbelievably, IMO) ignored. Beyond the small market cap, I think the primary driver for this lack of attention is the “complicated” nature of the company. The valuation for IDT is not really as simple as slapping a multiple on trailing earnings. The business is nuanced – a declining but cash generative legacy business feeds capital into growth-oriented internal startups with indeterminate runways that might be sold or spun in the near or distant future if incubated to success. Like many of the businesses I find myself looking into, this one requires more than a superficial glance which means it’s automatically bypassed by many market participants. Even the in realm of value investors, IDT seems to be a known but forgotten commodity. The CoB&F and VIC threads are basically dead and haven’t been particularly active since 2013. Even on Twitter the chatter is pretty sparse; Joe’s discussion of it in Old West’s letters and the MicroCap Planet podcast were certainly the first I’d ever heard of the company.

 I generally do not believe in the much maligned sum of the parts (SOTP) style valuations, however I think IDT is one of the rare instances where the methodology is valid (along with a few of my other portfolio holdings). In my mind I compare IDT to an IAC, albeit a lower quality version. Much like IAC, IDT is a collection of related or unrelated business that benefit from being part of a holdco for a time but must ultimately stand on their own. When the right moment presents itself, the parent must be willing to let that happen. And it’s precisely because IDT/IAC do this frequently and with success that the market is forced to recognize the previously obscured value of the new standalone company. This is all pretty well understood market dynamics and operational philosophy, but I think my point here is that it takes conviction to execute that playbook and relatively few companies do it well and consistently, but those that do can create tremendous value.

The slide below is from the most recent (Dec 2020) investor presentation for IDT. Management, presumably understanding the very issue I have spent the preceding two paragraphs discussing, has made their case painstakingly simple for anyone with the intellect and perseverance to… visit their corporate website and download a PDF. Here, management gives you an idea of what they think the range of value is for each of the key lines of business and what that rolls up to at the enterprise level. Obviously, there was a ton of upside (in their opinion) back in December when shares were still <$10. Today, the stock has run to the $20ish range, but I still think there is plenty of upside left here.

Sum of the parts suggests potential upside 
Money Transfer 
Revenue' = $43MM 
Industry Multiples = 5x - 10x 
Implied = $214MM - $430MM 
pos Network 
Revenue5 $20MM 
Industry Multiples = 7.5x - 10x 
Implied = $150MM - $200MM 
Cloud Communications 
Revenues = $39MM 
Industry Multiples = 5x - 10x 
Implied = $195MM - $390MM 
Traditional Communications Less 
Corporate Overhead 
Adjusted EBITDA* less CAPEX TTM6 = $50MM 
Discounted cash flow value = $275MM - $350MM 
Investor Presentation 
Implied EV/share7: $28.20 to $49.17 
Current EV/share8: $8.35 
Source: Dec 2020 investor presentation

Below, I will give a little background on each of the business lines and try to outline a bear/base case scenario for each. Before we get there, I should acknowledge a few things. As I alluded to earlier in this write up, the basic IDT playbook is to use the cash flow from the “traditional communications” legacy business to incubate and grow new diversified lines of business (currently the money transfer, POS network, and cloud communications subsidiaries). So as I try to value the “parts” below, it’s important to remember that these are still relatively early stage enterprises that have not reached stand-alone scale. As far as I can tell only the money transfer division is profitable and even that is a recent development and unlikely to be reliable moving forward, IMO. There’s a reason management is using revenue multiples and not EBITDA or operating income to value these – it’s reflective of the fact they aren’t mature enough to be cash flow positive. Also it’s probably indicative of how they think public markets might value these given today’s market environment (i.e. revenue multiples and growth vs. profitability). I fully recognize that good valuation work and the phrase “revenue multiple” do not often go hand in hand, but I do believe it would be completely disingenuous to say there’s no (or little) real value here. If I were trying to evaluate each of these as standalone entities in public markets it would be pretty challenging to get comfortable enough with any of them to buy shares individually. However, given that they are merely a component of broader IDT portfolio at the moment and benefit from the company’s strong financial position and management, I tend to view them as embedded call options. You may only need one of them to really payoff to make it worth the risk here. Anyway, here we go:

The engine that powers IDT is the Traditional Communications segment. This is the legacy telecom business that throws off all the cash that is fed to the more aggressive “growth” businesses. The segment breaks down into 3 sub-segments: Boss Revolution Calling (their consumer facing international long distance calling service), Mobile Top Up (allows customers to transfer calling, data, and messaging credits to other international and domestic mobile accounts), and Carrier Services (which is the core legacy business that provides wholesale voice and SMS facilitation and traffic management to other telecoms). Each sub-segment accounts for somewhere between 20-40% of revenues for the group. Collectively, the Traditional Communications accounts for 90-95% of IDT revenues and typically all of the operating income.

Traditional Communciations Segment Revenues 
% Chg 
2020 Prev Yr 
% Chg 
% Chg 
2018 Prev Yr 2017 
Carrier Services 
Boss Revolution Calling 
Mobile Top Up 
Segment Operating Income 
22 * 
*excludes one time non-income tax related liability charge on foreign subsidiary
Source: various IDT SEC filings

As you can see from the figures above, there are some definite questions about the future of some of the business lines. Carrier Services has been the hardest hit over the last few years as the industry has moved away from traditional long distance international voice providers and price competition from larger wireless and sovereign telcos has increased. IDT has openly admitted that they are no longer maximizing revenues or utilization within this line of business but are instead optimizing for economics. I’m generally more optimistic about the consumer facing business, Boss Revolution Calling, which has seen a more modest contraction in revenues despite accelerating competition from traditional wireless carriers (Verizon, AT&T, etc. are increasingly offering international calling as part of standard mobile plans). Unlike the Carrier Services division, IDT is still aggressively competing in this segment. They currently serve about 4M customers through both DTC apps/web portals and a retail partner network that boasts 30k locations and continue to add new services/offerings/features. Reading between the lines, economics seem to be moving in the right direction as more retail customers move to the DTC mobile app which I expect reduces costs to service & acquire customers. The last notable line of business in this segment is Mobile Top-Up which has seen increasing demand amongst users over recent years as IDT has added additional mobile providers and bundling option offerings. This appears to be the only sub-segment within Traditional Communications to see sustained top line growth in the last few years. Much like their other business lines, Top-Up seems like a niche space but an important need to IDT’s target customers. There appear to be several digital-only competitors in the space, but I suspect IDT’s mixed physical retail and digital offerings give them a branding and familiarity advantage here. Collectively, the Traditional Communications group did about $40M in operating income in FY 2020 but about $20-25M in the preceding 3 years. I think it’s reasonable to assume that the huge jump was partially driven by increased demand for their services due to COVID but through two quarters of FY 2021 the group is on pace to do $70M (I expect the actual may come in lower due to seasonality of the business) and, in alignment with their comments about optimizing economics, costs seem to be declining faster than revenues at the group level. It’s hard to say what forward expectations should be, but $30M in normalized operating income feels like a pretty conservative estimate to me given that you expect some regression on the recent results. D&A add back plus drag from corporate overhead (each ~$10/yr) offset one another to yield an “EBITDA” figure of about $30M from the business unit. As I write this, the EV for IDT is sitting at about $455M. If you ignored every other line of business that I will discuss below and just focused on the legacy core business, you’d be paying approx 15x EV/TTM EBITDA or 8x P/run rate operating income (i.e. $571M market cap on $70M in est. FY 2021 operating income). Maybe that seems expensive for a telecom business facing headwinds, but certainly not an absurd valuation. Not to mention IDT has $80M in cash, $80M in debt/equity investments and PP&E, and carrying no debt. To me, a 4x normalized EBTIDA valuation feels pretty conservative for the legacy telecom + corporate overhead portion of IDT which would give us a $120M valuation.

Boss Revolution Money Transfer (BRMT) is an international money remittance service launched in 2013 that provides connects U.S. residents to 60 foreign countries. Initially, the service relied heavily on a retail partner network for distribution, which seemed logical at the time given shared “Boss Revolution” branding between it and the calling business, plus the fact that many target customers dealt in cash. From what I can tell, the serious growth has come since 2017 when they launched a mobile app that seamlessly integrates the money transfer and calling services. BRMT collects revenue via transaction fees from customers and benefits from some currency fluctuation. Revenue growth has been strong (>100% from FY 2019 to FY 2020) and I suspect the business might be at breakeven/slightly profitable over the last two quarters. BRMT competes with both traditional retail based money transfer services like MoneyGram (MGI) and Western Union (WU) as well as digital-only offerings like Xoom (a PYPL service), TransferWise, Remitly, and World-Remit. When thinking about the valuation, I don’t think that MGI and WU are good comps given their brick and mortar footprint (and MGI seems like kind of a debt-laden tire fire) and the fact that BRMT is doing the majority of their business digital DTC (app or web) already. The digital-only comps are all private with limited valuation information, with the exception of Xoom which was acquired by PayPal in 2015 for ~$900M. From what I was able to find based on private valuations and reported user bases, the digital-only comps are valued at anywhere from $375-700 per user. I’ve not found any disclosure of the user count for BRMT anywhere, so we will need to make assumptions about that to get to a valuation. The Boss Revolution Calling business claims 3.7M monthly users and thus far BRMT’s marketing focus has been cross converting Calling customers into their user base. Let’s assume they can convert just 25% of those users (and ignore any potential new customer acquisition) and let’s give them half the valuation credit of their lowest rated private peer (WorldRemit, who recently raised at a $1.5B valuation with 4M users = $375/user). So we’d conservatively value BRMT at $375/2 * 25% * 3.7M = $170M. That works out to about 4x sales, which seems pretty conservative to me for a business that grew >100% YoY with plenty of avenues for additional growth (onboarding additional retail partners, acquisitions, etc.). As for what I really think a reasonable valuation might look like, your guess is as good as mine but “payments” in general is a hot space right now. A higher conversion rate for Calling customers (or god forbid brand new customers), fuller valuation credit relative to peers, or sustained revenue growth anywhere near their current pace – or  any combination of these things – would pretty easily get to something like management’s midpoint estimate ($300M) IMO.

National Retail Solutions (NRS) is a POS terminal system marketed to independent convenience, liquor, bodega, etc. stores. NRS is the youngest and smallest (by revenue) of the IDT “growth” lines of business, but has seen strong adoption thus far. IDT builds the terminals in house and charges $20/month per terminal to customers. They estimate their target market of independent store so be approximately 200k locations in the U.S. As of the end of January 2021, NRS had about 13k terminals across 10k retailers and projects to add 1k terminals per quarter (however, this seems a bit aggressive relative to actual results over the last few years). NRS also derives some revenues from display advertising and data/analytics resale, which should both compound in value as the network grows. IDT mentions time and again in their commentary that they believe their specific target market is underserved by more mainstream competitors like Square, Clover (owned by Fiserv), and NCR. That makes some sense to me as the IDT target market is fragmented and likely too small to move the needle for significantly larger organizations. Management cites a 7.5x-10x estimated revenue multiple based on peers (and also on 2021 FY projected revenues), which seems aggressive to me. Something like 3x revenues feels fair given the growth profile and potential runway here, which would land us at a bear case valuation of about $60M. Management’s low end estimate would peg valuation at about $150M and I have no reason to think that’s not possible, so let’s call that the optimistic scenario.

