Circle Of Competence Issue #19

July 9, 2018

What are you reading this week? Drop me a line or tweet @competence_co. Also, if you enjoy Circle Of Competence, please share it with friends, family, and co-workers. Have a great week!

 

HIGHLIGHTED INVESTOR: MOHNISH PABRAI

 

This week, I wanted to share some resources on one of my favorite investors, Mohnish Pabrai. He graduated from Clemson University as an engineer and after working for several years in IT, he started his own IT company with some money from his IRA and $70,000 in credit card debt. He later sold this company for $20M in 2000. While running his own business, he began reading Buffett's partnership and shareholder letters, and after selling his IT business, opened up a partnership modeled after the Buffett Partnership. It has no management fees but includes a hurdle rate of 6% after which Pabrai Funds takes 33% of the profits. It perfectly aligns incentives - if the funds don't do well, neither does its manager. Over the past 18 years, Pabrai has compounded the funds' money at astounding rates and become very wealthy hence. Here are some of my favorite speeches, articles, and books from Mohnish Pabrai:

 

Books by Mohnish Pabrai:

- The Dhando Investor: The Low-Risk Value Method To High Returns

- Mosaic: Perspectives On Investing 

 

 

Interviews:

- 2017 Forbes Interview With Mohnish Pabrai On His Investment Approach

- 2018 Forbes/SumZero Interview With Mohnish Pabrai On Advice For Value Investors

 

 

Articles By Pabrai:

- Mohnish Pabrai's Personal Website

- An Article By Pabrai On A Share Buyback Back-tested Portfolio Strategy (Uber Cannibals)

- Another Portfolio Strategy Based Around Spinoffs By Pabrai

- His 'Shameless Cloning' Portfolio Strategy Article on Forbes

 

 

Talks By Pabrai:
- 'Intensive Stock Research Can Be Injurious To Financial Health' - Pabrai's Talk At Google

- A Pabrai Lecture At Columbia Business School

- 'Compounding Is The 8th Wonder Of The World'

 

 

DEPARTMENT OF GENERAL FINANCE

 

Tails, You Win

I have become a huge fan of Morgan Housel's writing (works at Collaborative Fund), and this article doesn't disappoint. At its core, this piece describes what reality actually is vs. what we have theoretically been taught. It takes the assumption that reality is theoretically normally distributed and turns it completely on its head. In actuality, life around us is full of exponential processes and power laws, 'long tail' events, and fairly devoid of normally distributed events. I highly recommend that readers add this mental model (exponential distribution vs. normal distribution) to their toolbox, because as you will see, life isn't so smooth and 'normal' after all. Over long periods of time, life seems to demonstrate more of an exponential power law than a normal distribution, in SO many areas.

 

Brent Beshores From Adventur.es On Evaluating Investments

Wonderful article by Brent Beshore at adventur.es on how to properly think about valuation and evaluating an investing opportunity from a business analysis perspective. I can’t stress enough how important estimating actual owner earnings (spendable cash flow from the business after all necessary cash outlays) is to estimating a business valuation. Highly recommend!

 

The Stock Market Loophole That Screws The Little Guy

Interesting article from Wired about the differences between public and private company investments and investors and how there is a large disparity between the every day American and the elites in terms of access to uncrowded, private investment opportunities. 
 

Want To Run A High-Flying Hedge Fund? Don't Be A Cheapskate

Whitney Tilson, a former hedge fund manager, is no longer investing outside capital, but is teaching others now how to do so themselves. He ran a fund for 18 years, and then ran into a bout of underperformance from 2010 to 2017 at which point he closed his fund down. I’m sure he offers some great operational insights into running a money management business, but I’d rather save my $2,000 for the seminar and read Warren Buffett’s partnership and Berkshire Hathaway letters. 

 

Surprise! Student Loan Debt Forgiveness Isn't Free

Student debt continues to get uglier and uglier with hardly any options that are 100% “free”. Even with the complete forgiveness option with no taxes associated with the forgiven principal amount, you are still promising your labor to the public sector as repayment. Many are finding out the hard way the number one rule of economics - there are no free lunches. 
 

Twists And Turns In The Tesla Story: A Boring, Boneheaded Update!

Wonderful update on Aswath Damodaran’s Tesla valuation. His qualitative emphasis on stock valuations is a powerful tool for all investors, specifically his “3 P’s” of “is it possible?, is it plausible?, is it probable?” They increase in degrees of confidence and serve as very good qualitative filters for a specific company’s valuation. In Tesla’s case, I would say yes it is possible, but no it is not plausible, and hardly probable. 
 

Superinvestor John Rogers Of Ariel Investment Lauds KKR's Looming PE Corporate Conversion

Interesting case being made how Private Equity partnerships might be better off in a C-Corp form than a partnership entity to allow broader ownership as well as allowing more reinvestment into core business operations (fund management and private investing).  I like the theory in principle but wonder how these shops’ equity issues will perform if rates begin to rise and a deluge of private capital linked with higher borrowing costs reduces returns on deals. This will be an interesting trend to follow now that a broader investor base can invest in the actual private equity funds business even though they do not have access to their actual underlying funds. It begs the question - who will be better off over the long term? The private fund investors or public investors? 
 

