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Still Buying, But Not Really Buying It

After 3 months of seemingly constant portfolio churn – rotating from shorts to gold to mortgage REITs to SaaS to banks at break-neck speed, in the last couple weeks my portfolio has had a period of relative calm.

The themes have been the same.

  1. Own gold stocks
  2. Own work from home/stay at home SaaS names
  3. Sprinkle in community banks with management teams you trust that will recover eventually
  4. As always – look for special situations that appear mispriced

If there is a change, it is that I am creeping more to the short side.  Not truly short, like I was in February, but I have moved from my early June “not too far net long” description to “pretty much flat” today.

This is, as always, with gold being the wild card.  I had a great day on Friday with the market down, and most of that was due to the gold stocks.

So why am I positioned cautiously?  The same reasons that I described a few weeks ago.  They can be summarized by – I don’t really believe it.  On a few levels.

But there is one huge reason that I am not willing to replay my February playbook and go truly short here – the Fed.

I’ll describe these thoughts in more detail at the end (of what is a very long post, I apologize in advance).  But first, the interesting stuff: the stocks.

Stay at Home/SaaS

I pride myself on having the only blog in existence that talks about gold stocks and SaaS names in the same post (tell me if I’m wrong about this).  I’ll start with SaaS and then to gold.

My SaaS portfolio has seen some churn as I continue to try to figure out the sector.  There will likely be more churn to come, but here is where I am at now.

The four large cap names that I own are Atlassian, Workday, Slack and Dropbox.  Of the four, Slack is a very small position (because it is so expensive and they don’t generate free cash), while the other three are about the same size.

I have to say though, I’m not convinced about Dropbox.  Its more of a “value” SaaS play, if there is such a thing.   It doesn’t seem to have the growth outlook that other SaaS names have, and I don’t totally understand how it competes against Microsoft and Google in the long-run.  So it would probably be the first name that I drop in a pinch.

The smaller names I own are more interesting to write about.  I have bought Onespan, PagerDuty and Intellicheck.

Intellicheck has become one of my largest positions.  Honestly, it seems like a no-brainer to me, even after this pop to the mid-$7s.

Intellicheck offers an identity theft/fraud detection platform to banks, which then provide the platform to their retail customers.  It seems like a great customer acquisition model – they sign up banks and for every one they sign up that bank does the legwork to onboard a bunch of their customers.

Last week Intellicheck announced that they had signed up their eleventh bank.  As @RodiGo_ethe dug up, this is likely KeyBank.

Even in this environment, the customer adds seem to be snow-balling for Intellicheck.   They signed up Bank #8 at the beginning of the year, #9 and #10 somewhere in the March to May timeframe, and now #11 here in June.

So 4 banks on a base of 7 in 6 months?  Seems pretty strong…

I could spend a whole post going through each bank.  I’ve spent hours pouring over their conference calls and separating out the comments for Bank #1, #2, #3 and so on.  Maybe I’ll put out a detailed write-up at some point, but for now here’s the Coles notes: they sign up a bank, it stumbles a bit out of the gate getting ramped, then it brings on a few retail clients, then a few more, then a few more, and so on and so on.

It is the ultimate land and expand strategy, but with the banks doing the heavy lifting.

But here’s why this seems like a no-brainer to me. First, this is the year-over-year growth the last 5 quarters:

Second, at the price I have been buying it at, which is a little above the recent private placement price of $6.50, Intellicheck trades at ~11x EV/Sales.

In a world where 30-ish% SaaS growers trade at 25x sales or more, this seems mis-priced.  Here we have a company with way higher (and accelerating!) growth, a large runway, a great land-and-expand customer acquisition model and they are free-cash-flow positive (before working capital changes).

I mean quite honestly, the stars are well aligned here.

The only pitfall is that this is a retail driven business.  And retail is not in a good place.  To make matters worse, Intellicheck gets paid on a per-use basis. So even though it is SaaS, this is not a COVID friendly business model.  Intellicheck will gain from e-commerce, but will likely be hurt more by bricks and mortar.

But that’s okay.  It’s a bit like Schmitt and the ice cream business.  A tough go for a while but this too will pass.  I think Intellicheck will be extremely well positioned once we get through this pandemic.

OneSpan is another platform provider to banks.

I don’t know what it is about banks, but I am exceedingly comfortable owning banking related businesses. I like owning community banks, I like owning providers to banks – it just gives me a warm fuzzy feeling to know that the business is tied to banking.  I have no explanation.

OneSpan is not a pure SaaS play.  They are one of these hardware providers turned SaaS providers through acquisitions.  Like Intellicheck, they are in the identity-based security business.

On the hardware side OneSpan sells authenticators, which seems like the sort of thing that will go the way of the dodo (and appears to be doing so).