The last piece of IDT that should be discussed is the Net2Phone (N2P) business, which is a unified communications platform (which IDT refers to as Unified Communications as a Service – UCaaS) that allows businesses to manage their phone call, text, and chat traffic via one integrated application across the entire organization. Net2Phone also offers analytics/reporting capabilities as well as third party integrations like Salesforce, Slack, Zoho, and MS Teams. Since its U.S. launch in 2015, N2P has expanded to major South American Markets (Brazil, Argentina, Columbia, Mexico) and Canada (2018 acquisition) and Spain (2019 acquisition). IDT notes that they are specifically targeting new markets based on high market fragmentation, low UCaaS penetration, and general lack of attention from global market leaders. IDT cites future growth potential via increased features, new APIs, additional third party integrations, increased focus on specific industry verticals, and even a potential DTC offering (they recently launched some video chat functionality). N2P is playing in space that feels pretty crowded to me, especially with larger and more established players like Vonage (VG), 8×8 (EGHT) and RingCentral (RNG). But I appreciate that IDT is pursuing lower hanging fruit, rather than trying to compete head to head, and seems to be having some level of success. N2P is on course to do about $35-40M in revenue for FY 2021 and has been growing 20-30% YoY. I think N2P (and to some extent, this whole UcaaS trend) is still in the early innings from a macro perspective as several of the other publicly traded players in the space seem to be enjoying solid growth as well (even pre-COVID). To some extent, UCaaS looks to me like any other tech vertical nowadays – reaching critical mass in terms of customers will make or break the long term economics and viability of the individual players. To that end, you can see that IDT has accelerated their investment in the business as costs and capital deployed for acquisitions have really ramped up in recent years. Although there have been no disclosures of imminent plans, IDT has pretty decisively signaled that N2P is the next spinoff from the mothership. The story should be relatively easy to market to investors as a stand alone entity, the question is what kind of reception to expect from public markets. Management cites a 5-10x revenue multiple based on peers, and the public comps above seem to suggest 4-8x – so we are in a similar ballpark. At the lower end 5x multiple on today’s revenues we get to a $175M valuation and at a more aggressive 8x multiple we get $280M. This feels like a reasonable range to me right now.

Now, I know that was a lot to digest and, to be honest, it only scratches the surface of each of the underlying businesses. But the big picture here is that if you take all those valuation figures and put them together you get range of $525M to $850M which, as I mentioned in the section on the legacy communications business, ignores a lot of the optionality at the IDT holdco given it’s rock solid financial position and strong leadership. But given this valuation range you’re looking at a pretty limited downside and modest to significant upside in company that has a habit of creating it’s own catalysts.

The Bad:

There are two or three key issues I see with IDT. First, as I acknowledged above, I am pretty wary of assigning revenue multiples to businesses as a means of valuation, even if done conservatively. I could completely understand some level of skepticism applied to any of the comps or theoretical multiples discussed above. But I think that is just baked into the situation here. We are trying to value sub-scale businesses that are not ready to be standalone entities yet. Part of why this write up is absurdly long is that I wanted to provide context beyond just revenue multiples for each of the underlying business lines. As I alluded to previously, I think you could have any one (or multiple) of the businesses turn out to be less valuable than anticipated but still have a good outcome if another one is a homerun. Again, I sort of view IDT as a collection of embedded call options on any of the businesses creating a ton of unexpected value.

I mentioned above that Net2Phone will likely be the next spin (more on that reasoning below). Once N2P is spun, you’ll be left with the legacy communications business, NRS (the POS network), and BRMT (the money transfer business). To me, N2P makes a ton of sense as a standalone business – it is more of a true software business with lots of potential for growth and seemingly limited synergies with any of the other businesses beyond normal corporate overhead. Theoretically the next two options for future spins will be NRS and BRMT, but after having dug into those there seems to be tighter integration with IDT’s legacy communications business. For instance, the money transfer service is braded under the same name as the consumer facing calling service (which is part of the legacy communications line of business). To that end, consumers access both products via the same app and, in my mind, think of them as basically the same integrated service. I think that makes it pretty awkward to spin BRMT into a standalone when it shares the same app/consumer mindshare with a line of business left back at the IDT mothership. Alternatively, I suppose you could spin the calling business along with BRMT, but that probably complicates the narrative and reduces the “sexiness” of the payments angle for investors. Shifting back to NRS, I think we are a ways off from realistically considering that for a spin candidate. It’s still in the very early innings and I presume it has pretty different economics from any of the other businesses. NRS, too, seems to have pretty close ties with the legacy business in that they are targeting the existing retail footprint of the Boss Revolution products. In my mind, it remains to be proven if NRS can build out a large enough customer base to be viable long term. The Boss Revolution consumer calling product is distributed through 26k retail partners while management cites the 200k potential market for NRS. Even assuming 100% overlap between those two customer bases, I’m not sure we have enough info at this point to know if NRS growing to exactly the same footprint would be enough to be valuable as a standalone entity. I guess my large point here is that there is a pretty clear path to Net2Phone’s spin while the timing and prospects of the next catalyst(s) (i.e. spins) are a little less certain.

Joe was also on another one of my favorite podcasts, Andrew Walker’s Yet Another Value Podcast, to talk about another Old West holding (WildBrain). Early on in the pod, they chat a little about IDT/Howard Jonas and Andrew brings up the point there is some question about the fairness of IDT/Jonas dealings with minority shareholders. I think Andrew raised a fair question here. In the pod, he cites the recent 8-K that IDT filed announcing that Howard and Shmuel (Jonas, current CEO and son of Howard) were each granted 5% equity in the Net2Phone business. The grant is subject to meeting certain operational criteria (doubling run rate revenue and a $100M valuation) and only exercisable in a spin, sale, IPO, etc. It’s great that there are some strings attached here, but that’s 10% of Net2Phone that IDT has given away to two insiders (not even spread across the management team) and the bar has been set pretty low, IMO. The SOTP graphic above is from the company’s December 2020 investor deck and this grant was announced in early October. Notice that management already expects the value of Net2Phone to be well above the $100M criteria specified in the grant and, given the resources being allocated to N2P, I don’t expect the revenue goal to be difficult to achieve in the next couple of years either. To me, this looks like more of a reward than an incentivization tool. Now it’s pretty hard for me to know whether the Jonases were crucial to the success and future trajectory of N2P but apparently the board felt that way. Perhaps it’s a little heavy handed, but I guess at the end of the day IDT shareholders will also do well if N2P is successful. On a separate note, Howard Jonas and IDT are also involved in litigation related to the sale of their Straight Path spinco to Verizon in 2018. Several institutional investors allege that Jonas personally hijacked the company sale process in order to ensure IDT avoided certain liabilities related to FCC violations that Verizon would later pay $600M to settle. I’m not exactly sure what to make of this, but I highlight both of these issues to make the point that although Jonas and company appear to be talented value creators, it’s important to go into the situation with eyes wide open about the incentives and motivations of those in control. For me, it ultimately comes down to the fact that as a fellow equity holder, if Jonas and family/insiders are prosperous then I should be too.

The Key Variables:

  • Continued progress of Net2Phone –  As the obvious next spin, the continued success and growth of Net2Phone will be of particular interest. I also hope/expect that IDT will continue to be more transparent around N2P’s reporting and guidance ahead of a spin.
  • Deterioration of the legacy communications business – a severe decline in economics of the legacy business could be problematic. IDT has acknowledged that they are maximizing profitability here but if the money faucet gets shut off it becomes much harder to feed their growth-oriented businesses.
  • Roadmap for NRS & Money Transfer businesses – I think the NRS plan is fairly straightforward, simply roll out more installs and build the customer base. For Money Transfer it would be nice to see some signaling or outright communication about the intentions with that business. As I have stated above, I think the monetization of that business line is less clear at the moment.


If you’ve made it this far, I am grateful. This is by far the longest write up I have ever done and took me 2-3x as long as normal to actually write. Unfortunately, as a result of the extended writing time, the company has run quite a bit since I started writing (and since my initial purchase). And that is in addition to a meaningful surge in the shares over the last few months (notice that the investor presentation graphic above shows a current EV/share at the time of $8.35!). Still, as I hope I have made clear by now, I think this is still a great opportunity to own some undervalued assets and ride shotgun with some great capital allocators. I put IDT into the portfolio at ~8% position at cost and consider it part of my mean reversion/deep value bucket of the portfolio. GLTA, DYODD and feel free to reach out with thoughts, questions, or comments.


2020 Year End Update Extravaganza

Happy New Year to all – I hope that your 2021 is off to a great start and treating you better than 2020. As I mentioned on Twitter towards the end of the year, the last month or two of 2020 were very quiet for the blog and portfolio. I was swamped with work at my day job and trying to enjoy what little free time I had during the holidays. Now that I’ve had a bit of a breather, I am refreshed and ready to get 2021 kicked off.

I am a little late getting this update out so, much like your gluttonous eating habits over the holiday season, I suspect you have already gorged yourself on a buffet of vague market platitudes and are leery of another heaping helping of hindsight bias as has been offered on Fintwit. So I will skip the rambling commentary and get right to the specifics. I’ll talk a little about performance and then give a brief update on each position in the portfolio. I also want to discuss some of my bigger blunders this year, so we will cover that towards the end.

If you haven’t already, be sure to check out the portfolio page, which has been updated through 12/31. I closed the year out at +51% for 2020, which is pretty hard to believe given the course of events that unfolded. Despite the eye popping numbers coming out of some corners of Fintwit (looking at you, SAAS guys), I am extremely pleased with this outcome. The year started a little wobbly with Q1 escalating into a full blown crash by the end of March. The few percentage points of outperformance during this period were mostly because I wasn’t fully invested – had I been fully deployed I don’t expect I would have faired any better than the R2000 or RMicrocap. A ton of the performance this year was driven by two stocks, which I have covered on the blog before: Gravity (GRVY) and Collector’s Universe (CLCT). Performance over the summer was especially strong as both of these position really started to take off and continued to hold strong through the end of the year.

Next, I thought I would give a very brief update on each position in the portfolio. If there is a corresponding write-up I will be sure to link to it below. I generally write names up as I put them into the portfolio, but there are several that do not currently have full  write ups – one of my projects for 2021 is to remedy this. I am also going to sort names by which of the 3 portfolio “buckets” they fall into. If you want more info on how I think about the different sections of the portfolio and my general investment philosophy, check out this post.

Special Situations (target % = 10-20%, current % = 6%):

Rubicon Technology (RBCN): So far, so good with RBCN. There’s not much to update here outside of what I have already written on the blog.

