Some random thoughts on articles that caught my attention in the last month. Note that I try to write notes on articles immediately after reading them, so there can be a little overlap in themes if an article grabs my attention early in the month and is similar to an article that I like later in the month.
My monthly overview
I'm going to start putting this piece in at the start of every month. I just want to highlight two things
- I do four things publicly: this blog, my podcast (Spotify, iTunes, or YouTube), my premium site, and my twitter account. You can see my vision for the podcast here, and my vision for the blog and premium site here. If you like the blog / free site, I'd encourage you to check out the pod, follow me on twitter, and maybe even subscribe to the premium site!
- I try to be as helpful as humanly possible to anyone whose research / writing I enjoy. In almost every post I do, you'll notice I link to other subscription services or investors who I like. I don't get referral fees or anything for that; these are almost always organic links and highlight that I do not because I was asked to but because one of my goals with the (very small) platform I have is to shine light on other people who are doing good work.
- If you're launching a subscription service, or a new blog, or you're an investor who has done some really good research and wants to let the world know, please send me a line and let me know. If the quality is there, I would love to link to your blog post or subscription service or research (and if the quality isn't there, I'm happy to provide feedback!), and I'd love to have you on the podcast to talk about all of it. I can't promise anything, but most podcast guests / people I've linked to have been very happy about the reception / feedback they've gotten (I've even been called the king of the sub bumps, and I've generally heard from investors with LPs who come on the podcast that they're delighted by the response). My DMs are always open, so feel free to slide into them if I can be helpful!
Virtu (VIRT) investment thesis
- My "state of the markets" heading into 2021 was speculative excess and opportunity everywhere. The overarching theme was pretty simple; there are multiple bubbles / manias going on, but if you're willing to look at the edges of those bubbles, you can find a lot of opportunity. For example, I think there's a SPAC bubble going on currently, but that bubble created the opportunity to buy Worthington at a huge discount last year, trade around PSTH while they're still looking for a deal, and buy the "picks and shovels" to the SPAC bubble at a large discount (note: that's my premium idea for February, so unfortunately it is behind a paywall for non-subs).
- The headliner bubble this year (and likely for the next several years) was Gamestop. And while that mania was absolutely crazy, I think even that bubble presented opportunity. One play was to sell deep, deep out of the money puts on Gamestop (I highlighted this in my post on short squeezes, though as always I'll remind you that options are risky and nothing on this site is investing advice). The other interesting play Gamestop related play that seems to be still ongoing? Virtu (VIRT; I tweeted out a summary thesis earlier this month).
- VIRT is an electronic trading firm. Basically, VIRT (and firms like them) are the reason Robinhood can offer free trades. Robinhood routes all of their orders through the electronic trading firms, the electronic trading firms match all of the buys and sells against them and keep a small spread (with part of that spread going to Robinhood as a reward for giving them the trades; this is known as Payment for Order Flow (PFOF)), and retail traders get better prices than they otherwise would (plus free commission). Viewed from one lens, it's a win/win/win. There are... less generous views that the business model is actually taking advantage of retail traders. I tend to lean more towards the former than the later, but I'm perhaps biased and will also admit I'm not an expert. This piece from Matt Levine did a nice job of covering PFOF in more detail.
- So what's the opportunity? Again, Virtu handles orders for retail trading platforms. More volume = more money.... and volume exploded with Gamestop mania.
- VIRT is trading for <5x trailing (2020) earnings. The market is factoring 2020 as a onetime event. Obviously no one is hoping for a repeat of Q1'20 (when VIRT made $2.05/share in one quarter as volatility exploded into the pandemic), but I don't see why there's reason to believe 2021 will be any different from the back half of 2020 (VIRT made $2/share in H2'20). Gamestop mania should ensure Q1'21 is really solid for VIRT.
