Software has taken a beating YTD on so-called “SaaSpocalypse” fears of AI eventually being able to act as a cost-competitive, infinite, and on-demand bespoke app store for whatever need an enterprise may decide to spec for. Now, however, software has started showing strength (or at least a stop to the bleeding) relative to everything else during the volatility of continued US/Iran (and associated shipping & energy) concerns (as well as low correlation). I won’t try to “post-dict” exactly as to why, but it is happening (for now) —sans the occasional panic in the market each time a new LLM model is released or discussed by the big model labs. On that note, I thought it would be interesting to pick through the rubble of SaaSpocalypse survivors for those names that might be least affected by the concerns of that dip-inducing narrative and (ideally, maybe) even be beneficiaries.

BTW, when I say “AI”, what I mean (and I think what most others mean as well) is LLMs and the current wave of software tools/features that all use LLMs as the reasoning/interpretation engine behind their ability to act and plan/communicate with users, systems, or to themselves or each other for the purpose of completing generalized tasks. (Keep in mind that AI in the sense that was most commonly referred to right before the explosive popularity of ChatGPT and LLMs was really more accurately described as highly-specialized or task-specific implementations of “machine learning” techniques (think of statistics-based spam filters or recommendation/ranking systems for email or music streaming services as examples of this latter category)).

Commentary

The tech industry is going through a set of sudden step-function changes all at once. One is upwards in customer expectations & understanding of what is possible and a step-change downward in the speed and cost of code/data production/analysis/aggregation for all incumbents, outside challengers, and de novo developers. By leveraging AI agents, the total number of user seats that customers may need to pay for under traditional seat-based licensing is also declining, though the total amount of “activity” may be increasing due to using these agents. Meanwhile, AI is introducing whole new categories of black-box liabilities on all sides (eg. auditability/compliance challenges in environments that require determinism, causal reasoning, explainability, and accountability; LLM hallucinations; and new ways hackers can exploit these systems). What we want to do here, IMO, is determine what is becoming more scarce (or abundant) —in meaningful magnitude, direction, and de/acceleration— and determine who actually profits (or is diminished) by it.

Something I think is interesting is this 2022 graphic (below) of value capture along the aviation industry’s supply chain. We see that the vast majority of invested capital in the aviation industry —which comes from investors and lenders who, excluding the government, you would assume are trying to make a profit— is deployed into subsectors with average returns below their cost of capital. This apparent crowding into negative-value-creation subsectors included the most visible subsectors that come to mind when people typically think of the aviation industry and has persisted into (at least) 2024. I wonder what parallels to this might emerge in hindsight as the AI industry matures.

I think it makes sense to assume that the story of which parties in the AI ecosystem that ultimately emerge as the ones to capture the most value by the time we get to the “mature” era in the adoption S-curve will have many surprises. That is, the “winning” subsectors will not be predictable —they may not yet even all exist— and I’m not counting out (certain elements) of the software industry so soon.

There are many ways the future can play out, so it may be easier and less prone to salience- or availability-bias to simply catalog those sectors that presently have the most constraints imposed on them (or, invertedly, constraints keeping competition out) and have (de)accelerating “attack surface” (de)growth. The way I see it, going after the space(s) with the lowest/shrinking attack surface (but perhaps hardest/growing constraints) is a good way to increase the chances of picking winners occupying or soon-to-be occupying true bottlenecks (or at least to help avoid picking the biggest long-term losers).

Starting with the least attractive (and this will not be a comprehensive list), I put traditional horizontal SaaS businesses. Yes, there are switching costs but the situation is one of customers switching from a general tool to another general tool (apples-to-apples) while LLMs cut dev costs for comps (and cut (re)integration cost for clients thinking of switching), open-source LLMs kill any AI differentiation via the closing quality gap vs open-source, and the hyperscalers continue to bundle equivalent generalized functionality themselves (eg. Google Calendar + Gmail appointment scheduling integration for a Google Meet video call, perhaps with an attendee connecting from a Pixel phone running the Android OS, to discuss/collaborate on a budget saved to a Google Sheets doc) 1. A bit lower on the vulnerability list, I include the big standalone model labs. Often the most visible players in the ecosystem, they are continuously threatened by the aforementioned open-source quality catch-up and have little switching costs between them. (FD: I have a meaningfully-sized Alphabet position that was accumulated from before the SaaSpocalypse and through the US/Iran volatility).

Nearer to the very bottom of the competitive vulnerability ranking, I put “powered land” owners benefiting from the scarcity of appropriately zoned locations and physical scarcity of available land for such purposes that are also proximate to necessary energy/data generation/transmission infrastructure, yet also far from anti-data center NIMBYism. While not quite as protected along the dimension of hard constraints as the data center infrastructure & land owners, but in this same general safe area along the dimension of competition exposure —in contrast to the horizontal SaaS companies which I think score poorly on both constraints-hardness and competition— I also put niche vertical market software (VMS) in the tradition of Constellation Software and Roper Technologies (for reasons I’ll attempt to cover in this post).

.

This post is just a brain dump overview of a few of those beaten up software names that may have good chances to actually retain or strengthen their moats in the long-run as AI/LLM-use continues to develop. Given that it’s one of the most disfavored sectors of the market right now —and not for no reason, to be fair— I think it’s currently one of the more interesting areas to look at for individual oversold situations (keeping in mind that beaten-down does not necessarily mean oversold).

(FD: I own small amounts of most names here and may add or sell at any time. I don’t see any need to rush into any position in this space as I doubt there’s going to be any single major event that de-risks software all at once from the shadow of AI in peoples’ minds any time soon.)2

.

ROP (Roper Technologies)

Anyone unfamiliar with the Vertical Market Software can see the overview here (https://www.deepsailcapital.com/_files/ugd/50dba3_8f765d8366be4a28b9bc97092d44291c.pdf), here (https://www.colinkeeley.com/blog/vertical-software), and for a good overview on Roper specifically, the older podcast here (if you watch the video on YouTube, you can use their Gemini Ask feature right below the video player to interrogate the transcript to get an understanding of Roper as well):

Roper today owns high-margin software systems that cater to a wide range of niche, generally acyclical, industries in the US such as government contract billing/compliance mgmt, law firm billing/mgmt systems, healthcare IT, childcare & education administration software, North America’s largest freight/carrier matching network, a church engagement platform, and hardware + software for water utility metering and billing. The cashflows from these decentralized business operations are then used to acquire additional VMS systems for ROP’s portfolio either as tuck-ins to integrate/enhance existing systems or to branch into new niches. (I think of ROP as an experienced permanent capital VMS “fund” through which one can express the software-ain’t-dead-yet idea. Being part of the S&P500, most brokers also support buying fractional ROP shares, which even further lends to the “fund”-like character w/ which one could treat the stock).

ROP systems are highly integrated into customer workflows (in terms of both employee training and systems integration) and hold valuable historical customer data —data that can’t just be scrapped from the internet and fed to open LLMs— which makes the systems sticky (especially to the extent that ROP systems additionally function as cross-customer networks, as with the freight matching network of ROP-owned company DAT Freight & Analytics). 3

The fact that much of ROP’s existing segments and M&A targets are in industries with risky/complex regulatory/compliance validation hurdles means even more so that individual businesses will still likely be less inclined to try to bother building their own systems even as AI reduces internal dev costs (this is a rather overlooked element IMO). This switching cost compounds when coupled with ROP’s strategy of being systems-of-record, mission-critical, and low share-of-wallet for customers. (On the system-of-record point, mgmt. has explicitly stated that very little of their pricing is thus user/seat-based and so is less vulnerable to agentic AI productivity-per-employee boosts by customers). These systems also tend to need to be auditable and, most often, fully deterministic which is an inherent problem for LLMs whose outputs are probabilistic even at very low token-selection-variance “temperatures”.

One way we can validate this LLM-resistant stickiness is by observing that ROP’s weighted average gross retention ratio across their various business units (which measures the percentage of recurring revenue retained from their existing customer base between periods, excluding any gains from price increases, up-selling, or cross-selling to existing base) has remained steady around 95% gross retention in each year before and after the launch of ChatGPT in 2022 up to today. (Also keep in mind that the remaining 5% churn here does not necessarily imply that ROP is losing business to competitors as it can also be driven by customers going out of business or total usage of their ROP systems shrinking due to specific factors w/in their industry at any given time). Weighted average net retention (which includes cross/up-selling and expanded use by only existing customers) generally remains above 100%, meaning existing customers spend more YoY (though there are difference between the many products).

AI may also help ROP accelerate the problem-to-product feedback loops between their own decentralized business units and customers to further entrench ROP systems into customer processes and increase operational switching costs. Unlike with the horizontal SaaS players, ROP’s niche products all require a high degree of domain-specific knowledge (eg. to engineer for continued regulatory compliance, loopholes, and edge-cases), which is partially why ROP’s structure is so decentralized. This compounding bespokness leads to greater entrenchment; IMO the feedback loop is enhanced by agentic coding to the benefit of incumbents like Roper. Furthermore, as ROP targets small niche subsectors, the incentive for new competition to enter the space remains limited (unlike, again, for the horizontal SaaS players) 4. We can monitor how well ROP can actually monetize direct AI features in their existing software through 2026 vs any potential AI-native/enabled startups.

It may even be the case that AI and the lower cost of code could end up helping resolve concerns around the dwindling, high-quality, needle-moving M&A runway for VMS roll-up models such as ROP’s (to the extent that new entrant do (occasionally) break through). The company recently shifted from cheap cash-cow targets to growth-at-a-reasonable-price (GARP) M&A as was seen in the higher-than-normal multiples they paid for Procare (day-care mgmt. software) and Subsplash (a church engagement platform) in 2024 and 2025, respectively 5. IMO, these acquisitions were seen as manifestations/validation of a concern by the market that ROP was running out of good targets under the old strategy (irrespective of mgmt’s comments on the reasoning for the change) 6 and was one of several contributing factors to ROP stock’s price weakness even before the SaaSpocalypse in late 2025. Agentic coding + growth of the AI industry (and any resulting yet-to-be-formalized-or-invented subsectors/offshoots thereof) ==> more opportunities for VMS startups to cost-effectively address new niche markets ==> more M&A opportunities for ROP (while, again, I think ROP retains incumbency advantage in the spaces they already exist in). This benefits ROP in an asymmetrical way iff their scale, relationships, and reputation (as an acquiree “home of choice”) facilitates better M&A deal flow. This does seem to be the case as mgmt mentioned in the 4Q2025 earnings call that 60% of their recent tuck-in acquisition pipeline was “either proprietary or founder-driven”, meaning based on direct private outreach rather then from, say, an open competitive auction.

Note that ROP is currently trading at its lowest EV/EBITDA multiple since 2015 (when it initially completed its transition from industrial equipment to software/VMS and changed its name from Roper Industries to Roper Technologies) while YoY EBITDA growth has remained in the 9-12% range in each quarter since 2023, so you’re being paid to wait as price has stabilized in the $340-$350 range. Meanwhile, ROP initiated it’s first ever buyback program in late 2025 and has brought shares outstanding down 5%, back to around 2017 levels. ROP’s weighted average buyback cost basis so far is around $366.67/sh.

The market appears to be reacting to the AI concerns by completely resetting it’s terminal value assumptions on ROP. The compressed multiple on the higher EBITDA base implies the market is discounting the perpetuity growth rate of those earnings back to what it assumed at the start of ROP’s transition when they had no track record (unlike now); I suppose this is to reflect the extreme uncertainty around software businesses in the era of AI. IMO, for the reasons covered above, I think ROP will ultimately be beneficiaries —and we don’t need to be a hero in terms of sizing here to have a position make a difference in the long-run nor do we need to rush to allocate a full position all at once.

Aside from the roll-up considerations, these general ideas carry into most of the other software names I cover here…

CCLD (CareCloud)

Niche private practice outpatient EHR (Health Record System, eg. that often-clunky-looking UI you see nurses and doctors writing their notes into when you get a checkup) and integrated RCM (revenue cycle mgmt) clearinghouse biz (ie. clinical billing/reimbursement mgmt services). Note that EHRs must be CEHRT certified under the US HHS to be used by clinics for reimbursement from Federal programs; this is a very strict and complex certification process for any new (eg. AI/vibe-coded) EHR startup and hospitals are highly unlikely to take chances swapping this existing system-of-record for another, much less for a new entrant. The EHR system is priced on a per doctor basis, while the RCM business charges a percentage of the revenues collected by the RCM system.

After simplifying their capital structure (converting 80% the series A preferred shares and lowering the dividend payments for the remaining that could not mandated to convert), paying down their debt, bringing previously-outsourced R&D expenses in-house, settling several long-standing lawsuits, and shifting roles at the exec team, the company is now using their growing internal FCF (w/out any debt or dilution) for M&A. The company is rolling upstream and rationalizing similar/smaller EHR/RCM companies that service other private practice and rural hospital systems that are too small for the bigger EHRs and hospital rollups (which acquire private practices and then move them onto their larger standardized EHRs) to bother directly targeting. Particularly, CCLD’s 2H2025 acquisition of Medsphere now brings CCLD’s EHR capabilities to full-journey inpatient healthcare (vs previously just being limited to outpatient focus); that is, CCLD can now support the full patient journey from outpatient clinics to emergency departments & inpatient hospital beds. CCLD is maintaining the existing EHR systems for customers as they work to integrate them all together under the original CareCloud EHR + centralizing or downsizing acquired RMC operations and using their offshored workforce. CCLD appears to be cleaning itself up for, IMO, eventual sale at a higher multiple after receiving an unsolicited bid from a private equity firm in mid 2024 that seems to have lit a fire under the butts of mgmt.

I’d note that, as opposed to all other names covered here, CCLD may be particularly affected by ongoing US/Iran conflict since most of their medical bill coding workforce is outsourced to Pakistan, which relies on the —currently still closed/blockaded— Strait of Hormuz and Persian Gulf for the vast majority of it oil and gas supplies. On top of that, medical coding (the RCM task of translating a doctor’s notes on diagnoses, procedures, and supplies from a patient encounter into nationally standardized codes for billing and analytics purposes) is particularly vulnerable to ever-improving LLMs; whether this means that clinics opt to, or find viable vendors to support, doing this job in-house at more attractive rates vs using CCLD’s RCM services, which I imagine will be equally AI-assisted, is yet to be seen.

CCLD received an unsolicited takeout offer in May 2024 which they rejected, claiming that the takeout offer did not include any immediate buyout of the Series A preferred shares (these shares did not have the same explicit change-of-control protections as the series B preferreds at the time and would have presumably become a liability for the acquirer to be handled at a later time); mgmt reject the offer based on this disparity in treatment. At the time, the takeout offer was $5/sh for the 16.1MM outstanding common shares and a $25 redemption price of the 1,468,792 series B preferred shares ==> $117.22MM in cash for CCLD (w/ the series A preferreds still attached) ==> ~14x the avg. 2023 & 2024 FCF of $8.5MM (the prior year’s FCF was lower at $3.8MM, which would imply an even higher multiple, but let’s assume the buyer was accurately incorporating forward projections as well). While the company now is in better shape than it was in 2024, applying just that same multiple to CCLD’s higher 2025 FCF, we have a takeout price of ($20.5MM * 14x =) $287MM, which leaves $5.28 per common share after covering the $25/sh and (updated) $25.25/sh redemption prices for the remaining unconverted 984,530 series A and 1,511,372 series B preferreds. (From this, one can also do the math to play around with a lower or higher range limit by using, say, just the 2023 FCF number for a higher multiple (~30x) or just the 2024 FCF for a lower multiple (~9x); taking the mid between the 2023-based low and the avg-based multiple for a 12x FCF applied to 2025’s FCF, we get $4.31/sh for the common).

One last small gripe I have on this idea vs the others here is that it’s a one-and-done situation; the company cleans up and does a sale. I’d more ideally like something where I can put money in and just have it compound there over a long time without having to guarantee (even in success mode) that I’ll have find somewhere else to put it down the road (a nice problem to have, but a problem nonetheless).

AGYS (Agilysys)

Resort and casino management VMS (targeting middle- to upper-end resort operators) that is currently trading at the same valuation as when their near decade-long transformation (starting in 2017 under the current CEO) from computer distributor to pureplay VMS first went EBITDA-positive around 2022 (slightly lower now, even) after SaaS subscription profits started to offset the modernization R&D spend. It would seem their transformation from siloed on-prem software modules to profitable unified hospitality-focused cloud-based SaaS, on a relative time scale, arrived just in time for both a global jet-fuel crisis (via US/Iran/Hormuz conflict) and the LLM-driven SaaSpocalypse.

AGYS’s rGuest VMS modules handle and coordinate property/room mgmt/bookings (PMS), point-of-sales (POS), casino food & beverage comp and POS integration (highly regulated due to anti-money laundering laws), inventory mgmt, payment processing (fees here are volume based), and associated spa/wellness/amenities bookings. Note that (like many of ROP’s system-of-record products) these modules are not priced based on number of user seats, but based on volume of inventory managed (eg. number of rooms at a property or number of POS terminals & transactions). (As far as I know, hospitality PMSs like AGYS’s rGuest et al are not legally required to have any kind of data portability in the same way that exists for, say, EHR systems under the 21st Century Cures Act, so that’s a nice data lock-in feature vs CCLD).

As a testament to the stickiness of AGYS products, their Q3FY2026 earnings call 7 noted that several major customers switched some of their operations to different franchise brand flags, yet refused to switch to those brands’ mandated PMS systems in order to continue using their AGYS products (which are now being strengthened by integrating AI analytics into the existing data systems, eg. for better room/booking/upselling/upgrades mgmt).

As of calendar 1Q2026, AGYS has completed their pilot roll-out of AGYS installation/integration to replace legacy PMS systems for Marriott International properties across the US and Canada, a major project sales win for AGYS in 2022 that began development in 2023. (Is it crazy to think that luxury/premium hotels in the US and Canada should experience increased demand from travelers seeking safer alternatives to Persian Gulf luxury stays so long as Iran —now arguably more feather-ruffled than ever— keeps instability in that entire region elevated)? The project is now entering the full-scale implementation phase and is expected to 3x AGYS’s installed PMS base over the next several years (all of which is expected to require little/no incremental opex as most of the dev resources of the entire project are already in place from the piloting period) w/ significant financial contribution expected to start flowing to the bottom line by 2027. From this POV, one could maybe argue that AGYS is trading at (50/3=) 15x fwd (post-Marriott-implementation) EBITDA 8, not accounting for any properties’ additional use of the more-recently developed or acquired amenities-booking modules like AgilysysReserve or Book4Time that were not even available during the pilot leg of the rollout.

TBTC (TableTrac)

*Honorable mention

On the subject of casino mgmt VMS systems, TBTC sell and maintains the CasinoTrac casino mgmt system (CMS) and ancillary products that include modules for guest rewards & loyalty programs, marketing analysis, guest services, promotions, administration, vault and cage management, and auditing/accounting tasks. Again, US casinos and thus CMS systems are subject to strict state-specific regulations. Additionally, TBTC has exposure to casino operators on native american tribal jurisdictions (the company explicitly mentions the Indian Gaming Association Trade Show and the Oklahoma Indian Gaming Association Trade Show as key industry trade shows they prioritize annually to drive sales), which comes with additional and bespoke barriers to entry as well as risks.

Up until 2020, TBTC was focused on new system sales. Since that time, TBTC’s lumpy new-system sales appear to have come to a trickle (8 in 2025 vs 29 in 2019) and the company (quite unlike the growth focus at AGYS) now looks to be focusing on extracting more recurring value from it’s existing installed base of around 115 casino operators and 300 locations via higher-margin and lower-labor upgrade & maintenance projects. This idea is further validated by the recent 2026 transition of roles at the company where founder Chad Hoehne (owning 25.5% of the company) moved from CEO to CTO and the company’s CFO/COO moved into the CEO role, which to me suggests a re-focusing of the company on internal efficiencies and shareholder returns over growth. (Taking a page from Roper, we could consider TBTC, w/ their 10x EBITDA and EPS multiple, to be more like ROP’s prior cash-cow type of VMS, whereas AGYS is closer to their newer GARP focus).

The stock is extremely illiquid, so don’t expect any reasonably-priced orders to fill anytime soon. Recent insider buying —for the first time in 5yrs— has been around the $3.80-$4/sh range (w/ an absolute floor for the stock being around the $3.70 level).

CLBT (Cellebrite)

Israeli mobile device penetration & data extraction services/library (Cellebrite Unlock and Inseyets) + integrated digital evidence mgmt, (Pathfinder) ML analytics, and custody/case mgmt VMS (Guardian Forensics cloud SaaS w/ data volume-based fees).

After multiple quarters of disappointing Federal revenue growth and CIFUS-stalled Corellium acquisition (pentesting R&D platform), the company is now showing early inflection signs and is in the process of integrating Corellium into operations, launching the Guardian Investigate AI/ML module (similar to Palintir’s Gotham for storing, analyzing, and synthesizing all forms of digital evidence into court-admissible content), and approaching the tail end of FedRAMP High-level authorization to operate (ATO) certification which will open up greater Federal-level use/marketing TAM for CLBT’s Guardian suite 9. This certification was previously delayed —and the cause of some pre-SaaSpocalypse price volatility— in early 2025 due to DOGE shakeups in the Federal government that delayed the processing of the ATO as well delayed the required agency sponsorship (which eventually came from the DOJ) needed to start moving forward for Cellebrite Government Cloud. CLBT mgmt has already signaled that a large Federal deal is awaiting once the FedRAMP ATO is approved. 10

AI may get better and better at cracking mobile phones (though it also means the phone makers will get better at hardening them), but it won’t —by the fact of the probabilistic/stochastic way it is trained / generates outputs— be able to supply the court-admissible deterministic chain-of-custody audit and analytics data that CLBT systems specialize in providing nor can AI or synthetic data generation techniques replace the valuable corpus of real case evidence data that CLBT continues to collect (and charge recurring data storage fees on). CBLT is currently trialing AI-powered analytics to automatically comb through existing and incoming data to assist with, for example, finding new connections and leads related to existing cold cases.

Gross revenue retention for 2024 and 2025 (which, again, does not factor in any up-selling, price increases, or use expansion nor does it do well in capturing any customer-wide headwinds agnostic of CBLT’s competitiveness vs other substitutes) was around 92%, with net retention remaining above 100% through all years.

CASS (Cass Information Systems)

Another interesting VMS-like business I’ve been following (that, unlike the rest of the software world, has been slowly grinding upwards and approaching a technical breakout) is Cass Info. Systems.

CASS is a smallcap US-focused freight & utilities (energy, waste mgmt, telecom) invoice auditor (fixed price per transaction) and payment processing systems (dollar-volume/value priced, read as: inflation- or tariff-hedged) attached to a 120yr-old niche bank (interest income or think of as interest-rate-hedged) that is also used to facilitate said invoice payments. Around 40% of the bank interest income is from the funds held for the invoice/infosys customers during the time between invoice processing and payment (supplementing the profits they earn from the audit-to-pay cycle), while the remaining 60% are from loans to private businesses in the company’s home city of St. Louis, major restaurant franchises, and faith-based ministry mortgages (the latter being a sector that CASS also has exposure to via their TouchPoint church mgmt software). (CASS has also seen tailwinds from AI infrastructure buildout in the form of increased electricity usage and pricing flowing through to its utility invoicing business).

The company started in St. Louis, Missouri, in 1906 and began specializing in freight invoice auditing and payments as the city became a major trucking hub in the 1950s when the city was identified as a critical node in the Federal planning and construction of the interstate highway system —before which St.Louis was already a major railroad logistics hub.

Dividend investors may be interested to hear that Cass Bank began paying out a dividend during the middle of the Great Depression in 1934 and has since never failed to deliver a regular dividend —and actually raised their dividend through the years leading up to, during, and after the 2009 GFC (while their EPS remained generally unaffected as well through this period).

In handling the invoice auditing and payments for clients, CASS systems gathers data from a diverse & heterogeneous set of sources from various bespoke vendor invoices and customer procurement & sales systems (read as: inconsistent hodgepodge of non-standardized nonsense which is not inherently conducive to LLM processing). This is compiled to audit and assist with decision making against complex shipping contracts and parameters —that can differ greatly between customers— and spotting over-charges arising therefrom (https://www.freightwaves.com/news/freight-invoice-audits-and-why-they-matter). Combined with the banking subsidiary, CASS is able to act as a turnkey system for auditing invoices as well as paying/settling them, helping to entrench their products into client workflows as well as creating a regulatory barrier that AI-startups will have difficulty overcoming; there are strict regulations for non-traditional buyer companies attempting to acquire a bank and bank-holding companies are subject to compliance rules from Federal Reserve, FDIC, et al.

From the 10K: “The specific payment and information processing services provided to each customer are developed individually to meet each customer’s requirements, which can vary greatly.” That is, Cass systems are embedded in customer workflows and accounting systems in a highly bespoke manner that, again, makes it disruptive for customers to switch to another invoice auditor (requiring employee retraining and systems re-engineering, eg. to account for any differences in reporting style, format, or resolution from substitutes via what is returned from CASS). CASS pulls/pushes directly to/from customers’ various ERP and RCM systems to get/return invoice/audit/settlement data. Same goes for the utility/facility segment: “Many of Cass’ services are customized for the ESPs [energy service providers], providing a full-featured solution without any development costs to the ESP.”

CASS also acquired a small subscription-based (rather than fixed transaction-based) SaaS invoice auditing company —that they can also now supplement with their own data corpus and directly handle payments for— in late 2024 that specializes in ocean and international air fright auditing (vs their domestic US business). This small contributor could become a valuable segment in due time as/if deglobalization trends continue and supply chain auditing becomes ever more onerous.

Note that the bank funding from the non-bank side of the business is NOT held there because, say, there is some lag time between the moment where funds land at Cass Bank and when the goods arrive at the buyer destination like some kind of escrow arrangement. Rather, the lag time is mostly a contracted form of “payment” where clients allow CASS to make interest income on their funds before settling the transaction as the bank funds settle at Cass and the audit process takes place. As CASS’s audit process becomes more efficient with AI and more businesses take greater advantage of instant settlement methods like FedWire/FedNow or perhaps via tokenization, it would seem the actual necessary lag time should decrease and becomes more about clients simply “paying” with their own revenue cycle days. This should not be a problem (actual all-in “costs” in their various forms will work themselves out) so long as CASS can retain their value proposition in their auditing software (and customers still need to go thru a bank even if they want to use FedNow payments). That is, so long as they can leverage their data corpus of invoice transactions & audits and AI integration to defend against disintermediation from less-niche invoice auditing competitors, clients have less incentive to disintermediate from CASS on the banking side by settling at their own FedNow-supporting banks. (CASS also has developed CassPay to act as an integrated platform for general B2B integrated payments).

From an portfolio exposure POV, I personally —though this is not totally apples-to-apples in terms of customer type— compare CASS against the fright-matching network of Landstar Systems (LSTR); both generally being driven by US trucking transaction volumes. While avoiding making this any longer than it already is, I’d just say that LSTR’s business creates more variable layers of —largely out-of-their-control— expenses between their revenues and operating income lines vs CASS.