Cellular Biomedicine Group (CBMG): CBMG is small merger arb position that I haven’t gotten around to writing up in the blog. This is a management buyout situation with some outside private equity fund involvement. Management has been trying to pull together a deal for over a year now and seems to be pretty close as they have a special shareholder meeting lined up for February 8th to vote on the current $19.75/share offer. If all goes according to plan, CBMG will return about 15% from my entry price in mid-November.

PDL BioPharma (PDLI): H/T to @AlphaVulture on this liquidation situation. I would have never found this or invested had it not been for their great write up on the situation. [Full disclosure: at this point the stock doesn’t trade anymore as the company is liquidating, but I still recommend reading AV’s write up for the though process and analysis.]

Mean Reversion/Deep Value (target % = 40-60%, current % = 57%):

MSG Networks (MSGN): MSGN has been an interesting ride. My largest tranche of capital was invested in December 2019 with two smaller additions in January and February of 2020. Although I am now approaching break even on the total position, I could have had the shares at a much cheaper price shortly after I stopped buying, when COVID hit. This was one that I really wanted to add to during the COVID drawdown but I had already hit my personal limit for averaging down. In my short time as a shareholder, MSGN has continued to do dumb Dolan stuff like add James’ son (also a musician) Aidan to the BoD. Despite this, I still think this is an incredibly attractive situation. The company trades at a mid-single digit trailing P/E, they continue to pay down debt and buy back stock, and here in the early days of 2021 there have already been serious rumblings of legalizing sports gambling in NY which could be a meaningful tailwind for the business.

Ituran Location & Control (ITRN): ITRN is probably the name I feel the least confident about. COVID has been difficult on the business as people across the globe have been travelling less and therefore providing less demand for the company’s telematics products/services. Their international operating results, particularly in Brazil and their recently acquired Mexico venture, have been disappointing. I think there’s a lot to be optimistic about here: they are adding new product lines (like telematics integrated with auto insurer’s offerings), they are exploring exciting new markets (JV in India), and there is potential for substantial re-rating of the business as the Latin American economies normalize and their Mexican JV integration begins to bear fruit. If I had to choose a name that was closest to being sold in the portfolio, ITRN would probably be it.

Gravity (GRVY): 2020 was an incredible year for the Korean game developer/publisher and I think 2021 could be another big year. GRVY has a lot of momentum going into the year as they continue to launch new games (with notable success) and explore new partnerships across their various geographical markets. At this point it’s hard for me to envision adding more to my current position, but I also don’t think GRVY is at insane valuations relative to peers.

Namsys (NMYSF/CTZ): Namsys is one of the names I have not formally written up in the portfolio, but probably one of my favorites. They are a small Canadian software company that builds cash management products for “cash in transit” (CIT) service providers (basically armored truck companies, most notably Brinks $BCO) as well as multi-location retailers and banks. From a price action perspective, 2020 was pretty choppy for Namsys but I continue to be intrigued by this situation because of the consistency of growth and the niche nature of the business. NMYSF is intriguing but has a few notable wrinkles. The aforementioned Brinks is a key relationship that presents customer concentration that could be viewed as a potential threat or huge avenue for growth. The company also has a long term employee bonus plan that dictates that when 50% of assets or shares of the company are sold/transferred OR an outside party crosses 20% ownership, the company owes the employees and officers 15% of the transactions consideration. I always found the bonus thing to be quite odd, but I suppose it was a way to entice high-demand technical talent to work for a tiny (<25 employees IIRC) Canadian SAAS company. Anyway, there’s a major shareholder that is getting close to tripping the bonus and there’s a bit of a time crunch based on the when certain parts of the bonus pool are to be paid. So 2020 was pretty interesting based on these shareholder developments but I expect 2021 will likely be even more interesting as things catalyze one way or another.

Collector’s Universe (CLCT): CLCT was a situation in which my timing could not have been better. I added the name to the portfolio in April after having my eye on it for quite awhile. I was able to buy just ahead of Alta Fox’s activist campaign going public, which brought tons of attention to what I thought was a mis-managed company with lots of potential given a number of emerging tailwinds in the current market environment. Although the shares look a bit expensive o a trailing basis, I think Alta Fox (and others) have laid out compelling cases for value creation in the near to intermediate term. Late in the year, former Alta Fox board candidate and avid card collector Nat Turner joined forces with Steven Cohen and other PE backers to bamboozle the CLCT board into giving away the company at an underwhelming $75.25/share price point. But several large shareholders have now indicated that they plan not to tender, so early 2021 will likely hold some interesting developments for CLCT as well.

Long Term Value (target % = 40-60%, current % = 31%):

Constellation Software (CNSWF/CSU): Constellation is another name I have never really discussed on the blog. That is largely because I have nothing to add to the public discourse and do not believe I hold much of a differentiated view. I also feel quite guilty that it does not really fit my microcap/smallcap criteria for the portfolio, but I simply cannot help myself when it comes to this company. I love the management team, culture, execution, opportunity set, etc. that Constellation presents. There are many that are trying to execute the exact same strategy but even when I develop a wandering eye, I am never as smitten with any other VMS rollup as I am with good old CSU. Constellation is a portfolio holding that I rarely think about at all and will probably hold for a very long time. I am currently awaiting my Topicus shares with baited breath…

IAC (IAC): IAC was another addition during 2020. I’ve long admired the company and kept fairly close tabs on it but the MTCH spin earlier this year presented too tempting an opportunity to pass up. IAC is another holding that I feel quite guilty about because of their market cap, which is well out of the small/micro cap range. But ultimately I think of this portfolio and my whole “value” orientation to be more about finding misunderstood opportunities – it just so happens that those occur more frequently in small/microcaps so that is where I focus my efforts. But mid/large caps can have the same problem – especially in the much maligned SOTP situation. Where IAC gets the SOTP problem right is by trying their hardest to force those value gaps closed with spinoffs. That and the impressive track record of Diller and Levin were just to much for me to continue to pass up when I added the position in the late Summer. I could certainly see myself adding more to this position over time, perhaps even in 2021 depending on how the Vimeo spin goes.

Dream Unlimited (DRUNF/DRM): Dream was a new addition this year that I have written about on the blog. Not a lot to update here as the management team continues to execute and the market continues to ignore.

Terravest Industries (TRRVF/TVK): Terravest is another one of the names that I have yet to cover on the blog, but that I hope to remedy in 2021. This Canadian small cap is basically an opportunistic small-scale roll up strategy in the energy services space and is lead by a capital allocation-focused management team with ties to another very interesting Canadian investor, George Armoyan (and his Clarke holdco). The company selectively acquires small niche service providers and manufacturers in the general oil & gas services domain for extremely cheap valuations. Aside from the COVID disruptions and general malaise that hung over the energy sector in 2020, the year was surprisingly quiet for Terravest. Operating results were roughly within expectations (that is to say “good” given the conditions but not particularly exciting for any other year) but I really thought they might get the chance to scoop up some good deals after Q1.

OK now that we’ve run through the portfolio and talked about performance, I want to quickly re-visit some mistakes from the year:

  • Sold Yellow Media (YLWDF) @ $5.00/share on 4/6/20: this ended up being just about the worst possible time to sell Yellow as shares have rebounded to ~$9.50 as I write this. If all I had done was held, it would have turned my 30% loss to a 30% gain. I mentioned it in one of the portfolio updates during the year, but my thinking was that they were going to start bleeding customers uncontrollably (they provide a suite of digital marketing, website maintenance, etc. services to small businesses in Canada), which had been their whole problem to begin with. Even before COVID their customers were dropping them which is why the multiple was so low to begin with. From reading through management’s comments and the financials, I still don’t fully understand why they didn’t struggle more. My thinking was that marketing budgets would be the first thing cut in a pandemic, but it doesn’t seem to have effected them. It’s still puzzling to me, which is the only reason I haven’t re-entered the name (it still looks incredibly cheap and could still be at an inflection point with their turnaround). Still not sure what the lesson is here – I felt like this was a good opportunity (and might still be) but something just isn’t making total sense to me.
  • Sold FitLife (FTLF) @ $11.00/share on 6/1/20: this reasoning was very similar to my logic on Yellow above, namely that the pandemic would be extremely detrimental to the business. But I think this was just a case of not doing enough work to build my conviction sufficiently. I thought FTLF was already in trouble because their primary retail partner GNC had filed for bankruptcy – not only because of potentially unrecoverable receivables but also because I thought it was meaningful part of their distribution. Plus, although FTLF has ample online distribution, I assumed from personal experience with nutritional supplements that brand loyalty would be relatively weak and the demand would not follow to the digital space. Not only did this proved to be wholly inaccurate, but the economics of online/DTC distribution were significantly more favorable for the company. As a result, they turned in one of the strongest quarters in company history in Q3. The shares currently sit at $21, which would have been a 45% gain had a held instead of a 25% loss. This was a small position for me, but I think the takeaway here is to really be sure about the level of my conviction before I put anything on or decide to bail. I think I could have looked a little harder at this and built the resolve not to sell.

Updates on other posts/non-holdings:

  • Aaron’s separation: In September I wrote a quick post about the upcoming lease-to-own retailer Aaron’s split into two distinctly traded entities. The structure/naming convention was a little confusing but ultimately the company split into Aaron’s (AAN), which remained the legacy lease-to-own business, and PROG Holdings (PRG), which is a much sexier consumer financing business, on November 25th. At the time, my conclusion was that I saw the business logic in the separation but didn’t see a clear path to a lot of market value creation – so I elected not to buy any shares. The current market cap of the two companies combined is about $4.5B vs. about $3.5B when I wrote it up on September 8th. That’s about a 30% gain if you bought in early September, but is roughly in line with mid and small cap indices’ performance over the same time period. It’s a relatively short period of time, so I don’t know that there are any big revelations to discuss here, but the situation has roughly tracked with my expectations. There is still plenty of time for PROG’s shares to really take off and make me look like an idiot, but so far so good.
  • StoneX (SNEX): StoneX was another name that I devoted a lot of energy to and wrote about, but could not ultimately get on board. I still think the company is very interesting and has a lot of attractive qualities. Since the write up shares are +10% and about +15-20% from when I was doing my initial research. Even then, I think I was a little late to the party – the price was already up pretty significantly before I heard @puppeh1 discuss it on a few podcasts. Not much else to say here other than I continue to keep an eye on the company.

So there you have it. I know that was probably boring, but thanks for suffering some additional naval gazing here at the beginning of 2021. I am looking forward to another year of research, posts, and interaction with all of you. Please do not hesitate to reach out to me on Twitter or leave a comment here on the blog – I always enjoy talking to readers and fellow Fintwit folks.

Thanks for reading.