- So, bottom line, VIRT is minting money right now. They're trading insanely cheap to 2020 earnings. Maybe 2020 was a onetime thing, but the trends in 2021 seem to be in their favor. Even if not, VIRT is trading at a reasonable multiple to what they say their "normalized" earnings are ($2/share, so <14x that and it doesn't seem we're heading to that normalized market any time soon!). And VIRT is using their current huge cash inflow to return a ton of capital to shareholders; the dividend yield is ~3.5% and eh company is aggressively repurchasing shares (they authorized $170m in total buybacks, and they executed $50m from November 2020 through early Feb. 2021. That's ~1% of the company repurchased inside of 3 months, and the company seems eager to continue that pace given their current cash flow generation).
- Just to explicitly spell this out: I don't think we see another GME type mania any time soon, but I do think increased retail trading driven by WSB and reddit is here to stay. Just a few days after GME crashed, Cannabis stocks roared thanks to reddit. Between continued pumps and the retail move into SPACs, I think the market will remain very good for VIRT.
- Regulation is a risk, but Virtu dealt with regulatory threats on the heels of Michael Lewis's Flash Boys publication, and nothing ultimately came of it. I think we're trending that way on the heels of Gamestop as well (update: some coverage of the Congressional hearing and defense of PFOF here).
- Here's another strange risk: Robinhood raised $3B to meet margin calls at the height of STONKs, but now that the stonks have died out it seems like that extra capital is just sitting around doing nothing. On their Q4'20 earnings call, VIRt's CEO said that for a retail broker to build the infrastructure to internalize would take years and a 9-figure-plus investment. Well, Robinhood has a PR problem and $3B. Isn't a solution to both of those problems putting out a press release that says, "we're investing $500m to building an internalizer so we can make sure the Wall Street fat cats don't get rich at the expense of our clients?" Would that PR make any sense if you actually understood what was happening? Not really! But it would be great PR, and since very few people seem to be taking the time to understand what is happening I think it would instantly solve a lot of Robinhood's problems.
- Of course, that's a big investment for something that's probably not as good as the existing solution. Maybe the PR is worth it, but that's expensive PR! There does seem to be a moat here; perhaps there's a reason the majority of HFT firms launched decades ago.
- Anyway, I'm not an expert here. There are a variety of other risks that I've glossed over (a pretty obvious one: VIRT says normalized earnings are $2/share, but what assumptions go into that?), and there are open questions on how sustainable this business is in the long term. But the set up appears really interesting: very cheap on trailing numbers, tons of near term tailwinds, aggressive capital returns, and even if all that fails it seems reasonably priced on management's "normalized" earnings numbers.
- Note: I wrote this Feb. 12, the same day I tweeted my one tweet investment thesis of VIRT. If there's any huge changes between now and month end, I'll try to come back and edit this section, but if shares have changed by a dollar or three between now and month end, I'm not going to update and will just live with slightly stale numbers.
- This article reminded me: even as GME dies down, it does seem like retail driven trading flows are here to stay, and VIRT will benefit.
Free money for growth tech
- A wave of growthy companies are raising money by issuing convertible senior notes at 0% interest rates. Pelton, Spotify, and Dropbox are good examples, but I think I've seen a few more and I bet the trend accelerates if markets remain open to them.
- I understand that this isn't technically "free" money and all the option math behind the converts.... but it is still crazy. These are multi-billion dollar companies, and the volatility on them is so high that they can raise 0% debt just by offering investors the option to buy their stock 30% higher a few years out?
- Wild wild wild. Dropbox has said that their FCF is inflecting upwards and committed to an aggressive share repurchase program, so they're effectively raising money to leverage up and buyback their stock.... which, if successful, these convert investors will then be converting into at prices significantly higher than today's! Quite the arb.
- The dropbox case is funny just because they've been so clear that about repurchases are going to be a serious part of their capital allocation program. I think the free money is almost more interesting for something like Peloton. When you combine a founder / CEO with an incredible brand and effectively free growth capital, what's the limits to what they can do?
Venmo Credit Card
- Venmo launched a credit card, and it made me think of two things:
- First, just continues to drive home the optionality from owning the customer relationship / an app that people use frequently. I'm sure when venmo was launching they didn't have "build a venmo branded credit card" in their business plan, but the fact so many people use them frequently for payments made that an easy brand extension that I would guess has a good chance of making a decent amount of money.