But on the software side they sell a Trusted Identity platform – consisting of a web-authentication product (basically the verify who you are when you log into your bank and such), an e-signature product and an agreement automation product.

The key here is that these are products designed specifically for banks.  So they aren’t really competing against Docusign for e-signature or Okta for security.

The software/SaaS business is breakeven right now, while the declining hardware business is a cash cow.  The SaaS business is expected to grow 20%+ for the next few years while hardware declines:

When I was buying the stock, at $22 or so, it was trading at ~3x sales.  Now it is a little under 4x.  I’m not sure how much longer I will hold it if it keeps going up.  At some point here I might be inclined to sell.

OneSpan reminds me a bit of Vonage.  They are taking a declining hardware business and trying to lever it into a software platform by acquisition.  The one (important) difference here is that OneSpan is probably more like a leader in the space while Vonage is always playing catch up to Twilio, RingCentral and the like.

But I do suspect that banks, which are probably some of the slowest adopters of the online movement, are going to be playing a lot of catch-up here.  And I think OneSpan could put up some very good numbers as they do.

Gold Stocks

My list of gold stocks is long.  There are four familiar names: Roxgold, Wesdome, Gran Colombia and Fiore Gold.  To that I added two new names relatively recently: Teranga Gold and Superior Gold.

I mentioned Teranga in my last update.  They have mines in Burkina Faso and Senegal.  When I bought them they were trading at ~7x cash flow.

Teranga has plenty of room to grow through its Massawa mine (in Senegal), which they acquired from Barrick earlier this year.  This was one of those acquisitions that is truly strategic – Teranga already owned a mine next door (called Sabodala) and by combining the two they can realize economies of scale including much higher throughput.

Teranga said that Massawa will add around 100koz to their production next year – which is about 30% growth.  Even at $12 I’m inclined to hold on, especially given the gold market we are in.

Superior Gold is a name I have talked about in the past and that was brought to my attention again by @BrownMarubozu.  Unlike Teranga, which is a clean, growth story, Superior is more of a “dumpster dive” situation that I seem to tend towards (and often learn to hate).

The first thing Superior has going for it is that it is cheap:

Superior’s single mine asset is the Plutonic mine in Australia.  This is an underground mine that has been around for a long time.

It is not too often that you can sum up the reason why a stock is cheap in a single chart but in this case you kinda can.  While the chart below is a bit old (because Superior stopped including it in their slides, probably realizing that after a while, it is just embarrassing), it illustrates the issue perfectly:

The story is simple – fill the mill with higher grade ore.

Its actually even worse than the chart suggests as Superior is mixing in even lower grade ore from its open-pit sister deposit, Hermes, right now.

If they can find the ore, Superior could be a real winner.  They actually have a second mill nearby, currently on care-and-maintenance, that could add more production – if they could fill it.

What has me interested in the story again is that Superior is finding more ore.   Recent drill results (here and here) are in addition to extensions at other parts of the mine (Indian Northwest and Baltic).

The aggressive drilling and its success means there is the chance they hit on a really nice find – and if that happens, given the unused capacity, the stock will fly.

On the developer side, I continue to go with a basket approach: owning Gold Standard Ventures, Corvus Gold, and recently adding Gold X Mining, with which I replaced Probe Mining.

I bought Gold X on kind of an ill-fated idea that seems to have lucked out for different reasons.  It was ill-fated, because I bought it when Gran Colombia announced their proposed acquisition of both Gold X and Guyana Goldfields.

That acquisition made sense to me – I mean Guyana has a mill that they have never been able to fill with ore while Gold X is a nearby gold deposit.

At the time, Gold X was trading at a discount to Gran Colombia, so why buy Gran Colombia when you could buy equivalent shares of Gold X on the cheap?

Well, that turned out to be a dumb idea.  The acquisition failed, Guyana went to some Chinese bidder for way higher than Gran Colombia was willing to pay, and I was stuck with the Gold X shares.

I didn’t sell those shares because, even though the bid from Gran Colombia failed, the combination of Gold X and Guyana still makes sense.  This Chinese bidder that was so willing to pay top dollar for Guyana – which is basically a disaster of a mine – well you’d think they’d be able to step up and buy Gold X at what would be a cheap price (the stock comps well to other projects) and put the two mines together.  I guess we’ll see.

Stocks with no Theme

I could call these special situations but really, they are just stocks that do not fit into a particular theme.  There are a few new ones that I have found:  Protech Home Medical, Intermap Technologies, Globalscape, and Lantheus.

This is in addition to the list of existing ones that I have owned for a while: Identiv, Innovative Solutions, Overstock, Rada Electronics, Schmitt, Tel-Instrument Electronics, Tornado Hydrovacs and Velan.

Of these new names, the most ridiculous, most speculative, and therefore most interesting (to write about) is Intermap.