November Portfolio Update

The second half of 2020 has been eventful for the portfolio in very different ways than the first half, so I thought it was time for a quick update on a few positions. Overall I’ve been pretty pleased with YTD performance but, in hindsight, there have been some obvious mistakes that I will probably explore in more detail in a separate post later in the month. For now, here are some updates in chronological order:

  • Sold Central European Media (CETV) 9/1/20: This was a merger arb position that I wrote a little about in late June. The spread closed quickly once the acquirer (PPF) finally got around to officially filing with the European Commission thus signaling their intent to move forward. In retrospect there was still a little more juice to squeeze here but I’d captured the bulk of the returns and was ready to move on. 24% in < 3 months is fine by me.
  • Sold Fuling Global (FORK) 9/1/20: This was another “arb” position on a Chinese manufacturer that I never got around to writing up but did tweet about (shameless plug to follow me on Twitter if you don’t already). I say “arb” because it was total speculation on a quick repricing of a management buyout offer. Management (and existing controlling shareholders) lobbed in an offer on 6/22/20 that was a 6% premium that was already optically cheap. The thing was basically already left for dead here in U.S. markets and dirt cheap (assuming it wasn’t an outright fraud) so a take private made a lot of sense. With the acquirer being so deeply involved with day to day operations already, it looked to me like a call option on the board behaving like a real, independent board (possibly a big ask for a Chinese company, but the downside was pretty muted). They ultimately negotiated a slight bump from $2.18/share to $2.35/share and I closed at $2.30 for a 9% return in a little over 2 months (weirdly, I coincidentally opened and closed CETV and FORK on the same day).
  • Bought Rubicon Technology (RBCN) 10/15/20: write up here
  • Partial sell of Collector’s Universe (CLCT) 11/3/20: I trimmed my CLCT position at $65/share, which now looks pretty silly given yesterday’s news that the company has been offered $75.25/share in a take private transaction. The trimming had nothing to do with my intermediate/long term view on the firm at the time (or now) and was mostly a risk-control function for the portfolio. CLCT had gotten to >20% weight in the portfolio. In this situation, I was a little uncomfortable with that and am fine taking some chips off the table from time to time, especially when sentiment has shifted so radically in such a short amount of time. Regarding the take private deal by Cohen, Turner, et al., the press release cites a 30% premium to VWAP but that’s a measly 4% premium to close prior to the announcement. A lot of CLCT’s run this year has been driven by renewed interest in the company thanks to Connor/Alta Fox and (I believe) the emerging market view that CLCT was a play on COVID trends (accelerated interest in the collectibles space). I think it’s clear that there is still a ton of value that could be captured moving forward and that $75.25/share is an absolute steal for the private investor group given the untapped potential here. I can’t say that I’m surprised that management is trying to give the company away given their already mediocre track record. I’m not sure what to make of some of the language in the filings but I will be extremely surprised if the deal gets done anywhere near $75.
  • Bought additional Dream Unlimited (DRUNF) 11/12/20: No real epiphany or antyhing here, I just continue to build confidence in Dream and like what they are doing. I wanted to make it a little larger position, despite buying at prices +20% above my initial purchase, so I added just a little more in the middle of the month.
  • Sold FitBit (FIT) 11/23/20: I also exited my arb position in FitBit. Like CETV there was a little more profit to be had, but I felt that I’d gotten enough (~13% in 6 months). Also, I’m not sure how much longer this situation drags out given that all of the big regulators seem to be in a Mexican standoff with their global peers waiting for someone to try to stop this deal.

There you have it. All in all it’s been a great few months for the portfolio from both an absolute and relative return perspective. It’s quietly turned into a very nice year for the broader small/micro cap universe as well. Hopefully we can all hang onto these gains through a nice and quiet December.

Happy Holidays and GLTA


Rubicon Technology (RBCN)

  • Rubicon is a left-for-dead net-net in the midst of a multi-year turnaround
  • The company is trading below the net cash value on the balance sheet and is now under control of several capable allocators

The Numbers:

Price $8.45

Mkt Cap $20M

EV -$5M

Net $/share $10.20

The Company:

Rubicon Technology (RBCN) is a microcap based in Bensenville, Illinois that specializes in the design and production of monocrystalline sapphire products for optical and industrial applications (such as windows, optical systems, and use in semiconductors). Prior to 2016 it also sold its products to LED and mobile device manufacturers, but elected to exit that business as a result of competitive forces. Despite a long and, at times, profitable operating history RBCN fell on hard times beginning in 2012. From then on it has posted only one profitable year (2018), fought off a delisting with a reverse split, and saw the departure of numerous management team and board members – all while struggling to “right-size” its production capacity and refresh its business strategy. Today the company is controlled by a cadre of smart allocators that are pivoting the business and monetizing assets, all while trading for well below the value of cash on the balance sheet.

The Good:

This is usually the section of the write-up where I talk about the juicy margins, the interesting business model, or some hidden growth potential. There’s none of that here. It’s pretty clear to me that the future of RBCN looks radically different than it’s past and does not involve sapphire production.  Since 2016/2017, several notable activists have established significant positions in RBCN and begun the turnaround process. Their progress has taken awhile to unfold, but has included: replacing the previous management team & board, monetizing underutilized assets and protecting NOLs, as well as one small acquisition. Before we get too far, let’s run through the folks involved:

  • Timothy Brog (3% of shares) is the current CEO of RBCN and the MD of Locksmith Capital. I don’t know much about Mr. Brog or Locksmith but some quick Googling tells me he has turnaround/deep value experience and at least one good outcome (Peerless Systems PRLS) in the recent past.
  • Jeff Gramm/Bandera Partners (11% of shares) is on the board. Full disclosure I’m a big fan of Jeff’s and if you haven’t read his book Dear Chairman on shareholder activism already, I highly recommend it.
  • Sententia Partners (6% of shares), most recently of Schmitt/Ample Hills Twitter fame, are also involved.
  • Aldebaran Partners (6% of shares) is also listed as a major shareholder. Don’t know much about them, but Google tells me they are a Graham-style value outfit out of Indianapolis

Over the course of the last few years RBCN has shuttered a lagging business line and monetized a number of real estate (and other) assets under current leadership. I’ve not been able to find much in the way of commentary from management or those involved but ti’s pretty clear to me that the incentives are aligned here. Check out the disclosures on compensation incentives for Mr. Brog as outlined in the most recent DEF14 filing:

“In 2019, Mr. Brog was eligible to earn up to 40,500 shares (the “2019 Objective Bonus Shares”) of the Company’s common stock if certain goals were achieved. While Mr. Brog’s 2018 goal for earning his bonus was based solely on preserving and building capital through liquidation of assets, management of short-term investments, and reductions of liabilities, his 2019 goals included several specific, and more qualitative, targets that the Board believes are critical to the long term success of the Company. There is no set formula to weight the importance of each target — the Board will consider Mr. Brog’s performance in relation to all three targets when determining the amount of his bonus.

Goal 1: Progress towards an acquisition

The Board wishes to incentivize Mr. Brog to further develop the Company’s acquisition pipeline, with the ultimate goal of finding suitable acquisition targets and eventually closing a transaction. To achieve Goal 1, the Board wants to see material progress from Mr. Brog in improving deal-flow and allocating more time to the search for acquisitions. A signed purchase agreement or the actual consummation of an acquisition would also satisfy Goal 1.

Goal 2: Signed purchase agreements for the Malaysia properties

The Board believes the Company’s assets in Malaysia continue to be an unwanted distraction from Rubicon’s domestic operations. Mr. Brog would achieve Goal 2 by negotiating and signing a purchase agreement for one or both of the Malaysia properties with Board approval. Material progress in finding a buyer for the properties will also be considered by the Board for achieving Goal 2.

Goal 3: 2019 Year-End Cash

Similar to in 2018, the Board wishes to incentivize Mr. Brog in his efforts to preserve capital.”

Even if Mr. Brog hadn’t accomplished these goals (he did), this still signals to me that everyone involved is on the same page and rowing in the same direction. Notice also that goal number one is pretty relevant to the future trajectory of the company. RBCN announced in May of 2019 that it had acquired the assets of a Indianapolis pharmacy and launched “Direct Dose RX” which will be “focused on the delivery of prescription medication, over-the-counter drugs and vitamins to skilled nursing facilities and hospitals for patients that are being discharged” with licenses to operate in 11 states. I can’t seem to find a purchase price disclosed anywhere and based on the revenues that RBCN has begun showing in the financials the progress has been minimal, but I think this is a signal about how the company plans to move forward – taking interesting shots at new business lines completely outside the realm of their current/historical industry.

The Bad:

Probably the biggest question in my mind with RBCN is why bother continuing the old sapphire business at all. They exited the LED/mobile device business in 2016 but the remaining line sounds very similar. The space sounds competitive, they have high customer concentration, there’s commodity pricing elements to the business that make costs hard to predict, there’s high capital intensity, etc. My thought would be to shut it all down entirely and start fresh with your cash pile. Although I can’t find it mentioned in the filings, the only guess I can make is that they are locked into some supply contracts that would be prohibitively expensive to break and therefore have to see them through. Whatever the case, personally, I wouldn’t mind seeing the sapphire business go away entirely.

To play devils advocate, one might also question the Direct Dose RX acquisition in general. It looks to be relatively small ($300k in revenue over first 6 months of 2020) and unprofitable at the moment, plus I assume it will consume some capital to get it up and running. In the end, one could wonder how meaningful this could even be to the financial results. However, my opinion is that it’s probably just too early to tell on this one and at the end of the day you have to trust the judgement of the management team and board.

In a lot of ways, owning RBCN is a “bet on the jockey” situation. You’re hoping that these activists can come together and generate some value for shareholders, and there’s a lot of potential here. They’ve got $25M in cash plus some other assets and NOLs to work with, a pretty low burn rate on the existing business (about $2-$3M/yr in losses as far as I can tell), and a rock bottom valuation (which they have been taking advantage of by buying back shares). It’s a real turnaround story, but I like the odds of something good happening.

Key Variables to Monitor:

  • Continued monetization of legacy assets – they recently completed the sale of some Malaysian real estate and have a number of other real estate assets to divest.
  • Cash conservation/burn rate – moving forward I’ll be keeping a close eye on cash levels and the profitability/costs of the legacy business which could all impede further progress on the turnaround
  • Progress on acquisition(s) – obviously the big catalyst here is the completion of an acquisition of some sort which might prove to be challenging in this environment given the dry powder in the hands of private equity firms and SPAC management teams right now.


In my writeups I typically try to give some estimate of upside and downside but net-nets are a weird corner of the market where the valuations are already illogically low, so I’ll punt on the valuation part this time around. But suffice to say I have a hard time seeing the valuation get much lower than this and I see a ton of upside potential given the opportunity for a quick shift in the narrative around the company. Take for example the aforementioned Schmitt Industries (SMIT) which has appreciated ~50% since announcing their acquisition of Ample Hills Creamery in July. While not a perfect comparison, I think that shows how quickly things can change with these “left-for-dead” microcaps.

I hope that I’ve made the investment case obvious for RBCN, but obviously DYODD. This falls into my “special situations” bucket in the portfolio and I’ve put it in at ~3% position but am looking to add on any pullbacks.

Thanks for reading!