For personal sizing purposes, useful to note that the apparent price floor of $40-$45 has also shown validation via consistent insider buying at those levels.

.

What happened?

On April 7, 2026, Horizon Kinetics —the largest, and one of the oldest, single owners of TPL— announced that their founder, Murray Stahl, had passed away (https://www.sec.gov/ix?doc=/Archives/edgar/data/88000/000119312526147613/hkhc-20260407.htm).

We at Horizon Kinetics Holding Corporation announce with deep sorrow that Murray Stahl—the company’s Chairman, Chief Executive Officer, and leading light—passed away suddenly on April 7, 2026.

Murray co-founded Horizon Kinetics in 1994. He was instrumental in transforming it into a publicly traded company with a market capitalization of approximately $600 million, an impeccable and debt-free balance sheet, and a portfolio built for the long horizon. Murray’s dedication, wisdom, and leadership will be felt for generations to come.

The entire Horizon Kinetics family extends heartfelt condolences to Murray’s wife, Teddi, and their children—and to everyone else who loved him.

As we begin the work of preserving and growing Murray’s legacy, Horizon Kinetics is implementing its succession plan, starting with the appointment of Steven Bregman and Peter Doyle as co-Chief Executive Officers. They will join fellow Horizon Kinetics co-founder Tom Ewing on our newly established Founders’ Committee to oversee a seamless transition of responsibilities.

We feel it is our duty and obligation to finish what Murray started. And it is our honor to remain fully committed to delivering that vision for our clients and shareholders.

I’ve read nearly everything he published at HK and have listened to or read nearly every earnings call (and occasional interview) he ever gave and cannot recall detecting anything other than class, humility, intelligence, and patience. 1

Very sad to see this happen seemingly so soon.

.

What now?

You can read some background on how instrumental Stahl and HK were in implementing more shareholder-aligned, and ultimately more value-accretive, changes at TPL —and the uphill fight against incumbent mgmt that HK had to get through in order effect those changes— in the informative post here:

Special Situation Investing

TPL's governance battle (TPL)

Welcome to Special Situation Investing Episode 69…

Listen now

3 years ago · 13 likes · 10 comments · Six Bravo

With the unfortunate news of Murray Stahl’s passing, the market reacted by selling off TPL such that the stock dropped just a bit over 15% today (this, despite the very relevant US/Iran ceasefire and Strait of Hormuz reopening looking to be deteriorating just as quickly as it was announced). The situation for TPL is now, IMO, rather interesting.

HK co-founders Peter Doyle (who managed the HK mutual funds along with Stahl) and Steve Bregman (who is CEO of HK’s crypto-lab sister company, FRMO Corp., and may be more familiar to HK investors as supervisor and presenter of HK’s quarterly research commentaries that cover HK’s views on their investments and the market in general) have been named as HK’s new co-CEOs.

Meanwhile, by my reading of the company’s most recent proxy statement, HK is no longer restrained by the 2023 Cooperation Agreement that ultimately resulted from the 2019 proxy battle stalemate between HK et al and TPL mgmt.

HK no longer has any contractual rights to BoD representation (which they used to have under a 2020 stockholders’ agreement before the 2023 agreement), but is now also no longer obligated to vote their shares in accordance the existing BoD’s recommendations nor are they restrained by previous standstill agreements (which only applied so long as “one of Mr. Stahl or Mr. Oliver [who was also party w/ HK to the initial proxy fight against TPL mgmt, but did not stand for re-election in 2025] remains on the Board”). That is, as outsiders once again, HK is free to leverage their large TPL share ownership and visibility thereof —HK now also being freed from the old agreement’s non-disparagement clause— to more aggressively advocate for changes/representation at TPL in ways they could not do under the older, nullified arrangements.

For example, all TPL directors need simple majority vote in order to remain on the BoD. The board then has 90 days to publicly decide whether to actually accept it, though I imagine a BoD decision to retain a member that failed a majority shareholder vote would be a public governance event that proxy advisors will scrutinize intensely.

W/out HK forced to vote along BoD recommendations, the margins for all dirs. greatly reduces. Could HK (14.5% ownership) get Stahl’s estate (5%) + SoftVest (1.7%) + others to coordinate too? That collective bloc would be meaningful leverage over the remaining BoD —especially when considering existing dissenters per the last annual meeting vote.

(Notice that without HK’s forced votes, the For votes re. TPL’s CEO, Donald Cook, drop from 87% to 62%).

(I’d certainly cast my own little bit of shares in with HK’s lot in any proxy contest).

Note that Blackrock and Vanguard (and I assume State Street, and any other large index-based holders of TPL) do not just mechanically vote their shares alongside BoD recommendations (https://corpgov.law.harvard.edu/2026/02/27/vanguard-capital-management-proxy-voting-policy-for-u-s-portfolio-companies/ ; https://www.blackrock.com/corporate/literature/publication/blackrock-investment-stewardship-benchmark-guidelines-us.pdf) and would likely examine any proposals a larger holder like HK were to put forward on a case-by-case basis.

Blackrock:

Contested elections and other special situations are assessed on a case-by-case basis. We evaluate a number of factors, which may include: the qualifications and past performance of the dissident and management candidates; the validity of the concerns identified by the dissident; the viability of both the dissident’s and management’s plans; the ownership stake and holding period of the dissident; the likelihood that the dissident’s strategy will produce the desired change; and whether the dissident represents the best option for enhancing long-term financial value. We will evaluate the actions that the company has taken to limit shareholders’ ability to exercise the right to nominate dissident director candidates, including those actions taken absent the immediate threat of a contested situation. BIS may not support directors (up to and including the full board) where those actions are viewed as egregiously infringing on shareholder rights.

BlackRock also specifically mention situations where they determine that a BoD is taking action to “unreasonably reduce shareholder rights” or “entrench directors” as significant governance concerns —such as can easily be construed of the 2023 Cooperation Agreement TPL placed on Stahl/HK et al. I would think (though I don’t know) that the incumbent TPL mgmt’s history of using litigation (as in the initial proxy fight when TPL was still a trust) and restrictive cooperation agreements (like the 2023 agreement) would likely be a relevant piece of evidence in BlackRock’s “case-by-case” analysis in a new proxy contest —and the now-converted C-corp structure and declassified BoD somewhat de-risks voting along with a large dissenter for the big index-based holders here in way that did not exist during the initial 2019 proxy fight (and ensuing non-disparagement period) when TPL was still a trust with a BoT of lifetime tenures.

Vanguard:

Contested director elections will be analyzed case by case. The analysis of proxy contests focuses on three key areas:

The case for change at the target company.

• How effectively has the current board overseen the company’s strategy and execution?

• How does the dissident’s case strengthen the target company’s long-term shareholder returns?

  […]

The quality of company governance.

[…]

The quality of the company’s and dissident’s board nominees.

• Having made a compelling case for change, do the dissident’s nominees appear better aligned with long-term shareholder interests relative to the company’s nominees?

(Note that HK —via Stahl— was the main reformer at TPL).

Meanwhile, mgmt just saw the stock drop 15% in a single day (and it’s obvious that this is due to the absence of Stahl from the BoD) 2 , which —thanks to changes instituted by Stahl et al— is now much more tightly and formulaically linked to their actual compensation. (BTW, especially relevant while conflict continues between US and Iran, TPL comp also includes a commodity price collar for oil prices that effectively discounts the effects of volatile swings in oil from exec bonus pay, so they are not unduly assigned blame or credit for macro-driven commodity changes beyond their own control). Any material change to this compensation structure would require public disclosure (either as a shareholder proxy voting matter or simple 8K) w/in days of any such decision and would then be a documented piece of evidence that HK can use in any proxy campaign narrative to appeal to, say, Vanguard’s own “case for change at the target company” standards re. “the quality of company governance.”

HK can also use the new amended 2025 proxy access rights to forward new directors:

a group of up to 20 stockholders, who has continuously owned at least 3% of the Company’s outstanding common stock for at least three consecutive years, may nominate the greater of two or 25% of the number of directors in office as of the last day on which the notice of proxy access nomination

Per Rule 14a-8, HK has until May 29, 2026 to submit stockholder proposals (eg. like Prop 4 from the 2025 annual meeting) and has the July 9, 2026 and August 8, 2026 window to provide advance notice for director nominations. While proposals under Rule 14a-8 are non-binding, a BoD that does not not honor a majority vote for even non-binding proposals by shareholders could potentially face scrutiny from proxy advisors.

If a prior year’s shareholder precatory proposal has received the support of a majority of votes cast but the board does not act on the proposal, ISS will consider recommending against directors, committee members or the entire board. If the board does not implement such a proposal, ISS will examine the outreach efforts of the board, any disclosure regarding the subject matter of the proposal, why the proposal was not implemented, the level of support for and opposition to the proposal in past meetings, action taken by the board in response to the vote (including its engagement with shareholders) and the continuation of the underlying issue as a voting item on the ballot. ~~~ https://www.venable.com/insights/publications/2023/10/responding-to-annual-meeting-vote-results

Of course, there is also the possibility that HK settles for a new HK seat similar to that which Stahl’s BoD membership was previously structured under. IMHO, this would be a huge waste of HK’s existing & meaningful leverage and would be a mistake to take as the default path —which might indeed look attractive to HK in the interest of, say, expediency or smooth/drama-less continuity as they reel from the unexpected loss of Murray Stahl.

IMO, HK shouldn’t waste what leverage they have and they should go for max shareholder alignment; TPL’s CEO would still be on 100% cash comp under the trust structure were it not for Stahl et al. Hopefully HK was tempered by their courtroom loss in the prior stock-split case and can re-strategize now that the field has been somewhat reset. I can’t imagine that carrying out Stahl’s vision that HK stated remaining committed to delivering involves remaining unrepresented or handcuffed at TPL, despite being it’s largest shareholder.

The market —and how it ultimately values / prices TPL— will continue to be generally unpredictable, but so long as HK does not settle for the same or diminished representation / level of control as originally resulted from the 2019 proxy contest stalemate w/ TPL mgmt, then the underlying business that could emerge on the other side of any increased HK activism —assuming things play out in their favor (and I think chances of that are good)— will be one of higher quality than presently exists. 3

.

Liquidity spiral?

One thing to also consider (and IDK exactly how much this may end up being a major or simply a minor factor) is the possibility for redemptions and AUM outflows at HK to cause a liquidity spiral for TPL stock (a concern raised in the old Morningstar article here) 4 and reduction HK’s voting power leverage.

I have the estimated breakdown of HK’s various fund categories, based on HKHC’s 2025 annual report, like so…

Separately managed accounts (SMAs): 44% of AUM

Mutual funds: 22%

Private LPs: 18%

ETFs: 16%

Note that while the SMAs, LPs, and mutual funds likely have very high concentrations in TPL (say, 40-50%, if the various mutual funds are any indication), the ETFs were explicitly designed with much lower TPL exposure specifically, in part, to help diversify HK away from the TPL concentration —at most, I’ve seen a 5% TPL allocation in these ETFs.

“When you get new assets under management, we obviously can’t buy and we wouldn’t buy TPL at that allocation. So new assets are diluted. And for example, the Japan ETFs, say what you will about it, positive or negative, doesn’t have any TPL in it. And similarly speaking, the Blockchain Development Fund has no TPL in it. So as we raise new assets, there are different investment products, they don't have any TPL. So we get diluted [re. HK’s overall TPL concentration] over time even without selling.” ~~~ Murray Stahl, HKHC Q3 2025 earnings call

Also, unlike mutual funds, the ETF units are not subject to daily redemptions and small transactions instead happen in an “echo chamber” (as Stahl called in the Q1 2025 call) between buyers & sellers on the secondary market, lowering the risk of affecting HK’s actual AUM; money only enters or leaves these funds itself in large unit increments by institutional authorized participants.

For the SMAs and private funds, I’m also not too worried as I assume the SMA clients will be a good bit stickier; the lower limit for an SMA account with HK is in the millions and it’s not as if they were not already aware of Stahl’s age —though I suppose individuals could also explicitly ask to downsize their TPL positions specifically now that the key man behind that concentration is gone unexpectedly. Note also that the LPs are structured such that dividends and capital gains do not need to be immediately redistributed (ie. the GP does not need to fire sale assets just because clients are panicking —rightly or wrongly— at any given moment, think Michael Burry exercising his right to freeze redemptions in The Big Short).

“The Private Funds are intended for long-term investors and as such, HKAM reserves the right to impose restrictions, as it may deem necessary or appropriate, to discourage or prevent short-term trading activity in connection with its advisory services. Such restrictions could include, without limitation, a fee imposed on the redemption or transfer of assets made within a certain time period, a lock-up of investor money for a period of time, or suspension of a redemption for any reason, in the sole determination of the Firm.” ~~~ https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=1036773

(I really don’t think the communications at HK’s private funds are anywhere near as dramatic considering how much TPL has gained since HK’s initial investment, or even just since their 2019 proxy contest, relative to the recent post-Stahl drop so far).

This leaves the mutual funds which must provide daily liquidity and are thus the most exposed to this liquidity spiral risk. If investors in these funds sell their shares, HK has to get the liquidity from somewhere to pay them out at the value of the fund’s closing NAV (though HK does not have the obligation to sell these holdings in proportion to the fund’s existing composition and could, say, sell smaller holdings instead and thus actually increase their relative TPL concentration).

Unlike with the various independent SMAs, in a mutual fund, all investors share a single pool of assets and a single aggregate NAV. If investors redeems shares in fear of falling NAV, the fund must raise cash, which means selling assets from something in the shared pool. If these redemptions happen at a volume and urgency that results in the liquidation volume by the MF being such that the market’s normal volumes at the time cannot easily/quietly absorb those sales, then the MF is potentially forced to sell at prices below current spot prices and total NAV/sh declines —if this happens at great enough volumes to also move the entire market for those stocks themselves, the downward momentum is worsened and it feeds back to the NAV and so on. The remaining investors now hold a portfolio that has been partially liquidated on their behalf (regardless of their consent). If the selling happens at unfavorable prices, or generates taxable distributions, the remaining investors also bear those costs.

Per the Kinetics Mutual Fund’s website, these funds had $2.13bn AUM at the end of 2025. If we assume a collective 50% TPL concentration across all these funds, that would be 5.25% of TPL’s $20.3bn marketcap at the time. This $1.06bn TPL position would be around 7 days of market volume when using the most recent avg. daily volume figure of 537,632 shares/day and the Dec 31 2025 price of $297.33/sh. Again, HK could also sell off their smaller and/or at-a-captial-loss holdings —read as: lower conviction holdings— in order to satisfy redemptions and avoid selling TPL. Basically, I think HK can handle redemptions well enough —though this is one element that I’m still mulling over.

.

At the end of the day, I have no idea what HK will do or what other alternative routes they might pursue (or how much more the stock can fall from here), these are just some of my quick thoughts on the situation.

.

While my usual lumpy and cautious strategy aided in avoiding the early “Liberation Day” tariff shock, many of the winners that carried the portfolio in 2024 saw major drawdowns through 2025 (BTC, TPL, FRMO, VNOM, GEO); large positions that were working up to and through 2024 started not working in major ways (excluding significant gold and infrastructure exposure through positions like FNV and APG, plus some smaller positions that have since grown). The portfolio thus required some review and re-working through the year to mitigate these dragging effects and keep above water.

After re-deploying cash holdings as sentiment sank and the indexes went range-bound through the latter half of the year, I think the sizing and underlying fundamentals of the portfolio looks OK and still have a lot of flexibility to make changes or average up/down as things progress. While much time is left for things to develop (up or down), the portfolio has already gained +3.5% YTD in 2026 (with a cumulative weighted CashflowFromOps-to-Debt coverage of 1.7x and cumulative weighted P/E of 22x) 1 vs 1.8% for the S&P 500 (with a P/E of 31x) 2 and I’m looking forward to seeing how the rest of 2026 plays out.

(Readers using the substack desktop web browser site can skip to my random market commentary and top positions review via the navigable table of contents that appears as a very small stack of horizontal bars on the left of this page).

.

The positioning at the start of 2025 was partly been due to having been (and continue to be) in agreement with the general 3D-vs-2D, hard-assets-vs-software reversion trade (skeptics might call it a “revenge trade”) for a good while now which, for better or worse, has subsequently tended to result in low exposure to the big tech names that were the main drivers of the AI-driven index performance in the first half of 2025 —if you bought that April tariff-scare dip, congratulations.

The 3D-vs-2D reversion trade this year (excl. gold) has largely been pummeled by a market that continues to concentrate around software 3. Horizon Kinetic’s Murray Stahl is mentioned several times in the linked article above —he’s one of my favorite investment thinkers as well— so I think it’s relevant to note the performance of his hard-asset-focused flagship Paradigm mutual fund, $WWNPX, and HK-associated holdco $FRMO (currently trading just above 52-week lows and near it’s lowest historical P/B since COVID in 2020):

(This would have been me as well to a degree were it not for some tea leaf reading and quick adjustments early in the year).

(One could argue that, looking at the chart and the timing of movements, the 3D-vs-2D mean reversion had indeed begun in 2020 and that the big software/2D names were only saved by the launch of ChatGPT (late 2022) which kicked off the current AI Boom (which itself may end up being the trigger for a resurgence of commods/3D). This is also not meant to imply that Stahl/HK themselves haven’t done a good job of navigating the market despite this variant opinion, as shown by the slight out-performance of their headline mutual fund —though you’re certainly less happy as a Paradigm fund holder at the end of this year than you were at the start).

With these things in mind, ending the year flat in this case was one of the better outcomes relative to what could have happened if no action were taken.

.

Early into the new year, I was concerned with AI unk-profitability (ie. not just lack of profits, but lack of any model for what “success mode” would even look like; unknown profits), leverage + depreciation uncertainty, and overall business-model shifts to greater capex-intensity and the effect that would have on normalized margins and valuations as key risks to the tech/AI names and the general indexes which were so concentrated around them 4. I thus started a slow-rolling review that led to taking money out of the market while also pruning certain positions that had been faltering on their fundamentals for too long. Meanwhile, the market seemed not to give those concerns much thought as it rose off the April tariff-shock lows. Then around the third and fourth quarters of the year, despite nothing new about those same pre-existing AI concerns I just mentioned being markedly different from the beginning of the year, “AI bubble” articles came into greater narrative focuses in financial news & the wider investing discourse and AI’s dominance within the indexes then caused them to steer those indexes range-bound.

When those concerns did become more mainstream, the market seemed to digest the info rather well and without much contagion, instead reacting with orderly sector rotations and ranging. This made me a bit more optimistic about taking that declining sentiment and rising volatility as an opportunity to start gradually sizing back into positions given that the thing I was worried about was now hitting the mainstream and I could see that the underlying market reaction itself was not as bad as I had expected.

The concerns I was worried about materializing did materialized into the mainstream narrative along the lines I thought it would, but the market’s ultimate reaction was orderly rather than chaotic. The facts changed, so I changed my mind and started averaging back in —doing so slowly, given that I was already wrong once (if only by half). In retrospect, there were less radical ways I could have hedged; lessons learned.

Economic data (when it was available) 5 was mostly positive (if you trust the numbers being reported by the government and their calculation methodologies) 6. Again, the market actually showed resilience during the later months of AI volatility. Index drops caught bids at resistance levels in a slower (still-)upward grind as stress remained contained to the AI space and correlations remained low across sectors as they maintained their relative performance or made slight gains, while the tech sector’s contribution normalized off of it’s post-Liberation Day run.

As global investment firm KKR put it in their FY2025Q3 earnings call…

I think the 2 keywords are dispersion and bifurcation. […] [I]t’s clear many of us have PTSD from the financial crisis and are looking for, will it trigger the next one […] [F]rom our standpoint, what we don’t see talked about much is the fact that we’ve had kind of this rolling recession dynamic in the U.S., where some industries are already experiencing or have experienced their cycle. We’ve seen it in manufacturing. We’re now seeing in building products, maybe parts of chemicals, parts of leisure. And the public markets are also obviously seeing dispersion, very different performance if you look by sector. And so that part of the narrative is not included when we kind of look at what’s coming out in the media. But from our seats, it doesn’t feel like last time. You can’t paint it all with one brush. And that’s not to say there isn’t risk of excess and bad actors. But what we’re taking comfort in is like air is periodically being led out of the balloon. ~~~ KKR CEO, Scott Nuttall

Companies appear to be successfully using AI/automation to claim productivity improvements (though I’d assume this also affects employment and thus the wallets of the very consumers many of the companies are trying to extract dollars from), are re-configuring their supply chains, and implementing other cost-management initiatives in order to mitigate tariff impacts, localized pockets of inflation, and the effects of the continued “K-shaped” economy 7.

Looking across a basket of representative companies, my sense is that governments are spending more on defense and resource nationalism and people are spending less on discretionary products and more on necessities while splurging on experiences (eg. casual dining and cruises) 8. That is, high-earners are continuing to spend as usual (though even they are becoming a meaningful demographic for traditional discount retailers like Walmart), low/middle-earners are downgrading their spending or waiting for deals or price certainty (as well as, some might say, “doom-spending”, on experiences), while companies themselves are (successfully, for now) managing an overall decline or stagnation.

“As it relates to what we’re experiencing with customers and members here in the U.S., their behavior has been generally consistent. We aren’t seeing dramatic shifts. The way things have played out so far, the impact of tariffs has been gradual enough that any behavioral adjustments by the customer have been somewhat muted. But as we replenish inventory at post tariff price levels, we’ve continued to see our costs increase each week, which we expect will continue into the third and fourth quarters. Not surprisingly, we see more adjustments in middle and lower-income households than we do with higher-income households in discretionary categories where item prices have gone up. We see a corresponding moderation in units at the item level as customers switch to other items or in some cases, categories.” ~~~ Walmart CEO, Doug McMillon, FY2026Q2 earnings call

“[D]emand remains strong, as demonstrated by the outperformance in our fourth quarter by our onboard revenue per diem significantly outperforming prior year levels and our customer deposits up 7% year- over-year, hitting an all-time high for year-end. Our book position and recent performance are all despite Michigan’s U.S. consumer sentiment readings dipping quite low for several months throughout 2025, and in fact, last month dropping pretty close to its lowest level in recorded history. It is a true testament to the strength of the product offering across our portfolio of world-class cruise lines and our guests prioritizing their spending with us. In reality, the disconnect between consumer sentiment and actual booking behavior continues to reinforce what we’ve said for a long time. Demand for our cruise lines is proving far more resilient than traditional macro indicators would suggest.” ~~~ Carnival Cruise Lines CEO, Josh Weinstein, FY2025Q4 earnings call

IDK how long the high-income consumer can carry aggregate demand, but we see that the sub-$60K/yr consumer is struggling ever more (eg. looking at national restaurant and retail companies like Darden, Target, and Walmart). The system is presently functioning because the top percentile of earners are spending enough to offset the bottom 50%. That’s is surely not sustainable in the long-term, but could continue for years if productivity gains from AI continue delivering on margins while the high-income cohort continues getting wealthier. There’s also the interaction of the political dimension if/as that situation persists, I’d guess that would entail lower/capped interest rates and possibly various forms of wealth redistribution and ostensive explicit attempts at stimulating mainstreet (especially given that 2026 will be election midterms in the US) 9 10.

“We continue to benefit from higher income families choosing to shop with us more often. Middle income households have been steady, and while lower income families have been under additional pressure of late, were encouraged by how our teams are meeting them with greater value across necessities and doing what we can to help them stretch their dollars further.” ~~~ Walmart CEO, Doug McMillon, FY2026Q3 earnings call

Within my own portfolio, I was able to see enough of the writing on the walls for many large positions that would indeed turn out to be significant losers later in the year and exit or significantly reduce these problematic positions early on, relative to how bad the declines eventually got in those names in most cases, and avoided most of the April “Liberation Day” tariff shocks. However, I was ultimately left fighting an uphill battle of thoughtfully exiting from concentrated positions in (starting/soon-to-be) falling angles in the portfolio combined with what I saw as a lack of other interesting ideas to average into with size, outside of simply beta-riding on the AI/tech themes —that are presently very concentrated around a few particular “winning” sectors of the AI value chain— that have come to dominate the market indexes.

The portfolio has since been reconfigured and am looking forward to 2026, but it does feel like I voluntarily chose suffering for 2025.

.

Random Commentary

The one issue I see in the current AI-driven market is stretched valuation multiples as many of the top AI competitors are now moving from asset-light software-based business models to more capital intensive ones that require continual data center build-out, maintenance, and replacement. Their large share of the indexes risks a convergence of downside correlations across all equities if any significant shocks are introduced to those concentrated few headline businesses. (This is not to say that valuations drive the market or mean it must crash or rise, but rather to highlight the left-tail concern that the market, as modeled by the S&P 500, is increasingly exposed to a single factor that is distributed across a narrow set of correlated stocks with very high expectations currently priced into them).

This skepticism is not an original opinion —though it is a non-consensus one if the market indexes are any indication— and you can find many articulations of this idea around the internet 11, I just happen to agree with it… to the detriment of my 2025 performance.

I’m also skeptical that the 3- to 5-years-out incremental increase in calories, joules, or Tomahawk missiles that will be produced by AI (or, more likely, produced through AI-assisted process optimization) is going justify the massive levels of capex and capital being poured into the space; perhaps I simply lack the vision here re. the magnitude of how transformative this is going to be. Furthermore, I think there is a not-insignificant left-tail risk probability for existing levels of active and planned AI infrastructure investment to become rendered outdated and unnecessary overnight in stepwise (rather than linear) movements with the release of evermore efficient LLMs and associated tech like (eg. the release of DeepSeek) that requires orders-of-magnitude less kW per token. This would instantly change the forward valuations of many infrastructure-specific AI companies that have been valued based on assumptions of continued massive AI capex spending. (This is maybe just another way of posing the general concern of uncertain asset-useful-lifetime and depreciation concerns for AI data centers as the new industry evolves).

Meanwhile, some tech CEOs seem to be justifying their AI capex as massively expensive, yet existential, call options on owning a piece of The AGI Singularity (https://fortune.com/2025/09/19/zuckerberg-ai-bubble-definitely-possibility-sam-altman-collapse/) —and TBF they have the cashflows and ROEs to afford it (for now).

To be clear, I’m not saying people shouldn’t invest in AI. I am saying that one should size their position carefully and that I don’t think that the general market indexes are sizing that AI exposure carefully. Furthermore, the market is presently focusing on particular pieces of the AI value chain and IDK that these segments (hardware, infrastructure builders, LLM trainers) are necessarily going to be the most durable bottlenecks (read as: value-capture centers) as the industry matures.