- Second, it makes me worry about the legacy banks. I mean, how much does capital one spend to get new customers signing up for credit cards? I would guess a good amount; Venmo got me to sign up for a new credit card with a nice rewards program, an email, and integration to my venmo account. That's a huge customer acquisition cost advantage. I get this is n=1, but there are a lot of fintechs backed by a lot of money coming for banking products. For years, one of the best / safest investments to make has been buying small cap banks when they trade below tangible book value and waiting for them to get bought out. If you did a basket of those, you would have made good money over time. I wonder if eventually those small banks will be destroyed by a nuclear arms race of tech, regulatory spend, and customer service (big banks spend tons of tech and regulatory that they can spread over a very large asset base, so small banks can't match them there, while small banks also can't match the customer service / speed of fintech start ups, so small banks lose on all sides).
- Maybe I've simplified too much here. The history of betting against small banks when purchased at reasonably cheap levels is pretty poor (they generally consolidate and buying a basket cheaply does well). The scariest words in finance are "this time is different...." but the actual scariest thing in finance is betting that this time isn't different and being proven wrong. I'm worried that's what could happen here.
Psychology / Ego
- This article (on how Bruce Berkowitz stumbled) is really excellent. So much rang out to me; I don't agree with everything, but everything in there is well thought out and on the whole the article is great / I agree with most.
- One line in particular really stood out to me:
- "I recently had a great discussion with a close friend who said to me that one of the sharpest people he knew seemed to be getting less thoughtful. Probably because a certain amount of fame was getting to his head and starting to impact his judgement. I feel that the amount of signal a person generates right after they nail a big win is actually lower than it was before, though most people tend to increase their confidence in that person’s takes and analysis."
- As someone who can have..... a little bit of an ego, there's a lot of wisdom in that to me. When I look back, most of the failures in my career have been on the heels of big wins. Wins create arrogance, which maybe leads to less rational thinking or less thoughtful investing, which leads to big losses.
- Buffett said, "you never know who is swimming naked until the tide goes out." And we all know the simplistic meaning of it (a bull market makes a genius of everyone). But I think there's a deeper level to it too. A little success can make you feel like a good swimmer. Maybe a better swimmer than you are. Maybe it encourages you to swim in the deep end, or try to swim races or distances you wouldn't have swum before. Maybe all of your success was buying growthy microcaps, but that success makes you think you're a genius and encourages you to swim in the leveraged turnaround water, or in the macro waters.... and eventually, you'll discover that you were swimming in much deeper waters than you can handle.
- Anyway, I know a lot of people think it's weird for someone who is on the "professional" buyside to write publicly as much as I do. But I enjoy it, and I find it comes with tons of benefits. One of the key benefits is that writing publicly helps keep my ego in check. Every now and then I'll write something and look at it and think, "ok, you're being an asshole, time to check yourself." Or I'll post a super detailed thing that took me a week of writing and research, and someone will come and blow the whole thing up in two sentences by pointing out something obvious I missed. Very humbling, and certainly helps keep the ego in check!
SPACs SPACs SPACs
- Blank-check companies sets eyes on corporate spinouts or vice-verse
- I've been saying this for a while, but the boom in SPACs eventually has to bleed into general valuations. All of these SPACs need to get deals done or else their founders lose millions in promote; they will find companies to take public, and there are only so many EV companies to go around. Eventually, the SPACs will need to turn their eyes to unloved segments within conglomerates or lifting PE portfolio companies.
- RSVA PIPE at a premium (CCIV / Lucid did a premium pipe later that afternoon)
- I'm highlighting for two reasons
- First, I haven't seen a PIPE at a premium to trust before, so highlighting a new trend.