How One Small School's Endowment Is Topping The Class

Quinnipiac bested some of the greatest endowment money managers in the world by sticking to simple, long term allocations. I also wonder if there may be a size factor here as they run $500M vs. the largest Ivy’s that are running multi billion dollar funds. 

 

M&A Market Headed Towards Record Year

Frothiness abounds. 

 

 

DEPARTMENT OF TECHNOLOGY AND STARTUPS

 

Fortnite Is Generating More Revenue Than Any Other Free Game Ever

The growth in Fortnite's user base and revenue is legendary, but when I took a look at the comparisons in this article, I couldn't help but asking myself, "how are these other games performing now?" - take for example, Pokemon Go, Clash of Clans, or Clash Royale. They are mobile games. What are their numbers running at now? If I had to guess, the revenue curves either form an S curve, leveling out over time, or worse, a bell curve, where newer games overtake the old in terms of revenues and users. I wonder what the case will be with Fortnite. 

 

How Segway-Ninebot Became The Go-To Scooter Maker For Rental Startups

Classic shovel salesman capitalizing on the gold rush of the electric scooter movement in large cities. What is interesting is that this company bought Dean Kamen’s Segway scooter technology and made it smaller and more tenable for city dwellers. Their next pivot was to electric scooters. I like their strategy of becoming the “Boeing of electric scooters” but wonder if their bargaining power is anywhere close to Boeing’s given the nascent status of the scooter industry.

 

 

DEPARTMENT OF PODCASTS
 

Capital Allocators Podcast - Peter Troob And Monkey Business In High Yield 

I think this was my favorite podcast of the week. Troob is the author of 'Monkey Business: Swinging Through The Wall Street Jungle' and head of his family office. He discusses middle market and down market distressed debt investing, venture debt investing, and what it's like competing against the biggest distressed players in the world. This was very enlightening for me, as I am not up to par on much of what goes on in the private debt world, but it was extremely interesting.

 

The Investors Podcast #197 - The Creative Curve W/ Allen Gannett

In this episode, Preston and Stig interview Allen Gannett, a 27 year old founder and author who is absolutely crushing it. He is a New York Times best seller and wrote a book titled "The Creative Curve" about why products, companies, music, etc. just seem to 'take off'... and why there is more to the story than a genius engineer, artist, manager, etc. Highly recommend!

 

BiggerPockets Episode #286 - $13M In Equity From One Deal! Interview With AJ Osborne

Inspiring story about AJ Osborne who battled and overcame an extremely dangerous medical condition, but had luckily set his family up to be financially free through his real estate deals. He is currently investing full time and has since made an almost full recovery, but the message struck home - you can absolutely never predict the future, and it is always better to have a margin of safety in your personal and financial life. 

 

Rangeley Capital Discussion - Who Will Catch Fox: Disney Or Comcast?

Wonderful discussion by Chris DeMuth and Andrew Walker over at Rangeley Capital on what the ultimate outcome will be of the media industry's competition over Fox's assets. 

 

 

DEPARTMENT OF LETTERS

 

This week I was tracking an interesting deal that was announced Monday.  Dell Technologies announced that after a long review of its options, it had decided to buy out the Dell Tracking stock which had been issued to track Dell's 81% economic interest in VMWare (VMW) when it bought EMC with Silver Lake Private Equity Group in 2016 for $67 Billion. Essential to the issued stock was the fact that one share of DVMT (the tracker stock) was supposedly equivalent to one share of VMWare (VMW), albeit there were some terms in the prospectus that probably warranted a small discount to VMW due to terms that Michael Dell was able to secure.

 

What is interesting is how the market actually valued DVMT relative to VMW. Prior to Dell announcing its buyout of DVMT for $109/share, VMW was trading for almost $150/share. So while minority shareholders of DVMT are hypothetically receiving a nice premium to the DVMT price of $84 prior to the deal's announcement, why was it trading at such a substantial discount to VMW's $150? Of course there are reasons why the market thought that DVMT would never receive the full economic value of one VMW share, but a 45% discount? Even more interesting is the fact that Elliott Management and Carl Icahn, known activists, have large stakes in the company. With such a large discount to intrinsic value, some angry minority shareholders, and the potential for activists to get involved, I think there may be the potential for a higher price coming for the DVMT buyout.  (Disclosure: Long DVMT. Do your own research as this does not constitute investment advice)

 

Here are links related to the transaction that I would recommend reading in order:

 

New Year Idea #1 - Dell VMWare Tracker (DVMT)

 

Dell Technologies Stock Exchange Deal Press Release

 

Dell Technologies Class V Common Stock FAQ 

 

Some Thoughts On Getting Screwed By Dell (DVMT)

 

Some DVMT Updates And Additional Thoughts

 

Dell Technologies: Dell Class C Reverse Merger Via DVMT

 

 

What are you reading this week? Drop me a line or tweet @competence_co. Also, if you enjoy Circle Of Competence, please share it with friends, family, and co-workers. Have a great week!

 

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