Gravity (GRVY) and Hidden Value

Gravity is one of the names in the portfolio that I haven’t officially written up here on the blog, but has really carried the portfolio (along with CLCT) over the last few months. I haven’t taken the time to do a full write up on it because I personally would not be comfortable initiating a new position anywhere near the current prices, so I didn’t feel that there was much value in it for readers. GRVY is up about 260% YTD and +300% from my initial purchase a little over a year ago, so maybe it would have been more valuable to write it up than I thought. Nonetheless, this post is not meant to be a victory lap in any way. Instead, I want to use Gravity as an example of a concept I’ve been thinking a lot about lately: hidden value, specifically franchise value. I don’t mean “franchise value” like the way people think about Apple (i.e. brand), but “franchise value” as in valuable (and in this case undervalued) intellectual property.

Gravity is a South Korean small cap game developer/publisher with a focus on mobile games. Their primary asset is a 20 year old piece of IP called Ragnarok, which has taken many forms over the years but whose most popular incarnation has been as a fantasy-based MMORPG whose primary player-base is focused in southeast Asian markets.

EDIT: It should be noted that Gravity does not, in fact, own the Ragnarok IP outright, but instead have a licensing agreement with the content creator. According to their 2019 20F filing this agreement ends January of 2033. While this fact is pertinent to the long term investment case for GRVY, I felt it was beyond the scope of this post. As always, do your own due diligence. (h/t @gamesinvest)

Assault! Ragnarok - Gravity holds media conference to preview new game -  MMO Culture
Promotional art for one of Gravity’s most popular properties Ragnarok Online
System I, 0900 Job 
System I GetZenyx3000 
System I 
cart Attack!! 1 
Gameplay screencap from Gravity’s Ragnarok M: Eternal Love

At the time of my initial purchase GRVY was trading at <3x trailing EV/EBITDA and <5x trailing P/E. At first glance, it was undeniably cheap but for a laundry list of valid reasons:

  1. It’s a small cap – even now with the run up in price its market cap is sub-$1B
  2. Despite it’s NASDAQ listing, it’s headquarters is based in Seoul, South Korea and primarily operates in SEA markets – all things that I suspect to be deterrents for American investors
  3. It’s a controlled company – Japanese game developer GungHo Online owns ~60% of GRVY shares
  4. From it’s NASDAQ IPO in 2005 to 2016, the stock was down ~95%, rendering it effectively dead to most investors
  5. The company has failed to pivot away from the success of the Ragnarok franchise into any other successful properties of note
  6. With their 2018 annual filing, the company disclosed material weaknesses in their accounting controls and  introduced remedies to address the situation
  7. From a personal perspective, I find the gaming (especially mobile-based) industry generally unattractive. My perception is that game development is expensive, predicting the success of any given game is extremely difficult, and the entire industry is subject to whiplash-inducing fluctuations in consumer tastes. I think GRVY financials are evidence of this – quarterly revenues, profits, etc. are extremely variably from quarter to quater due to sporadic launches of new titles and staggered roll outs across geographic markets.

Despite all of this, I thought I recognized something interesting about Gravity. Growing up, I was intimately familiar with a similar franchise that perhaps you have heard of: Pokemon. Although you may not realize it, Pokemon is widely reported as the highest grossing media franchise of all time. While I am in no way implying that Gravity’s Ragnarok property could approach anything close to Pokemon’s value, I do think there are some similarities to the business mechanics. Specifically, the content strategy is pretty simple: every few years you refresh the property with some new content/characters/storylines and release a whole slew of new products (in Gravity’s case new games/expansions). The only limits to the amount of marginal content is your imagination, beyond that you need only to make the economics of additional products work. I was encourage by the simple fact that Gravity had survived as a growing concern for nearly two decades on this IP alone – clearly there was some longevity to the property, some “franchise value.”

When you think about it, the strategy is pretty obvious. Once you have some demonstrated success with a property, you reheat that content and serve it up in as many varieties as possible. Pokemon’s catalog of content, for instance, includes trading cards, comics, cartoons, movies, video games, licensed merchandise, etc. Gravity’s Ragnarok is still limited just to video games, but the principle remains the same – there is always room for expansions, add-ons, bonus content, geographic-specific content, and so on. But all of that only works if you have a nostalgia-fueled base of loyal fans, which I would propose that a 20 year track record validates. Beyond that you must also consider the upside optionality of finding traction with a new generation of fans. Every release, every expansion, every launch in a new geographic market is an opportunity to bolster that base and create new devotees. Of course, the holy grail is that someday Gravity/GungHo set their sights somewhere outside of the realm of video games and start leveraging the content in other media formats.

The problem here is that franchise value like this isn’t captured on any balance sheet – it requires some abstraction from the financials. I found the Pokemon comparison to be useful, but the fact is that there are any number of other franchises with similar mechanics (sports franchises like Madden, FIFA, etc.; Harry Potter; college textbook content is notoriously rehashed over and over with monopolistic economics). The real key here is finding it in a publicly traded entity and at a sufficiently cheap price.

When I bought GRVY, I categorized it into the deep value/mean reversion portion of the portfolio (read more about my thinking on that here). With these holdings, my thesis is basically that the market has priced a company irrationally cheaply and that you don’t need many good things to happen in order to reverse that, regardless of the long-term quality of the business. I thought it was clear that GRVY could generate impressive returns on capital, but that they were quite lumpy. However, there would be a lot of opportunity for the market to reconsider it’s assessment of GRVY as they are constantly launching new titles in new markets and creating opportunities for success. Plus, at the time, it had about a third of its market cap in cash and no debt on the balance sheet. It was a classic example of what I usually look for: high upside optionality (if a new game is a smash hit) and limited downside (as a result of their strong financial position).My point here is that the siuation didn’t require some complex insight, deep understanding of industry dynamics, or intense scuttlebutt. At sufficiently cheap valuations you just need something to go right.

[I would, at this point, be remiss if I did not mention the work of a few Swedish investors from whom I have gained considerable insight on GRVY just by following their Twitter feeds. They do far higher quality work and more granular analysis than I could hope to do. If you’re at all interested in GRVY check out: @ValueGARP, @Pappakeno1 and @89Olle Edit: See also @lilsneakyfox and @pokertrader1 (h/t @ValueGARP)]

Anyway, this was quite a ramble but I wanted to get some thoughts out there about GRVY because I think it is/was an interesting situation. Again, just to reiterate, I would not be looking to open a position at current prices but I do think the characteristics here are quite informative when evaluating future media properties. I hope you got something out of this. Thanks for reading.


Aaron’s (AAN) Separation

A piece of news that caught my attention awhile back was the announcement that Aaron’s (AAN) intends to split its two primary business lines into stand alone publicly traded entities. I’m always game for a nice corporate action catalyst in small/mid-cap land and I have kept my eye on competitor Rent-A-Center (RCII) for some time now (without having actually gotten around to taking a deep look). For the uninitiated, Aaron’s is a U.S. based NYSE listed mid cap ($3.5B) that describes itself as a provider of lease-purchase solutions to underserved and credit-challenged customers. Basically, if you are someone with dicey financial history and living paycheck-to-paycheck but would like to purchase furniture, appliances, electronics, jewelry, etc. Aaron’s will sell you these items on a payment plan. You get the items you want with little to no upfront payment, but pay some interest above standard purchase price to compensate them for the credit extension.

Over the years, the business has diverged into two distinct segments: the store-level operations (which will retain the legacy Aaron’s branding moving forward) and the leasing/financing business (to become standalone “Progressive Leasing” post-separation). On the surface, the split is kind of a no brainer. The legacy Aaron’s business has a number of obvious headwinds: 1,400 brick and mortar locations in an increasingly online world, low margins & sluggish growth, and intense competition from existing competitors (Rent-A-Center) and new entrants (Big Lots). Meanwhile, Progressive has gradually overtaken the legacy Aaron’s operations to become the primary business line. At this point it’s essentially a consumer financing franchise focused on the underwriting and extension of credit to subprime borrowers – it just so happens to be attached to the legacy Aaron’s brand. Progressive has been growing by establishing partnerships with retailers like Best Buy, Ashley Furniture, Cricket Wireless, Lowe’s, etc. to provide their underwriting and financing services to their own customer bases. In sharp contrast to the dwindling albatross it’s currently handcuffed to, Progressive is actually growing and offers better seemingly better economics. The numbers below tell the story pretty effectively.

Aaron's Business 
YOY % Change 
progressive Leasing 
YOY % Change 
Aaron's Business 
YOY % Change 
Progressive Leasing 
YOY % Change 

You might notice the screeching halt in revenue and EBIT growth for Progressive in 2019. For revenues, an accounting change forced them to start netting some allowances for doubtful leases against top line revenue whereas they previously reported those costs in bad debt expense (so in previous years imagine revenues are 5-7% lower than reported in this table). As for EBIT, turns out Progressive got in a little trouble with the FTC and paid a $175M penalty to settle the inquiry in 2019. So, excluding the penalty, they were on track for more growth.

At this point my thinking is that there are a couple of angles to play here:

  1. Go with the logic of the logic of the corporate action – Progressive is clearly the better business. You could:
    1. Buy AAN now, wait for the spin and sell the Aaron’s stock on spin date
    2. Wait until the spin date and buy the Progressive stock outright hoping to be early before the market notices that it’s a much better business
  2. Wait for the Greenblatt special:
    1. Wait for the Aaron’s stock to be sold to an illogically cheap level post-spin and scoop it up for a bargain once the selling has subsided
    2. See if the Progressive business trades cheaply (post-spin it will still be in the low mid-cap/high small-cap range so maybe it gets ignored altogether) and try to pick it up post-spin without having to touch Aaron’s

So the logical next step is to look at valuations on these two and see if there’s some potential value here.


I’ll start with this because I think it’s very straightforward. Aaron’s easiest comp is clearly Rent-A-Center (RCII) which operates a very similar business model (including having a financing component similar to Progressive) and trades pretty reliably around 10x TTM earnings. If I apply that multiple to a “normalized” earnings estimate for 2020 assuming no growth/shrinkage from 2019 figures, I get to about $700M in market value. FYI I still think there’s all sorts of problems with this estimate – they are constantly taking write downs and restructuring charges, earnings have been declining anywhere from mid single digits to high teens YoY for awhile now, and I think 10x may be a little optimistic given that RCII has a leasing component with (presumably) better economics than a pure play Aaron’s will. But, sure, $700M in estimated value.