I preface this discussion by saying that the stocks I write about are not always the ones that I have the most conviction in, or the biggest positions in.  It is often quite the opposite – the stocks that are most fun to write about are the one’s that are completely speculative flyers.

Intermap fits that bill.  Here is the crazy deal.   On the third of June Intermap announced that they had agreed to settle all of their outstanding Vertex notes (which are now owned by an entity called Pender Funds) for $1 million.

What is crazy about that transaction is this:

Under the terms of the Settlement, all of the outstanding Notes totalling US$33.9 million shall be settled for US$1 million in cash. Upon the delivery of a US$1m cash payment, Vertex/Pender shall release liens, extinguish the Notes, and the parties shall provide for a general release from all claims associated with the Vertex financings.

Wait, what?

In all honesty, it does not make any sense.  Its like going into bankruptcy and having the debt holders wiped out while the equity remains fully intact.

I’ve been intending to call the company but things keep coming up.  I’ll try to find the time next week.  Because I need some sort of explanation.

As far as I can tell, Pender doesn’t even own any shares anymore (they sold what they had last year).  So its not like they are wiping out their debt because the see that they have more to gain from the equity position.  There is no logic to this that makes any sense.

Unless Pender is a benevolent fund, there just has to be more to it.

At the same time as the debt announcement, Intermap announced that they signed a new deal with the NOAA with a potential $40 million of revenue over 5 years and they signed a SaaS agreement for NEXTMap One terrain data with the State of California.

So why would Pender just walk away?  Its bizarre.

I took a very, very small position on the off chance that this is actually a real deal, and I am at peace with the likely probability that my position goes right back to 10c.  Because it is hard to believe that the deal is real.  But it certainly makes for an interesting story to write about.

Protech Medical and Lantheus are pretty straightforward stories.  Protech is quite cheap, even though it has moved up from where I bought it at ~$1.  It trades at under 9x trailing free-cash-flow.  It is growing EBITDA.  And the pandemic is actually a tailwind to the business, which supplies oxygen supplies and ventilator equipment, among other things.

Lantheus I’m less sure about.  Again, this is a business trading at a nice FCF multiple – I calculate about 9x based on last years numbers.  There is some debt here and growth is pretty “meh” apart from acquisitions.  The biggest problem is that the business centers around diagnostic medical imaging agents, which means it is tied to hospital admittance, which puts it at odds with a second wave of the pandemic.  I already sold CRH Medical because I was uncomfortable with their exposure to a second wave, and so I’m pretty waffley on Lantheus for the same reason.

GlobalScape is a new name that I just bought.  I was going through the list of additions to the Russell and I found it.  I’ll write about it more later.

Why I Remain Cautious

As I said at the beginning of the post, I remain skeptical as to how much further stocks can go primarily on two accounts.  These two considerations keep me cautious, while one other consideration: the Fed and global Central Banks, keeps me from going short.

First, I have a hard time believing that this time is different.  That Robinhood retail investors represent a new class of long-term successful investors.  Or to say this another way: I don’t believe that stocks only go up.

Every time we have had large retail investor enthusiasm it has ended poorly.  Being a retail investor myself, I’d love to believe it is different this time.  But I have to ask quite honestly – is there a historical precedent for retail investors leading a new bull market?

Portnoy is observant with his catch phrase, but it is really quite ironic.  Because the concept that stocks only go up is truly the premise of all these episodes of enthusiasm.

At some point there will be a bear market and that premise will fail.

Are we there yet?  Eh, who knows.  But man, when I listen to a PlanetMoney podcasts interviewing a government employee that has made 7x her money in 2 weeks day trading bankrupt Hertz stock in her Robinhood account… well, that sort of stuff makes me uncomfortable.

But all this has already been said by others and I have no axe to grind.  After all, I’m retail, and these are my folks.  My only somewhat original thought is what I debated on twitter on Friday.  This is somewhat off-topic so feel free to skip ahead.

The argument I took contention with went something like this: The Robinhood movement is an attack on the fee-based performance industry.  This industry perpetually under-performs but still takes exorbitant fees – it is ripe for disruption and this is that disruption.

I don’t disagree with much of that statement.  But my response is this:  While I’d love to believe a disruption is upon us, I think there is an important nuance, and that is this: managing your own money through the cycle takes a large mental toll, particularly when the cycle turns south.  And I am skeptical that any more than a small fraction of people have the mental makeup (and maybe the stubbornness) to manage their own money in the face of that.

With that in mind I hypothesize that the fees you pay are not only for performance.  They are also paid in return for the service of not being directly tied to the outcome on a daily basis and for having someone to blame (other then yourself) when things inevitably go south.

The success of the Robinhood movement depends not on the performance (or lack there of) of the fee-based industry, but on the ability of individual investors to deal with the stress of making decisions for themselves throughout the cycle.