Suppose AI becomes just another moatless commodity feature like cloud computing or mobile integration and P/S valuation multiples collapse from 8x to just a bit above pre-ChatGPT levels (to factor in the remaining incremental value of AI) of, say, 5x (38% decline). Supposing that the rest of the market remained intact, that means 32% of the index (that composed of the Mag7) falls by 38% for net effect of -12% to the index (0.32 * -0.38 = -0.12) that would have to be made back up by gains in other sectors going forward and Mag7 lowers to 23% of the total index 12. If we suppose that AI/LLMs ultimately become a commoditized net expense, yet remain must-have loss-leader features for the the big LLM companies and P/S multiples fell back to, say, the 4x P/S trough levels of the pre-ChatGPT boom in 2023, then that same math leads to a 16% index decline. Meme-stocks and SPACs may have been localized bubbles in the recent past that popped in an orderly fashion, but the difference here is that those past groupings were not 32% of the general market and so, for one thing, were less affected by additional sympathy selling and mechanical unwinding that might happen in such a “bubble” scenario for AI.

How does one size a position where the upside in success mode is not just uncertain or unlikely, but just totally undefined? I’m betting it’s not with a position that’s 32% of one’s portfolio. I could also be totally wrong about how transformative (or more importantly how profitable) AI is going to be within the next, say, 5-7 years.

In any case, in the longterm, I don’t think one needs to be first if indeed the industry is truly going to be transformative. We can wait until the industry gets to the point on the (possibly longer and more drawn-out than expected) S-curve where there are both attractive setups and established/proven models for profitability before investing with size into any particular participant across the AI value chain 13. (Note that it is not a given that the particular AI activities being pursued most heavily by the big tech names are going to be the ones that capture the greatest economic value spread (of ROIC - WACC) within the wider AI value chain hat ultimately establishes itself as the industry matures).

(The actual progress of AI may be something like the RHS at the macro level with mini versions of the LHS at the micro level making up the slope along the way, each time representing a new set of opportunities)

.

Top positions (excl. cash / money market):

The gradual sizing into positions on strength has been progressing well. Here is the general breakdown of underlying drivers of the equity portion of the portfolio (as of Jan 1 2026) as I subjectively categorize them 14. The way this chart works is by taking the portfolio weighting of all positions (excluding cash) and a list of underlying external drivers I’ve associated with each position and splitting up the position weight equally among the categories in this list to come up with a per-driver portfolio weighing chart 15. (Note: these positions are not set in stone and I may change them up rather dramatically at any time).

GOOG (Alphabet Inc.):

Google currently has the best LLM models in the world, a clean balance sheet, and —at the time I started gradually accumulating the position in mid-2025— the lowest LTM P/E of all the big public AI-centric software names (AMZN, META, MSFT).

While “intelligence” differences between top-tier AIs has become pretty narrow, GOOG’s AI is also generally cheaper and faster than the competition 16 17 18. At the same time, they are highly motivated to win the AI race given the existential threat this represents for their search biz (as the future of online ads will likely be LLM response-embedded ads, bypassing much of the top-search-results “real estate” that Google traditionally auctioned to monetize their search services). *UPDATE 20260116: Eg…

(On the flip side, if AI —here defined as LLMs— turns out to be a dead end before achieving the singularity (AGI) or something close to it, then Google’s trad. ad business will remain intact, whereas I’d expect many other comps will have that new realization translate to much harsher valuation re-ratings for their stock).

Google should also theoretically have more (and more diverse) data than Meta, Microsoft, et al for training their models in the form of a vast corpus of proprietary of data from search queries, YouTube, Maps, Android, Workspaces, plus decades of experience in data indexing.

One way to look at it is that tech companies are collectively buying long-dated moonshoot call options on AGI (or becoming critical infrastructure in a (near) post-scarcity world). They’re basically rolling these contracts forward quarter after quarter and paying big premiums on the calls (capex investments), but the exact contracts they’re buying are not all the same; some are buying contracts that are relatively close to being in the money and with lower premiums (ie. they have better balance sheets, existing profitable businesses to fund the calls, and already incrementally improving their base biz with the marginal gains on their calls). For these companies, the options are already paying off something in the present, even if the net basket of calls is still somewhere in the red.

Other AI companies are buying deeply OTM LEAPs at big relative premiums (ie. their core biz needs an explosive payoff to justify the spend or to defend against disruption from the big tech incumbents). If their strikes never hit (eg. LLM scaling plateaus without reaching AGI), those options expire worthless without having contributed any marginal value to any base (non-commoditized) business of theirs that will still exist beyond that. These companies have no moat yet and are racing to find one.

.

Meanwhile I look at Google Cloud as a kind of hedge against some degree of search monetization loss/cannibalization from AI via offsetting revenues likely to come from the explosion of code and hosting demand as AI lowers the barrier to creating and deploying new software. (BTW, as I see it, more vibe-coded software ==> greater ratio of unoptimized or bloated software in addition to growing overall denominator ==> more cloud deployments that individually require more cloud resources). Meanwhile, I also see their specialized proprietary TPU technology as a call option for competition to Nvidia’s GPUs for AI demand 19. Deals like Anthropic’s billion-dollar commitment to using Google TPUs highlights growing external adoption beyond Google’s own models 20.

Alphabet also owns a 14% stake in Anthropic and 7% stake in SpaceX 21. At some point these companies are going to IPO and their estimated marketcaps are already on par with some of the existing Mag7 companies ($350bn for Anthropic, comparable in size to the 25-26th largest US companies General Electric & AMD, and $1.5T for SpaceX, comparable to 7-8th largest Tesla & Meta) 22. Note that the S&P 500 inclusion criteria and weightings are primarily based on marketcap 23 and these aforementioned companies would thus need to be mechanically bought by the index in proportion to their relative sizes.

Risks include AI over-investment 24 as well as the risk that LLMs end up not to be a winner-takes-most environment like these tech giants may be used to (as LLMs don’t presently generate any network effects) and rather end up as must-have, table-stakes, cost-centers for the tech giants going forward.

(Additionally, while hard to map the approximate correlation to EPS growth or support-floors, I also see Google as a not-widely-recognized, systemically-important defense contractor of the US DoD —not just via their data mining, mapping, intelligence tools, and AI integration within the military 25, but— in assisting the DoD’s 5th-generation warfare efforts to grow, influence, and control the global digital memesphere/noosphere simulacra that has increasingly become the way that IRL social conduct and culture is increasingly mediated (even for people who don’t directly interact with social media)… IMHO).

Financial exchanges (MIAX, ICE, CBOE):

I wrote a bit about the interesting business moats of (incumbent) exchanges and my skepticism around the recently IPO’ed MIAX in an earlier post here:

I was initially skeptical of MIAX and wrote about the exchange a few days before its IPO, but bought into price & volume-profile strength incrementally from an initial tracking position around the $29-30 zone as the position started working. After that additional round of averaging up as price and volumes moved positively into the $35-40 zones and continued beyond, MIAX has become the largest exchange position of the basket, followed by ICE then CBOE. These latter two exchanges are pretty well covered, so IDK how much I should talk about them here, but I’d just note a few things…

The individual position sizing here is partially based on the rank order of the ratio of CEO stock ownership value vs total comp, with those values being around 73x, 17x, and 1x for MIAX, ICE, and CBOE 26. Based on the primary revenue driving products at the various exchanges, I see them has providing general asset-light exposure to…

• retail investor sentiment (with 75% of revenues from options trading & 15% equities) for MIAX,

• global energy volatility (certainly relevant during what’s looking to be an era of deglobalization and resource nationalism), fixed-income demand, and call option on political action re. the major issue of housing affordability via volumes on their mortgage management and securitization systems 27 for ICE,

• and market volatility and retail sentiment/degeneracy 28 (w/ 50% of revenues coming from SPX and VIX options trading and remaining 40% & 10% coming mostly from North American & European+Asia equities trading) for CBOE.

Another way to think of exchanges is as a diversified basket of long straddles, not on the index prices, but on investor changes in positioning, whatever the direction, via whatever index-linked securities are offered on the exchange. Here the straddle’s “premium” cost is the on-going expenses to host and maintain the index and associated data feeds (this is highly scalable, BTW). Meanwhile, owning an index product is like owning a long call that you only pay for once (ignoring annual ETF expenses) 29. The exchanges don’t get paid on the direction of the index, they get paid on the volume of flows that (may) influence the direction. That is, their straddle’s X-axis is not price, but the overall changes & investor interest in positioning within a given index that fuels demand for index securities (ie. TX fees), data feeds, and 3rd-party licensing.

In options terms: If delta is the expected change in price (reflected IRL by whatever the static state of current investor positioning in the index is), then exchanges are long gamma (the 1st derivative of delta). That is, they are long the change in expected change, reflected IRL —at least where TX fees are concerned— by the dollar-weighted change or re-shuffling activity in the (re)positioning of traders and investors in the index.

Furthermore, one can view ownership of market exchanges as superior to owning any particular index themselves. This is because the exchanges gain from the fees people pay to participate in the broad basket/portfolio of products trading on their platforms (be they related to equity indexes, commodity indexes, catastrophe indexes for insurance-linked securities, or any other manner of thing that can be conceived of, tracked, and packaged as an index to derive securities from). Those fee volumes rise in proportion to the popularity of the indexes to the extent that they draw in activity to make the indexes go up or down in the first place. So the exchanges ride along with the overall popularity of all of the various products that trade on their systems, without as much care for the direction of the products at any given time. The casino only cares about hosting popular games (and collecting the “rake”), not about which tables are hot at any time; the popular SPY S&P500 ETF being just one such table hosted there.

As I mentioned in the linked MIAX post, liquidity begets liquidity and incumbent exchanges are hard to displace; any new index or associated ETF products that people might think of can come along to displace any other existing index, but those products are only going to trade on the exchange platforms of a few entrenched incumbents. So, unlike any individual index, the exchanges also benefit from the endless right-tail of new indexes and other financial securities that can come into existence and gain massive popularity (which may work as exact left-tail events for any particular established index one may hold).

Gold (IDR, TFPM, FNV):

I’ve written about FNV as well as the general way I look at the gold royalty companies in the older FNV post here:

One change in overall gold exposure was a shift of some of the gains from the FNV position to a position in US gold miner Idaho Strategic Resources (IDR) as a part of a broader theme of escalating resource nationalism. This was initially a very small position that I’d been averaging into in small amounts as the position continued working (which was most of 2025) and it has since become the largest gold exposure.

I liked IDR for the higher gold-beta exposure, exchanging some of the gains in the more diversified and capital-light FNV for IDR’s higher gold-beta and domestic de-risking (re. deglobalization and South American jurisdiction risks, FNV’s Cobre Panama closure issues being a good example; gold as a political-volatility hedge/beneficiary does no good if your gold is “stored” in the vary regions that are experiencing / victims of that same vol) as well as it’s call option on domestic REEs that are becoming greater priorities for the military and the target of resource nationalism spending 30. Unlike other gold miners, I think management is very well-aligned with shareholders and much less likely to over-extend financially or in terms of equity dilution. IDR’s tangible book value per share has grown at a rough CAGR of 28% since 2015 to Q3CY2025 vs just 11% and 3% for the largest global gold miners, Barrick and Newmont respectively, that I could have chosen as alternative gold-beta proxies.

Furthermore, when we compare stock ownership value to total compensation (inclusive of equity awards and bonuses) of IDR’s CEO vs Barrick and Newmont, we see a big difference: 42x vs 9x and 0.35x 31 32.

FNV (55% gold and silver revenue, mostly gold, and 45% energy exposure) is now the smallest “gold” exposure. I downsized here simply because of it’s diversification into oil and gas royalties which I believe are mostly light sweet and thus overlaps with existing exposures from Permian oil & land royalty company, Texas Pacific Land Corp. (TPL), via my “HK Complex” positioning.

Horizon Kinetics “complex” (FRMO, HKHC, TPL):

Very quick background references for FRMO and HKHC can be found here.

For both FRMO and HKHC, I started buying after these names started finding support near the P/BV=1x levels for each (or historical valuation averages in the case of TPL) in the latter half of the year after they had gone through significant declines. I’m not saying these stock must thus go up from here, but that at a 1x P/BV you are now riding alongside these businesses at much less risk of tracking error between the experience (up or down) of the business vs your experience as a shareholder.

I see FRMO and HKHC as low P/BV HoldCos with thoughtful, longterm-oriented, often-non-consensus, and heavily-aligned mgmt (with management/founder ownership stakse vs total compensation being around 400x for HKHC and approaching infinity for FRMO, where management takes no cash salary or equity awards).

HK is also the longest and highest-single-stake owner of TPL (one of the Permian basin’s largest land, oil, and water rights owner), which recently made an initial development deal with a new company, Bolt Data & Energy (BD&E), started by former Google CEO/Chairman Eric Schmidt with stated intention of transforming TPL land into a vast data center and energy hub (oil, gas, renewables, and nuclear) 33. I see HKHC as a more shareholder-aligned proxy for TPL exposure vs the nearly-zero ownership-vs-compensation ratio of the management team of TPL itself (with legacy TPL mgmt beginning to buy any equity stakes in TPL at all only after a proxy fight initiated by HK in 2019 aiming to establish better governance at TPL which resulted in HK & allies gaining representation on the BoD). A fuller breakdown on that drama can be found here:

Special Situation Investing

TPL's governance battle (TPL)

Welcome to Special Situation Investing Episode 69…

Listen now

3 years ago · 13 likes · 10 comments · Six Bravo

On a look-through basis (considering that HKHC owns TPL shares outright as marketable securities as well as concentrated in virtually all of their managed funds, which they invest in alongside their clients and makes up 70% of HKHC’s book value), I estimate HKHC’s total TPL exposure for their own economic benefit to be around 32-35% 34 35.

One thing that I’d caution on this point —of HKHC as a more trustworthy agent through which to gain TPL exposure— is that there is the risk that HK either wouldn’t (for psychological reasons) or couldn’t (due to the size of HKHC’s TPL holdings and liquidity constraints) sell off their TPL position in an orderly manner even if they decided that selling was the best course of action 36.

I will have more to say about FRMO et al in a short post that I am planning to publish later, but for now I’ll just note that the current valuation of FRMO is historically abnormal and has tended to be the best times to buy for FRMO and that major underlying holdings of both FRMO and HKHC appear to have found technical price support. Furthermore, TPL’s price has declined greatly through 2025 partly due to continue market disappointment on any data center developments on TPL property. As mentioned earlier, in December 2025, some concrete developments on TPL’s AI front was announced in the form of a press release where TPL announced an agreement with BD&E to develop and enable large-scale data center campuses and supporting infrastructure across TPL land (https://www.texaspacific.com/investors/news-events/press-releases/detail/176/bolt-and-tpl-announce-strategic-agreement-to-pursue-data).

An interesting tid-bit on this subject is that BD&E co-founder, Allan Tessler, was a party to HK’s 2019 proxy fight with TPL management.

.

For what it’s worth, I think do see recent oil developments in Venezuela are a risk to US shale prices, but IDK to what degree. I see arguments about the apparent dysfunctional state of Venezuela’s oil infrastructure and the time it may take to restore it (not to mention oil companies’ hesitance to invest, given the countries socialist history of nationalizing assets after companies had invested significant capex) 37, as well as arguments pointing out the differing types of oil from that region vs US shale 38. I think the “risk” is that presently-high expected breakevens 39 for Venezuelan reserves are brought down quicker than expected by the major oil companies under a less-sanctioned and more cooperative/stable Venezuelan government. This is very contingent on things working out well of the US in Venezuela, but that is where the “downside” (in terms of shale profitability) is. Also, US oil refiners along the Gulf of America —which are mostly configured to refine heavier oils— will then benefit from access to cheaper inputs 40. Venezuelan oil is not a direct competitor to Permian shale oil in the sense that they are of different quality, but most of these refineries are equipped with coker modules that allow the refineries to break down these heavier oils from Venezuela into shorter hydrocarbons that are chemically similar to the lighter crude oils from US shale and can be used for similar final products. The story for US shale when it comes to oil-rich Venezuela-neighbor Guyana, which now faces much lower threat of hostilities from Venezuela and thus has been de-risked from an investment POV, is also going to be a knock-on effect from the change in Venezuela’s government 41.

MKL (Markel Corp.):

A mini-Berkshire 100-bagger I’ve been following for a while and bought as the stock began recovering from long-term P/BV lows of 1.75-1.80x in late 2025. When the P/BV is at or below the historical norm of 2x, I’m fine to add to MKL as a better-aligned S&P500-substitute to park money in when I don’t have any other ideas for what to do 42. Basically a well-aligned mini-Berkshire (with a VC segment concentrated around construction services, building supplies, and consumer products) that I think one can confidently park their money in (when valuations allow) in lieu of better ideas w/ greater room to grow than BRK as it exists today; especially useful as a trustworthy default now that Buffett has stepped down from BRK and the future of that org and mgmt is more uncertain.

Competent management is table-stakes and even if you think your riding a superstar’s coat-tails, it still matters what kind of underlying exposure that superstar is adding to the portfolio, so we can quickly cover that here. The general breakdown of underlying exposures is: Insurance (50% of revenues); Markel Ventures (30%) with around 40% of those revenues coming from the Construction Services segment, 30% from Consumer and Building Products, and 10% from Transportation-Related Products; Investments (20%).

(Note: my understanding is that MKL’s construction services and building products are much more strongly associated with residential housing and commercial real estate more related to offices buildings or malls/retail, rather than with the industrial construction that’s benefited from the recent AI-capex boom).

MKL has been restructuring from 2023 to 2024 since CEO Tom Gayner become sole CEO in 2023 (vs previous co-CEO dual setup) and getting rid of non-performing business segments while simplifying costs. Management thinks that these improvements should start showing up in bottom line starting 2026 43. Gayner owns an MKL stake worth 10x his total FY2024 compensation with total mgmt. group ownership vs total aggregate compensation at 20x. MKL has been a safe choice for a while with a long track record of beating the index since Gayner was added; operational changes here just add to that tailwind. Again, this was mainly an opportunistic, abnormally-low-P/BV + bet-the-jockey addition.

On a final note re. the MKL - BRK comparison: While past performance is not indicative of future returns, on the subject of MKL’s size and the idea that they’ve “already made their 100x”, I’d just point out that 1999 is when Buffett first cautioned BRK shareholders that he expected future returns for BRK to only moderately exceed the S&P 500, with “truly large superiorities over that index [being] a thing of the past” due to BRK’s large captial base (BRK having a marketcap of $78bn at start of 2000 (vs MKL’s present day $27bn))44. BRK then went on to compound a 938% return by the end of 2025 (end the of Buffett’s official tenure as CEO of Berkshire) vs 435% over the same period for the index.

In any case, for full disclosure, this chart below is the general extent of my actual add/hold/sell decision at this point…

Defense basket (CACI, BUKS, HII, RTX, SODI):

CACI stock and most other defense companies initially took a big hit due to sector-wide valuation downgrades after the announcement of the D.O.G.E. following President Trump’s victory in 2024, yet the company’s fundamentals remained fine, nothing about the general deglobalization trend precipitating increased military competition was changed, and the key thing to observe IMO was the general bipartisan lack of enthusiasm towards actually codifying any of the DOGE changes into law. Without the backing of Congress, any DOGE spending pauses, contract terminations, or agency reorganizations, would be much more temporary and easily reversible by future admins or courts —and, again, nothing about the general deglobalization trend precipitating the need for increased military spending was changed. One can read more about this general idea in an older post, here:

Indeed, DOGE turned out to be a bit of a boondoggle of its own and only realized a tiny fraction of the savings it set out achieve. Meanwhile, CACI announced that it had been buying back shares at an average price that turned out to be the near-bottom for the stock from Janurary to March of 2025. The market seemed to begin catching on as well, with valuation multiples nearly back to previous highs by April.

CACI is an asset-light defense contractor that has recently completed (according to management) a long-running transition from a services-based business to a software/product-based one, selling software final products and SLA outcomes rather than billable labor hours. It’s a common complaint from affected defense contractors that is often feels like the military likes to screw over services-based contractors as much as they can 45 46, so transitioning from services to software is a positive move here and the DoD’s recent increased focus on software solutions is a cherry on top (https://media.defense.gov/2025/Mar/07/2003662943/-1/-1/1/DIRECTING-MODERN-SOFTWARE-ACQUISITION-TO-MAXIMIZE-LETHALITY.PDF). This unhappy dynamic doesn’t require any special access to figure out. The issue with services-based contractors in this context is that they are essentially just IT/programmers with a security clearance —not to say these aren’t scarce, but it’s table stakes. That services-based work is much more easily commoditized/replaced than a software system which is more tightly entrenched (and scalable) into operations in a way that is not so easily swapped out for another; you can change your sysadmin, but you rarely change your email client or operating system. One might think of CACI as having transitioned from Linux tech support specialists to RedHat developers, distributors, and maintainers of their own (open architecture) operating system(s) and working with different clients to continually modify OS versions for evermore bespoke (read as: entrenched) purposes.

As MorningStar puts it, product-focused defense contractors benefit from “extreme [and particular / military-specific] product complexity that thwarts new entrants, bolstered by decades long product cycles [that increase sunk cost risks for comps], contract structures that reduce risk for the contractor [though I believe the military is moving away from cost-plus pricing, which is what I think is being referred to here] and lock out alternative suppliers, and the switching costs of a risk-averse customer facing significant time and risk to potentially switch [mission-critical] products [or vendors]”.

.

5

Eg.

https://www.friendsofbls.org/updates/2025/11/12/2025-government-shutdown-faqs-on-bls-data ;

https://www.nytimes.com/2025/11/19/business/economy/labor-department-economy-data-october.html ;

https://www.msn.com/en-us/money/markets/economic-calendar-these-are-the-government-data-reports-we-re-still-waiting-on-after-the-shutdown/ar-AA1TPQxQ

27

For example…

BTW I wrote this part of the post before the new year, when the President posted this.

Launching it’s first options exchange, MIAX Options (currently 16.4% fo total US options market share), in December 2012, Miami International Holdings (MIAX) has since expanded into exchanges for equities (1.1% market share), as well as futures & derivatives (<1% US market share), clearinghouse services, along with some niche international exchanges. In 2022 MIAX filed it’s initial paperwork for it’s IPO and recently started their IPO roadshow on Aug 8, 2025.

Exchanges can be interesting businesses from a competitive advantage POV, as scale and liquidity can create self-reinforcing flywheels that enable better execution and more opportunity for sufficiently supporting new types of more bespoke contracts (that often require nothing more than some new idea for something traders can bet against each other on and a few new servers in a data center) that thus attracts even more liquidity and so on.

Furthermore, an exchange may have it’s own dedicated clearing house that maintains a guaranty fund that all members contribute to in addition to posting collateral into for each open position, either in full or margin depending on the clearinghouse license, to spread default risk and cover possible obligations/losses that could be incurred upon liquidation or expiration of a contract that a trading party may end up defaulting on. A trader wanting to trade on an additional/competing exchange with it’s own clearinghouse would have to put up an additional tranche of capital that would be locked in the pooled guaranty fund of that exchange (vs being available to compound at some opportunity-cost rate elsewhere) 1 2, thus a firm may be more reluctant to even consider doing business on a new exchange unless there is a compelling reason to trade at that venue (ie. an enticing and unique type of futures or derivative) 3. In the event of a counterparty to a trade defaulting, the exchange would seize that defaulting members collateral and guaranty fund contribution, plus a portion from other members contribution if needed, in order to settle the trade for the other side; so more members means greater spreading of risk. New clearinghouses, with their lack of initial contributing members, don’t have as much pooled collateral to mitigate/spread counterparty risk in case of a trade default, which can create a chicken-egg problem where firms are less willing to join because others aren't already part of the clearinghouse (https://www.paystand.com/blog/what-is-a-clearing-house). 4

Given these advantages (in addition to the fact that one of MIAX’s major shareholders is Murray Stahl, whose investing ideas I always find very interesting), I thought it would be interesting to look a bit more into the up-and-coming exchange. (Spoiler: those same advantages I mentioned that make exchanges such interesting businesses also make it very hard for new entrants, like MIAX, to gain headway and in MIAX’s case I think it shows).

https://www.miaxglobal.com/news/miami-international-holdings-announces-launch-initial-public-offering

https://www.sec.gov/Archives/edgar/data/1438472/000162828025037294/0001628280-25-037294-index.html

Some observations…

Some quick observations from MIAX IPO prospectus...

Technology so good, we have to pay people to use it

In the prospectus, MIAX highlights their technology advantage, among others, saying… “[w]e are not encumbered by legacy systems or reliant on our core data revenues to date, so we have significant flexibility in how we monetize and distribute our data, providing an attractive growth opportunity. Our proprietary products may also provide an additional avenue to create exclusive data and analytics products for our customers. We believe our strategic investments also create opportunities for development of additional products as well as data and analytics offerings.”

MIAX has been paying for order flow via liquidity payments, rebates, and —something I’ve not seen at other exchanges5— several equity right programs (ERPs) to key market makers and trading firm members of the exchange. These ERPs provided warrants for MIAX equity in exchange for participants directing their order flow through MIAX exchanges and in some cases resulted in put rights that gave holders the option to require MIAX to repurchase the puttable securities; note these specific liabilities are nullified after the IPO. The EPRs resulted in exchange members accumulating significant ownership stakes in the company 6. If MIAX’s tech was meaningfully superior vs incumbent “legacy systems” why have they needed to give away so much of the company to get people to use it?

(One interesting note about the beneficial ownership table here is that Citadel Securities, the market making giant, is not present here because they converted virtually all of their existing 6,218,504 common stock and remaining warrants into a perpetual “pre-funded” warrant in June 2025 ahead of the IPO, obscuring their ownership as well as potential share dilution. This would be 9.7% of MIAX shares, post-IPO, if fully exercised. Lastly, this warrant includes a provisions where Citadel can have MIAX buy back the value of the underlying shares at any time and for any remaining is also “entitled to receive its share of any dividends or pro rata distributions to stockholders on an as-exercised basis.” That is, they are able to recieve any dividends or other shareholder distributions without having to actually exercise the warrant; very favorable terms.)

Note that these programs have been ongoing since MIAX’s founding all the way through it’s 12 years of operation and were only ended this year ahead of the IPO. It’s an interesting attempt to align incentives, but I wonder if this dilution will continue post-IPO (via new ERPs down the road) or how order flow might change in the absence of any new ERPs for key exchange members.

Non-operating profits

2024’s positive earnings seems to have been chiefly due to the sale of unlocked Pyth tokens earned from their Bermuda Stock Exchange’s (BSX) contribution of market data feed (from MIAX Pearl Equities market) to the DeFi Pyth Network (as well as due to the accounting “profit” from unrealized gains on remaining held Pyth tokens). To be brief, the Pyth Network is a decentralized finance platform for market data distribution (people or smart-contracts pay for data requests on the network via Pyth tokens that can also be “staked” to participate in / influence network governance). BSX earns Pyth tokens in exchange for providing select MIAX market data to the network. BSX currently has rights to several tranches of Pyth tokens that are scheduled to unlock for available sale over the course of the next few years into 2028 7. One can read more about the Pyth Network here (https://www.thebigwhale.io/tokens/pyth-network).