I’ll admit that I’m not very familiar with this type of financial services business. I have no doubt that it’s a better business than Aaron’s but I was a little surprised that the economics weren’t better than the <10% EBIT margins that show up in the reporting. Plus, I suspect that it is pretty cyclical given that you are dealing with uncreditworthy borrowers to begin with. Nonetheless, the attraction here is clearly the potential for continued growth. So in trying to value this thing I tried to find some comps that did something remotely similar in the consumer/retail subprime finance space to see what sort of valuations were out there. Here’s what I found:

Mkt Сар 
Р/Е (ПМ) 
p/s (ПМ) 
Sales Growth (5“) 
Net Margin 
HoIdings (0MF) 
Enova lntl 
О. бх 
согр (WRLO) 

The only real outlier appears to be WRLD, which seems to trades a premium to others for some reason that I can’t quite discern based on a quick look at the financials. Either way the cohort is not very encouraging. Assuming you get 25% EBIT growth (2020E EBIT = $280M, less 21% statutory tax rate = E of $220M) and applying a seemingly optimistic 10x P/E multiple, I only get to $2.2B in market value. At 1x sales and assuming 20% revenue growth for 2020, you could get to $2.5B.

So, together I am saying that Progressive ($2.5B) and legacy Aaron’s ($700M) should be worth about $3.2B. AAN’s current market cap is $3.7B. Whoops! Clearly something is awry here.

If I’m AAN management, I’m not doing this transaction for kicks and giggles. I’m doing it because I think one of two things:

  1. There’s actual value to unlock here – Progressive is much more valuable than the market is giving credit for and should trade at more of a premium as a standalone. I think in this case you are banking on a multiple higher than 10x earnings post-separation, in which case my valuation above is not high enough. Objectively, if all you showed me was an anonymous company with revenues growing at +20% over a handful of years with positive earnings I’d say it probably trades over 15x earnings. That would put Progressive somewhere in the +$3B market cap by itself.
  2. The legacy Aaron’s business is so bad and dying so quickly that I need to throw it overboard to save Progressive before it’s too late. This implies that Progressive is more or less fairly valued but that the Aaron’s business is worth much less than the $700M I estimated above.

To be honest, I can’t tell which it is (and maybe it’s some of both).

I think the wild card is the valuation on Progressive. There’s definitely a goodco/badco dynamic here and it’s tough to determine just how much legacy Aaron’s is weighing on Progressive. To be fair this was a very quick and dirty look and I could be completely missing a ton of nuance here, but I don’t think that it’s obvious that there’s going to be a lot of value unlocked here. You would really need an outlier multiple assessment on Progressive to see a meaningful move up, which isn’t to say that won’t be the case – I’m sure AAN has spent a ton of money on bankers and consultants that have told them this is a slam dunk. So that is certainly within the realm of possibility given that the growth has been very strong and there appears to be a long runway (there are lots of potential retailers that could be customers). But I don’t know that I would want to hang my hat on a rich valuation as my base case and, to be honest, having looked at both sides of the business now I don’t find either particularly attractive irrespective of the corporate action.

I will of course watch this fairly closely, but I think the verdict here is a pass for me. I hope this was at least somewhat informative for you and if you have a different perspective on the situation I’d love to hear from you. Thanks for reading.


StoneX (SNEX)

I don’t normally write up names that I don’t invest in, but I spent so much time on this one that it felt like a waste not to get some blog content out of it. Plus, I want to memorialize my thoughts on StoneX (SNEX) here and now so that when it’s (inevitably) a multi-bagger in a few years I can point to this post and call myself a moron for not putting money into it.

Let me start by saying that I REALLY wanted to pull the trigger on SNEX. It has a number of the attractive qualities that I like in a portfolio company: an interesting rollup/platform build strategy, a focused management team, a niche industry, clear room for growth, generally misunderstood by the market, etc. I just couldn’t quite get all the way comfortable with it, but it’s definitely going to be high on my watch list and I could easily see talking myself into it a position later on.

It’s funny – I actually spent a little time back in 2018 or 2019 looking at SNEX (then still INTL) but didn’t get very deep before I felt it was too complicated and moved on to simpler things. My ears perked up after I heard Jeremy Raper (@puppyeh1) on Special Situations Cast discussing the company’s impending acquisition of GAIN Capital (GCAP) and what a steal it looked to be. I put it on my to-do list and didn’t think much more about it. A few weeks ago Jeremy made an appearance on the new Yet Another Value Podcast with Andrew Walker (@AndrewRangeley) and talked more about the company (now officially post-deal and re-branding) and at that point I thought there was enough to warrant further work. I spent a ton of time looking at this thing and trying really hard to talk myself into it, but here we are so let me lay it out as I see it.

StoneX, formerly known as INTL FCStone (INTL), is a U.S.-based small cap financial services company serving retail, institutional, and enterprise customers around the world in a variety of products/services. SNEX pitches themselves as a rollup of various niche financial services, which rings true when you take a look at their business lines, which include: commercial hedging/consulting, securities (lending & market-making), physical commodities trading, global clearing & execution services, and global payments processing. The current management team has been in place since 2003 and has built the company as a platform in which they are looking to add new offerings or bolster existing business lines via acquisitions. These are usually money-losing/breakeven bolt-ons of smaller sub-scale businesses at attractive acquisition prices where synergies with the existing platform offer a path to future profitability. Historical results have been impressive over the past 15 years or so as the company has grown book value at around a 20% CAGR. Incrementally, growth is a little lumpy given the volatile nature of revenues/income, but over a long enough time frame you can see the value grinding higher.

High level, here are some things I really like about the business:

  • As of the beginning of 2020 SNEX has begun their re-brand to StoneX from the legacy INTL FCStone branding and completed, as far as I am aware, their largest acquisition to date (Gain Capital – GCAP) which appears to be a homerun of a deal (they claim a purchase price of 4x next year fully-synergized EBITDA). They have also just crossed over the $1B market cap (although they also did this briefly in mid-2018) which might garner more attention from investors. I think this confluence of factors offer a great opportunity for the market to ‘reset’ the narrative on the company and reassess SNEX’s value .
  • Their general roll-up strategy makes a lot of sense to me. They buy (usually) unprofitable, small businesses that offer access to new services/clients and can be quickly restructured into the existing SNEX platform as profitable contributors. This deepens their service offerings for existing clients and creates cross-sell opportunities for the acquired client base. Reading through the rationale on the Gain transaction really crystallized the value/rationale on the acquisitions for me – it’s clear that there are meaningful economics that can be wrung from these businesses (at least in GCAP’s case) and that management is intensely focused on the execution and how it impacts shareholder value.
  • They operate in niche business lines. Their core business began as a consultancy and trading execution service to commodity users (i.e. commodity producers or consumers). In addition to that business they now have a variety of complimentary offerings from high-margin global payments processing to low margin securities lending and everything in between. Logically, putting all of these things together makes sense to me because it adds a lot of value to client relationships while creating certain economies of scale/synergies across the platform.
  • From a portfolio composition perspective, SNEX thrives when markets are at their most volatile. High volatility in their service markets (equity, fixed income, commodities, etc.) means more trading, wider spreads, etc. which all lead to higher revenues and profitability for the firm. Theoretically, if equity markets are choppy and the rest of your portfolio holdings are struggling, SNEX will be at it’s most profitable.

Here are my main concerns with SNEX:

  • Although the rollup strategy makes sense to me in theory, I’m not sure that you can be certain about the quality of the acquisitions. GCAP appears to be a killer deal on the surface, but you have little to no visibility to any of the other (albeit much smaller) acquisitions as they get integrated into their respective business lines. In a vacuum, maybe that’s not a problem but SNEX’s business lines have pretty volatile revenue streams which means it’s hard to look at the results, even in aggregate, and draw any meaningful conclusions. I suppose the counter argument here is that over a long enough period of time the ‘average’ economics/results should drive the value realization but I’m having trouble getting comfortable with that.
  • Since 2003, the stock has achieved ~20% CAGR for shareholders, but a lot of that value was realized in the first 2-3 years when current management took over – the CAGR since 2005 is ~13%. I have a personal problem here which is that I underwrite everything in the portfolio to a 15% hurdle rate. Admittedly that’s a completely self-constructed issue and I’m sure that doesn’t matter to you at all. But it means that I have to look at SNEX and try to figure out what’s different about the next 3, 5, 10, 15, etc. years that’s going get it to a 15%/yr return. Maybe their rate of acquisitions increases meaningfully, maybe we have an extended period of market volatility and the business is suddenly gushing cash – I don’t know but it’s hard for me to pick out something I expect to be meaningfully different with any level of certainty. My ultimate point here is that if you can’t reliably predict any meaningful increases in the bottom line, I think you need a multiple re-rating to get to my 15% hurdle. So speaking of multiple expansion…
  • Ignoring the nit-picky hurdle rate problem and thinking about it more generally, SNEX looks pretty cheap right now – Koyfin shows a 10x TTM P/E – but that’s coming off two of the best quarters in company history thanks to unprecedented market volatility. Their pro-formas from the GCAP transaction presentation suggest there’s opportunity to add to the bottom line assuming a meaningful amount of cost cutting and synergies, but even by their own estimates that suggests that at today’s prices they’d be trading at 10x adjusted net income two years out. The current prices are also 13x 2019 earnings, which is in the ballpark of their historical average multiple. At the end of the day I think the market has to look at this company and completely re-assess the value. My worry is that the re-rate never happens and, in the meantime, the general cash flow volatility and possibility of underachievement on this rather large acquisition are all on the table. The bear argument here is, and will continue to be, that SNEX is an unfocused amalgamation of related but very different businesses with pretty volatile economics – all characteristics that don’t normally manifest in high multiples. I think the splashy acquisition and the re-brand create an opportunity for the market to take another look but I’m not sure that the story is obvious enough to warrant a meaningful change in pricing.
  • My last (and sort of obvious) point is that there’s a financial ‘black box’ element to SNEX. They do market making, trading, etc. which means they have some principal capital at risk each and every day, not to mention the implicit liability associated with doing billions of dollars worth of financial transactions on behalf of clients. For instance net income in 2017 was basically $0 because of a huge credit loss on a piece of their physical trading business (although subsequent recoveries have offset almost all of it at this point, to be fair). They are implicated in lawsuits whenever a shady customer implodes and takes a bunch of client money down the drain. I guess my point here is that on any given quarter/year they could step on a landmine and make already volatile earnings even less predictable with a big loss in one of the operating groups.

I spent a lot of time thinking about this situation and ultimately (for now, anyway) decided I couldn’t get all the way committed to the position. Could I be kicking myself, even just a year from now, because SNEX has ripped – absolutely. I could totally see the rebranding and GCAP deal catalyzing a revaluation on the back of some fat TTM financials thanks to 2020’s volatility. It feels like I’m disqualifying SNEX on a personal technicality, but my hurdle is also a key part of my investment process so to cheat and ignore it now just because I really like the narrative/management/whatever feels disingenuous. And maybe there’s something to be said for not pulling the trigger if I’m not fully confident in a position – I think it’s better not to go into a position with shaky hands to begin with. This post was a little ramble-y but I feel like it helped me clarify my soup of thoughts and I hope it was somewhat informative for you. Thanks for reading.