IMO that’s the deciding factor of whether the movement succeeds or fails.  And why I am skeptical that the movement lives through the next bear market.

So while I will try to opportunistically “catch the wave” of Robinhood stocks where I can (though I can’t bring myself to buy Hertz), I think the movement is doomed in the long run.

My second point.   As I wrote about a few weeks ago, is that I don’t believe that this pandemic is over.

I still feel like it is a false narrative that the government proactively shut us down.   It seems to me that the truth is more like the government moved re-actively (like it always does) to do what everyone was already about to do anyway.

That differentiation in narrative is relevant now because we may be on the verge of a second wave of hospital overruns.  In a few weeks there could be some cities without enough hospital beds.

In February, when investors did not have this virus on their radar, when they were still running the stock market up to new highs and I was shaking my head in disbelief, I said a shutdown seemed like the inevitable consequence of the dilemma we were in.  Dilemma being the operative word.

Dilemma is a choice between bad options.  While in retrospect we may frame the road not taken as a “good” option, that is only because we didn’t take it.  There was no good option.

Without a shutdown I believe hospital beds would have filled up in a number of cities and then, as a consequence (and not because the government told them to) people would have stopped doing things anyway.

If you know there are literally no hospitals beds available, you think twice before getting in your car for a long drive (the off-chance of a car accident), or going for a hike (what if you fall and break a leg).  And of course, the big one being – if you go out to a restaurant, bar, the beach, even to get groceries and get the virus, there may be no bed for you.

We take for granted how important having the medical system as a backstop is.  Our whole system depends on the knowledge that if something happens to you, the medical system can help you deal with it.  Without that backstop everyone becomes more cautious and some become much more cautious.  So the economy tanks.

The virus skeptics I read are saying the following – what we are seeing right now is partly just increased testing, it is partly just young people, and the beds that are filling up will be vacated quickly.  In the mean time the virus is simply “burning itself out”.  So in their interpretation, there is really nothing to worry about.

Maybe they are right?  But that seems like a big gambit to me, at least to put a significant bet on with the S&P at 3,000+.

Again, this isn’t about deaths rising or what the actual death rate is or any of the other stuff that I see.  Its about one thing – hospitals filling up and what happens when they do.  And it won’t matter if its filled with young people or middle-aged people or old people.  A filled hospital bed is a filled hospital bed.

I don’t know how this plays out.  But it certainly seems like it may be replay of what happened in February.  This is a virus.  It follows a pretty knowable trajectory once that trajectory starts.  The skeptics are basically saying – yes there is a trajectory, but this time it is different.  I hope it is, but I’m not willing to make an actual bet on that.

But as far as the market goes, that is just part of the story.  The call is way more complex now than it was in February, and I’m way less sure of what that call is.  I am simply not sure about how far the market can fall.

Consider that A. the Fed is backstopping everything but equities and B. the odds are that the Fed will backstop equities if equities fall too far.

To put it another way – even though I am skeptical, I do recognize that Portnoy is onto something.  This time is different in one important respect – when you have the kind of liquidity we have, and there is no where in the real economy for that money to go – then stocks really should just go up.

On top of the printing related reasons I add one more.  C. The market does have companies that will go up even if the skeptics are wrong.

There are a whole bunch of companies that are going to do well if the pandemic strings itself along with another wave.  I talked about this in my bifurcated economy post – small businesses die and many big public companies flourish.  Not good for most people, but good for many stocks.

Bottom line – it is best to be careful.  I said last post I could see 2,000 or 4,000 on the S&P.  I am perhaps exaggerating with the numbers, but in terms of symbolizing the chaos, I still feel that way.

Schmitt Buys an Ice Cream Shop

Schmitt was one of the companies that I was comfortable adding to during the pandemic induced sell-off in March.

At its lows, the stock traded into the $2.40s.  I added mostly in the $2.50s and got some at close to the lows as well. I added fairly significantly, for me at least, increasing my position by about one-third.

The reason I was so willing to add, even though I wasn’t a very aggressive buyer of stocks at the bottom of the market in general (I never seem to be good at this) is because at that price Schmitt was trading at ~20% below its net cash position.

This gave me some confidence that I wasn’t going to lose my shirt.

When you added to that the value of the company’s Portland real estate, which Schmitt valued at $6.5 million at the annual meeting last year, and the value of the two remaining businesses (Xact and Acuity), it seemed like one of the safer bets out there.

At the time the stock was falling Schmitt was exploring a shareholder opportunity that kept them from buying back stock.  Without the company’s support of its shares the general illiquidity of the market (not to mention the upcoming delisting of shares) there was plenty of room for the stock to fall on fear of the unknown.