For the purposes of evaluating the business, I tend to want to exclude this BSX-Pyth arrangement as I see it as not really a part of the main operations of the business and very speculative, as well as having a rather limited duration.8

Without this Pyth token sale boost (accompanied by the purely accounting profit of unrealized gain on the remaining locked Pyth tokens for the period)9, MIAX’s total 2024 net income would have been negative, similar to 2023 results. The 2022 operating income was slightly positive, with earnings getting a major boost from a markdown of MIAX’s ERP liabilities in that year —ie. the assessed fair value of MIAX stock went down— (resulting in an accounting gain on the income statement) without which the company’s interest expenses would have again resulted in negative earnings for the period. It’s worth mentioning here that around 50% of the planned IPO proceeds are intended to go towards extinguish most of the company’s remaining indebtedness. 10

By my calculation of the FCF margins for the reported periods, we have…

1H2025: 6.50% (w/ Pyth token sales); 4.03% (w/out Pyth sales)

2024: 6.35% (w/ Pyth token sales); 1.75% (w/out Pyth sales)

2023: -7.21%

2022: 12.74%

Compare this to the FCF margins of the incumbent exchanges over the same periods:

(One could argue that this difference represents opportunity for lots of growth, but we should also keep in mind that MIAX has been operating since 2013; over a decade of operating history and MIAX is yet to come anywhere near these incumbents’ margins).

Hidden incumbent advantages

Re. data monetization…

MIAX generates market data revenues from direct subscriptions to their market data feeds as well as from required participation in U.S. Tape Plans with securities information processors (SIP) (e.g., OPRA for options, Consolidated Tape Plans for equities), which then distributes revenues charged to vendors and subscribers back to data suppliers based on each exchange’s market share of total volume, trades, and quotes; you can see how venue liquidity can have a positive flywheel effect in this regard.

For the first half of this year, 1H2025, MIAX reported a 27% YoY increase in market data fees (which made up around 10% of their total gross profits), with 88% of the increase ($3.7MM/$4.2MM=0.88) being attributed to “fee increases and new product offerings.” (I would have liked to see a further breakout between increases to fees vs new product offerings). 2024 also saw a 11.7% YoY increase in market data fees, specifically due to fee increases in MIAX Pearl Equities data.

So far, it appears that MIAX has been able to raise prices just fine, but a broader point of interest that I’m reminded of by this particular selling point is the SEC roadblock that smaller exchange IEX faced in November 2021 when trying to charge for their real-time market data that they had previously offered for free. 11

The SEC stepped in and suspended the proposed fee change in December of that year citing concerns about the reasonableness and potential impact of the fees on market participants despite these fees being much lower than those charged by the larger exchanges for similar types of data. 12

IEX was ultimately allowed to change their fee structure, but the moral of the story here is that incumbents often have a advantages from regulatory complexity not just in their ability to navigate them, but also in their grandfathered-in status quo treatment or existing state of operations (built up in earlier times of laxer enforcement or less complicated regulations) that new entrants might not have the fortune of encountering from regulators when trying to work their way to the same scale/status.

(From this POV, the BSX-Pyth data feed agreement is actually an interesting way to try to avoid these kinds of specific issues and explore new means of data monetization).

Liquidity goes where liquidity (already) goes

Basically, MIAX’s main advantage vs the big players seems to be that they are small enough that they can take advantage of smaller/niche assets classes (eg. crypto, wheat futures, and insurance linked securities) or jurisdictions (eg. BSX in Bermuda and TISE under the British Crown Dependency of Guernsey) and have that make a meaningful impact on their bottom line; their “strategic investments” intended to “create opportunities for development of additional products as well as data and analytics offerings.”

Instead of somebody saying, “I’m buying these stocks because I think the economy is going to be good, bad, or indifferent,” you’ll actually be able to make an investment based specifically on your forecast. You might say the GDP is going to be up 2% or 3% or something other figure, and if it is up that much or more and your analysis is correct, you’ll get paid based on some pre-agreed upon formula. And if the GDP doesn’t go up by that amount, or even goes down, you might have to pay in accordance with some prearranged formula. The idiosyncratic nature of investing will be radically different. […] Why would you buy the S&P 500 [just] because you think the economy is going to go up, if you can invest in the GDP figure itself? ~~~ Murray Stahl (9.45% MIAX beneficial owner, post-IPO) on the future of exchanges, https://www.frmocorp.com/_content/letters/2021_Q1_FRMO_Transcript.pdf

While this is an interesting opportunity for MIAX and other exchanges, one thing I think about is: why can’t any popular contract that MIAX comes up with not essentially then be duplicated by the major exchanges and instantly become more attractive simply due to the existing liquidity at those venues? 13

I will note that we have some recent short-term data on how this might play out for future MIAX futures by observing the case of their Hard Red Spring Wheat (HRSW) futures. The MIAX Futures segment, formerly named the Minneapolis Grain Exchange lists lists HRSW futures and options contracts. Incumbent CME started trading the same futures and options on HRSW contracts on April 14, 2025, directly competing with MIAX futures. Despite this, in the six months ended June 30, 2025 (which we should recognize as only accounting for 2.5 months of CME’s competition re. wheat futures), MIAX Futures reported 2,222,907 agricultural products total contracts traded vs 1,627,528 in the same period in 2024, a 37% increase. This looks good for now, but I think it’s actually too soon to tell and a 2H2025 vs 2H2024 YoY comparison would be a better indicator once those numbers are available to see if we can get a sense of if the larger CME is making any progress in taking share from MIAX on this front.

We can see a reverse example of this dynamic in MIAX’s own attempt to copy CBOE’s VIX futures by constructing their own SPIKES volatility index and futures in 2019 (https://pro.thestreet.com/trade-ideas/the-vix-and-spikes-have-similarities-but-there-are-meaningful-differences-16079100); it was ultimately delisted from MIAX in 2023 (I assume due to inferior liquidity), https://www.miaxglobal.com/alert/2025/01/17/miax-options-exchange-miax-product-feed-will-stop-disseminating-spikes.

In 2024, MIAX obtained a ten-year exclusive license with Bloomberg Index Services to develop and list proprietary products based on Bloomberg’s portfolio of indexes, including the Bloomberg 500 Index and Bloomberg US Large Cap Volatility Index. I’m sure MIAX would like these to be competitive with the popular S&P 500 and VIX futures, though I’d bet on these seeing a similar unfavorable outcome as the delisted SPIKES for similar reasons (too similar to much more liquid derivatives elsewhere).

There are different economics between proprietary products versus those listed across multiple exchanges and MIAX appears yet to develop home-run products of the former category. MIAX’s attempt to compete with the SPX via Bloomberg indexes is a speculative call option with a precedent of failure (and IDK exactly the meaningful difference in setup here between SPIKE-vs-VIX and SPX-vs-Bloomberg).

Conclusion

As it stands, the Options segment is the only part of MIAX’s business that consistently generates positive Operating income (this holds across all reported periods in the prospectus):

The International segment only shows a positive Net Income in 2024 due to the $52.6MM sale of unlocked Pyth tokens and an accounting profit of $83.8MM in unrealized gains on the remaining locked Pyth holdings from the BSX business (recorded as “Gain on sale of intangible asset” and “Unrealized gain on derivative assets”, respectively). Without this boost, total Net income for 2024 would have been a loss of -$34.46MM.

Thus, IDK how much of MIAX’s niche/innovation story really even stands up to their actual results here (eg. the BSX and TISE acquisitions fall into the International segment which have had no operating profit in any reported period and the same can be said for the Equities, Futures, and Corporate/Other segments that consistently show an operating loss across all reported periods) 14.

IMO, they appear to just be shot-gunning small allocations of M&A across a bunch of niche asset classes and hoping that some of those ventures grow into big winners, which this seems to have had mostly lackluster results thus far.

.

Extrapolating MIAX’s 1H2025 numbers to calculate run-rates (and excluding the non-operating profits/losses from recent unlocked Pyth token sales, which represented a net investment loss vs the most recent assessed fair value on MIAX’s B/S 15 and were thus recorded as an accounting earnings “loss” in addition to recording unrealized losses on remaining locked Pyth tokens, but was still ultimately a $16.239MM cash profit), we can get a sense of the business valuation vs the post-IPO expected EV ($1,306.872MM) 16 and marketcap ($1,562.018MM)...

EV/Revenue = 1.00x; 1.10x when included Pyth sales (which, again, was an accounting loss).

EV/EBITDA = 28.20x (nominal reported EBITDA).

EV/adjEBITDA = 7.35x (based on reported EBITDA and adjusting for gain/loss in puttable stock and warrants, loss on sale of Pyth tokens, unrealized derivatives gains/losses, and unrealized gain from a re-measurement of TISE acquisition equity); 16.40x when including Pyth token sales accounting losses.

MC/FCF = 32.07x; 19.24x when including Pyth token cash proceeds.

These numbers may seem cheap or reasonable vs the major exchanges depending on what multiples you’re looking at…

… but, as mentioned, we should keep in mind that MIAX doesn’t enjoy same kinds of strong competitive moats as the majors (ie. liquidity feedback loops from sheer scale or recognition MIAX as the “standard” venue for any popular proprietary products).

BTW, via the early ERPs for insider exchange members, I calculate their average cost basis to be around $5/sh (vs the $20 planned IPO price). Just another thing to keep in mind.

.

Overall, I'd say I'm not too keen on the business as a whole, but am open to hearing a bull case for it. They are trying interesting little niche things, but it’s just that those things haven’t seemed to do much for their bottom line so far.

.

I’m no expert on exchanges —just made this post because Murray Stahl, whose ideas I always find interesting, is a major shareholder and I’ve not seen much written about MIAX elsewhere (also because someone asked me about it)— and this is mostly based on jumping around MIAX’s IPO prospectus, so if there are critical value signs that I’m just totally missing on this name that others are looking at, do feel free to let me know in the comments.

.

.

UPDATE 20250818: Full disclosure: I ended up buying a 1.5% position at the IPO, but may sell at any time. I like Murray Stahl and if the exchange can get the newer segments to profitability and approach anything near the marketcap of the incumbents, then a 1% position would still be very significant in a 50-100X’er.

If the famous oil royalty company, Texas Pacific Land Corp (TPL), is the “ETF of the Permian basin”, then LandBridge (LB) is an exchange trading floor of the Delaware. LB owns uniquely positioned surface acreage in the Delaware basin and has an integrated relationship with WaterBridge (WB) midstream water management, which shares the same management team and majority owner. The both companies benefit from WB/LB’s ability to provide oil companies —and other water users and recyclers— with a path for a more efficient permitting and development process in the Delaware basin by virtue of this relationship (vs other water pipeline networks in the area that may need to negotiate with multiple land owners during the permitting/development process).

WB collects fees on the volumes of water transported, treated, and/or disposed of for customers through their pipelines and at their facilities, while LB collects resource sales, easements, and surface use royalties on water sourced from, infrastructure atop of, and waste water disposed of on their lands —usually from WB 1. The positioning and scale of LB’s acreage also acts as a call option on all other manner of surface use demand that may require water, energy, and acreage in the Delaware basin.

However, IDK that, at a high level, the growth expectations baked into the current price are a great bet to take and a lot of the near- to mid-term price action seems to depend on a tug of war between Jevon’s Paradox driving greater total data center capacity and infrastructure demand vs innovation-driven LLM kWh-per-token deflation —with LB longs rooting for the former.

I’d be a more willing buyer in the sub-$55/sh range at the moment.

.

While I own a good amount of shares 2, I’m not actually too certain that the stock is a particularly great buy right now. However, I thought it would be good time to set down some thoughts on the name while the year is just beginning and LB set to have their earning call tomorrow. (There’s always more to learn, questions to ask, and threads to pull, but just wanted to convert some of my major existing notes from spreadsheet cells and textfile notes-to-self into something more centralized/structured and will add more down the road).

Business

I think LB’s advantage can be summed up as owning uniquely positioned tracts of land that are set up to act as a (maintenance) 3 capex-light platform, connected by a large network of water handling pipeline operations via coordination with LB’s sister company, WaterBridge (WB), to service the fracking industry (and any other type of infrastructure that requires cheap and/or proximate access to land, energy, and water) in the Delaware basin. Both LB and WB share the same management team and are both majority owned by Five Point Energy LLC.

WB is the largest pure-play water midstream company in the US and operates a large-scale network of pipelines and other infrastructure in the Delaware basin 4. LB has a network advantage in the Delaware basin, vs other acreage owners that might compete with selling/leasing resources or acreage for similar use cases, that stems from LB and WB’s integrated operations due to their shared management team and ownership. WB collects fees on the volumes of water transported, treated, and/or disposed of for customers through their pipelines and facilities, while LB collects resource sales (eg. of brackish water and caliche5), easements fees, and surface use royalties on resources extracted from, infrastructure atop of, and waste water disposed of on their lands.

If TPL is the “ETF of the Permian basin” 6, then I look at LB as an exchange (of the Delaware sub-basin), where the exchange extracts volume-based fees on all operations that cross through the platform/acreage, the trading floor network/connectivity operations are handled by WaterBridge 7, and all the various easement users, resource buyers, and royalty payers are the exchange members.

(Base image source: https://www.sec.gov/divisions/marketreg/marketinfo/nysemi.htm)

Compare this to a map of WB’s developing pipeline network to get a sense of the breadth of the network that LB will be a platform for:

(“WaterBridge Assets Map”, https://www.sec.gov/Archives/edgar/data/1995807/000119312524172433/d752700d424b4.htm; note that this older map does not include the Wolf Bone Ranch property, acquired in December 2024, that sits near the eastern corner of Reeves county, below the Ward county line which can be seen on pg.12 in the more up-to-date prospectus here).

(For future reference, LB’s convention is to refer to the acreage north of the lateral southern New Mexico - Texas border as their “Northern position”, the acreage within the horizontal bounds approximately traced by the borders of upper and lower Winkler county as their “Stateline position”, and everything below Loving/Winkler southern border as the “Southern position”)

Note that the blue outlined area of mutual interest (“AMI”) is shared with the popular royalty company, Texas Pacific Land Company (TPL), which owns the non-LB acreage in the checkerboard pattern within that area. We’ll see in a few other maps that show that this area at the intersection of the Eddy, Lea, and Loving county lines gets a lot of use in terms of water handling operations.

.

By the way, just because the northern network looks sparse, it does not mean that it cannot service a lot of the surrounding —or distant— acreage. (The irrelevancy of contiguous physical connection when it comes to getting produced water from the wellhead to a pipeline will also be evident when we look at the pipeline maps of WB’s comps in the area; contracted acreage that a pipeline network may service need not be physically connected to the main lines themselves).

Aside from selling water to fracking operations in the basin, one of LB’s main operations for which they partner with WB comes from handling “produced water” for oil & gas operators. Produced water is the industrial waste byproduct of fracking and oil extraction that comes from both fracking “flowback” and naturally occurring water in geological formations that must be properly disposed of 8. After separation from the extracted oil and gas at the wellhead, it is collected and stored in tanks on site. It can then be collected and transported to water treatment facilities (or pipeline connection points) by water tanker trucks. An increasingly common trend in the Delaware basin is for storage tanks to be directly connected to small gathering lines (think of branches in a tree) that all converge from the wells in an area (think of these as the leaves) to the main pipeline (think of this as the tree trunk) 9 10 —it really just depends on cost and demand for tanker trucks. However it’s transported, the waste water ultimately ends up at a facility to either recycle/reuse or treat/dispose of it (typically via injection back into the earth), hopefully on LB acreage where they can collect a royalty per barrel handled (think of these like the ends of a tree’s roots).

.

Something to note about pipelines like WB’s is that they have a kind of local monopoly/oligopoly advantage where it costs less for an incumbent to extend an existing pipeline rather than for a new entrant to try to build out a whole new network to compete with the incumbent —a similar dynamic as was seen with railroads in the 1800s 11. Given WB and LB’s close integration via shared management team and existing agreements, LB also benefits from those network effects as they are able to coordinate development plans. (I think of the relationship between Diamondback Energy (E&P) and Viper Energy (mineral rights owner) as being somewhat analogous). For example, one of LB’s biggest drivers of expected 2025 EBITDA is the increased surface use royalties from the handling of produced water expected from a long-term partnership struck in August 2023 between WB and E&P company, Devon Energy, where WB will handle all of Devon’s produced-water within a large area of the Delaware basin, which will ultimately result in increased use of LB lands on which WB assets handle produced-water treatment and disposal. 12 13

We can see the extent to which the other water handling pipelines in the area (NGL LP and Aris Water Systems) avoid —or overlap— each other by looking at a map of their networks in the area.

(https://irp.cdn-website.com/3038c594/files/uploaded/NGL_EC_Deck_3Q25.pdf; https://eic.energy/uploads/aris-water-solutions-eic-fireside_vf.pdf)

Here’s those same maps overlapped with WB’s network development plans (and LB’s surface acreage) for visual reference (it’s a bit blurry because of the overlapping and my bad photoshop skills, but we can see how WB is planning to move into the gaps of the other players’ existing pipeline network and contracted acreage):

NGL owns about 50% of the lands on which their facilities are located 14. Based on other hints from NGL’s 2024 10K, we can assume that the NGL-owned land is mostly on the Texas side —or at least that what they’d like— as the company recently sold acreage in both Nex Mexico counties of Eddy and Lea the basin 15. Meanwhile, if one examines the NGL pipeline network and facilities that lie right below the Eddy and Lea county lines, it appears that those NGL assets rest upon the LB/TPL AMI.

Likewise for the Aris asset map, for which I could find no evidence that they own any of their facility acreage, they plainly mention in their Q2 2024 earnings call that they “have relationships with landowners like Texas Pacific […] where we have the ability to go ahead and permit on TPL land and then drill as needed.” Conversely, the WB/LB relationship gives the added advantage of making it easier for customers to work with WB as the company can coordinate with LB for planning, permitting, and facility development, vs other pipeline operators that do not have as integrated a relationship with the various surface owners they must negotiate with to host their facilities.

“[O]n the WaterBridge side, continue to see good commercial traction. I think that's largely because of the land and the pore space access that we have via LandBridge. And I think conversely, to LandBridge's benefit here, we're seeing the synergies of that WaterBridge relationship given the fact that all of these commercial wins WaterBridge is achieving are just working in the benefit of LandBridge in the form of those [surface use] royalties [for produced water disposal]. And so part of the thesis from the get-go out of the gate was the water company and the land company really serve each other well.” ~~~ LB CFO, Scott McNeely, LB Q3 2024 Earnings Call

One thing I’d point out is that Aris’ various water management facilities are mainly situated in the New Mexico side of the basin, whereas we can see from WB’s pipeline map that WB will offer greater capacity for New Mexico operators to access the less-regulated Texas jurisdiction for water sourcing and disposal by plotting LB acreage and WB facilities on the Texas side of the New Mexico border —as NGL appears to be doing via their pipelines that extend into Texas’ Reeves and Andrews counties.

.

Aside from the benefit of WB’s network effects, much of LB’s acreage also have a unique intersection of advantageous geological characteristics that make their positions particularly well suited to serve operators in the Delaware basin.

As can be seen from the middle images in the composite above, LB acreage is nearby to areas in the Delaware basin that have…

+ High O&G estimated ultimate recovery (EUR) (representing the total amount of oil and natural gas expected to be recovered over the life of a well) 16, thus attracting O&G operators.

+ High water-to-oil ratios (WOR), where the geology of the area results in oil wells that create high levels of produced water byproduct relative to the barrels of oil extracted. This creates demand for water management services such as those offered by WB/LB to take away and recycle of dispose of this waste water. The WOR and total absolute amount of produced water from O&G activity the Permian basin has been rising over time and this trend is projected to continue. 17 Additionally, as wells remain in production, they can be drilled to extend horizontally (laterally) —as well as bend and curve as needed— and these longer laterals require more water for fracking as the fluid has a larger surface area to cover to fracture, thus requiring a greater volume of water to create the necessary pressure.

… Meanwhile, LB acreage itself sits atop geology with high capacity for waste water disposal, having both high porosity (lots of empty space existing in the formations) and permeability (water can move through / be injected easily into the space). These nearby or underlying geological advantages are all mentioned in their prospectus, which you can find here (or here, which is more recent and includes a more up-to-date map of LB’s expanded acreage in Reeves and Lea counties).

Something that is not mentioned in the prospectus is the unique thickness of aquifer formations underlying LB acreage, granting the company access to large volumes of (brackish) water; LB’s Stateline position sitting atop the the Capitan Reef Complex minor aquifer within the major Pecos aquifer 18. It may be interesting to compare this aquifer map (below) to the map of TPL and LB acreage displayed earlier in this post. LB covers some of the thickest sections of the aquifer (ie. higher water yield potential) 19 in Winkler county along the NM-TX border at some of the lowest elevations (giving those sections a greater rate of recharge as water flows from formation outcrops and zones of higher elevations to lower ones). 20

(https://www.twdb.texas.gov/publications/reports/numbered_reports/doc/R382_PecosValley.pdf, Figure 6-5; I didn’t want to just dump a bunch of maps in this post —any more than I already have— but I also found the section “6.1.4 Structural geometry” of this study to be very illustrative, for those interested in seeing the underlying cross-sectional shapes of the geology).

As mentioned earlier, LB’s Stateline and Northern positions also create the most direct opportunities for New Mexico operators to take advantage of the NM-TX regulatory arbitrage arising from the relative laxity of regulations on the Texas side of the border (as opposed to New Mexico operators trying to gets those same resource infrastructure projects permitted and developed on their own side of the border).

“In contrast to New Mexico, Texas generally provides a more favorable regulatory environment for produced water permitting. Between January 1, 2021 and March 31, 2024, the Texas produced water permitting process has taken an average of 171 days from initial submission to approval for produced water handling facilities located in the Delaware Basin (as defined by the EIA’s Permian Sub-Basin boundary), compared to an average of 655 days in New Mexico for produced water handling facilities located in the Delaware Basin over the same time period. Furthermore, we believe that New Mexico regulatory agencies have been less likely to approve shallow geological produced water handling wells. […] The combination of favorable geological characteristics and a comparatively less restrictive regulatory environment drives increased demand for produced water handling facilities on the Texas side of the Texas-New Mexico state border. […] New Mexico also presents a more restrictive regulatory and hydrological environment for sourcing brackish water used for oil and natural gas well completion activity. As a result, much of the brackish water supplied to the oil and natural gas industry in New Mexico is sourced from Texas. Our Stateline and Northern Positions contain significant underground brackish water sources from which brackish water can be produced for sale to companies that deliver this water to E&P companies in New Mexico for use in their drilling and completion activities.” ~~~ LB prospectus, https://www.sec.gov/Archives/edgar/data/1995807/000119312524172433/d752700d424b4.htm

(This regulatory differential may soon shrink a bit due to New Mexico’s greater amount of federal lands 21 which will be affected by Trump’s recent executive orders related to US energy policy which 1] directs agencies to review regulations burdening domestic energy resource development as and 2] orders the expedited permitting for energy projects deemed essential for national security 22. This differential compression may be offset by an overall increase in drilling activity in the Permian as new energy secretary Chris Wright works to enact Trump’s “drill, baby, drill” policy agenda, which in terms of what can actually be done looks to be more like “deregulate, baby, deregulate” 23. The President is also looking to decrease taxes for the O&G industry and expand LNG export capacity 24 in what appears to be a way to keep operators profitable while he and Treasury Secretary Bessent work to bring oil price to the $50/bbl level.)

Taking the exchange analogy, LB’s Texas acreage positioning along the NM border combined with WB’s pipeline network between the states, making it the closest and most direct route to access less-regulatory-burdened water sourcing and disposal sites in Texas, is akin to how the US OTC Markets exchange acts as the cheapest and least-regulatory-burdened route for foreign companies to access US capital markets (“capital markets” in this case being water, land, and disposal pore space). One difference being that —unlike the greatly reduced subset of total US investors/capital that are willing and able to invest in OTC securities— the water sourcing and disposal geology on LB’s Stateline acreage is as good, if not better, than anywhere else in the Delaware basin. That is, unlike the less-efficient execution and lower liquidity of US OTC markets vs other major exchanges, LB’s border acreage lies in the more regulation-lax environment of Texas (ie. quick transaction “execution”) and sits atop some of the thickest parts of the Capitan aquifer for water sourcing as well as above high capacity pore space for water disposal (ie. high “liquidity”).

LB acreage is also located in areas with lower population density (ie. lower NIMBY-ism). The ability for LB to provide projects with access to energy and water all on low-NIMBY acreage is mentioned by Five Point CEO (and LB Chairman), David Capobianco, in a recent interview here:

“[F]or instance Loving County, if it were a country itself, it would be a top 10 or 15 oil producing Nation. It’s got a population of about 130, to put it in context. So there are massive swaths of land with very few people and that’s unique because nobody cares about seeing your data center, your water source is not taking from population center water sources, and your power can be built and developed for you on your own site [eg. via off-grid gas turbine].”

On the topic of data centers, Texas —with it’s cheap energy, large area, and business-friendly regulatory environment— is presently the second largest market for data center development in the US behind North Virginia 25 26, the latter of which is seeing increasing community push-back on additional data centers being constructed in the state 27. Note that the vast majority of data centers in Texas are in the north Texas Dallas / Fort Worth (DFW) area, due to existing robust power and telecom/fiber infrastructure (to actually get energy in and data out of the facilities), proximity to other businesses (ie. existing and potential customers), proximity to universities (ie. potential employees), as well as hosting the DFW International Airport (one of the largest in the US) 28 —all things that are lacking in the counties of LB’s west Texas Stateline position.

However, as the number and scale of data centers in Texas continue to grow, they will increasingly come into competition with residents for energy, space, and water resources if they continue to be built in the DFW area and the prediction that LB longs would also be betting on is that this is a politically untenable situation in the long run and that new data centers will ultimately have to move off-grid to directly draw power from natural gas lines into co-located turbines in, say, the Permian 29. There are a few data centers in the west Texas area where LB operates and one of those few —a data center owned by, crypto miner, Core Scientific— is actually located on LB acreage near Pecos city in Reeves county (the blue (1) dot nearest the New Mexico corner border in the map below) 30.

A final note: LB makes relatively little revenues from ownership of oil and gas royalties. This translates into lower sensitivity to oil and gas prices; unlike other land owners in the Permian like TPL or VNOM, LB is more focused on volumes / activity. This can be a double-edged sword that hurts returns if oil prices rise (though they’d benefit indirectly from the likely subsequent increase in drilling activity for Permian operators), but dulls the impact of any down-swings in oil prices (such as those that might come if President Trump is successful in lowering oil prices and increasing total hydrocarbon production in the US).

Success mode

Here is the full suite of the company’s aspired use cases for their land (of these aspired use cases, I’ve circled the types that I know LB currently hosts):

Much of the bullish narrative around LB stems from the anticipation of data centers being built in the Permian (for the various reasons already mentioned) and LB being able to capitalize in their massive needs for continuous access to cheap energy, water cooling, and surface acreage. The term “data center” is frequently mentioned in the company prospectus and at every earnings call since the company’s 2H2024 IPO. Currently, LB is in the initial phases of possibly hosting a single data center for another Five Point sister company, Powered Land Partners 31, but management has alluded to 5-6 other data center projects that may be interested in developing with LB 32.