Fortunes in Special Situations in the Stock Market by Maurece Schiller

It has been awhile since I wrote up a book review, so I thought I would remedy that by discussing Fortunes in Special Situations in the Stock Market by Maurece Schiller. If you’ve read the rest of the blog, you might recall that I generally consider my “special situations” portion of the portfolio to be my weakest area of ‘expertise’ and to help with that I’ve been trying to read up on the space. I can’t remember exactly how I happened upon Fortunes, but I do recall it being highly recommended and well reviewed. I must admit that I had no familiarity with Maurece Schiller prior to reading the book, but as it turns out it was well worth the gamble. To cut right to the chase, I will say that I absolutely loved the book. In one of the introductory sections one of the books’ contributors, Tom Jacobs of Huckleberry Capital Management, describes Schiller’s works as the Rosetta Stone for special situation investing. While I cannot attest to the quality of the other books (Schiller apparently wrote 4 other titles with similar subject matter), I can whole heartedly endorse Jacobs’ statement. To the extent that one can systematize (or even merely catalog) the process of running a special situations portfolio, Schiller does it masterfully. I highly recommend the book regardless of your familiarity with the special situations investing – I think there’s something here for newcomers and veterans alike.

To contextualize everything for you, the book was originally published in 1961, so some concepts are a little dated. The version I picked up is the 2017 “authorized edition” with includes additional (modernized) interjections & case studies from a group of interested parties (some professional portfolio managers and private investors who are breathing new life into Schiller’s body of work).

The book definitely shows it’s age in some respects; there is ample discussion of railroad and utility breakups/reorganizations that are not particularly relevant to the modern investor, but I think the editors do a nice job of counterbalancing this with modern case studies and commentary. There’s also little to no discussion about activism in the book – I suspect primarily because this is a more modern phenomenon that became more prevalent after the junk bond/corporate raider era in the 80s. Hard to blame Schiller for not having a crystal ball, but I would love a modernized version of the book that examined some newer types of special situations.

As for Maurece Schiller himself, he was born in 1901 on Long Island and attended Dartmouth before making his way to Wall Street as a runner (and eventually broker) in 1922. Schiller spent the rest of his career shuffling between brokerage firms before publishing his own works and opening his own shop. It seems that despite the high quality of his work and the monumental task of systematizing an entire field of the investment industry, Schiller has gone largely unrecognized for his contributions. In the book, the editors boldly describe Schiller’s books as the missing link between The Intelligent Investor (1949) and You Can Be a Stock Market Genius (1997) – which I endorse fully after finishing this book. You can read more about Schiller and the ongoing campaign to bring his works to light at

One more thing on Schiller as a person before we get into details – Schiller’s passion for special situations and investing really shines through in his writing. I particularly liked this passage early on in the book:

“While the procedure for making money requires work, it should not be a chore. The very nature of these situations is a stimulating one: in their elements there is the surprise of a windfall, there is unusual romance, like the little bistro in the “off the usual” neighborhood, and there is the stimulation that comes from satisfactorily solving a problem.”

It’s not often you find investors (especially those who write about investing) which such colorful imagery and the guile to use the word “romance” when talking about their work.

Defining Characteristics of Special Situations

I found Schiller’s general descriptions of special situations to be informative and grounding for me. I think a lot of times we, as individual investors, have a jumble of concepts and thoughts in our heads with no real organization or structure. So it’s particularly useful when someone comes along and articulates it as clearly and thoroughly as Schiller.

Schiller begins outlining the concept with this statement:

“Special situations are investments in stocks or bonds that reflect corporate action, meaning activities occurring within the administrative scope of the corporation rather than at the business level. “

It’s a nuanced distinction, but an important one. One of the things I find most appealing about special situation holdings, and ultimately why I choose to incorporate them into my portfolio, is the idiosyncratic exposure that they offer. Schiller goes on to put some finer points on this concept by writing:

“risks are at a minimum and achievement of the expected profit is a calculated probability, regardless of the trend of the securities market.”

“corporate action is an administrative move affecting the capital structure; it is not directly concerned with long term trends of profits or losses from operations of the business”

These are also important supporting concepts because, again, I think these are really the crux of special situations – reduced correlations to broader markets and, as a result, an opportunity for information and/or risk arbitrage.

To that end, the editors included a small excerpt from Ben Graham in Security Analysis that I thought aligned nicely with Schiller’s comments:

“Special situations are the happy hunting grounds for the simon-pure analyst who prefers to deal with the future in terms of specific, measurable developments rather than general anticipations.”

Schillers goes on to further flesh out his definition with these accompanying characteristics:

“Apart from corporate action, which is the common denominator of all special situations, we can usually find the following identifying characteristics:

  1. Profits develop independently of the trend of the securities market.
  2. Risks are at a minimum (reflecting prior knowledge of anticipated profit).
  3. Corporate action is in the development stage.
  4. The securities (stocks, bonds) are undervalued.
  5. Information is available inviting comprehensive analysis.”

The Framework for Special Situations Investing

Schiller sorts the special situations universe into two broad categories: “something doing” companies and “discount situations.”

“Something doing” situations include turnarounds, old companies entering new business lines, large cash asset companies, and what Schiller describes as “new era” companies. Schiller points out, astutely, that the presence of dynamic management teams if often needed in these positions. He also mentions that these types of situations often allow for greater appreciation (i.e. have a higher ceiling) than the “discount” situation category.

One point of contention here: while I agree wholeheartedly with the first 3 items in the preceding list of “something doing” situations, I think the inclusion of “new era” companies shows the age of the text here. Schiller includes industries such as electronics, semiconductors, data-processing, etc. and goes on to discuss the analysis process. These were basically just up-and-coming industries at the time the book was written which strikes me as more aligned with modern “growth” investing rather than true “special situation” investing. I don’t think these fit well into his definition of a special situation and I suspect if Schiller were alive and updating/re-writing the book today he might exclude the “new era” companies from the book entirely.

“Discount” situations are the classic opportunities that we most commonly associate with the value/special situations world: mergers/acquisitions, tenders, spin-offs, recapitalizations/reorganizations, etc. Schiller notes that these situations engender a more methodical approach as there are clear catalysts, timelines, and expected profits/losses relative to “something doing” situations.

Ultimately, the common denominator between the two categories is the corporate catalyst, but equally as important is the ever-present value perspective of the investor.

The Details

Beyond the broad strokes that I have outlined above, Schiller provides a very thorough examination of each type of situation and provides a full blown procedure for analysis and execution. He discusses nearly every aspect of each type of situation – from potential risks to consider and specific sources of information to entry and exit trading strategies and everything in between. I don’t mean to gloss over this aspect of the book, but this is ultimately the heart of the subject, so it would be a disservice to examine these in any greater detail in this brief blog post. Suffice to say that I think it is well worth your time to pick up a copy and read it yourself.

Reading Fortunes has truly opened my eyes to Maurece Schiller’s legacy and the tragic injustice that he is not mentioned among the forefathers of investing. I found it to be extremely informative and a very easy read. I hope that if anything in this post has sparked your interest, you will check out this or any of Schiller’s other works.


Dream Unlimited (DRM/DRUND)

Price (DRM) $18.35

Mkt Cap $870M

EV $1.1B


P/E (LTM) 1.8x

Before we get started, I want to (once again) point you to Tyler’s work at Canadian Value Stocks. His writing on Dream formed the basis for my research and got me interested in the name.

The Company:

Dream Unlimited (DRM / DRUND) is a Toronto-based real estate development and asset management firm. Dream was founded in 1996 by acting President Michael Cooper, was privatized in 2003 and re-listed in 2013. In that time it has spun out a number of other publicly traded entities – Dream Office REIT (D.UN /DRETF), Dream Industrial REIT (DIR.UN / DREUF), Dream Hard Asset Alternative Trust (DRA.UN), and Dream Global REIT (no longer public as it was acquired by Blackstone in 2019) – which operate within various real estate niches. This write up will focus exclusively on the parent company but it should be noted that the fortunes of all are tied closely together as Dream Unlimited (“Dream” or “DRM” from here on out) is the manager/lead developer for each of the trusts, holds a number of overlapping assets in partnership with the trusts, and (in most cases) is a major direct shareholder of each of the trusts.

Dream splits its business into two primary segments: recurring income assets and development assets. The recurring income segment consists of two underlying lines of business: asset management (fees derived from management of the public REITs and other development agreements plus the ownership stakes in the REITs themselves) and stabilized assets (a variety of income generating properties to be held indefinitely). The development segment is sub-divided into “Urban” (condo, rental, and mixed-use assets in Toronto & Ottawa to be sold or moved to the “recurring income” segment in the future) and “Western Canada” (raw land, housing, commercial, and multi-family assets in Saskatchewan and Alberta that may be sold or held). Assets are split fairly evenly between the recurring and development lines of business.

Dream Unlimited Corp. 
Recurring Income 
Management G 
Ownership in 
Dream Office 
Toronto G 

At this point I would like to say a few things about the rest of my commentary below. I tend to stay away from asset-based valuations, particularly real estate investments. Maybe I’m just dense, but I find real estate to be hard because 1) the accounting is complicated and nuanced and 2) valuations are extremely hard to predict. Call me a dolt, but I like the ease of hanging a multiple on some measure of income/cash flow and calling it a day. So, just a fair warning, take everything you see below with an extra grain of salt. I approached the valuation and research in a way that I thought was reasonable, but I allow for the fact that I am omitting some thing(s) here. I suspect that DRM is more complicated than most given the variety of their assets and business lines. The financials are no walk in the park: they consolidate the Alternatives REIT into their financials (so you have to disentangle all of that), the accounting is different based on the classification of different property types, and it’s hard to normalize anything when there’s constantly fair-value changes and non-recurring transactions happening all the time. Anyway, enough belly aching – I just wanted to up-front with you about the quality of analysis here.

The Good:

I’ll walk through two versions of valuations at the end of this section (a “bear” case and a “reasonable” valuation), but obviously I own it and therefore believe it is cheap by some measure. But before we get there, let’s discuss some easier to digest data points.

First, I believe the company is very well run. Book value per share has grown at about 20% since 2014. Debt to assets stands at about 30%, which appears to be well below peers. Management has communicated (and taken action to implement) a clear emphasis on the quality of income and diversity among the business lines. And, if you’re into owner-operators, you’ll be pleased to know that founder and President of DRM, Michael Cooper, holds 40% of the shares outstanding.

Turning to the business segments themselves, I like the diversity that Dream presents. Although relatively small, I believe the asset management business presents the most interesting opportunity for growth. Dream has the dependable fees from managed REITs, but recently announced a more focused effort on managing outside assets. I believe this is excellent timing given their strong track record with the Dream platform and their recent successful sale of the Global REIT to Blackstone. Within this segment, Dream also holds large positions in the public REITs and opportunistically manages the positions. This creates further cash flows from distributions on the REITs and further magnifies Dream’s exposure to the underlying assets. The stabilized income assets include a mix of residential, rental, commercial, retail, and recreational assets (such as the Arapahoe Basin ski property in Colorado). The profit contributions from this segment are modest but the company has expressed a desire to grow this stream in the future, which should also contribute to more stable cash flows. The development side of the business is where the most tangible potential for appreciation lies, but where uncertainty seems the highest as cash flows/income/etc. are “lumpier”. Dream engages in a range of development projects: residential communities, multifamily housing, hospitality, commercial, office, etc. Often properties are partnerships, either with the public REITs or other third party development partners. Some assets are developed specifically for sale, others will be moved to the recurring income segment once the property is stabilized. From a macro view, I think the business lines provide a unique and somewhat diversified mix of income streams.