I was hopeful that the shareholder opportunity would be a game-changer for the company.  I have some confidence in the decision making of Michael Zapata and his team.  So, I crossed my fingers for some sort of accretive use of their $10+ million cash balance.

Unfortunately that didn’t happen.  We never even found out what the opportunity was.

Schmitt announced at the beginning of June that they had ceased discussions on the opportunity.  They also announced a Dutch auction giving shareholders the ability to sell their shares back to the company at between $3-$3.25, depending on demand.

I have to admit that I was considering participating in the Dutch auction.  Not to sell my entire position, but I toyed with the idea of selling a few shares at a price was a nice, quick return.

But then, on June 11th, Schmitt announced that they had been the successful bankruptcy bidder for the assets of Ample Hills Holdings.

Talk about out of left field.  It has taken me a while to wrap my head around this deal.  It is a total change in the thesis.  But I’m actually really liking the move, though I recognize the risks have went up a notch or two.

Ample Hills Holdings

The first thing to understand is what Schmitt is paying for Ample Hills.  The bid they made was $1 million dollars.   In addition they are assuming the cure amounts associated with the assets.  According to Schmitt’s 8-K they have to assume at least 7 of the 10 active leases.  They may assume all 10.

So what are the cure amounts?  Well, there are more than 10 leases listed in the bankruptcy documents, all listed below.  I believe that the last 3 in the list below wouldn’t be part of the 10.  Prospect Park West and Dekalb are not yet open.  The Lake Buena Vista location is on Disney’s boardwalk, which I don’t believe they operate it themselves – they just supply ice cream to it (though I don’t really understand why it is mentioned then?).   Finally, Factory/Red Hook and HQ are all considered one location I think.  The cure amounts for all the leases are:

If Schmitt assumed all 10 remaining lease locations including the headquarters, that would be total cure amounts of ~$925,000.

Add it up and Schmitt is taking Ample Hills Creamery for about $2 million.

Now I’ve read/skimmed through every single one of the bankruptcy filings (ie. I’ve read through all the one’s that are relevant and not just reiterating an objection, listing creditors or introducing a lawyer).

My conclusion is – $2 million bucks doesn’t seem like a lot for this business.

The first thing is, Ample Hills is not just your regular local ice cream shop.  This is not just some no-name local mom and pop shop.

This is a real brand – with notoriety and a following.

Consider these comments from the bankruptcy filings:

From their Instagram account:

I have a friend whose company has built an app that, among other things, analyzes, compares, and ranks the footprints of businesses on social media.  Before either of us knew about the celebrity of the company, he screened it on his app.   He was scratching his head why this dinky little ice cream shop was punching so far above its weight on the social media scale.  Clearly, now we know.

Honestly, there are a lot of things to worry about with this business acquisition, and I will get to them all, but my over-arching thought is this – how can the Ample Hills brand be worth only a couple million bucks?

The Ample Hills History

The history of what happened to the Ample Hills business is described in this declaration by Brian Smith.

It is worth reading in full.  These are the Coles notes.

Smith and his wife Jackie Cuscuna founded Ample Hills in 2010.  They sold ice cream out of a cart.  They opened a shop in Prospect Park (Brooklyn) in 2011.  In 2012 they opened another, in 2013 another.  All in Brooklyn.

In 2014 they started a nation-wide mail order ice cream business.  Bob Iger became a customer and liked the ice cream so much that he made a deal to open a shop on Disney’s boardwalk.

They expanded even more quickly – raising $4 million in 2015 and taking out an SBA loan at Flushing bank.  They added more locations and – here is where it all went wrong – they built a factory (called the Factory) in Brooklyn in 2017.

The Factory was a cash incinerator.  It cost $6.7 million to build – $2.7 million more than it was supposed to.  It took 18 months longer to build than it was supposed to.  It was supposed to run at full capacity, supporting the wholesale business and new shops, but the shop openings were delayed.

The Factory ran at an annual rate of 200,000 gallons last year versus a capacity of 500,000 gallons.  In the filings Ample Hills says the Factory has resulted in dis-economies of scale.

According to the filings, Ample Hills “began to lose money as they started construction of the Factory”.  Here are how those losses evolved beginning in 2017:

But at the same time, at the store level, Ample Hills was actually doing quite well.  In 2019 “on average” the shops generated 15% EBITDA margins.  The combined entity loss of $6.9 million was a result of “depreciation, amortization, interest expense, payroll and other operating costs associated with supporting the Factory” (my underline).

What Schmitt is Buying

So the short answer is – we don’t know for sure.  My guess is that Schmitt will take on the leases of the most profitable stores.  Here are the revenue figures for the remaining 10 leases from last year:

The Essex Crossing location was only open for a short time in 2019.  It looks like a promising location (it’s a farmers market in the Lower-East Side) and they did $55,000 of revenue in the first two months of 2020.