The current overall trends seems to be in favor of LB’s data center growth thesis. We can examine the projections for the various public AI-related companies and see how they intend to significantly increase their spending on data center capex for 2025 relative to the previous years since OpenAI launched ChatGPT:

Valuation

Here I have LB valued at various multiples (including the current implied multiple) to management’s 2025 EBITDA projections, with my assumptions noted, with and without an additional expectation value of future data center projects that are already prospectively looking at LB acreage for development. We also can see the implied growth rates for those price targets such as would be required for a simple DCF to reach the same price conclusions.

(Here DC is short for data center)

Note that, while I put a 6yr estimate on all of these facilities being built, President Trump has made AI dominance and energy infrastructure development key elements of his policy goals and intends to use deregulation a key lever towards those ends.

To look for an example to demonstrate the magnitude and uses cases for which red-tape-cutting could speed energy infrastructure development, consider the data center that was built by Elon Musk (apparently without first getting the proper permitting and circumventing local government approval) to power X/Twitter’s Grok AI. Rather than using a connection to the local electrical grid, the facility was initially built to rely primarily on gas turbines and was built in under a month 33.

We can examine the implied growth rates of the different price levels as compared to the segment-weighted average growth rate for the, more mature, Permian land owner TPL over time. (Again, TPL is the more mature company and one should consider the fact that WB’s pipeline network and LB’s acreage is still growing as management continues to seek acquisition opportunities).

.

For my money, I’d be willing to take the longterm TPL multiple of 28x on LB, but at the price point that assumes zero data centers actually get built, for a buy range around $50/sh.

.

We can also compare LB’s valuation multiple relative to other, more directly-associated, AI-beneficiaries:

Risks

Let’s just assume that tech companies find LB’s acreage suitable for data center construction (never mind the additional challenges posed by the Permian’s higher temperatures that may strain cooling systems, lack of existing fiber connectivity, danger to equipment from frequent dust storms due to the flat and arid environment, and seismic risk from local fracking operations vs the DFW area which does not have these issues). Some other risk factors that I think could be important issues to monitor are…

• At least narrative-wise, the data center angle has been important to LB’s price action. Over time, increased land acquisitions in combination with WB’s pipeline buildout may alone be enough to justify LB’s implied growth expectations (note that most of the growth in their 2025 EBITDA vs 2024 comes from a water-handling deal negotiated by WB and not anything related to data centers), but the price has been very sensitive to AI-related news. For example, between the release of the free and open-source Chinese DeepSeek-R1 LLM model on Jan 21 and the rapid ascent of the company’s associated chatbot app to the top spot on the Apple and Google app stores by the 28th 34 35, US AI stocks slumped with the tech-heavy NASDAQ falling 3% and NVIDIA falling 20% 36. Meanwhile, LB stock fell by a similar 23%, peak to trough.

  

  (https://www.google.com/finance/quote/LB:NYSE?sa=X&ved=2ahUKEwiZ5KbSo_WLAxW2HEQIHbdrKMMQ3ecFegQIOxAf&window=YTD&comparison=NASDAQ%3ANVDA)

• (Sudden and unexpected) deflation of data center kWh requirements (and subsequent water and acreage requirements) for processing the same volume of prompting and inference tokens via rapid step-wise tech and algorithm innovations, a la DeepSeek 37. There is a tug of war between Jevon’s Paradox (to increase total data center capacity / infrastructure demand) vs innovation-driven kWh-per-token deflation.

• Earthquake risk from continued produced water injection disposal in the Permian may make the area less attractive for large data center investments and other non-fracking-related projects. Looking into why DFW is such a popular data center hub in Texas, one of the reason I continually see is the low risk of dangerous weather conditions that may result in damage to the expensive equipment housed in those facilities 38. Would the increasing risk of earthquakes in the Permian make the area a less attractive location for hosting data centers despite the cheap access to land, energy, and water? (My understanding is that earthquake risk in the Permian is localized to certain specific areas with certain geological characteristics and that there are ways to mitigate these risks by monitoring fault locations, subsurface pressure changes, and wastewater injection depths 39. Inversely, this could also make acreage that sits upon high capacity, lower pressure, pore space more valuable.)

(https://producedwatersociety.com/wp-content/uploads/2021/07/00118_Solaris-Midstream-Keynote-Presentation.pdf)

Here is a map of seismic activity from a 2018 study of the Permian:

(The A,B,C lines indicate fault lines in the earth’s crust with line thickness representing decreasing confidence of the illustrated direction; I’m pretty sure the blue to yellow gradient illustrates increasing fault stress where yellow indicates higher built-up stress that can trigger an earthquake; red dots indicate locations of recorded earthquakes of varying magnitudes; https://www.researchgate.net/publication/322907739_State_of_stress_in_the_Permian_Basin_Texas_and_New_Mexico_Implications_for_induced_seismicity)

• Development of closed-loop water cooling systems vs conventional evaporative systems. Mass adoption of this technology would cause LB’s water advantage to be greatly diminished vs other locations. (See https://www.microsoft.com/en-us/microsoft-cloud/blog/2024/12/09/sustainable-by-design-next-generation-datacenters-consume-zero-water-for-cooling/).

  

(This would be very bad for LB’s data center water sourcing story)

• Existence of other contiguous, high-quality, (Texas-side) Permian acreage. While LB has tried to be strategic in their land acquisitions, in terms of where a data center might end up in the entire Permian basin, there are much larger land owners than LB (such as Apache, Occidental, and Chevron) that could host them and help to develop their necessary infrastructure 40. For example, Exxon owns twice as much land as LB and has recently announced plans to build a natural gas power plant specifically to contract with data center companies 41.

• The developing ability / permitting to dispose of (treated) produced water directly into surface-level water sources, like the Pecos river, could affect the value of LB acreage for produced water injection disposal. “Certainly, there are opportunities working with the regulators and applying for the appropriate permits for surface discharge into the Pecos River. That is an alternative. We are actively looking at that, as are others. And I think you will see that continue to progress over the next year.” ~~~ ARIS founder and chairman, William Zartler, FY2024Q3 earnings call

• A situation of declining productivity in Delaware basin that cannot be offset by longer laterals nor is offset by rising water-to-oil ratios, resulting in net declining water sourcing and recycling/disposal revenues.

.

.

update 20251023

16

One can compare LB’s acreage and EUR maps with the production maps here, from 2019 —which also contain an interesting discussion on the nuance of oilfield acreage tiers, see https://jpt.spe.org/whats-difference-between-tier-1-and-tier-2-not-much. (There’s many other maps that show a similar story, but this is just example to check that management is telling a story consistent with everyone else’s understanding of the actual geology of the area).

19

Aquifer thickness refers to the vertical depth of water-bearing rock or sediment that can store and transmit groundwater. Think of aquifer thickness as the the height of the underground water container. Note that the entire thickness of an aquifer isn’t usually filled with just water, but rather filled with rock or sediment with pore spaces filled with water, see https://wellntel.com/farmers-should-track-aquifer-saturated-thickness-to-plan-crops-and-irrigation/ and https://www.kgs.ku.edu/HighPlains/atlas/apst.htm.

30

We can guess this by simply looking at the data center map, zooming on Pecos and examining the highway pattern at the intersection (a cross shape angled north-west with an extra leg going southward), then comparing this pattern to a map of LB acreage + the fact that LB cites having contracted with *a* crypo miner —of which Core Scientific is one— in their most recent prospectus (“we have entered into various surface use agreements through which our customers have built and own or are developing infrastructure on our land, including […] a data center and a cryptocurrency facility, as of December 30, 2024.”).

(https://www.datacentermap.com/usa/texas/pecos/)

(https://www.sec.gov/Archives/edgar/data/1995807/000119312525014364/d898161d424b3.htm, see the yellow/beige LB acreage partially covered by the “Pecos” label on the map).

Performance

Compared to the actual returns of the S&P 500, midcap, smallcap, and Vanguard total market (which is the better one to use IMO as it helps to mitigate the survivorship bias inherent in the narrower indexes like the S&P 500 that focuses on the existing top 500 largecap companies)1 ETFs YTD, the portfolio’s 27.76% return won out by a few percentage points:

(https://www.google.com/finance/quote/SPY:NYSEARCA?sa=X&ved=2ahUKEwi4l8CO2pyKAxVWKEQIHRcDNyYQ3ecFegQIPBAf&comparison=NYSEARCA%3AIJH%2CNYSEARCA%3AIJR%2CNYSEARCA%3AVTI&window=YTD)

Comparing to the theoretical indexes themselves, the portfolio just beat out the S&P by 2-3% and fell behind the tech-heavy NASDAQ by around 1% —looks like should have just quit while I was ahead in early December.

In the above chart, we can see my strategy for the portfolio of “do OK (or at least don’t lose very much) on the backs of the past winners I continue to let run, while hoping some of the portfolio’s smaller-sized call options —usually not literal call options contracts, but companies that act like long-lasting call options— give the portfolio an additional boost without having taken much additional cost-basis risk” payign off, where the portfolio did just fine through the majority of the year with a few larger bumps near the end as certain small “call options” (one literal and the rest figurative, in this case) happened to pay off in an outsized manner to the indexes. I’ve written a bit more about this idea in the past, here: https://lemoncakesinvesting.substack.com/i/45570065/the-logic-of-investing-in-non-perishable-optionality

********** UPDATE 20250221: We can put the portfolio’s 2024 results in greater context by looking a several other different indecies as well, from the Semper Augustus LLC 2024 letter (https://drive.google.com/file/d/1e2weviKQVWUklifj5RG7p_Zlmp0jJY_d/view):

**********

Some of the larger contributions to performance came from continued holdings in TPL, Bitcoin (via ETFs, FRMO Corp, and Windland Holdings), and new addition GEO Group. Most of that drop off near the end of the year is due to the general pullback from peak in smallcaps and industrials (which is much of my portfolio) in addition to some individual losses in larger positions like FNV (after their recent earnings call) and PMD/PMDI (which has been unsurprisingly volatile after the reverse/forward-split and de-listing). There was also a loss of exactly 2% in December from speculative call options in the Kroger-Albertson’s merger (1%) and Nippon-US Steel acquisition (1% + continuing 1% equity position) —I thought they were good risk/reward setups and I thought my positioning was fine, but they just didn’t work out this these cases (unlike my GEO calls).

We can see the general breakdown of specific drivers and macro diversification of the portfolio here:

Considering the general quadrants of possible macro environments (with x-axis as GDP growth and y-axis as inflation rate and consider center at (2%,2%)), we can also look at a breakdown of the portfolio’s macro diversification vs the tech-plus-Tesla-heavy general market.

(The top 60 stocks of the S&P 500 make up 66% of the entire index; the way that I calculate all of these charts is detailed in the post here).

Portfolio top holdings / updates

Cash / money market funds (10%)

I look at cash as a recession and growthflation / interest rate hedge —eg. when markets are falling due to economic weakness or due to rate hikes being used to address inflation (causing asset price to fall).

This Buffett commentary from Berkshire’s 2014 annual meeting comes to mind:

“I’ve always said that, you know, cash is — available cash or credit — is a lot like oxygen: that you don’t notice it — the lack of it — 99.9 percent of the time. But if it’s absent, it’s the only thing you notice. And we don’t want to be in that position. So we will keep 20 billion. We will never go to sleep at night worrying about any event that’s taken place that could hurt our ability to keep playing our game. And above 20 billion, we’ll try to find ways to invest it intelligently. And so far, we’ve generally done it.”

Note that, at the time (May 3, 2014, but MRQ being reported for March 31), $20bn constituted 12-13% of Berkshire’s tangible book value and 8-9% of their total equity, so I think the amount I have presently is a fine amount —of course, in your personal life, one should also consider the discretionary cash they may also have in high-yield savings accounts outside of their investment portfolio. (Of course, as with anything re. Buffett’s investing or portfolio mgmt strategies, it’s important to consider the phase in his career in which these things were happening (here, well into the Berkshire-famous phase); I wonder if his earlier partnership was run as conservatively and, if not, why).

GEO Group (10%)

********** UPDATE 20250117: After exercising my remaining $12 call options, the portfolio is now 14% allocated to GEO. **********

I talked in greater detail about my investment case for GEO Group ahead of the November elections, here:

The setup was very amenable to a strategy of exposure via call options; I had an upside and downside PT that I was pretty confident in, with most of my baked-in fundamental assumptions made explicit, a known time schedule for when the high-impact fundamental changes would be happening for the company in the bull case (a Trump 2024 election win), and a reasonably knowable —or at least explicitly-stated— probability for that outcome (via the prediction markets). My use of options are often extremely simple wherein I mostly just use call options to allow myself to reduce cost basis value-at-risk, while still having claim to the same amount of underlying shares that my adjusted Kelly ratios suggest (which I based on the options’ breakevens) in case things played out in my favor; in this case they did.

Now the the election has been decided in Trump’s (and thus GEO’s) favor, I’ve exercised most of the options and will see how things start to shake out in early 2025 to determine if I’m going to hold the position in it’s entirety or start paring down to lock in some profits. Trump has promised strong action on immigration and deportations on day one of his inauguration, so it won’t be too long before we get a taste of the how the new administration and any political response thereto will affect GEO.

My 2026 PT for GEO is $42/sh, but we’ll see how much political will there really is for expanding immigration detention and ISAP projects once Trump is actually in office.

For their part, the company looks to be exiting survival mode and gearing up for what they believe to be “potentially unprecedented future growth opportunities.” Brian Evans served as GEO’s CEO from Jan 1, 2025 and announced that he would be retiring at the very end of the year on Dec 31, 2024. He is being replaced by J. David Donahue on Jan 1, 2025 (https://www.sec.gov/Archives/edgar/data/923796/000119312524279667/0001193125-24-279667-index.html; https://www.sec.gov/Archives/edgar/data/923796/000119312524074555/d717730ddef14a.htm#toc717730_4).

Evans’ experience was primarily in finance as he served as GEO’s CFO from 2009 to 2023 before his CEO appointment. Meanwhile, Donahue —who GEO is bringing out of his 2020 retirement in order to fill the CEO role— was more focused on operations at the company. To me it seems like GEO appointed Evans in 2024 for his financing experience as GEO faced an uncertain future and needed a finance person to make sure they could keep the ship solvent and work on paying down debt; Evans was “instrumental in successfully executing the Company’s strategy for three secondary public offerings of equity; the execution of multiple financing transactions; and the successful completion of major business transactions”.

However, now that Trump will be the incoming President in 2025 and has promised to enact a historic deportation project on “day one” of his Presidency, it seems like GEO is swapping CEOs for someone with more operational experience as it looks like those operations will be heating up bigly in 2025. Additionally, GEO promoted a former ICE COO Daniel Ragsdale as Senior Vice President of Contract Administration and Compliance, further hinting at heightened focus on ICE opportunities. The company also announced a $70MM investment in expanding capacity for ICE-related services, while also exploring the sale of under-performing state-owned facilities; again, emphasizing the focus on ICE operations.

Stephen Miller, Trump’s deputy chief of staff is predicting that Republicans in Congress could get a budget reconciliation bill (which only requires a simple majority vote of, the now Republican-controlled, Congress) to Trump’s desk by the end of January or early February. (https://thehill.com/homenews/administration/5033341-trump-prioritizes-immigration-policy/; https://www.crfb.org/papers/reconciliation-101)

As one final note, I also like GEO due the relatively low correlation of it’s fundamentals to the rest of the market. GEO’s main source of funding comes from government contracts, which puts the business on a different cadence that the rest of the market as government spending can be totally non- or anti-correlated to the general health of the wider economy. In GEO’s case, the incoming administration has (rightly or wrongly) identified illegal immigration as a primary source of inflation and a declining economic experience of average Americans and GEO will be a direct beneficiary of the government response to this conclusion. Regardless, I think that GEO will continue to exist in some form so long as the US has borders that is cares to enforce (noting that even when Biden signed his 2021 executive order restricting the renewal of private prison federal detention contracts, the EO only applied to DOJ/BOP contracts and not DHS/ICE). Furthermore, while this would not be reflected in the existing data, I expect that GEO’s new going-forward focus on lowering debt levels and continued refinancing will reduce it’s earnings sensitivity to capital market cycles and interest rates vs the past 2. I think of the position as swapping/diversifying market risk for policy risk.

GBTC/BTC/IBIT (10%)

Another big winner of 2024 has been Bitcoin and the incoming Trump admin has been seen as largely positive for the industry (https://archive.ph/aDdeA).

The majority of my position was bought during the 2022 “crypto winter” (which you can read about in a section of a previous post, here). I sold off all of my initial cost basis after BTC passed $100K late this year, but because of the big gains in BTC since buying the bulk of my position, that still leaves a rather large percentage of the portfolio in these Bitcoin ETFs.

As I’ve mentioned elsewhere, one consideration with owning GBTC or any other BTC ETF, now that GBTC is an ETF rather than a trust, is that the discount to NAV no longer occurs. Given this, it may be better for investors that want exposure to BTC to buy and hold the cryptocurrency directly (eg. via Gemini, Coinbase, hardware wallet, etc). One of the main advantages here is that owning BTC directly gives one the added call optionality of benefiting from any hard-forks of cryptocurrency that may occur in the future.

Given that not much about the protocol itself —nor restrictions on BTC ownership— have changed too much, neither have my general thoughts on BTC as an investment from when I first wrote about it, here:

FRMO/WELX/RCG (3% / 1% / 6%)

Collectively, I group these all as a singular Murray Stahl-based bet-the-jockey position. IMO, a big problem with this conglomerate is that manager Stahl is already rich and, by the way, never started HK or FRMO in order to get rich in the first place —rather he has stated that HK was founded as a way to allow Stahl and the co-founders to work on the problems they wanted to in the way they wanted to. I think this —in addition to his age, now 70— stops him from making bolder moves when he analyzes situations. Eg. he did not use FRMO’s large cash reserves to finish up buying their desired majority stake in WELX during the lows of the 2022 crypto winter, despite having stated many times in the past that FRMO’s incremental approach and conservative balance sheet management was so that the company could make bold moves at times when other crypto miners could not).

FRMO:

Composed mostly of public companies (even more so now that Horizon Kinetics Asset Management itself is a publicly traded company (OTCMKTS:HKHC)), you can basically create the returns of FRMO yourself without directly paying the book-value-premium for FRMO’s “intellectual capital” (which you can get for free every 3 months off of the company’s website of disclosures and earnings call transcripts). I’ve been selling down my position over time as the stock has risen over the year in exchange for RCG. Given the current SOTP, I don’t think it’s really worth putting money into FRMO unless it ever trades at a discount to TBV —or starts accumulating large positions in private investments that can’t otherwise be independently accessed publicly. As things stand, you can easily emulate FRMO by simply investing in TPL, HKHC, GBTC/IBIT, and WELX where relative amounts can be derived using FRMO’s own public disclosures. This is not so easily done with RCG, which has a lot more individual holdings (all very illiquid) as well as several private equity investments selected by Stahl.

“When you look at your portfolio and if you could emulate your portfolio without using the stocks in your portfolio, you’re not really investing in those stocks, you’re investing in a bunch of other factors that will give you the same return.” ~~~ Martin Shkreli (yes, that Martin Shkreli)

WELX:

Stahl-influenced crypto company; like a BTC fund that still has the ability to trade at big discounts (and, presently, premiums) in a similar way that the Grayscale Bitcoin Trust (GBTC) did before it converted to an ETF.

FRMO has stated that they plan to acquire WELX and run the mining business themselves, so it may be better for FRMO bulls to simply average into WELX (just as FRMO is doing) with the near certainty that you will likely being having your Winland shares exchanged for FRMO shares (plus maybe some cash) in due time. While both FRMO and WELX trade at a premium to SOTP value, I notice that FRMO tends to trade at a much greater premium vs WELX across time. It will be interesting to see how Stahl and Bregman do as crypto mining operators, rather than allocators, when that time comes.

One can calculate the existing SOTP value of WELX’s BTC + cash + PP&E NAV as well an simple NPV for the stagnant device legacy business, factor in some amount of BTC accumulation as the company mines and HODLs more crypto across t=1,2,3…, and come up with various price targets for different points in time. By my calculations (some which are shown below), it’s generally better to just buy IBIT or another direct Bitcoin ETF unless WELX is trading at a discount to it’s SOTP value. That is, I don’t think —using even if using rather optimistic assumed BTC mining/accumulation rates— that there are many cases where WELX is a better value than the BTC ETFs unless already trading at a significant discount to SOTP, but also that WELX is also more likely to trade at a discount than the ETFs are.

IMO, considering their historical BTC accumulation rates (and taking the LTC and BCH accumulation to be negligible given that their existing holdings are so small), there is almost never a time where buying WELX shares makes sense vs simply buying BTC ETF shares. The only exception is when WELX trades at a discount to it’s SOTP value in which case it is akin to buying a BTC fund at a discount to NAV (given the majority-BTC and cash makeup of their book value). This is because WELX’s BTC value needs to overcome it’s existing premium to SOTP (which I currently have 10%) before it starts to contribute to total NAV growth —noting that the legacy biz is totally stagnant and Stahl mentioning no interest in investing in its growth— whereas more direct BTC ownership does not have this handicap.

RCG:

This close-ended fund has a very similar major holdings to FRMO, but with a smaller crypto element. This disaggregation means that you can independently customize your crypto exposure to fit your comfort level —as mentioned before, FRMO’s crypto investments are largely via public companies that you can buy on your own (GBTC, IBIT, and WELX). Also, unlike FRMO, 1] the CEF trades at a discount to NAV (often greater than 20% discount), and 2] has more holdings, with several being more private company VC bets by Stahl, that makes the fund harder to replicate by simply buying the components individual on the public market. At the same time, RCG is still managed by Stahl, so you are getting the same chief investor and similar ideas, but at a discount, rather than at a premium.

(https://www.google.com/finance/quote/RCG:NYSEAMERICAN?sa=X&ved=2ahUKEwjA8qjnzMuJAxVzle4BHTNsEMEQ3ecFegQIMhAf&comparison=OTCMKTS%3AFRMO&window=YTD)

While the discount to NAV has closed quite a bit this year, not much has structurally changed about the fund or it’s investments, so IDK that there’s much more to say on it. You can read my initial post on RCG, here:

TPL et al (10%)

Sold BSM from this oil & gas royalties basket simply to end the hassle of the annual K-1 form, yet still have the remaining basket of TPL and VNOM (simply holding the existing position from 2021, though they’ve both grown around 100% since that time) as well as a smallish position in LB (noticed the ticker in a recent holdings disclosure from the RENN Fund and thought was interesting).

.

People often associate TPL with Horizon Kinetics and consequently may sometimes equivocate TPL to LandBridge (LB) (whose shares HK has been buying and currently has a 30% stake in). However, keep in mind that, while “78% of [LB’s] pro forma [2023] revenue was generated from uses of our land and its resources to support the development and production of oil and natural gas”, LB does not own a lot of the subsurface mineral rights for the majority acreage they own the surface rights to. This makes them less sensitive to O&G price fluctuations (though this cuts both ways to the upside and the downside). The company expects that they will “acquire additional mineral interests only incidentally in connection with property acquired primarily for other purposes and, consequently, oil and natural gas is expected to become a smaller percentage of our total revenues over time” (https://www.sec.gov/Archives/edgar/data/1995807/000119312524172433/d752700d424b4.htm).

I would say, though, that IDK if there are a lot of great comps for LB beyond TPL. Both businesses focus on a mix of mineral and surface rights ownership (both collecting royalties or sale revenues from hydrocarbons, sand, and water), primarily generate revenues on hosting oil and gas operations, both have a shareholder base that is also pricing in the potential for hosting renewable energy and AI projects, and both are in component basins of the larger Permian basin (LB being in the Delaware basin and TPL revenues mainly focused on Delaware and Midland) 3. Below, I’ve overlaid LB’s acreage map (colored) with TPL’s (black and white):

(And, just because I mentioned the name earlier, here’s TPL and LB acreage overlaid on VNOM’s acreage (light yellow and light green) for even more of a mess)

(https://www.landbridgeco.com/about739ec34a; https://www.texaspacific.com/investors/presentations; https://www.oilandgaslawyerblog.com/the-tplt-proxy-war/; https://www.viperenergy.com/news-releases/events; IDK that some of that Loving county TPL area in the second map is still totally accurate)

(Other maps of interest: https://www.rrc.texas.gov/resource-center/research/gis-viewer/ (see https://www.rrc.texas.gov/media/kmld3uzj/digital-map-information-user-guide.pdf); https://www3.twdb.texas.gov/apps/waterdatainteractive/groundwaterdataviewer)

On the subject of LB’s surface rights coverage, one interesting thing from their prospectus was the discussion of a regulatory arbitrage that makes their land and water sources and treatment/disposal locations more attractive to New Mexico operators in the Eddy and Lea counties due to the relative laxity of regulations on the Texas side (as opposed to New Mexico operators trying to gets those same resource infrastructure permitted and developed on their own side of the border).

“In contrast to New Mexico, Texas generally provides a more favorable regulatory environment for produced water permitting. Between January 1, 2021 and March 31, 2024, the Texas produced water permitting process has taken an average of 171 days from initial submission to approval for produced water handling facilities located in the Delaware Basin (as defined by the EIA’s Permian Sub-Basin boundary), compared to an average of 655 days in New Mexico for produced water handling facilities located in the Delaware Basin over the same time period. Furthermore, we believe that New Mexico regulatory agencies have been less likely to approve shallow geological produced water handling wells. Only 30% of all approved permits in the Delaware Basin in New Mexico from January 1, 2021 to March 31, 2024 were for shallower intervals (defined as injection formations above the top of the Woodford formation), compared to 99% in the Delaware Basin in Texas over the same time period. Building infrastructure for deep geological produced water handling is time consuming, operationally complex and expensive, which increases the economic risks and limits operational flexibility and certainty desired by water midstream companies and E&P companies. The combination of favorable geological characteristics and a comparatively less restrictive regulatory environment drives increased demand for produced water handling facilities on the Texas side of the Texas-New Mexico state border. […] New Mexico also presents a more restrictive regulatory and hydrological environment for sourcing brackish water used for oil and natural gas well completion activity. As a result, much of the brackish water supplied to the oil and natural gas industry in New Mexico is sourced from Texas. Our Stateline and Northern Positions contain significant underground brackish water sources from which brackish water can be produced for sale to companies that deliver this water to E&P companies in New Mexico for use in their drilling and completion activities.”

This strategic positioning between Texas and New Mexico is also mentioned by TPL director, Eric Oliver, here.