Moving on to the valuations below, I will lay out a downside scenario in which I make some fairly draconian assumptions to demonstrate where I think the floor might be, as well as a more reasonable assessment of value assuming a “normalized” environment. In both cases I use as a basis for valuation: the market value of the REIT holdings, a income multiple on stabilized income assets & the asset management business, and book values on the development assets.

The “Bear” Case:

REIT Holdings Value: $310M

Today, the REIT values to Dream are about $400M in straight up market value, comprised of 29% ownership in the Office REIT and 24% ownership in the Alternatives REIT. Backing the market value of the REITs out of the $870M market cap of DRM means the DRM equity is really valued at about $470M currently. I got to the $310M number above by assuming the both REITs’ market caps fall (further than they already have) to about half of their current book value. In normal times the REITs seem to trade around book, but currently the Office REIT trades at about 70% of book and the Alternatives REIT trades at 60% of book. Both were hit fairly hard in the early days of the COVID crisis and have recovered little. My base case is that in the next few years real estate values revert back to roughly their pre-COVID levels, but assuming that the value of their assets gets cut in half seems pretty conservative to me. Note here that I am completely ignoring the value of the distributions from the REITs themselves which totaled about $20M in 2019.

Income Producing Assets Value: $80M

Normalized annual net margin on these assets looks to be about $15M (again, with intent to grow in the future). Standalone public companies in the “real estate operating companies” sub-industry trade around 10x TTM P/E currently. I’ve assumed the “E” here declines by about 20% and you get further P/E ratio compression of 1/3rd (i.e. $12M annual income x 6.6 P/E = $80M). I think you could validly poke holes in either of these assumptions. The mix of assets is pretty diverse but does include office properties and a major recreational property (the ski hill) that could see real impairment. You could also argue the multiple one way or another – perhaps it’s way too high unless this were a standalone entity, perhaps it’s way too low even in today’s uncertain environment. The idea here is to be conservative and I think this get us there.

Asset Management Business Value: $45M*

The management and development fees from the asset management business generate about $10M in annual net margin. Public companies in the general “asset manager” space average about 13x TTM P/E. I get to $45M by assuming the fees are cut in half (as the value of the public REIT assets fall drastically) and that multiples compress by 1/3rd (i.e. $5M x 8.5 P/E = ~$45M). The management fees themselves seem typical for most REIT managers: some percentage of net assets (subject to a hurdle rate) with other function specific fees sprinkled in. The development fees tend to be lumpier as they are one-time fees based on specific projects within the partnerships/REITs. I think it would be very difficult to model the revenues streams with any real accuracy, so I’m assuming that getting cut in half would be conservative enough here. I would also point out this cohort of asset managers is not real estate specific – it is asset managers in general (i.e. mutual fund families, companies with broker/dealer or private wealth management businesses, etc.) – so the comparison is not apples to apples. You could make the argument that this multiple should be higher for a real-estate focused manager, or lower because the business would be so small as a stand alone entity, or any direction you want really. Again, I’m just trying to get in the ballpark here.

Development Assets & Corporate-Level Value: $100M

One nice thing Dream does in the financials is break down all of their statements by segment. I walked through all of the individual “recurring income” lines of business above, but for the rest of the value I am lumping together the development segment and the other corporate-level assets & liabilities. The corporate “equity” is accounted for separate from the recurring income or development segments and mostly consists of cash/debt that is not specific to any particular project. FYI, one unfortunate change in the most recent quarter’s financials was the way Dream discloses the balance sheet assets/liabilities for the segments so I am basing this piece of the valuation on the year end 2019 financials rather than the most recent quarter’s balance sheet.

I arrived at the $100M above by first applying a 50% discount to the development segment’s land, housing, condo, and investment property inventories as well as any capital/other operating assets (i.e. anything that might be actual property they own). Then, I add in all of the other assets and back out all of the liabilities from the development segment and the corporate-level holdco to get to the book value of $100M.

My point here with the 50% discount is to allow for the fact that maybe Dream made colossal mistakes in purchasing the properties they did and will do nothing in the future to improve the value of those assets (i.e. they will not actually develop them). My concern here is: Dream’s newer assets have increasingly been located in the Toronto and Ottawa markets which have seen substantial growth and appreciation in the last few years and could perhaps see a reversion in values. Alternatively, Dream has a ton of legacy assets (namely 9,000 acres of land) in less “sexy” West Canada markets like Calgary, Saskatoon, Edmonton, and Regina where slacking oil/commodity prices are impacting the local markets. Development assets are held on the balance sheet at the lower of cost or net realizable value, so in reality I’d bet that the fair value of these assets in aggregate is greater than book value, but lets just assume Dream paid 2x what they should have and still owe on the associated debt/liabilities. You still get $100M in book value in a cataclysmic scenario like that.

Total “Bear” Case Equity Value: $535M (-38% from current market value)*

The “Reasonable” Case:

REIT Holdings Value: $480M

The $480M value assumes that the REITs close 1/2 of the gap between their current P/B and full book value (for example, the Office REIT goes from 70% of book to 85% of book). It’s not rocket science, but I feel that this reasonably allows for some impairment on the assets and/or continued short term disruptions in collections. This also ignores the upside of the REITs recovering to their full book value (which would be $585M in equity value for Dream).

Income Producing Assets: $120M

Here, I just assumed the full 10x multiple (cited above) on $15M in TTM net margin. I still think this is relatively conservative given quality of the underlying assets. This valuation also gives little optimism for future growth in the income stream, which management has specifically prioritized.

Asset Management Business: $100M*

For the asset management business, I assumed a modest 10x multiple on TTM net margin. I think this is relatively conservative but justified given the current state of things. Dream manages about $9B in assets, which strikes me as fairly small in the global real estate world. The majority of their experience has been within their own public vehicles (DRM and the REITs) with some smaller private partnerships. That being said, Dream recently announced a new private investment division (Dream Equity Partners) as the newest extension of the asset management business. If DRM could get some traction with allocators over the next few years, I see this as a potential engine for growth.

Development Assets & Corporate-Level: $650M

This is just the book value of the development and corporate-level assets/liabilities. I’ll be honest I still have no idea how to handicap the value of the development assets. On one hand there are the dangers I discussed above: perhaps the hot Toronto market that Dream has increased their exposure to cools off and the Western Canada assets continue to decline in value. On the other hand, if things do normalize or even continue to appreciate, the book values are probably understating even the current value of the assets, much less the future value of the fully developed assets. I think this is probably the biggest question mark for me, but I’m putting my faith in Dream’s successful track record here and trusting in the strategy. I think there’s a good chance this is a very conservative value for this piece of the business.

Total “Reasonable” Case Equity Value: $1,350M (+55% from current market value)*

So in summation, I think you are looking at a relatively attractive risk profile given a pretty apocalyptic “bear” scenario and a “return to normal” scenario. To be honest, I believe that the “reasonable” scenario outlined above still leaves a lot of potential value unaccounted for, but I try to be more thoughtful about my downside than my upside. Consequently, $1.4B is roughly book value for DRM, which the market has shown a willingness to value DRM at as recently as Q4 2019.

The Bad:

If you can’t tell already, probably the thing I worry the most about is Dream’s Toronto exposure. When it comes down to it, I have no real idea whether Toronto property has been irrationally bid up in the past few years or is on a sustainable long term trend given its growing global profile. I’ve seen all the anecdotes about foreigners speculating on core “greater Toronto area” (GTA) commercial and residential RE in hopes of unloading it to some greater fool in the future and COVID will undoubtedly force corporates and residents alike to re-assess the need for expensive metro property going forward. So it’s possible that Toronto (and to a lesser extent Ottawa) are not the no-brainer bet they have been in the recent past, but Dream has obviously decided this is where their future is, so they’ve pivoted hard in that direction while unloading legacy western Canada assets. Ultimately, I don’t know what the future looks like but my base case is that COVID put a small pause on a macro growth trend in eastern Canada that will continue into the future. If that is the case I think Dream reaps the rewards.

Heavy insider ownership cuts both ways. It can be a great alignment of incentives but it also means certain insiders wield nearly total control. I think that you have to be comfortable with who’s in charge here and President Michael Cooper seems as capable as anyone. Cooper holds 40% of the economic interest and nearly all of the voting power in the company and under his tutelage Dream has put together a strong track record of creating value. I have no reason to expect that to be any different moving forward, but it still feels like a lot of the success or failure of DRM will be tied to Cooper’s decision making. It does make me a little nervous, but it’s something I think I can live with. Here are a couple pieces to give you a feel for Cooper.

One of the other downsides I think about with Dream is that there’s this “conglomerate” discount that gets applied to the stock. It’s a mix of businesses that are traditionally siloed off from one another. It’s part REIT, part developer, and part asset manger. My perception is that this mix of business lines plus all of the legacy exposure to western Canada weighs on the market multiple here. I don’t know that there’s an obvious way for them to overcome that , but that’s also a big component to why I think there’s an opportunity here. The market will simply have to come around to realizing the value at some point.

The Key Variables:

The key things I am looking for from Dream are:

  • Short-term collections and write-down trends: I plan on keeping an eye on these because I think they will give some indication of the intermediate term impact of COVID. Of particular interest will be DRM’s reactions to these trends as I think that will tell us how worried they are about their existing asset portfolio.
  • Asset management growth: continued traction in the asset management line of business would help create more diversified revenues and potential for more exponential growth. Demonstrated market interest in the new Dream Equity Partners division would be exciting to see.
  • Leverage: although Dream seems conservatively positioned to me, especially against peers, leverage is very much part of the development playbook and inherently makes me nervous. I will probably keep a closer eye than most on the debt levels moving forward.


So, I hope by this point I’ve made clear that I think there is a lot of value here with Dream. It’s more than a traditional real estate business and has some built in optionality that I think makes for an attractive opportunity. Also, I think the quality of the underlying assets and the management create limited downside for the business. I’ve mentally categorized this as one of my deep value/mean reversion holdings and put the position in at about a 7% position in late May.


*Edit: I goofed! In the initial version of this post, I incorrectly estimated that earnings from the asset management business was roughly $25M/year (excluding development fees). This figure did not properly account for the loss of revenues previously collected from the Global REIT (which was sold to Blackstone in 2019 and therefore will not be contributing to revenues moving forward). The $10M reflected above is a more accurate representation of management and development fees moving forward. My previous “bear” and “reasonable” valuations for the AM business was $110M & $200M, respectively. This translated into original “bear” and “reasonable” valuations for DRM at $600M & $1.5B, respectively. Oops! Special thanks to Tyler from Canadian Value Stocks for showing me the error of my ways.