- Second, I just find these weird. Consider CCIV / Lucid: their stock was a $60 when they announced the deal. They had PIPE investors willing to invest $2.5B at $15/share. CCIV's trust was $10/share.... why would Lucid agree to merge with CCIV at $10/share? Why not demand the $15 that the PIPE investors were putting in at, or simply go raise money with them directly?
- I also wonder if we start seeing sponsors whose SPACs trade at premiums to trust monetize their forward commitments. I mentioned this in my PSTH write up, but PSH has committed to invest at least $1b at trust value in PSTH when PSTH announces a deal. With PSTH trading at a ~50% premium to trust, PSH is already $500m in the money on that commitment. Why not sell half of that at a premium (i.e. sell the $500m commitment for $750m and split the value difference with the buyer)?
- Beachbody going public through a SPAC
- Hat tip to the beachbody team; they've evolved with the times and negotiated a deal that gives them top dollar. But this business has been around for a really long time; they got a nice bump from the pandemic but even on those bumped up numbers this seems to be a pretty rich price....
- Also, very interesting for a company that sells meal plans to comp themselves to Chewy.... (hat tip here)
- CLOV response to short seller
- I mentioned it in my notes from Bill Brewster's podcast, but I honestly cannot believe the company went public / deSPACd without disclosing a freaking DOJ investigation.
- Chamath interview on CLOV on CNBC (ignore the click-bait title on the YouTube video); I think the discussion on his promote was very disingenuous on his end (he appears to completely ignore the value of the ~11m private placements warrants he got as a sponsor), and it spoke to a lot of the criticism that many people (including myself!) have made of him.
- The story gets even better! Billionaire Clover Health CEO Expletive-Ridden Tirade.
- Endless boom in blank check companies is wearing out insurers
- Two things on this
- First, there are lots of questions of how the SPAC bubble ends. It won't end until you see a wave of SPAC deals fail. When SPAC deals fail, sponsors / founders lose all of their risk capital. This increase in insurance rates will bring that end on a little sooner; higher insurance costs (and other costs attached to a SPAC) means that founders need to put up more risk capital.
- Second, this is going to create a little bit of a moat for repeat sponsors and/or sponsors with very good track records. If D&O insurance is more expensive for fly by night SPAC sponsors than repeat sponsors, over time you'll see fly by night sponsors priced out.
- Investors in SPACs need to know the real deal
- The SPAC boom, visualized
- NEBC / Rover's clever presentation
- SPAC dream (rap video).
- Nevin's Thoughts on Investing: Issue 4 (SPAC mania)
- SPAC boom drives gains at CS investment bank
- From butter deal to lucid: inside citi's 15-year-old SPAC desk
- A-rod joins blank-check derby to build the Yankees of SPACs
- New breed of firms vies for stakes in NBA teeams
- Typos on CCIV / Lucid merger deck
- Look, I get those are small. But the merger deck is the most important marketing for a SPAC. This is a $16B deal. Reams of bankers and consultants are pouring over everything they are publishing. For two typos to escape on one slide is absolutely bonkers.
- You hear tons of rumors that SPAC sponsors are doing.... very light due diligence in a rush to get deals done before the SPAC bubble collapses. Things like that slide do absolutely nothing to dispel those notions!
- One more CCIV shenanigans slide while we're here
- WSJ: nothing Lucid about a $57B valuation for an electric-vehicle start up
- Ok, last thing on CCIV / Lucid. I mentioned this in my post on PSTH, but bubbles can pop for really weird reasons, and the fact that Lucid (the biggest / most buzzy SPAC) dropped ~50% on deal announcement seems as good a reason as any for a bubble to pop. Markets have been reasonably weak since that deal, and it's still early / only one deal..... but I certainly feel like some of the air has come out of SPACs since that announcement, and pre-deal SPACs have traded down notably since then (though many are still trading at big premiums!).
- Tweet thread on coming era of SPAC shorts
Let me get weird for a second
- Three random and weird thoughts. I figure if you've read this far, this is a safe space to throw some out there thoughts at you!