We can further see how LB is looking to benefit from this Tex/NewMex regulatory arbitrage by examining a map of, sister company, WaterBridge’s (WB) active and planned water-handling pipelines across the two states and into LB acreage. WB is the largest pure-play produced water midstream company in the US and operates a large-scale network of pipelines and other infrastructure in the Delaware basin (where I believe it’s the largest pipeline network in the area):

(“WaterBridge Assets Map”, https://www.sec.gov/Archives/edgar/data/1995807/000119312524172433/d752700d424b4.htm; note that this older map does not include the Wolf Bone Ranch property, acquired in December 2024, that can be seen between the southern Reeves county position here and Ward county line in the previous maps) 4

(I wish this map included a breakdown of what specific type of water handling facility each dot represented, eg. brackish water sourcing/distribution vs produced water treatment/recycling/disposal). 5

Something to note about pipelines like these is that they have a kind of incumbent advantaged, network effect where it costs less for an incumbent to extend an existing pipeline rather than for a new entrant to try to build out a whole new network to compete with the incumbent. Given WB and LB’s shared management team and existing agreements, it would be safe to assume that LB will also be benefiting from those network effects as they will be able to coordinate development plans. (I think of the relationship between Diamondback (E&P) and Viper Energy (mineral rights owner) as being somewhat analogous). For example, one of LB’s biggest drivers of expected 2025 EBITDA is the increased surface use royalties from the handling of produced water expected from a long-term partnership struck in August 2023 between WB and an E&P company, Devon Energy, where WB will handle all of Devon’s produced-water within a large area of the Delaware basin, which will ultimately result in increased use of LB lands on which WB asset handle produced-water treatment and disposal. 6 7

.

Because the mix of royalty types at LB vs TPL is so different (LB’s revenues nearly completely based on surface royalties and easements whereas TPL’s is a bit more evenly split between surface and mineral rights), we can’t directly comp their price on purely a per surface- or net-royalty-acre basis, exclusively. One thing we can maybe do is look at their revenue mix and create a weighted use-based acreage unit (WUBA) for each company and see how much each company’s present and future growth is being valued per WUBA (here using most recent quarter data for TPL and LB as well as TPL’s 2023 10K and LB’s initial filing prospectus for additional info)…

TPL: 57% of MRQ revenue came from oil and gas royalties (NRAs); 43% from surface-related acreage (SA).

LB: 90% of MRQ revenue came from surface acreage (SA); 10% comes from oil and gas royalties (NRAs).

WUBA = SA*(surface revenue mix) + NRA*(oil & gas revenue mix)

TPL: Market Cap = $26,811MM (as of Dec 27 2024); Surface Acres = 868,446; NRA: 199,000 acres

LB: Market Cap = $1,110MM (as of Dec 27 2024); Surface Acres = 220,000; NRA = 7992.16 (= 4,180 gross mineral acres * 0.239 avg weighted royalty interest * 8, if we’re normalizing to 1/8th)

(Note that double-counting is not an issue here since we are accounting for two different types of economic resource, but also the majority of LB’s mineral acreage directly underlies it’s surface acreage (96% per their prospectus)).

This give us values…

WUBA (TPL) = (868,446*0.43)+(199,000*0.57) = 486,862 WUBA

WUBA (LB) = (220,000*0.90)+(7992.16*0.10) = 198,799 WUBA

Price to WUBA (TPL) = $26,811MM/486,862 = $55,069/WUBA

Price to WUBA (LB) = $1,110MM/198,799 = $5,584/WUBA

From this POV, LB is orders of magnitude cheaper than TPL.

Of course there is even more that one could drill into on this route if we consider the fact that not all surface- or mineral-acres are equally valuable/productive, making the differences in acreage types even more problematic; acreages can differ in quality across sub-basins and across individual acres within the same basin (thus attracting more or less operators to utilize those surface or mineral acres). There is also the issue of cost structure, as the earnings contribution mix from the various business lines may be very different to how things appear at the top-line, but neither company breaks this out. Furthermore, it’s not hard to find things cheaper —on almost any relative basis— than TPL; I’d be curious to comp LB’s price-to-WUBA against other, more surface-based comps, if I could find any.

Lastly, I’d note that LB does not seem to have quite the same degree of optionally as TPL because LB is mostly surface rights (vs mineral rights). More and more oil can be discovered underground or new technologies can be developed to economically extract more resources, but IDK that you’re going to find more surface on your surface acreage (though maybe more or more-efficient uses for existing surface) —though, as I mentioned, this oil-price sensitivity is a double-edge sword. Thus, we can’t really treat surface- and mineral-acres as having the same value or growth potential and just split by present-day revenue mix.

.

Some lingering TPL/LB things I’m thinking about…

How much of TPL and LB’s strategic value comes from its particular physical location along the Texas - New Mexico border versus intelligent operation (which could theoretically be copied by well-funded competitors) or from the particular quality of their mineral acreage (of which better deposits could theoretically be discovered elsewhere in the US that could divert operator development dollars, eg. in California if the politics there were ever to change or internationally in Argentina shale given the new political environment there)? That is, how critical is the position along the Texas - New Mexico border to the value of TPL/LB and are there other private or public competitors that can just as easily facilitate competing land use agreements with TPL and LB's potential customers? Is it the scale of contiguous land tracts that make their assets unique? I’m still trying to get an idea of the competitive landscape for TPL and LB's land operations and who management sees as these companies’ most significant public and private comps.

********** UPDATE (week of) 20250121:

Asking this question during the recent FRMO shareholder meeting, mgmt had already had much to say about, not just TPL/LB’s positioning along the Texas - New Mexico border —as it pertained to facilitating regulatory arbitrage activity by New Mexico operators— but about the (continually reusable) value of the brackish water underlying the acreage and the major role they believe it will play in AI and data center cooling —in addition to the value of future easements associated with the infrastructure that will be required to feed energy, water, and data in/out of those data centers, which many TPL and LB discussions like to cover. (One risk I see to LB’s water value as it pertains to data centers is the prospect of data centers being built with closed-loop water cooling systems that recirculate a fixed supply of water, rather than needing to continually contract with WB and LB to recycle and replenish the water that traditional evaporation systems require. I suppose LB could charge the data centers a one-time price that is X times the $/bbl price they charge to evaporation-cooled ones, where X is proportional the expected lifetime of the water being taken, but it would still seem to detract from LB’s water advantage).

Management pointed out that LB/TPL land sits atop the Pecos Valley aquifer which is continually recharged by the surrounding mountain ranges and playa lakes (see https://gsa.confex.com/gsa/2008AM/webprogram/Paper142825.html; https://www.texasalmanac.com/articles/aquifers-of-texas; https://texasaquaticscience.org/aquifers-and-springs-aquatic-science/; https://www.twdb.texas.gov/publications/reports/numbered_reports/doc/r380_aquifersoftexas.pdf; https://www.twdb.texas.gov/groundwater/docs/studies/TexasAquifersStudy_2016.pdf; https://www.twdb.texas.gov/publications/reports/numbered_reports/doc/R382_PecosValley.pdf).

It may be interesting to compare this depth map to the map of TPL and LB acreage displayed earlier in this post. TPL covers some of the thickest cross-sections of the aquifer (ie. most water) in Reeves and north-east of Loving (along with LB), while LB covers some of the thickest parts in the north-east of Winkler (overlapping the Capitan Reef Complex minor aquifer, https://www.twdb.texas.gov/groundwater/models/gam/crcx/ConceptualModelReport_Final.pdf)

One would have to model the incremental cashflows to TPL/LB’s extremely-captial-light business in order to understand the data center opportunity. Doing this as a theoretical exercise might not even be necessary and we may soon see real-world examples of this very kind of development as Trump has recently signed several relevant executive orders. The EOs in question are relate to US energy policy (https://www.whitehouse.gov/presidential-actions/2025/01/declaring-a-national-energy-emergency/; https://www.whitehouse.gov/presidential-actions/2025/01/unleashing-american-energy/) which 1] directs agencies to review regulations burdening domestic energy resource development as and 2] orders the expedited permitting for energy projects deemed essential for national security (https://www.morganlewis.com/blogs/powerandpipes/2025/01/trump-vance-administration-issues-executive-order-to-promote-american-energy). The second relates to AI which repealed the previous Biden admin’s 2023 executive order on AI safety and regulation (https://www.reuters.com/technology/artificial-intelligence/trump-revokes-biden-executive-order-addressing-ai-risks-2025-01-21/; https://fedscoop.com/trump-rescinds-biden-ai-order-creates-doge-orders-in-person-work/), meanwhile —just as a sign of how the winds are blowing for new data center development— a joint venture has been announced between OpenAI, SoftBank and Oracle which plans to invest billions in AI infrastructure development (https://archive.ph/21IgD; https://news3lv.com/news/nation-world/trump-axes-bidens-executive-order-on-artificial-intelligence-plans-to-invest-billions-chat-gpt-apple-ai-elon-musk-sam-altman-openai-congress-legislation-safety-advocates). Trump also recently signed an executive order “removing barriers to American leadership in artificial intelligence” which is intended to “revokes certain existing AI policies and directives that act as barriers to American AI innovation, clearing a path for the United States to act decisively to retain global leadership in artificial intelligence” (https://www.whitehouse.gov/presidential-actions/2025/01/removing-barriers-to-american-leadership-in-artificial-intelligence/).

Just for fun, we can try to model in the near-term data center opportunities based on comment from management and some info I could find around data center water usage and acreage requirements (https://dgtlinfra.com/data-center-water-usage/; https://westernlandowners.org/water-rights-restoration/; https://www.cushmanwakefield.com/en/united-states/insights/data-center-development-cost-guide):

(And this does not take into account any additional easement revenues for the infrastructure that would be required to bring the power and water resources to the facility, nor for the infrastructure easements related to installation of transmission lines, substations, underground cables, or telecommunications infrastructure; not to mention the deflationary element )

**********

********** UPDATE 20250125:

A small Chinese company called DeepSeek recently open-sourced an AI/LLM model of the same name which, to my understanding, was notable not only for beating or performing comparably to the major US LLMs across the most common benchmarks, but for doing so while making massive efficiency gains on training and deployment compute requirements (https://www.yahoo.com/news/u-just-pledged-hundreds-billions-023900941.html; https://www.cnbc.com/2025/01/24/how-chinas-new-ai-model-deepseek-is-threatening-us-dominance.html; https://archive.ph/2eYBu; https://daily.dev/blog/deepseek-everything-you-need-to-know-about-this-new-llm-in-one-place).

My takeaway is that it should be expected that kWh (and subsequently acreage and water) requirements for data centers, for which LB aspires to sell/lease water and acreage in order to facilitate, should come down and be deflationary over the medium- to long-term as tech companies continually improve the efficiency of their technology and algorithms. As evidenced by the recent step-wise efficiency gains of DeepSeek, it appears deflationary forces may be a lot stronger —and a lot more unpredictable— than companies expect. I’d guess that, going forward, companies will be much more cautious about the actual deployment of AI data center capex as they realize that the cost per token of inference for the same volumes of token usage can rapidly decline, sometimes overnight.

Consider this in tandem with Jeff Bezos’ vision of AI output as becoming a base layer commodity used in a similar way —for applications yet to be fully enumerated in the market— to how water powers a waterwheel or electricity runs your refrigerator (https://archive.ph/06sOO). I think a major risk to LB’s data center thesis in the long-run is that kWh requirements (and thus water and acreage requirements) per unit of AI output ultimately decline over time at a rate much faster than what may be offset by the rate of adoption/integration of AI output such that they necessitate additional data center build-outs. Efficiency gains pull total data center water and land utilization down, while profitable/sustained adoption lifts utilization up; a new data center need not be built if you can just replace an existing facility with more efficient chips running a more efficient model (that performs just as well if not better then the previous one a la DeepSeek). LB owners should hope that Jevon’s Paradox —as many nervous AI investors are citing— applies here (https://en.wikipedia.org/wiki/Jevons_paradox) strongly enough for incremental data center capacity / infrastructure demand spending to win the tug-of-war vs innovation-driven kWh-per-token deflation.

(https://transportenergystrategies.com/2023/01/26/the-jevons-paradox-applied-to-electromobility/)

While LB currently has zero such facilities on their lands at the moment, which I’m very confident will not remain the case as I don’t think I we’re very near whatever steady state resource equilibrium AI efficiency-vs-adoption is going to eventually end up at, the proper multiple on EBITDA, EPS, FCF, or whatever for LB’s price to reflect that growth into the future is another question.

**********

.

On the whole, not much has changed here since my previous portfolio review where I mentioned that the failure of climate change policies is resulting in an increase in demand for coal, oil, and especially natural gas. It seems likely that governments and businesses, no longer able to hide the inadequacy of green-energy policies, will turn to fossil fuels like natural gas as a more viable option, leading to a surge in demand beyond current forecasts. Investments in oil and gas may become more attractive as the narrative shifts away from strict adherence to ESG ideals.

The political push away from fossil fuels to green/renewable energy technologies is the first energy transition that is 1] artificially imposed (being legislated into existence vs being pursued by organic market forces seeking a better energy efficiency product), is 2] going from a more efficient energy source to less efficient ones, and 3] attempting to remove, by force, the use of the incumbent (and more efficient) energy source, rather than expecting natural competitive forces to result in the phasing out of the older source (which one would expect to happen if the newer source were actually superior). Green energy politics picked a fight with physics and appears to be losing (https://www.city-journal.org/article/the-magical-thinking-behind-the-energy-transition; https://www.hartenergy.com/exclusives/physics-limits-green-dreams-184328).

********** UPDATE 20250225: In a similar vein, this was an interesting article on the realities of the attempted energy transition: https://www.foreignaffairs.com/united-states/troubled-energy-transition-yergin-orszag-arya

**********

.

As AI has been a major stock market theme for 2024, TPL’s largest stakeholder, Horizon Kinetics, has painted a rosy picture for how some of these holdings may benefit from the recent growth of AI in a recent quarterly commentary (https://horizonkinetics.com/app/uploads/Horizon-Kinetics-Q3-2024-Commentary_Final.pdf, see “Next Up: When AI Meets the Permian Basin.”), but I’m not really sure what to make of that story as of right now —and it really is just a story at the moment (with Stahl noting that there were no data center construction projects planned for TPL, to his knowledge as a member of the BoD, as of Sept 5, 2024 (https://www.frmocorp.com/_content/letters/2024_FRMO_Transcript.pdf, see “Questioner 4”)).

In any case, I think the general idea is summarized well here…

“[T]here is a significant timing mismatch between the speed with which nuclear plants can be brought online for AI and the urgency of the industry’s electricity demand. […] Things that do the same thing don’t sell for different prices indefinitely, and hydrocarbons will be no exception. Either by changing the engines or manipulating the molecules or a combination of both, arbitrage will prevail. […] As the cleanest-burning hydrocarbon capable of producing a steady supply of baseload electricity, natural gas is inherently well-suited to meet the application’s needs. If Microsoft is willing to “overpay” for nuclear, surely natural gas, which can be rapidly deployed to create electricity at scale, is substantially more valuable than current prices indicate?” ~~~ Doomberg (on AI and energy demand)

.

There is also the issue of how Trump’s energy secretary pick, Chris Wright, will affect overall oil prices and production volumes? It seems that the US oil industry would like the Trump admin to expand LNG export capacity and lease more Federal lands for exploration.

My understanding is that much shale hydrocarbon supply constraints in recent years have been due to reduced land leasing and insufficient off-take capacity from drill sites (ie. due to slow or cumbersome Federal land leasing and pipeline development permitting processes from the Biden administration). The incoming Trump admin’s aim to reduce red tape for private sector development of energy infrastructure could result in increased development and use of surface acres on TPL and LB lands as E&P, oilfield services, and midstream operators see quicker permitting for, say, water handling, sand mining, drilling, and pipeline construction. This could end up being net positive or at least offset the impact of any reduction in oil prices achieved by the Trump admin —though LB is more directly linked to activity and volumes whereas TPL is much more exposed to oil and gas prices, with more than half of it’s revenues from generated from mineral interests.

It seems, in this POV, that LB has similar characteristics to a stock exchange where they make money on “volumes”. In the case of a securities exchange it’s on volume of trades that go through the exchange, while with LB’s surface rights it’s about the “volume” of drilling activity and other energy projects that require land and water usage (on which LB collects easements, sales revenue, and royalties). While similar to a midstream pipeline owner, LB dosen’t need to spend anything on maintenance capex and have multiple options for how they can profit from the land they acquire through growth capex that can happen immediately (rather then needing any of their own infrastructure to be up and running beforehand).

One example I’ve seen used to demonstrate the magnitude and uses cases for which red-tape-cutting could speed energy infrastructure development —and ties into the previously-mentioned AI opportunity for surface rights owners in the Permian— is the data center that was built by Elon Musk (apparently without first getting the proper permitting and circumventing local government approval) to power X/Twitter’s Grok AI, which —rather than using a connection to the local electrical grid— relies primarily on gas turbines and was built in under a month (https://www.reuters.com/business/environment/musks-xai-operating-gas-turbines-without-permits-data-center-environmental-group-2024-08-28/; https://time.com/7021709/elon-musk-xai-grok-memphis/; https://www.cnbc.com/2024/08/28/musk-xai-accused-of-worsening-memphis-smog-with-unauthorized-turbines.html).

Depending on the balance between natgas production and North America’s export capacity, greater exports could mean domestic supply deficits and thus higher energy prices. The US currently enjoys much cheaper natgas prices vs the rest of the world as massive amounts of imports of Canadian, Mexican, and US domestic production are bottlenecked and locked into North America due to insufficient export capacity. As more export capacity is built in the US to reach foreign markets —while the most productive domestic natgas plays begin reaching production plateaus— US consumers may go from a natgas surplus to shortage as LNG is exported to the rest of the world to profit from the pricing arbitrage and prices balance out somewhere in the middle. This idea is also articulated in the a Goehring & Rozencwajg letter here and in a MacroVoices interview here.

(https://www.statista.com/statistics/673333/monthly-prices-for-natural-gas-in-the-united-states-and-europe/)

(BTW, Trump’s plan to “drill baby drill” does not seem like a desirable domestic policy from a very-long-term POV. Better to let others empty their own countries of their domestic natural oil reserves first, as there is no guarantee that a more scalable, energy-efficient, energy-dense, and transportable source of fuel will ever be found to replace it). 8

“Every barrel that you use up that comes from somebody else is [one less] barrel of your [own] precious oil which you’re going to need to feed your people and maintain your civilization.” ~~~ Charlie Munger

FNV (5%)

Whereas cash can hedge a portfolio against deflation caused either by a recession or the Fed’s response to growthflation, gold hedges a portfolio in situations where inflation simply can’t be addressed by rate hikes (or where governments do not have the will to use rate hikes due to already-weak economic growth). That is, I see cash as a (managed-)growthflation hedge and gold as a stagflation hedge —and both as a valid recession hedge (if/when governments cut rates).

.

Looking at the movements of gold vs real rates, which typically move inversely to each other, we see that trend has departed over the last 2 years 9:

It could be the case that gold prices are indicating bearishness on real rates, either due to worsening inflation or anticipation of a move to deflation and lower rates caused by economic weakness. (I suppose you may have to ask yourself: Who is more sophisticated? The bond market or gold market? Who really moves the respective markets the most?) Central Banks have been net gold buyers through 2024 (https://www.gold.org/goldhub/gold-focus/2024/12/central-bank-gold-statistics-october-2024; https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q3-2024/central-banks) and one may be inclined to say that CBs know something others don’t 10. (BTW, I’d note that the CB net buying figures that I often see in major news outlets are usually all sourced from the World Gold Council who include confidential estimates factored to their buy/sell figures that should be taken with a big grain of salt (https://www.bullionstar.us/blogs/ronan-manly/gold-remains-strong-as-central-banks-sustain-upward-gold-buying-trend-in-2024/)).

.

FNV posted a 12% decline in YoY earnings and 11% decline in YoY revenue for 2024Q3. The stock fell a corresponding 15% from $133 to a low of $113 in the following days. These issues were mainly due to slower-than-expected ramp-ups at new mines and lower grades and production figures at the Candelaria open-pit mine due to underground cavities from previous, underground mining activity. (https://finance.yahoo.com/news/franco-nevada-earnings-miss-estimates-172800074.html)

When an open-pit mine expands downwards, it also has to expand horizontally —you’re essentially excavating a pyramid shape into the earth. When the pit walls are nearing underground cavities from older mines —or if their expansion would result in such— this creates additional issues of wall stability that have to be worked around.

(https://www.bba.ca/us-en/publications/challenges-to-open-pit-mining-through-historic-underground-workings)

Apparently, this caused delays in mining operations at Candelaria which ultimately resulted in certain shipments of gold not being delivered/sold in time to be recorded in FNV’s Q3 as well as inducing the operator to turn to processing stockpiled ore in the meantime while the issue was being sorted —with stockpiled ore typically being of lower grades than ore that is typically immediately processed when extracted. This issue of delivery mismatch causing the superficial appearance of overall GEO-delivery weakness from the mine and FNV’s expectation of “a stronger quarter for GEOs delivered and sold from Candelaria for Q4” seems to be corroborated by the Candelaria operator, Lundin Mining’s, 2024Q3 call (which was on the same date as FNV’s) which described Q3 as “one of Candelaria’s strongest quarters on record.” (Though note that Lundin’s primary interest at the mine is copper, vs gold for FNV, and FNV mentions that “Lundin Mining has revised its 2024 gold production guidance for Candelaria at lower”). Overall, I take the Candelaria issue as temporary or overblown, while I chalk up the ramp-up delays at new mines as forgivable.

Thus —assuming no massive decline in gold prices— I’m inclined to think FNV should still be priced at around that $133/sh level, ex-Cobre. As I’m writing this, the stock has already recovered to around $120/sh.

.

I was recently re-reading some old copies of “The Micro Cap & OTC Stock Letter” by Marcus Frampton, CIO of the state-owned Alaska Permanent Fund, and thought Frampton POV on gold in a portfolio was interesting. (The site is no longer maintained, not sure what happened to it, but you can read some of the old posts here (if you click through the back-issues, it takes a few seconds to load the PDFs, but it does still work)). What Frampton mentions in these letters is his use of gold ETFs as a hedge on a dollar-for-dollar basis against his microcap positions, partial reason being that those microcaps were very often too illiquid to directly short or to hedge via options. Frampton also included gold as a way of diversifying correlations in his portfolio and hedging market volatility and inflation —providing opportunities to rebalance and “sell high and buy low” when one side of this uncorrelated barbell rose as the other fell depending on market conditions.

Like I mention in my initial Franco Nevada post, the company’s fundamentals are rather uncorrelated from the rest of the market.

(Note that I ignore the 2007-2008 change in CFFO for FNV from their IPO in the chart)

Given the current Cobre setup for FNV…

• with the CEO mentioning that “[i]f and when it comes back at its full operating rate, that would be roughly a 30% increase in our GEOs and revenues” per the 2024Q3 earnings call, around the same upside I valued the Cobre re-opening at in my initial FNV post

• the recent Q3 weakness that I see as largely temporary

• plus the fact that the business is basically just ownership of a big vault of gold, distributed underground and around the world,

… I plan to use it as my “gold ETF” portfolio diversifier in a similar fashion as Frampton.

Like I mentioned earlier, gold hedges a portfolio in situations where inflation can’t be solved by rate hikes (or where governments do not want to use rate hikes due to already-weak economic growth). That is, I see cash as a growthflation hedge and gold as a stagflation hedge —and both cash and gold as a valid deflation hedge when governments cut rates. Meanwhile, around 16-17% of FNV’s revenues are also generated from royalties on energy assets which benefit in growthflation and Goldilocks environments and slightly hedge FNV’s gold portfolio in these scenarios where it tends to do less well. Furthermore, gold is also commonly thought of as a hedge against political volatility and the Trump Presidency is more likely than not going to be a volatile one (https://www.reuters.com/markets/us/wall-street-girds-trump-20-tariffs-tax-cuts-volatility-2024-11-06/).

My current PT for FNV is $152/sh with the expectation that Cobre is re-opened in 2025.

*One problem I have with gold investments as a portfolio hedge is that gold itself, while having a rather Lindy global acceptance through human history as a store-of-value asset, is not a productive asset —aliens might find FNV not too different than a purveyor of Beanbag Babies. To this end, I think that a business like OTC Markets might be a better investment (which also benefits from inflation as well as market volatility, remaining profitable through 2007-2009 as well as through every quarter of the 2020 global shutdown and the 2022 inflation shock). However, I think that it has it’s own problems and most importantly, unlike FNV, I think is fairly valued at the moment.

In any case, unless this decade is finally the one out of the hundreds of years of prior human history where everyone finally decides that gold is not a legitimate store of value (in which case I hope Bitcoin is agreed upon as a replacement rather than a as a similar liability), then I think FNV will at least be a you-don’t-lose-too-much investment.

.

2

This is what my quick analysis actually showed for GEO’s historical relationship with the market…

Here compared against my “market” proxies: Berkshire, Johnson & Johnson, and Proctor & Gamble over a 20-year period:

We can also look at a linear regression of quarterly price changes in GEO, BRK, JNJ, and PG vs the S&P 500 (SPY) from start of 2011 to 12/26/2024 to get a sense of GEO’s coupling to the market vs these larger proxies. Here we make a scatter plot with SPY quarterly price changes in the X axis and the target stock’s price changes in the Y axis (note that these are plotted totally independent of the time the occurred):

The R-squared values mean that if R^2=X for a linear regression line, then (100*X)% of the variability in the Y-axis variable is explain by the line derived from the X-axis (ie. the quarterly price changes in the S&P 500). In this case, we can see that virtually 0% of change in GEO stock are generally explained by price level changes in the wider market, whereas BRK and JNJ stock changes are explained to a much greater degree by the wider market (IDK what to make of PG). This these R-squared relationships hold even when I try to “over-fit” the curves to the data by adding higher degrees of polynomials to the linear models. This is not exhaustive (eg. chopping up data across time or, say, defined market “eras” or leaving out subsets, etc.), but it passes my “yeah, ok, good enough” threshold for believing that GEO is indeed non-correlated with the rest of the market.

4

The prospectus is also interesting as it includes maps that highlight the attractiveness of LB’s Delaware basin acreage in terms of relative total recoverable oil reserves on their lands as well as the relative amounts of produced water as a byproduct of oil well operations on those lands that then must be transported, treated, and disposed of or recycled —with LB collecting right-of-way, easement, and royalty fees throughout this process. The maps also help to give one a sense of LB’s ownership ratio of and proximity, or planned pipeline connections, to the overlapping areas of the more oil-rich —and high water producing (produced water-to-oil ratio, WOR)— land within the Delaware basin. LB highlights that “as of April 25, 2024, within the Delaware Basin, approximately 52% of active drilling rigs, 50% of active drilling permits and 52% of drilled but uncompleted wells (“DUCs”) were located within 10 miles of our land position.” Keep in mind that even if there is no pipeline connecting water resources on LB land to a particular area, operators there can still buy brackish water from —for well drilling and fracking completions— and dispose of produced water into —as a byproduct of fracking as well as naturally occuring within formations that must then be separated from extracted O&G— LB property via tanker trucks to transport the water.

(https://archive.ph/6KAv5)

See the prospectus sections regarding “Overview of our Land Position” as well as “Northern Delaware Basin Pore Space for Water Handling” for these maps (https://www.sec.gov/Archives/edgar/data/1995807/000119312524172433/0001193125-24-172433-index.htm), noting that lower pore space pressure in a given area means greater injection capacity for produced water and that there often many regulations around maximum allowed pressures to prevent fractures of geological formations and subsequent contamination beyond intended disposal/injection zones (https://www.epa.gov/sites/default/files/documents/21_McCurdy_-_UIC_Disposal_508.pdf; https://www.gwpc.org/wp-content/uploads/2023/01/Pore_Space_Occ___FINAL.pdf).

