Mutoro Group Partners, LP
“Tenacity is the most underrated quality. We always speak about talent, intelligence, glamour, but tenacity is the common thing for every successful person in life. Maintain that motivation to go from A to B and to keep your focus on the target without any weakening—that is called tenacity. Stamina in your motivation.”– Arsène Wenger
“You shouldn’t buy a company’s stock because you like its prospects; you should buy it because you think the current market price is lower than those prospects warrant.”– Justin Fox
“Too much tail. All that jewelry weighs it down. Like vanity. Can’t nobody fly with all that shit. Wanna fly, you got to give up the shit that weighs you down.” – Toni Morrison, Song of Solomon (1977)
Dear Partner,
It is easy and dangerous as a student of business and investing to think there is only one good way to do things. There are in reality always different ways to win. Nearly all of the ones I favor, however, have one thing concrete and powerful in common; our playbook runs deep but is thematically consistent. When applied well, it is acutely effective against a vast array of defenses. Two recent decisions I made highlight this. In the year to date, we have completely exited two of our original investments, both made in 2015, namely the ones in previous letters I called Company A and Company B. While both were media companies, on paper they could not otherwise have appeared more different.
Company A is squarely in the world of "old media"; it was founded in 1890, incorporated in 1950, and joined the New York Stock Exchange in 1978. At its core, it owns various small-town and regional American newspapers. Its papers play a central role in their communities, selling subscriptions to residents looking for local journalism they can't find elsewhere, especially not in national news outlets. Company A in turn sells ad space to businesses looking to reach the subscribers to its papers and the visitors to its various websites. Supporting its subscription and advertising revenue are costs such as newspaper printing and delivery (38 per cent of sales) and the salaries of its editorial and journalist staff (40 per cent). After reemerging from a bankruptcy that followed the poorly-timed and over-indebted acquisition of one of its rivals in 2005, Company A has been aggressively cutting these costs over the last decade, keeping capital expenditures and reinvestment to a minimum. It has used the cash it saved to almost exclusively service the interest and principal payments on its debt. This is necessary because its revenue has fallen from $678 million in 2013 to $567 million in 2017, declining at 4 per cent annually as print subscriptions and ad sales declined and new digital ad spending was all but claimed by Google and Facebook. At the time I initially acquired our position in Company A, its leadership was the latest in a stable, many-decade-string of professional managers. Its share price was at 2x its roughly $80 million a year in free cash flow.
If Company A is “old media”, we can categorize Company B as "new media"; it was created in 2003 and listed on the New York Stock Exchange in 2012. At its core, it is an online marketplace for creator-contributors to sell their editorial and stock photography to people or enterprises looking for media content they can license and reuse without worry of copyright infringement. Its biggest cost is the fixed percentage of each download it gives to its contributors (40 per cent of sales), followed by its sales and marketing initiatives (25 per cent). If Company A sells subscriptions and advertising space, Company B sells the content many businesses need to create their ads. Unlike Company A, which is incredibly levered, Company B has no debt at all. And while Company A's revenue has been declining, Company B's sales are growing, rising from $235 million in 2013 to $557 million in 2017, a compound annual growth rate of 24 per cent. As with Company A, it was cash flow generative, but its cash flow was rising over time. While Company A has professional managers in its leadership, Company B is still led by a strongly entrenched founder-CEO with a revolving chair of managers at his side. Compared to the 2x multiple of its earnings that was our entry price into Company A, we first acquired our shares in Company B at a 50x multiple of its most recent earnings.
Almost across the board, in their revenue trajectories, balance sheets, and market multiples, these two companies could not appear to be more different. So what could possibly unite them in my eyes, these entities born 113 years apart, other than both being in the media business? What unites them is that they had similar answers to the one question I ask of every business or asset I analyze: "What is it worth?" To answer that question successfully begets many other lines of inquiry. Notably, you must assess the company's ability to meet its future obligations, how good a job its managers are doing operating the business, and whether its earnings are likely to be stable or higher in the future than they are today. Sometimes this is all very tough. The truth often requires a shovel. But you do not substitute easier questions that in themselves or their answers overemphasize popular impressions or currently circulating stories.