Schmitt appears to be trying to negotiate leases for some of these stores.  After the auction there have been 3 objections, from the Chelsea, Esses and Astoria lease holders, complaining that Schmitt has engaged them to try to sign a new lease rather than just paying the cure costs and taking on the existing lease (it looks like these objections were overruled).

So there is a lot of uncertainty about which leases Schmitt ends up with.  Assuming Schmitt ends up taking the top-7 revenue leases and Essex Street, they probably are looking at $8 million in revenue annually.

Ample Hills did about 7% of its revenue from wholesale and another 3% from e-commerce last year – so there is another $1 million all-in from this side of the business.

That is $9 million dollars of revenue from the existing locations.

But will it be profitable?

One problem, and maybe a reason that Schmitt was the only bidder, is that Ample Hills doesn’t appear to have provided corporate financial statements from the last few years.

I don’t have a lot of experience with bankruptcies, but I kinda thought this would be a requirement.  But I have gone through every document and unless I fell asleep skimming through (which is possible), I don’t think last years financials are there.

So, all we really have to go on are A. the numbers I have already presented and B. The Ample Hills post-petition forecast.  This was before COVID-19, at least before the lockdown, so I am assuming its roughly the run rate of the business.

They expected to be slightly EBITDA negative.  Given that this is a very seasonal business – for example Ample Hills said that their labor costs are roughly double in the summer of what they are the rest of the year, that they are close to EBITDA breakeven from March to May seems pretty decent.

The other thing I could do is add up all the cost disclosures from Ample Hills and see what that sums up to.  As part of the filings Ample Hills has provided utility costs, lease costs, labor costs usually at a granular lease by lease basis (including phone, internet, gas, electric – its pretty detailed).   They’ve probably covered a lot of the operating costs.  I haven’t gone through this exercise yet, but I have it on my list of things to do.  It is going to be time consuming though.

The biggest issue I think is how does Schmitt either A. get this Factory up to its utilization rate or B. reduce the Factory costs to a point where it is not such a big drag on the business.

So there is a lot that is unclear here.  We don’t know

  1. What Ample Hills looks like post-bankruptcy
  2. What assets Schmitt is taking on
  3. What they are planning to do with the Factory

On top of this there is also this whole pandemic thing, which it kind of goes without saying is a bit of a fly in the ointment (though maybe the worst is over for New York?).

Nevertheless, I can’t help but think that a couple million bucks for a business with this kind of social media presence, a strong following in one of the trendiest cities and a history (pre-Factory) of doing pretty well on a store basis, is a pretty cheap price.

As an aside I talked with Zapata literally the morning of the same day (June 9th) that the bankruptcy court awarded them the business.  I talked to him because I wanted to better understand the go-ahead plan before deciding on what to do with the Dutch auction.

He did not so much as hint at Ample Hills.   Like not even a vague comment about good things being in the works.

I really respect that.  He is very forthright that he will only disclose to you what he has disclosed for everyone.  I think that is a very good sign.

Schmitt has the cash to turn this business around.  To wait out the pandemic.  It is going to eat into the “value” story, but it also adds a whole other layer of upside.

Of course, it is also total thesis creep.  But we always figured they would do something with their money.  We knew they were going to burn some of it trying to right the Xact and Acuity business.

Schmitt can now focus their attention on a well-established ice cream business – that seems preferable to me.  It is probably riskier than it was when this was just a cash and asset play.   But I think the upside has grown quite a bit as well.



I bought it, but I didn’t believe it

Jimmy cracked corn and I don’t care

It is a Constanza market.  Everything you might want to do – do the opposite.

If you think a stock is overvalued – buy it.

If you think it might go bust (or already has) – go all in long.

If something looks overbought – it’s not.  If it looks oversold, it’s not.

But most of all – remember the #1 rule of fight club – every event is good for SaaS.

I’m kidding of course.  Kind of.   In a market like this there is just no point in looking too hard at companies.  Analysis is out the window.  You just shoot first on both ends of the trade and don’t think to much about the long-term.

To take but one example: what is the point of a deep dive into Air Canada’s social distanced load factors and where their breakeven profitability might be?  All you needed to know was that the company raised cash and wasn’t going bankrupt.   And then after that 30% move in a week, that the market was getting pretty extended.  None of this has anything to do with the business.

I could go on with other examples of silliness.  But that is the past because I am off that train.

I played it as best as I could, but it had to end – for me at least.  We might be at that point more generally – I see the indexes are down again today but clawing back up so who really knows.  But last Thursday was the end of the speculation for me.

I started selling some things as early as a couple of weeks ago but I still got caught by Thursday’s sell-off.  It wasn’t too painful, but it was the omen I needed – I had made myself a deal – when we get our first big correction, I’ll step away again.