5

********** UPDATE 20250130: My current guess —and it is a total guess— is that the facilities in the Stateline AMI are probably a 50/50 mix of brackish sourcing and produced water disposal. My thinking on this simply comes from the fact that the AMI agreement between TPL and WaterBridge give WB exclusive rights to market produced water in the AMI, but the prospectus also mentions sourcing water into New Mexico and the LB acreage within the AMI is directly above a particularly thick area of the Pecos Valley aquifer (which can be seen directly south of the intersection of the Eddy, Lea, and Loving county border intersection in surveys). (In combination with their positioning along the New Mexico boarder to most directly facilitate the regulatory arbitrage on the more development-friendly Texas side in the shortest distance, I think this (sizable) positioning above and around some of the thickest parts of the Pecos aquifer makes LB’s acreage particularly attractive vs other surface rights owners in the Delaware basin).

(https://www.twdb.texas.gov/publications/reports/numbered_reports/doc/R382_PecosValley.pdf; this has some other interesting maps as well)

Meanwhile, the planned facilities in central Stateline position (between Loving and Winkler) are likely more for produced water recycling/disposal in Loving and brackish sourcing in Winkler (only because those dots in Winkler are atop a particularly water-rich region of the Capitan Reef minor aquifer within the major Pecos aquifer). From the pore pressure map in their prospectus, we can assume that the planned facilities in north Winkler and Andrews are going to be much more geared towards recycling/disposal facilities. **********

IDK when exactly the take-private reverse/forward split is scheduled to happen, but it already got the required votes at the Nov 25, 2024 shareholder meeting (https://www.sec.gov/Archives/edgar/data/806517/000117184324006571/0001171843-24-006571-index.html), so I’d expect it to happen rather soon —it could happen tomorrow as far as I know— and so I’m just trying to quickly write this over the weekend based on my existing saved notes (and will update this post with smaller details I might have skipped if more time passes between now the actual event). This is well enough, as the idea is rather simple.

********** UPDATE 20241213: Psychemedics is now trading under the ticket PMDI on the OTC Pink sheets (https://www.otcmarkets.com/stock/PMDI/overview). From the take-private proxy: “We expect the delisting of our common stock will be effective 10 days after we file the Form 25 with the SEC and the deregistration of our common stock under Section 12(b) of the Exchange Act will take effect 90 days after the filing of the Form 25.” However, the company filed the Form 25 today and it is already trading on the OTC markets under the ticker PMDI and the PMD ticker on the NASDAQ has stopped trading (as opposed to a 10-day delay); there is ostensibly 90 days remaining before they deregister the with the SEC and are freed from certain reporting requirements (which may result in the stock moving from the Pinks to the Expert Market). Meanwhile, the price has dropped significantly (to $1.70/sh at the time of this writing) —which is just as well as I was planning on marking the position to zero until an eventual sale of the business or other final outcome, assuming that it would only trade on the OTC Expert Market after deregistration— so maybe I should have waited to buy (and maybe I will add a bit if the price gets really low, keeping in mind that the last two quarters reported TBV/sh of $0.99-0.92). However, I had some uncertainty has to how fast exactly things would move after the split in terms of delisting (as demonstrated by the immediate delisting after the Form 25 filing) and how liquidity would look on the other side, so I wanted to make sure I got the shares I wanted before things started moving. In any case the intermediate volatility isn’t an issue for the ultimate business-sale thesis (not to say that other things can’t go wrong before that end of the tunnel).

I was also asked about Kamin’s latest selling activity in a recent Form 4 filing (https://www.sec.gov/Archives/edgar/data/806517/000142050624002619/0001420506-24-002619-index.html). If my interpretation of the footnotes is correct, it looks like Kamin (indirectly through 3k) sold some amount of shares back to PMD (now PMDI on the OTC Pinks) for the reason that they ended up buying more than originally estimated would be required “following the final determination of the purchase price required to purchase fractional shares in the Issuer’s recently completed reverse stock split.” (ie. they bought more than needed to buy out the fractional shares expected in the recent split). Note that even after this sale, Kamin has still nearly tripled-down on his position (which was bought at much higher costs basis), going from 647,737 shares (https://www.sec.gov/Archives/edgar/data/806517/000117152024000290/0001171520-24-000290-index.html) to 1,736,741 (https://www.sec.gov/Archives/edgar/data/806517/000117152024000386/0001171520-24-000386-index.html).

**********

**********

UPDATE 20241202: So it looks like the split ratio is going to be 1-for-5000 on December 3 after market close and the ticker will continue to trade publicly thereafter for the time being.

[T]he Company’s Board of Directors has approved a 1-for-5,000 reverse stock split of its common stock (the “Reverse Stock Split”) followed immediately by a 5,000-for-1 forward stock split of its common stock (the “Forward Stock Split,” and together with the Reverse Stock Split, the “Stock Split”), to be effective at 5:01 p.m. and 5:02 p.m., Eastern Time, respectively, on Tuesday, December 3, 2024. Beginning with the opening of trading on Wednesday, December 4, 2024, the Company’s common stock will continue to trade on the Nasdaq Capital Market on a post-Forward Stock Split basis under the existing symbol “PMD” ~~~ https://www.globenewswire.com/news-release/2024/12/02/2989790/0/en/Psychemedics-Corporation-Announces-Reverse-and-Forward-Stock-Split.html

I’d expect the stock may drop lower after this as those who were buying/holding shares for the cash-in-lieu from the take-private spread go away —though the market might also take Kamin’s tripling-down as a bullish signal of confidence. This may be a better time for anyone interested in holding through the take-private and betting on a later sale of the company to buy at a lower price. May buy a bit more if it goes low enough, though note also that liquidity could to be a lot tighter after the split and many of the remaining shareholders are more likely to be those that intend to hold the shares into the going-dark phase.

Per the deal proxy, there should be 88 days between now and the delisting (iff the company files all the necessary paperwork with the SEC right after the split).

The suspension of our obligation to file periodic reports and other documents under the Exchange Act will become effective after the filing with the SEC of both a notice of removal from listing of our common stock from listing on the Nasdaq Capital Market and termination of registration under Section 12(b) of the Exchange Act on Form 25, and a certification and notice of termination of registration on Form 15. The deregistration of our common stock under Section 12(b) of the Exchange Act will take effect 90 days after the filing of the Form 25 and the deregistration of our common stock under other provisions of the Exchange Act will become effective 90 days after the filing of the Form 15. ~~~ https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/0001171843-24-005690-index.html

**********

TLDR

Opportunity to bet-the-jockey and follow well-known activist nanocap investor, Peter Kamin, into an going-private deal as he triples down on his existing stake in hair-based drug testing company, Psychemedics, and takes it private to —I believe— re-work the cost structure and eventually facilitate a sale of the company himself after several failed attempts by previous management whom he’s now eliminated from the company. His track record with getting on the board of companies that are later acquired at a higher price is good and at the very least you’re unlikely to lose money at the current price. The incoming Trump admin in planning on taking tougher stance on the fentanyl epidemic in the US (https://trumpwhitehouse.archives.gov/ondcp/the-administrations-approach/the-administrations-strategy/) in 2025 and serves a nice potential bonus as well that could increase the value of PMD’s drug testing product/services in the coming years.

Business

Psychemedics Corporation is the world’s largest provider of hair testing for drugs of abuse. The company utilizes a patented hair analysis method to detect the presence of drugs of abuse in human hair samples. This method involves three steps:

1. Hair Digestion: A patented technology is used to digest the hair sample and release the drugs trapped within it without destroying the drugs themselves. This step ensures that virtually 100% of the drug is extracted for accurate measurement.

2. Enzyme Immunoassay (EIA): A proprietary and patented enzyme immunoassay (EIA) is performed on the liquid supernatant above the residue material obtained from the digested hair. This test helps detect the presence of specific drugs.

   

3. Mass Spectrometry Confirmation: The results from the EIA are confirmed using mass spectrometry, a highly sensitive and accurate analytical technique. This step ensures the reliability and validity of the test results. Not that it really matters for our purposes, but I thought these videos on how mass spectrometry is used to identify elements were interesting…

PMD serves a diverse customer base, including:

• Fortune 500 companies

• Small to mid-size corporations

• Schools

• Government entities

Management and setup

Prior to Kamin’s active involvement in the company, PMD had been run by CEO and Chairman Raymond C. Kubacki since 1991. Under his management, the company’s stock price saw some periods of volatile spikes, but generally languished and had declined severely by 2021. Meanwhile revenues had remained stagnant (really declining, in inflation-adjusted terms) notwithstanding a breif revenue boost from the Brazilian drug testing market (2015/2016 - 2019) due to the passage of a favorable 2015 law in the country. However, this ultimately turned out to be an unprofitable boondoggle (see “Distribution” and MD&A section re. revenues in the 2019 10K, https://www.sec.gov/Archives/edgar/data/806517/000117184320001248/0001171843-20-001248-index.htm).

… These were some of the primary complaints raised against the company’s unjustifiably-tenured management team, as he might put it, by well-known smallcap investor, Peter Kamin, in his public letter to the board on September 23, 2021 (https://www.sec.gov/Archives/edgar/data/937541/000092189521002309/0000921895-21-002309-index.html). The letter itself serves as a nice basic checklist for things you don’t want to see from a management team…

As you are aware, I am one of the largest stockholders of Psychemedics Corporation (“Psychemedics” or the “Company”), owning approximately 8.4% of the outstanding shares of common stock of the Company. I have decided to send this letter as a follow-up to my September 14, 2021 private letter (the “September 14 Letter”) to the Company’s Board of Directors (the “Board”). […] [B]y any measure, the Company has vastly underperformed any minimal expectation of performance and/or profitability under Mr. Kubacki’s leadership. On an inflation adjusted basis, the Company’s revenues are lower and its stock price is less today than when Mr. Kubacki became CEO 30 years ago in 1991. […] [E]ach of the current Directors have served for over 18 years, and in the case of lead Director, Fred Weinert (“Mr. Weinert”), for over 30 years. […] [T]he Board and management collectively own less then 7% of the Company – and these amounts are almost irrelevant relative to the rest of their compensation package. […] Even more alarming to me than the Board’s failure to govern the Company was its recent decision to downplay an apparent approach from a third party concerning a potential strategic process. […] Mr. Kubacki and this Board, with a thirty-year track record of underperformance, owes us an obligation to publicly commit to conducting a transparent, robust and unobstructed sale process. I believe there may be many strategic buyers for Psychemedics and I urge the Board to consider any strategic alternatives that will generate superior returns for stockholders. I also strongly urge the Board to retain a nationally recognized investment bank and to form a special strategic committee chaired by Director, Robyn Davis to initiate an objective and comprehensive strategic review of the Company. ~~~ Peter Kamin to PMD’s BoD (emphasis included from original letter)

Kamin is a rather famous activist in nano/smallcap investing circles and not for no reason. Looking at all of the public companies that Kamin has been involved in over the years (https://investors.tileshop.com/board-member/peter-kamin; https://www.marketscreener.com/insider/PETER-KAMIN-A00KKI/), we can see that his participation is usually a net positive and usually materially so vs general market returns:

By June of the next year, about eight months after filing his public letter, Kamin and Darius G. Nevin (whose expertise appears to be in advising private equity firms) were jointly appointed to the board or directors as part of a cooperation agreement with PMD and Kamin’s hedge fund, 3K L.P. (https://www.sec.gov/Archives/edgar/data/806517/000117184322004265/0001171843-22-004265-index.htm). (Nevin’s direct association to Kamin and the takeover are further solidified by the fact that Nevin was identified as a director “affiliated with the Investors” (ie. Kamin and his associated entities) in the context of the going dark transaction), https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/0001171843-24-005690-index.html).

CEO Kubacki would also be replaced by Brian Hullinger two month after that on August 17, 2023 and Kubacki’s Chairman titled appointed to Nevin (https://www.sec.gov/Archives/edgar/data/806517/000117184323004498/0001171843-23-004498-index.html; https://www.sec.gov/Archives/edgar/data/806517/000117184323005387/0001171843-23-005387-index.html). In a near exact inverse ratio to Kubacki’s past compensation, Hullinger’s compensation for 2023 was comprised of around 80% stock option awards (that would vest in 3rds over a 10yr period) and 20% cash compensation (https://www.sec.gov/ix?doc=/Archives/edgar/data/806517/000117184324001671/pmd20231231_10k.htm).

Examining the BoD and exec team of the company in the year prior to Kamin’s appointment to the board vs the composition right before the take-private announcement, we see that only two of the original nine members remained (Robyn C. Davis and Andrew M. Reynolds).

(https://www.sec.gov/Archives/edgar/data/806517/000117184322002192/0001171843-22-002192-index.htm; https://www.sec.gov/Archives/edgar/data/806517/000117184324001671/0001171843-24-001671-index.htm)

.

2020 and 2022 strategic review + going dark discussions…

The public filings seem to indicate that Kamin was a driving force in re-starting the BoD’s strategic review to find a buyer for the company in 2021; they tried and failed. Now it looks like he’s kicked out most of the old management team and is going to get the company ready for a sale himself, starting with cutting the time and reporting costs of remaining a public company. On Aug 12, 2024, the company announced the negotiated offer from Kamin’s 3K L.P. to take the company private in a reverse/forward stock split that will cash out minority shareholders of (at least) lesser than 4000 shares at $2.35/sh before the delisting and deregistration of the company’s common stock with the SEC.

Post-take-private, Kamin will own around 35% of the company’s common stock. that is, he is more than tripling down on the size and value of his existing position (given that all his other buys were at a higher cost basis than current price) from 624,737 shares as of the latest 13D filing with an additional 1,595,744 shares post-transaction (https://www.sec.gov/edgar/search/?r=el#/q=kamin&category=form-cat3&ciks=0000806517&entityName=PSYCHEMEDICS%2520CORP%2520(PMD)%2520(CIK%25200000806517)). Additionally, his hedge fund 3K L.P. will have the right to designate 2 directors and limit the total BoD seats to 5; he will essentially have total control of the board given that he is also on the BoD and the 4th seat is occupied by Chairman Nevin who was appointed as part of the original cooperation agreement between PMD and Kamin’s 3K L.P.

Below is a graphical timeline of the relevant events —I think things are a bit more understandable in this visual form, though at the expense of being able to add the relevant filing links. (In any case, most of the relevant timeline and deal details can be read about in the proxy related to the going-dark transaction here https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/0001171843-24-005690-index.html).

(Base image from https://www.insidearbitrage.com/symbol-metrics/PMD/insider-transactions)

(Note that most of the details of the 2020 strategic review, including the $12.00 offer, were mostly left hidden/opaque to investors at the time —as decried by Kamin in his 2021 letter— and were only revealed in 2024 via the definitive proxy related to Kamin’s take-private offer. It may be relevant to keep in mind that he increased his stake to 10.99% in April before actually joining the BoD in June, so it’s somewhat unlikely that this $12.00 price point informed his buying at the time.)

.

Before joining the company’s BoD, Kamin owned ~8.4% of shares. Examining his public filings, it appears that around half of this block was acquired at a cost basis of around $4.50 (https://www.sec.gov/Archives/edgar/data/937541/000117152020000488/0001171520-20-000488-index.html) and the other half at around, say, $7.00 (https://www.sec.gov/Archives/edgar/data/937541/000092189521002154/0000921895-21-002154-index.html). Some months after writing his letter to management, we see that he later upped his stake to 11% at a cost basis of around $6.50 - $7.00 (https://www.sec.gov/Archives/edgar/data/937541/000092189522001328/0000921895-22-001328-index.html). If the proposed reverse split at $2.50/sh occurs at the midpoint of 1-for-5000, his stake would increase to around 35% ownership of the company (34.94%, https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/0001171843-24-005690-index.html). I think it’s fair to assume that Kamin expects to be able to get north of $7.00 in a sale of the company based on his past purchase prices.

(More of his Form 4 and 13D filings can be found here: https://www.sec.gov/edgar/search/?r=el#/q=kamin&category=form-cat2&ciks=0000806517&entityName=PSYCHEMEDICS%2520CORP%2520(PMD)%2520(CIK%25200000806517); https://www.sec.gov/edgar/search/?r=el#/q=kamin&category=form-cat3&ciks=0000806517&entityName=PSYCHEMEDICS%2520CORP%2520(PMD)%2520(CIK%25200000806517))

Valuation

We can glean some idea of what the company might be worth by looking at the buying history of the person who is now planning to take the company private. Kamin’s main bulk of share purchases occurred at around $4.50, $7.00, and $6.50, so we can assume he thinks it’s worth at least $7.00. (https://www.sec.gov/edgar/search/?r=el#/q=pmd&ciks=0000937541&entityName=Kamin%2520Peter%2520(CIK%25200000937541)). $7.00/sh was also the price of the 2022 verbal offer and well below the 2021 $12.00 non-binding offer that was abruptly dropped.

As part of PMD’s “going dark” discussions, the company commissioned Mirus Securities Inc. as an independent advisor to evaluate the company and provide a fairness opinion on Kamin’s take-private offer, which was apparently internally code-named “Project Northern Lights”. As part of their fairness analysis, in addition to comparable going-dark reverse stock split pricing precedents, Mirus conducted valuation analysis of PMD based on comps analysis, comparable/precedent transaction analysis, DCF analysis, and estimates for how the company would sell in an LBO scenario (https://www.sec.gov/Archives/edgar/data/806517/000117184324005038/exh_cii.htm; https://www.sec.gov/Archives/edgar/data/806517/000117184324005522/0001171843-24-005522-index.html, see Exhibit (c)(ii)). (The Mirus presentation slides below are from the August 2024 valuation section).

(Something to keep in mind is that the DCF and LBO valuations by Mirus were informed by management’s given forecasts for the business —which were likely not accounting for any planned cost-cutting or other changes that Kamin may be planning for the company once he takes it private).

(In this last table, I remove the extreme high and low outlier values included in the Mirus precedent transaction valuation analysis)

Note that even on the low end, you wouldn’t lose too much money buying in at the $2.35 reverse split price and in most cases you are at least doubling your money.

My downside estimate of $1.60 is purely based on taking the minimum between the Mirus valuations (in this case, the DCF valuation low) and the 52-week lows that the stock traded at (which was actually a 20yr low for the stock) in the time prior to the disclosure of the Kamin take-private deal.

Catalysts

Kamin take-private, turn-around / cost-cutting, and subsequent sale of the company.

Risks

Perhaps this doesn’t need mentioning, but I will mention it anyway: there is no guarantee that Kamin will ever be able to successfully sell the company, what that timeline might be, or if that is even his actual intention. ********** UPDATE 20241203: For an example, see the comment thread here. ********** Based on the past events and what I’ve written in this post, I think that is exactly what is planned and think he will be successful, but others may disagree (if you have a good reason to doubt, do let me know before the transaction actually happens!).

Note that in the intervening time between the going-dark event and the —expected— sale of the company, the deal proxy does not guarantee that shares will even trade on the OTC Pink or Expert market. That is, you should assume you will be locked in for the foreseeable future.

Any trading in our common stock after the Stock Split and deregistration under the Exchange Act will only occur in privately negotiated sales and potentially on the OTC Pink Market, if one or more brokers chooses to make a market for our common stock there, subject to applicable regulatory requirements; however, there can be no assurances regarding any such trading. ~~~ https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/0001171843-24-005690-index.html

Furthermore, some of those precedent comparable transactions documented by Mirus occurred at times where interest rates differed from where they are at today and likely make a difference in how much a strategic buyer is going to be willing to pay (both from a DCF equation POV and a debt burden / financing POV).

(https://fred.stlouisfed.org/graph/?g=1BRzG)

Some odds and ends

An interesting twitter thread on potential regulator tailwinds lining up for PMD’s business: https://twitter.com/ragnarisapirate/status/1672244729394917376?s=51&t=oE6GN6vLZWb087-UBs2QXA

Note that the reverse/forward split is currently planned to be within a range from between 1-for-4000 to 1-for-6000, so, to be conservative, one would need to purchase a block of 6000 shares if they wanted to ride along into the take-private.

********** UPDATE 20241211: This is a bit late at this point, but just wanted to clear something up. The way the reverse forward split worked was like this: Market closes, shares are set to reverse split at ratio of 1-for-5000, anyone who would end up owning less than 1 share as a consequence the reverse split instead gets all of their shares bought out at $2.35/sh right before the split, the reverse split then happens, then the forward split was done in order not to cause an artificial spike in stock price nor affect liquidity for remaining shareholders. So if you had 5001 shares going into the split, you did not lose that 1 share nor and up with 5001 shares after the forward split, you ended with that same amount you went in with because you owned at least 5000. Why not directly buy shares at that $2.35 price (up to the total amount specified in the going-dark proxy filing) via a rights offering? It’s because the goal was not to reduce float or simply obtain more stock, but to reduce the total number of stockholders of record (which the proxy filing estimated would be reduced from 201 to 39). Doing the reverse/forward split provided an indirect way to forcibly buy out smaller shareholders (those with less than 5000 shares). **********

If you do buy a sufficient block of shares and intend to allow them to go dark along with Kamin, you should also be sure to contact your broker in cases where your shares are held in “street name” by you broker, rather than yourself, to ensure that they will not unintentionally cash you out in the reverse split. (The company intends to treat “street name” shares no different than any others, but you may want to double check ( https://www.sec.gov/Archives/edgar/data/806517/000117184324005690/def14a_101824.htm, see “Treatment of Beneficial Holders (Stockholders Holding Shares in “Street Name”)”)).

One should also take care that they own their blocks of shares in a single account, rather than only in aggregate across multiple accounts that would result in them being cashed out on an individual basis.

.

.

Intro

These walls private prisons are funny. First you hate them, then you get used to them. Enough time passes, you get so you depend on them.

“In response to voter rejection of funding for new prisons and orders by federal judges to relieve overcrowding, some states turned to private companies to build new prisons. Private prison arrangements are attractive to state officials in part because the companies are able to build prisons quickly and without the need for voter approval.” ~~~ https://www.hamiltonproject.org/publication/paper/the-economics-of-private-prisons/

(https://www.aclu.org/news/immigrants-rights/unchecked-growth-private-prison-corporations-and-immigration-detention-three-years-into-the-biden-administration; https://www.aclu.org/news/immigrants-rights/more-of-the-same-private-prison-corporations-and-immigration-detention-under-the-biden-administration)

.

As the US Presidential election day nears, I thought I’d do a quick post for a related idea I’ve been playing with.

When thinking about companies that are hated, yet selling at a reasonable value or being sold for non-economic reasons, what’s happened with private prison operator GEO seems like a pretty good example of what one would be looking for.

(https://investigate.afsc.org/company/geo-group)

I look at this long list of non-economic-based divestment of institutional money from GEO and am reminded of Nick Sleep’s Nomad partnership letters (https://igyfoundation.org.uk/wp-content/uploads/2021/03/Full_Collection_Nomad_Letters_.pdf):

“We consider ourselves contrarian, value-based investors. Ordinarily what we are buying is hated and reasonable value. When investments go from hated and reasonable to despised and cheap something is normally up in the markets.”1

Furthermore, I’d wager that this company, on even a quantitative level, screens rather poorly for non-fundamental reasons as well —adding to it’s mispricing. I subscribe to the stock data service TIKR (which supposedly uses S&P Capital IQ, a major data source used by many institutional investment firms and hedge funds, to get their primary stock/financial data). The data that they have on the primary data feed is severely incomplete: income statement data that only starts at the EBT line (eg. no info on revenues, opex, interest payments, SG&A, etc); balance sheet data missing many line items from 10K (even as simple as AR); cashflow statement that does not include capex, debt issuance or repayments, etc. That is, TIKR’s —and so I assume S&P Capital IQ’s— B/S and CFS data cannot be used to accurately arithmetically derive their own stated net totals and rather just grab the right answer externally to plug into the aggregates without having any of the line item details that would actually add/subtract to those totals; a majority of I/S data is simply missing. (I will note that their Secondary Data source option for the stock is much more complete, yet even then, the many numbers appear to be inaccurate (eg. missing capex figures or EBITDA numbers that do not match GEO’s own nominal or adjusted reporting of those same metrics)).

As another bullish signal, GEO founder/Chairman George Zoley recently upped their holdings, by around 7%, at prices not too far from where we’re at right now (https://www.sec.gov/Archives/edgar/data/923796/000095017024096460/xslF345X05/ownership.xml).

.

Meanwhile, customer spending continues to grow at a CAGR of around 5.4%/yr:

“Since the creation of DHS in 2003, ICE spending has nearly tripled from $3.3 billion to $9.6 billion in FY 2024 (Figure 2). Much of this funding has gone to increasing the agency’s ability to hold immigrants in detention around the country, to electronically monitor noncitizens on “alternatives to detention”, and to carry out deportations.” ~~~ https://www.americanimmigrationcouncil.org/research/the-cost-of-immigration-enforcement-and-border-security

Looking at the graphs below, we see that ICE budgets either increase or remain stable through both Democrat and Republican administrations.

(https://www.americanimmigrationcouncil.org/research/the-cost-of-immigration-enforcement-and-border-security)

Meanwhile, GEO revenues themselves have grown at an average (and similar CAGR) of around 7%/yr (vs the 2.6% inflation rate in the same period).

.

Business

GEO Group is a company that specializes in the ownership, leasing, and management of secure facilities, processing centers, and reentry facilities. They primarily operate in the US with additional operations in Australia, South Africa (via South African Custodial Management Pty. Ltd., SACM, and joint venture, SACS), and the UK through a joint venture, GEOAmey.

(GEO 2024Q2 earnings slides)

The ways in which someone moving through the US justice system might interact with GEO’s contracted services looks something like this (GEO services in green)…

(My understanding is that the vast majority of GEO’s facilities, including those under BOP and USMS contracts, house illegal immigrants convicted of Federal crimes (https://wearegeo.com/dispelling-myths/transparency/; https://www.geogroup.com/GEO-statement-on-President-Biden-DOJ-EO)).

Through their subsidiary BI Inc. (acquired by GEO in 2011), they are also the exclusive electronic monitoring provider for ICE’s Intensive Supervision Appearance Program (ISAP), the largest alternative to detention (ADT) program operated by ICE. BI Inc. has been the main (sole?) case management and monitoring services operator for the program since its inception in 2004 (https://investigate.afsc.org/company/geo-group; https://www.americanimmigrationcouncil.org/research/alternatives-immigration-detention-overview), so unless the US goes with an open-borders policy, there’s not a huge risk of product/service substitution for GEO as they manage the largest alternative to detention program. BI Inc, like the rest of GEO’s business segments, also has contracts with state and local community corrections agencies across the United States.

So far as I can tell, BI’s ISAP contract has never been subject to any competitive bidding process since the time they won it and the existing contract has simply renewed and expanded with BI remaining the exclusive manager of the program. Sticking with BI as the ISAP program evolves would make sense as their experience operating the program would naturally make them most qualified —an advantage that only compounds and entrenches them over time— and least disruptive-to-continuity choice for such a high-profile and operationally complex program.