Though they think they are, most market participants do not ask "What is it worth?"; they instead ask "Where will this trade?", “What happens next?”, or "Do I like this product?" They will point to the constantly changing consensus of their investment staff, the spring they get in their step from a company's wares, or the fleeting next twelve months estimates of outside experts. To be clear, I do not think I brought industry expertise to analyzing these businesses; as a generalist, I tend to think that would have held me back or mired me in other people's biases and sunk costs. Yes, digital photography is a deep and abiding hobby of mine (at this point I have surely taken more pictures of my dog than there are verses in the Bible); and while that might have made it a little faster for me to understand the market in which Company B competes, it did not warm or cool me to the business. And while I love reading newspapers and my first job as a child was as a paperboy—still wafting through my memory is the scent and routine of prepping for delivery, with rubber bands and slim plastic bags, fresh copies of The Daily Hampshire Gazette—I do not think it influenced my thoughts on Company A in the least bit. What matters most, for better or worse, is how much cash a business is likely to generate in its remaining life, as uncertain as the magnitude and timing of those cash flows might be.
Hence, before our purchases, I did not shy from trying to answer that all-important and tough question of Companies A and B. In both, I saw that their prices had recently declined significantly. But that in isolation tells me little of any value. What is important is how a business is doing, not its stock price. While stock prices in the near-term usually follow the fleeting emotions and opinions of the marginal market participant, in the long-term they tend to follow company earnings; but because the date at which price and value become one is unknown, calling upon patience is always necessary. After doing my homework on the businesses, I thought the declines in price overdone. I saw opportunity in the descent.
Looking at the fundamentals for Company A, I saw a business with cash flow not deteriorating as quickly as the market expected, especially as seen in the rock-bottom pricing at which the market was exchanging its shares. My math suggested it was selling at a 75 per cent discount to the bottom range of my estimate of its probable long-term value, or 25 cents on the dollar. By analogy, instead of an ice cube melting quickly on the hot sidewalk of a summer day, I saw a bag of frozen peas thawing slowly on a kitchen counter. In Company B, I saw an enterprise capable of sustaining growth above the market's newly lower expectations. This suggested it was selling at a 26 per cent discount to the bottom of my value estimate, or 74 cents on the dollar. By analogy, instead of an aging star past his prime, I saw a canny veteran with a few more tricks up his sleeve.
I thought they both were mispriced because their true worth was above their new market prices, and most importantly, that the difference between that true worth and the current price was significant enough that even if I were wrong about how big that delta was, we could still win. I put relatively more of our portfolio into Company A because the margin of safety was larger. Stating what I look for in a business, though, is not to say that the price and value of our investments immediately join in lockstep upon our purchase. In previous letters, I have written of the violent fluctuations in the prices of the shares of both Companies A and B, and how I used the declines in their prices to accumulate more shares after doing my homework. It was in those moments that our underlying reason for owning the shares mattered greatly, as well as an overabundance of stamina.
If a margin of safety between price and value was the common attraction, did we sell Companies A and B for the same reason? We sold our stake in Company A in March and sold our stake in Company B just after the quarter ended in April. To be clear, we sold Company A not because my opinion of local journalism changed. As I wrote in our first quarter 2017 letter:
None of this is to say that the day of the newspaper is done. Far from it. Regional newspapers like those Company A owns play crucial roles in their communities culturally, socially, and politically. But this important role is one of many considerations worth weighing in an investment.
Rather, we sold Company A because the cash flow dynamic at the business had changed for the worse, suggesting to me that the thawing peas were becoming ice cubes. We sold Company B because it became clear that the business’s growth was increasingly predicated on acquiring new market entrants with significantly lower returns on their invested capital. While Company B was growing each quarter and year, it was not building scale and was increasing its cash flow at a rapidly decreasing rate. As such, it would likely see a fall in its intrinsic value, multiples, and share price. This is all to say that yes, we sold both for similar reasons, namely that our estimates of “What is it worth?” had become materially lower. The fundamentals of the businesses suggested our original theses were no longer valid, and whatever new reasons we might find for ownership going forward were increasingly speculative. Thankfully, we stayed on top of both companies to profit from the ups and downs in price (i.e., a 49 per cent return on Company A; a 35 per cent return on Company B).
I want to now briefly review the rest of our portfolio. In aggregate, we finished the first quarter of 2018 up 0.83 per cent net of fees and expenses. The table below summarizes our portfolio composition at quarter end:
Portfolio Holdings
Thank you for your partnership in the Fund. I remain grateful for your ongoing confidence and committed to protecting and growing your capital. I am always available for any questions or comments you may have.
Sincerely,
Godfrey M. Bakuli
Managing Partner