- First, I absolutely love fantasy novels. I read Warbreaker this month (one of the few Sanderson novels I hadn't read); it started slow but by the end it was just dropping bombs left and right. Reading Warbreaker reminded got me thinking: Brandon Sanderson is operating on a different plane of existence than other mere mortal fantasy writers. The only other author who I'd even put in his class is Patrick Rothfuss (of Name of the Wind / Kingkiller fame), but I don't think that's fair once you consider output: Sanderson is out here writing like 1.5 books a year, while Rothfuss is barely writing one a decade and hasn't even finished a series.
- Why do I mention this? First, because Warbreaker was so good I had to share it somewhere. Second, because I wanted to think about people who are performing at levels just leaps and bounds above their fields. What other examples of there are people who are operating at just a different level than the rest of their industry? There aren't many. For example, LeBron James might be the best basketball player ever, but the difference between his performance and, say, Kevin Durant isn't "other plane of existance higher."
- With investing, I think there are three historical examples of people operating on a different plane than there competitors:
- Second, while I'm on books, another weird thought: I feel like most of my friends who are value investors / more real estate focused investors enjoy fantasy, while I feel like my more growthy or VC driven friends enjoy sci-fi more. Is that just a broad generalization, my imagination, or is there something to those two different mindsets leading people to like different types of writing?
- Honestly, as I write this I get it soudns silly. I guess the thought here would be "growthy investors are more interested in speculating in the future and how tech evolves, while value investors are more interested in the past (where most fantasy is based)." Probably silly, but feels sort of right based on my understanding.
- Another related but probably equally silly theory: investors who focus on very hard assets (investing in stocks for less than net asset value, investing in banks and insurance companies) are much more into non-fiction / history books than most other investors (who like nonfiction books, but read more broadly).
- Third weird thought: obviously I need to mention my current obsession, Peloton. I recently discovered Peloton and ESPN hosted an all star ride at the depths of the pandemic. Three things on that:
- My god, you want to talk about brand strength? I know ESPN was desperate for content during all of the stay at home orders, but for ESPN to host essentially a 60 minute infomercial for Peloton where a bunch of elite athletes came on and effectively said "I love Peloton; it's what I use to train at home" Wow!
- I just love what these results reveal about the underlying athleticism of these people. At his weight, Rory's results are equivalent to a low level professional cyclist (or at leash that's what a locked account on twitter told me; I believe them!). This is one of the best golfers in the world, and on the side he's casually putting out the results for elite cyclists. That's incredibly impressive.... but I don't even know how to speak to how unbelievable Colleen Quigley's results are. She almost freaking beat Rory, who I was just raving about for putting up a borderline professional power output! The difference between her and second place in the women's was almost double the difference between second and last place! A "Brandon Sanderson writing fantasy" level of dominance from her.
- I did my first FTP test a few weeks before seeing that ride; I'm planning on doing one every six weeks or so. My first test was fine, but I went into the test blind in terms of how I should pace myself and what cadence I should use. Super excited to take my next one with better pacing / cadence / form; looking forward to catching Rory at some point (don't worry, my body weight is much higher than Rory so I'm not planning on putting up professional cycling levels anytime soon!). If you have tips for training or pacing an FTP test, I'm all ears!
A quick cable follow up
- I posted: Big Three Cable; still too cheap early this month. A quick follow up.
- Charter raised ~$3b of debt this month. Look at the rates they're raising at! 30 + 40 year paper at <4% yields. I just wanted to highlight it because it just hammers home the buyback math all of them are looking at (and Altice is explicitly stating is driving their buyback): their stocks are pricing in mid to high single digit after tax cash flow yields to equity (depending on the company and how you treat some growth investments), and that yield should grow pretty healthily over time as capex intensity comes down and the businesses get some operating leverage. Debt markets will fund them, pre-tax, at low single digit yields, and the cable companies can take that debt and buy back equity at higher yields. That's an incredible arb. Obviously it's not risk free, and it requires confidence in the long term outlook for the cable business (something both the cable execs and myself are very confident in), but I think the risk-adjusted returns on those buybacks are outstanding.
Other things I liked