My earlier sells were my earliest purchases – the mortgage names, some gold names and some one-off plays that have moved significantly (like DLH Holdings and Sonoma Pharmaceuticals – which was a bit of a fluke).

But I did a bit of buying too and it more than offset the sales: a few small regional banks – Bank7 Corp, Sound Financial and Parke Bancorp.  A few new names like Digital Turbine, Intellicheck, CRH Medical, Protech Home Medical and a very small position in Intermap.  Increased position sizes in existing positions like Rada and Schmitt.   And the biotech basket I mentioned in the previous post (which I have since re-formed into positions in Dare, Eiger, Enlivex and Obseva).  Most speculatively, I had taken on some “economy” names – like Air Canada and American Axle.

My net exposure was going up.  I was monitoring that exposure but with the market rising I was allowing it to stay a bit elevated.  I should have known I was getting a little too offside when I had a big up day (for me) last Tuesday – more than 1%.

Of course, this was followed by the opposite on Thursday, to the downside this time – 2%.

That may not sound too bad, after all the market was down 5%, but I’ve really tried to create a portfolio that doesn’t go up or down more than 1% on any day no matter what the market does.

So last week was a wake-up call that I had strayed from that.  I was compelled to correct that imbalance.  I sold the longs I was least comfortable with (which was anything economically sensitive), reduced some others to lower weights, and most importantly, added to my index hedges.

I’m not short now, but I’m (hopefully at least) not too far net long any more.  My basic objective remains the same as what I articulared in February – I want to do well when my individual names do well (like when Schmitt buys an ice cream business for a million bucks) and not get creamed (pun-intended) if the market does.

Looking back

What strikes me most about the last few months is how closely they mirrored the 2008 playbook.   The big difference this time around was that about 2 to 3 years worth of rotations were fast forwarded into the last 3 months.

First you had the golds move, right at the bottom of the market.  Then you had the growth names.  Then the mortgage names.  Then the banks and value.

It was interesting to me how it was basically the same song all over, only performed by the chipmunks.

But now?  I’m not so sure.

Other than from perma-bears, I don’t see too many predicting a second wave, or even thinking about what a second wave actually is.  Instead all I see are justifications for the rise in cases.  Mostly, that it is just testing.

Okay.  That could be.  I know from our experience in Alberta that this logic was on display in early April: its just testing…we don’t have to worry… the numbers lie.  I said it myself.

Then we found out there were two super-spreader events and that the testing explanation was a red herring.  It was bullshit.  The real indicator was that percent positives were 3-4%.  In states with so-called elevated testing we are rarely even down to that level from what I can see.

So I am skeptical of this hypothesis.  I’m also not sure whether the same can be said for what is going on globally.

I also see a lot of finger pointing to data that is improving.  I don’t find that argument all that compelling either – not with the market at 3,000+.  If it is the economy that the market is going to rise on – what matters from here would be the last 5%, and there is no indication yet of when we get that back.

The most compelling argument to me by far is that you simply do not fight the Fed.  Or in this instance, every central bank in the world.

I think it is best to be honest: this is really the single leg of the bull case from here.  Its not really about earnings or economic growth or green shoots or things getting better faster than some bogus projection that no one really could have guessed at any way.  Its just about liquidity – and how maybe we have triggered a massive bubble in stocks where higher prices beget higher prices regardless of what the economy does.

Don’t get me wrong, I’m not saying this derisively.  I am 100% onboard with this possibility.  I don’t think anyone really knows how high a market can go on liquidity alone, and the possibility exists that the answer is much higher.

But I think you gotta be honest and admit that this is the single reason, albeit a very big reason, to bet on the upside.  That’s the bet.

Meanwhile, I am uncomfortable with all the speculation I see.  Every time we see some guy like this barstool dude become an investing guru overnight, you gotta raise an eyebrow.  When have we ever seen something like that and looked back in 2 years and said, yup that was the start of a real run?  Or when have we seen the start of a bull market coincide with the rise of retail investor speculation, or with crazy moves in stocks in bankruptcy that have no business going up?

So even as I realize that this is possibly the exception to the rule, possibly the next 1999 (which I don’t think you can brush off – this could be the next 1999 given the liquidity), it seems more likely that this is evidence of excesses that needs to be worked off first.  I am choosing to be cautious, for now at least.

Anyway, like I’ve written a few times, I don’t have to be right.  I just have to be not wrong.  To see my portfolio continue to creep up slowly in fits and starts.  And by balancing back out my exposure I should be able to do that.

Onto some specifics

First, the other big thing I am still waffling about – gold.

I’m really unsure about gold.  The employment report a couple of Friday’s ago gave me a big pause.  As did the rise in the stock market.

But at the same time, I am reluctant to cut my exposure too much.  The central bank positioning is ideal for gold right now.  It seems likely further stimulus will be passed.  It seems possible that rates go even more negative.

What’s more, the movement of gold since the employment report has been surprising to me.  Honestly, when I saw that number I thought it was done for gold.  It seemed like a disaster.  And on that Friday, it was.

But since then, well I have to admit – it hasn’t cracked.  It keeps getting whacked, like it did today, but each time it gets whacked it comes back.  And each whack is a little less exuberant then the last one.  So I don’t know…

That unemployment report should have been a knock-out blow that sent gold reeling.  It should have been months to recover.   Yet here we are.  Still above $1,700.

As well, the gold stocks, the one’s that I own at least, seem to be very reasonably priced.

Roxgold trades at 3.5x trailing EBITDA, Gran Colombia trades under 2x trailing EBITDA, Teranga Gold (which I recently added) trades at under 4x next years EBITDA once the acquisition is integrated, Wesdome is more expensive, at 12x EBITDA, but will look much cheaper once Kiena gets into production.  And yes I know, EBITDA is not the right metric to sue, but its right there on my screen whereas I’d have to dig into each name to get cash flow, so this is what you get.

Similarly, the bucket of developers I own are barely higher than they were pre-pandemic.

It is also interesting that inflation expectations have spiked.

Hugh Hendry

Two of the most influential interviews for me over the last couple of months involved Hugh Hendry.  Both were on RealVision.

RealVision gets a lot of hate and I think it is misplaced.   I get a lot out of it.  Their interview with Emad Mostaque, which I watched during the first week of February, was a game-changer for me – Mostaque outlined a very coherent view of what was likely to happen with the coronavirus.  That interview alone saved and made me way more money than I will ever pay in subscription fees.  I feel like investors like to rail on the service because they or their guests are often “wrong”.  Who cares.  You subscribe for divergent views and you make your own decision.  Its not about trying to find someone to tell you what to do.

Anyway, back to Hendry.  I didn’t really know much about the guy, and I still don’t, but he said some stuff that really resonated with me.

In the first interview, he was interviewed by Raoul Pal.   In the second, Hendry interviewed the author of the Princes of the Yen author Richard Werner.  The Princes of the Yen interview was particularly insightful.  It gave Werner’s views on the workings of central banks, and many of the insights were things that I hadn’t considered before.

But I’ll keep the talk to Hendry for now.  Hendry thinks this environment is likely good for gold – but that gold, as I am so painfully aware, will do everything in its power to buck you off before going to its rightful place.

And Hendry makes another very good point – that you may want to be long gold here, but don’t believe in it.

The idea is this.  Gold doesn’t just go up just because of money printing.  It goes up because of the belief that money printing will lead to inflation.

For example, gold tanked in 2012-2013 when investors started to clue-in that all the money printing was not leading to an increase in the velocity of money.  There was no transmission to the economy.

This time around?  Well, Hendry is again skeptical that there will be transmission.  Count me in on that.

But in the short-term, that likely “truth” is irrelevant.  What matters is whether investors think there will be transmission.  They have so far, and most likely will continue to.  So gold should go up on that expectation.

You can act on that, but you don’t want to believe it.  Hold through the rally, but don’t trust that it will last.  Because the better probability is that money velocity won’t pick up and gold will eventually tumble back down.

Hendry also seems to be cautiously uber-bullish on equities.   If that sounds like a paradox, it probably is, but that is where we are at right now.  His perspective, again like what I’ve been thinking, is that the middle of the road is not very likely right now.

I get the impression that Hendry would not be surprised to see 4,000 or 2,000 on the S&P – and maybe both.  That’s basically how I feel.  Things are that messed up right now.

He’s not the only one.  @Volslinger, who is a fintwit follow I always look for (though I wish he said a bit more) summed it up well on Friday.

My take is this: I don’t feel like this is a good time to pretend you know what is going to happen.  You may end up a hero, but you also may end up getting punched in the face.

It is anything goes time.  Maybe if your goal is seeking publicity for your barstool media business its the perfect time to be all in one way or another.  But if you are actually managing money for your family and your future prosperity depends on these decisions – well, I don’t think that this is the right time to be taking a big risk.

Anyway, the bottom line on all of this is that I am back to hedged. I’m not net-short like I was in February (After all, the Fed), but my portfolio should not go down much if the market continues to swoon.  In fact, if at the same time the Canadian dollar falls back down down after this ridiculous rally (which my god, it has to, right?), I suspect I could go up a bit.  I took off all my CAD hedges last week.

Today when the market fell 2% at the open, I was flat, even with gold down $25.  That’s what I like to see.

I think I will leave it at that for now.  I was going to talk about individual stocks in this post, in particular Schmitt, but this is getting long so I will write something separate up later this week.