While this segment makes up less than 20% of GEO’s revenues, the business is asset-light and the electronic monitoring segment has made up 40%-60% of their operating income since the segment has been dis-aggregated from the re-entry services segment.

How does someone crossing the US border come to into contact with GEO’s detention facilities, secure transportation, or electronic monitoring (EM) services? My understanding is that is goes something like this (where GEO services are again in green)… 2

.

Why it’s cheap

My understanding of GEO’s stock price decline from 2017 to present day is that it was mainly driven by concern over the company’s growing debt burden and subsequent stalling of the dividend, which suffered several cuts before being completely discontinued by 2022.

Adding to GEO’s troubles, on January 26, 2021, President Biden signed Executive Order 14006 which banned the renewal the Department of Justice’s contracts with private prisons operators (https://www.nbcnews.com/news/nbcblk/biden-s-order-terminates-federal-private-prison-contracts-here-s-n1255776; https://www.wakeforestlawreview.com/2023/01/president-bidens-executive-order-14006-a-positive-but-likely-fleeting-attempt-to-address-the-injustice-of-private-prisons/; https://www.geogroup.com/GEO-statement-on-President-Biden-DOJ-EO). While this did not affect GEO’s ICE contracts, it has lead to the near-total loss of their contracts with the Federal Bureau of Prisons (BOP). Meanwhile, it appears that the US Marshals Service (USMS) has been able to circumvent this EO by going indirect to continue contracting with GEO (https://www.aclu.org/press-releases/u-s-marshals-service-evades-biden-executive-order-to-end-contracts-with-private-prisons-aclu-obtained-records-indicate; https://www.motherjones.com/politics/2023/12/warren-private-prison-us-marshals/).

Shorty thereafter, on April 7, 2021, the company announced it was suspending its quarterly dividend payments “with the goal of maximizing the use of cash flows to repay debt, deleverage, and internally fund growth” and that “the Board of Directors has determined to undertake an evaluation of GEO’s structure as a REIT” (https://investors.geogroup.com/node/9961/html#d166890dex991.htm). On December 2, 2021, the Board of Directors “unanimously approved a plan to terminate GEO’s REIT election and become a taxable C Corporation, effective for the year ended December 31, 2021. As a result, we are no longer required to operate under REIT rules, including the requirement to distribute at least 90% of REIT taxable income to our stockholders, which provides us with greater flexibility to use our free cash flow.” (https://www.sec.gov/ix?doc=/Archives/edgar/data/923796/000095017024023181/geo-20231231.htm)

So we see changes in political climate and subsequent regulation leading to a material loss in business for the company, which led to a cutting of the dividend and reconsideration (and later termination) of GEO’s REIT status. Aside from the end of the dividend and REIT status likely causing a selloff by yield-focused investors, the situation probably also highlighted concerns about GEO’s growing debt burden and leverage ratios and contributed to further stock decline.

Since then, GEO’s deleveraging efforts appear to have paid off and the company’s debt ratios are near the lowest they’ve been in over 10 years. Furthermore, in 2024Q2, the company refinanced the majority of their existing debt with further-out maturities and a lower average interest rate. Here is a comparison of their new capital structure vs their pre-refi one…

(See sections “4. FAIR VALUE OF ASSETS AND LIABILITIES” and “Financial Condition”, https://www.sec.gov/ix?doc=/Archives/edgar/data/0000923796/000095017024093922/geo-20240630.htm)

We see a slight decrease in total liabilities (by $36,511,000), simplification of debt structure, and extension of debt maturities. Also note that, while the value-weighted interest rate for the various liens and notes under the new structure is slightly higher then the old (now 9.42% vs previous 8.52%), the new credit facility agreement now makes up 77% of debt (vs previous 51%) and is based on a floating-rate SOFR+3%, so the company is benefiting from the recent Fed rate cuts more than they would have under the old capital structure and reduces their total interest expense.

“The weighted average interest rate on outstanding borrowings under the Credit Agreement as of June 30, 2024 was 9.46%.” vs “As of December 31, 2023, we had no borrowings under our revolver, and approximately $75.8 million in letters of credit which left approximately $189.2 million in additional borrowing capacity under the revolver. The weighted average interest rate on outstanding borrowings under the Credit Agreement as of December 31, 2023 was 12.35%.” (https://www.sec.gov/ix?doc=/Archives/edgar/data/0000923796/000095017024093922/geo-20240630.htm; https://www.sec.gov/ix?doc=/Archives/edgar/data/923796/000095017024023181/geo-20231231.htm). Using these numbers for the credit facility, we get a new average weighted interest rate of 9.43% vs 10.30%.

Meanwhile, management has discussed the desire to return capital to shareholders again (per the 2024Q2 earnings call). The new refi gives management the ability to retain excess cash flow for “restricted payments”, eg. dividends or buyback (so long as debt/adjEBITDA remains under 3.5x), per 2024Q1 call —something they apparently could not do under the previous arrangement. 3

“In addition to pushing out our maturities and lowering our average cost of debt, the recent refinancing transactions have given us greater flexibility to explore options to return capital to shareholders. Under our new credit facility covenants, we will be able to retain 25% of excess cash flow until September 2025 and 50% of excess cash flow after that date as long as our leverage remains between 2.5 and less than 3.5x adjusted EBITDA. This would give us the ability to use our cumulative retained excess cash flow for restricted payments, such as dividends or share repurchases as long as our total leverage remained below 3.5x adjusted EBITDA. Under our new senior notes indenture, we will have an initial restricted payments basket of $125 million, which will increase over time by 50% of net income.” ~~~ GEO CEO Brian Evans, 2024Q1 earning call

If management actually believes their own $45/sh NAV valuation (I’ll get back to this later), then I’d expect them to go for buybacks over dividends at the stock’s current price.

Here we see that debt ratios have been falling to decade lows (dotted lines), while FCF margins and ROCE have remained positive and been steadily rising to decade highs. Meanwhile, the company is cheaper on an EV/EBITDA basis than it’s been in over 10 years.

At the same time, FCF conversion on net income has been improving due lower spending on growth-capex projects and the completion of expansion projects in Australia from 2017-2020 as well as asset dispositions from 2021-2023 of less productive assets that likely reduced total maintenance-capex needs (eg. the sale the company’s youth business, Abraxas, and certain real estate assets 4).

.

Here’s some quarter-by-quarter stats on the business through some of the past periods of general market volatility. Notably the company remained CFFO positive through the 2008 financial crisis and CFFO and FCF positive through 2020, with ROCE remaining positive throughout both periods. (I just thought it was interesting, but wouldn’t read too much into it).

.

Examining some other periods of stock price declines in the company’s history, my interpretation is this…

2010-2012: I’m not totally sure on this one; it could be due the near 2x increase to GEO’s debt ratios during this period —and the initiation of the dividend at that same time may have been been cause for worry among shareholders concerned with the company’s capital allocation policies. There were also several controversies involving the company that all happened within a short time of each other in that period that may have contributed to negative investor sentiment (see https://en.wikipedia.org/wiki/GEO_Group#2010s).

2015-2016: Under the Obama administration, the DOJ announced plans to phase out the use of private prisons for federal inmates, stating that it would not renew its contracts with private prison contractors and causing GEO’s stock price to fall by around 40% that same day. However, this announcement was later rescinded by the Trump administration in 2016 (https://digitalcommons.molloy.edu/cgi/viewcontent.cgi?article=1139&context=etd; https://www.migrationpolicy.org/article/profiting-enforcement-role-private-prisons-us-immigration-detention; https://www.npr.org/sections/thetwo-way/2017/02/23/516916688/private-prisons-back-in-mix-for-federal-inmates-as-sessions-rescinds-order).

.

Valuation(s)

Prediction markets have Trump at around a 50% chance to win the Presidency (GEO’s external tailwind bull case), so you can paste that into your Kelly ratios and size appropriately (https://ballotpedia.org/Prediction_markets_in_the_2024_presidential_election; https://blogs.cfainstitute.org/investor/2018/06/14/the-kelly-criterion-you-dont-know-the-half-of-it/). Though, I recall that the prediction markets had Trump favored to win in 2020 and turned out to be wrong, I’d probably disregard anything that isn’t pretty close to 50/50 at the time of my writing this.

My simple PT is a 40% discount to management’s own estimated NAV of $45/sh. I use this discount to account for any actual liquidation of such niche assets, though I get that regulations and NIMBY-ism likewise make these same assets very hard to replicate. This gets us to around $27/sh and I use a default downside floor price of the BVPS, $9.43/sh (https://investors.geogroup.com/news-events-reports/presentations). My simple upside probability is 50% chance of a Trump 2024 win x 80% chance of company’s continued successful execution of deleveraging ==> 40% bull case probability.

I’ve been playing with unit inputs in a simple model of the business as well to check if I can work backwards from fundamentals to a similar confirming PT without having to make too heroic of assumptions under a Trump admin and that target does seem achievable. At 8x FCF (around the same multiple the stock traded at before the COVID global shutdown and pre-2021 Biden EO), we don’t need to project too much to get to $26/sh (or 14.30% CAGR).

Here, we assume a Trump win, resulting in just the reactivation of BOP facilities (9,732 idled beds, per 2023 10K) at 2019 occupancy rate (92%, implying 8953 added active beds) without any other additional ICE detention5 or USMS bed activation (+/- some arbitrary churn) as well as projecting declining unauthorized immigrant population. Rising ISAP enrollment is based on an expectation of stricter enforcement policies to result in higher conversion of the remaining unauthorized alien population into ISAP participants.

Keep in mind that there are lots of assumptions and simplifications here, so I just try to make them explicit and I’m mainly just using this sheet as a guide / tool to play around with numbers to see how the magnitude & direction of outcomes are affected vs current price. Also wanted to keep things very simple so can easily plug in a minimum set of key actuals (or run-rates) as they come out going forward.

.

Even if Trump doesn’t win the White House in November, I think GEO’s future looks basically fine as the deleveraging strategy has been playing out well, with debt/EBITDA at it’s lowest in over 10 years, and management discussing return of capital options for 2025 that could re-rate the stock (though the B/S improvements are already a kind of return of capital iff it can translate into greater distributable FCF/sh).

Furthermore, getting unauthorized immigration under control is a bi-partisan issue and Federal funding trends appear correspondingly positive.

“A majority of Americans (54%) say that “controlling and reducing illegal immigration” should be a very important foreign policy goal for the United States, up from a previous all-time low of 42 percent in 2018.” ~~~ https://globalaffairs.org/research/public-opinion-survey/democrats-and-republicans-starkly-divided-immigration-policy, May 2024

(https://www.progressivecaucuscenter.org/federal-spending-on-immigration-examining-key-programs-and-impacts; https://www.americanimmigrationcouncil.org/research/the-cost-of-immigration-enforcement-and-border-security)

Given the stability of USMS detention populations (per GEO 2024Q2 presentation), a possible return of BOP contracts as well as trends in illegal immigration enforcement/budgets are the main inflection point / drivers for growth of GEO’s business.

.

I also played with the numbers to see how a status quo situation under a Kamala Harris White House admin might play out with a more lax border policy (though one should keep in mind that the US ultimately runs on Congressional consensus rather than a Monarch-In-Chief)…

Here we model declining active bed growth and growing unauthorized immigrant population, while ISAP enrollment percentage remains status quo. We see that the numbers are not too catastrophic; a 2028 PT of $14.40/sh (or -5.37% CAGR).

.

Democrat policies towards immigration could also end up being just as, if not more, accretive to GEO’s sustained FCF/sh than a Trump admin and the company could see a win-win situation no matter who’s President in 2025. A southern border continuing to lean more towards the “open” side of the spectrum would mean even greater immigration court backlogs and necessitate improvement & expansion of ICE detention and ATD programs like ISAP which “after years of expansion, decreased by 39 percent in FY 2023, due in part to court orders and a lack of resources.” (https://www.fosterglobal.com/blog/justice-delayed-immigration-courts-drown-in-backlogged-cases/; https://www.migrationpolicy.org/article/biden-three-immigration-record).

“[T]he immigration court’s backlog of cases has risen every single year since FY 2007. […] Despite the demand, as of the first quarter of FY 2024, there were only 725 immigration judges across the entire country for an average of nearly 5,000 cases per judge. So long as Congress continues to supercharge enforcement at the expense of adjudication, these backlogs will likely persist, and the funding poured into enforcement will not produce the results intended.” ~~~ https://www.americanimmigrationcouncil.org/research/the-cost-of-immigration-enforcement-and-border-security

“Democrats broadly favor policies that make it easier for immigrants to legally come to, and stay in, the United States. But moderates (55%) more than liberals (24%) see controlling and reducing immigration as a priority.“ ~~~ https://globalaffairs.org/research/public-opinion-survey/democrats-and-republicans-starkly-divided-immigration-policy

“To respond to the record migrant encounters in fiscal year (FY) 2022, which were topped the following year, the Biden administration fundamentally changed its policy on border enforcement. […] One year on, the challenge has persisted.” ~~~ https://www.migrationpolicy.org/article/biden-three-immigration-record

(https://www.bbc.com/news/articles/c0jp4xqx2z3o)

The main difference in this scenario, between a Trump admin vs Kamala admin, is that between a bigger slice of an existing/declining pie or a bigger pie (and hoping GEO’s slice grows proportionally).

Here we project consistent continued growth of unauthorized alien population with small increased in ISAP enrollment over time —in addition to a few added active beds to model additional ICE detention activation— for a 2028 PT of $27/sh at 8x FCF.

(This would actually be a preferable outcome IMO as, in the course of doing research on this company, I’m starting question the efficacy of private prisons vs government-run facilities —not even in terms of cost efficiency, rehabilitation, or recidivism reduction (which is rather irrelevant given that GEO’s facilities almost exclusively hold unauthorized aliens convicted of federal crimes), but in simply ensuring officer and inmate safety. 6 Meanwhile, the benefits of ATD seem a lot clearer in addition to being a higher-margin business for GEO.)

It should be noted that “an increase in enrollment in ATDs over the last decade has not corresponded with a significant decrease in detention numbers” (https://www.americanimmigrationcouncil.org/research/alternatives-immigration-detention-overview), so monitoring services could go up with bed occupancy related to ICE contracts remaining stable rather than being substituted by the former. By segment, the 2023 EBIT margins for GEO were: secure services & detention, 18%; electronic monitoring (EM) being the most profitable at 50%; re-entry services, 18%; international, 6%. GEO’s EM segment is both higher margin as well as less socially offensive, so growth of the EM business is a way to improve overall ROIC and reduce the company’s political risk at the same time —improving the overall attractiveness of the business.

Of course, if a more lenient WH admin allows unauthorized immigrants to simply cross into the US and join the already large ranks of non-detained, unsupervised, and gotaways rather then adding to ISAP participation, then obviously GEO’s EM segment is not going to benefit from their presence in the US. Similarly, high rates of absconding could call into question the utility of existing ATD programs (https://cis.org/Feere/Should-Congress-Continue-Funding-ICEs-Alternatives-Detention).

.

As shown my initial model, the benefit to GEO from a Trump admin would come if the “concepts of a plan” for his presidency ultimately expand the currently small fraction of the undocumented population that is detained or monitored in the US (less than 2%) to cover a larger portion of the country’s substantial population of unauthorized non-detained/unsupervised/gotaways (https://www.foxnews.com/politics/over-98-illegal-immigrants-not-under-federal-supervision-analysis ; https://www.pewresearch.org/short-reads/2024/07/22/what-we-know-about-unauthorized-immigrants-living-in-the-us/).

For example, during Trump’s previous term as President, he signed two executive orders aimed at increasing ICE enforcement actions.

“Executive Order 13767 included plans to tighten enforcement along the U.S.-Mexico border, increase the use of detention in order to end “catch and release” of migrants pending their removal hearings, and expand detention capacity. The desired scale of this expansion was revealed in a leaked White House memo calling for a doubling of people in immigration detention to 80,000 per day. Further, Executive Order 13768 reversed Obama-era policies by prioritizing all unauthorized immigrants for enforcement, in addition to reviving Secure Communities and pushing for new agreements allowing state and local law enforcement to enter into partnerships to assist ICE in immigration enforcement.” ~~~ https://www.migrationpolicy.org/article/profiting-enforcement-role-private-prisons-us-immigration-detention

A Trump admin would also likely mean a reversal of the Biden 2021 EO dictating that the US DOJ not renew contracts with privately operated detention facilities, which caused the drying up of GEO’s business with the US BOP. This EO appears to be responsible for the majority of GEO’s currently idle facilities (just based on inspecting the facility names in their 2023 10K “Asset Impairments” section). A resuming of operations at these facilities at average occupancy and per diem rates, management estimates, would have increased 2023 EPS by “approximately $.28 to $.33 per share based on our average operating margin“ (or around a 40%-50% increase to 2023’s actual $0.72 diluted EPS) (https://www.sec.gov/ix?doc=/Archives/edgar/data/923796/000095017024023181/geo-20231231.htm).

.

FYI: While not a very large holding for me in terms of current cost basis, I have call options around the $12-$15 breakeven range that, in terms of the underlying if exercised, would be a significant percentage of my portfolio. Given that we know the timing of a major inflection point for the business (here, the 2024 election outcome), I think options are a better way to play this. Though, again, despite any price volatility that may result from an presumably less favorable WH candidate winning the election, I think that GEO could still ultimately be a good buy in the long-run.

To paraphrase Presidential candidate Kamala Harris:

“We’re talking about the significance of the passage of time, right? The significance of the passage of time. So, when you think about it, there is great significance to the passage of time in terms of what we need to do to lay these wires compound capital. What we need to do to create these jobs confirm or falsify our value thesis playing out. And there is such great significance to the passage of time when we think about a day in the life of our children portfolios.”

.

Catalysts

• Trump election victory in November 2024

• Reinstatement of the dividend

• Continued deleveraging

Risks

• Trump loses in November, Kamala and Democrat establishment wins and increases (rather than holds steady) political pressure on remaining private prison business with BOP

• Kamala/Dems win and decrease ICE funding

• Trump wins and either fails to follow through on hard-line immigration enforcement policy or attempts to follow through, but implementation becomes a quagmire

• Basically, anything that ultimately results in anything that ends up greatly impeding GEO’s deleveraging or dividend plans.

.

Share Lemon Cakes Investing

.

20241113 Post update

So, there it is…

(https://apnews.com/article/election-day-trump-harris-white-house-83c8e246ab97f5b97be45cdc156af4e2; https://www.nbcnews.com/politics/2024-election/trump-says-no-price-tag-mass-deportation-plan-rcna179178)

… and he’s not even been sworn in yet.

The way I see it, the company’s capital structure is much improved, with leverage ratios lower than they’ve been in over 10 years, and is now in a better position than it’s ever been from a government environment standpoint. At the 2024Q3 earnings call, Chairman George Zoley thought that the incoming Trump admin’s more aggressive stance on immigration could mean the company is looking at “a potential doubling of all of our services, whether it’s in the detention segment, in the transportation segment, as well as the ISAP program […] So we’re looking at maybe March as the additive funding for this fiscal year.” The stock’s previous all time high around $30 may just be a reasonable floor for 2025 if the Trump admin is actually able to get all the funding from Congress that they feel necessary for their immigration policy (though I’m not planning on adding to my position, FYI).

20241216 Post update

GEO looks to be exiting survival mode and gearing up for “potentially unprecedented future growth opportunities.” Brian Evans served as GEO’s CEO from Jan 1, 2025 and announced that he would be retiring at the very end of the year on Dec 31, 2024. He is being replaced by J. David Donahue on Jan 1, 2025 (https://www.sec.gov/Archives/edgar/data/923796/000119312524279667/0001193125-24-279667-index.html; https://www.sec.gov/Archives/edgar/data/923796/000119312524074555/d717730ddef14a.htm#toc717730_4).

Evans’ experience was primarily in finance as he served as GEO’s CFO from 2009 to 2023 before his CEo appointment. Meanwhile, Donahue —who GEO is bringing out of his 2020 retirement in order to fill the CEO role— was more focused on operations and the company. To me it seems like GEO appointed Evans in 2024 for his financing experience as GEO faced an uncertain future and needed a fiance person to make sure they could keep the ship solvent and work on paying down debt; Evans was “instrumental in successfully executing the Company’s strategy for three secondary public offerings of equity; the execution of multiple financing transactions; and the successful completion of major business transactions”.

However, now that Trump has won the 2024 elections and will be the incoming President in 2025, it seems like GEO is swapping CEOs for someone with more operational experience as it looks like operations will be heating up bigly in 2025. Additionally, GEO promoted a former ICE COO Daniel Ragsdale as Senior Vice President, Contract Administration and Compliance, further hinting at heightened focus on ICE opportunities. Today, the company also announced a $70MM investment in expanding capacity for ICE-related services, while also exploring the sale of under-performing state-owned facilities; again, emphasizing the focus on ICE operations.

Stephen Miller, Trump’s deputy chief of staff is predicting that Republicans in Congress could get a budget reconciliation bill (which only requires a simple majority vote and Republicans now control all of Congress) to Trump’s desk by the end of January or early February. (https://thehill.com/homenews/administration/5033341-trump-prioritizes-immigration-policy/; https://www.crfb.org/papers/reconciliation-101)

The way I see it, the loss of the BOP contracts from the Biden EO was already priced into the stock’s depressed price and the stock’s recent upswing seems based —for the most part— on an expectation of greatly enhanced ICE operations. I actually like GEO more as an ICE-focused contractor vs the more politically risky business of detaining US citizens (who, for example, tend to have more ties to people in the US that can actually vote and participate/dissent in government to a greater degree); I think government demand for enforcement of immigration laws and the country borders is generally going to be pretty consistently non-zero, thus so too demand for GEO’s ICE-based services without too much need to for diversification into domestic detention services. (Though I do still think that private contractors’ profit-motive (and loss aversion) do have the ability to be better stewards of US prisoners iff incentives and enforcement mechanisms were better configured and managed than they appear to have been handled thus far; BTW, more onerous regulations help to entrench incumbents, so there’s a win-win element there as well).

20250222 Post update

https://www.pogo.org/investigations/private-prison-giant-hired-ice-detention-chief

https://www.npr.org/2025/02/21/g-s1-50100/senate-budget-resolution

https://www.cbsnews.com/amp/news/senate-republicans-budget-plan-vote-a-rama/

https://immigrationimpact.com/2025/02/21/gop-budget-reconciliation-plan/, “This expansion in capacity is exactly what Tom Homan, Trump’s “border czar,” has called for.”

“[T]he Senate is expected to begin the process for passing a budget reconciliation bill, a somewhat obscure Congressional procedure which allows a funding bill to pass both houses of Congress with only a simple majority threshold. […] Senate deal will reportedly include at least an unprecedented $175 billion for immigration and border enforcement, nearly six times the latest annual budget of Customs and Border Protection (CBP) and Immigration and Customs Enforcement (ICE) combined. […] This expansion in capacity is exactly what Tom Homan, Trump’s “border czar,” has called for. He is seeking at least enough funding to detain 100,000 people at any given time”.

Playing with the model, I’d up my base case PT —if the reconciliation package is passed— to around $32. This assumes that GEO is contracted for a similar proportional share of Homan’s 100,000+ requested additional detention beds as their detention operations usually are of ICE’s custody operations budget line (consistently around 60% after the 2021 Biden EO that limited GEO detention operations to ICE). The real uptick would come from seeing how these funds may be allocated to ISAP ATD, which GEO is the exclusive manager of and has much higher margins for the company. This could put GEO in the $50-$60 range. If the percentage of the US illegal alien population simply went from the current 2% to 4.5% (which could be funded at a $6 per diem per person if just half of the similar proportion as with regular appropriations budget that flows to ICE ATD (3.9%) goes to ATD from the Senate reconciliation package as well), in addition to hosting the extra requested beds, I have GEO at around $43.

Here I just set...

- The “change in active beds” to the amount implied by GEO's expected share (based on their implied 2024 share of ICE's ERO > Custody Operations line item) of the 100K requested beds.

- The “ISAP count / total alien pop” percentage such that is approximates the implied annual participants at $6/day based on my estimated % of supplemental reconciliation funding to go to ICE's ATD.

From another POV, the supplemental funding is projected to add $0.450bn/yr-$1bn/yr to GEO’s usual revenues. At a historical mean EV/Sales multiple of 2x, that would put GEO’s EV at $43/sh-$51/sh or a mktcap of around $31/sh-$39/sh after subtracting debt and adding back cash —which coincidentally lands right in between the modeled PT— with that value climbing up as mgmt is able to pay down debt.

20250703 Post update

With the successful passage of Trump’s “One Big Beautiful Bill” (OBBB) through both chambers of Congress today, the government will be sending $150bn in supplemental ICE/CBP funding (spread over the next 4yrs); $45bn of that is for additional detention capacity, $30bn for additional transport and deportation operations, $6.2bn for border tech (maybe this includes money for ATD, but there is not explicit mention of ATD program funding in the OBBB that I can find anywhere online); see https://en.wikipedia.org/wiki/One_Big_Beautiful_Bill_Act.

One of the goals of the OBBB is to add an additional 100K+ beds for ICE detention purposes. Currently ICE is funded for up to 41,500 total active beds —they are currently operating above that official funded capacity with 59,000 beds as of June (https://www.cbsnews.com/news/ice-record-59000-immigrant-detainees-half-no-criminal-record/). So ICE needs to fill a gap of, say, (116000−((41500+59000)/2)=) 65,750 additional detention beds.

This is from GEO’s 2025Q1 10Q…

We are currently marketing (or awaiting activation) 7,453 vacant beds at six U.S. Secure Services and at three of our Reentry Services idle facilities to potential customers. […] However, if the remaining idle facilities were to be activated using our U.S. Secure Services and Reentry Services average per diem rates in 2025 (calculated as the U.S. Secure Services and Reentry Services revenue divided by the number of U.S. Secure Services and Reentry Services mandays) and based on the average occupancy rate in our facilities through March 31, 2025, we would expect to receive incremental annualized revenue of approximately $255 million and an annualized increase in earnings per share of approximately $0.20 to $0.25 per share based on our average operating margins.

IMO, it’s quite reasonable to think that GEO can have this existing idle capacity filled as part of ICE’s new push for an additional 66K detention beds; GEO’s 7,453 beds would only meet 11% of ICE’s total goal (GEO also very recently bought a 770-bed San Diego detention facility, but that appears to be solely related to their USMS customers (https://investors.geogroup.com/news-releases/news-release-details/geo-group-announces-it-has-entered-purchase-agreement-acquire)). Per the Q1 2025 earnings call, for 6,500 of these idle beds, GEO was already “currently in active discussions with both ICE and the Marshals Service regarding their interest in these facilities” with a 60- to 90-day activation period.

Just on this additional idle reactivation alone, at current EV/Sales multiple of 2.15x and using TTM revenues and MRQ balance sheet numbers, we would end up with a mktcap/sh of…

((TTM revenue + incremental est.)*(EV/Sales mult.) - Debt + Cash) / Shares =

(((2422.68+255)*2.15)−(1658.09+25.24)+64) / 138.57 = $29.86

However, this is likely just the floor price, as GEO has additional beds beyond this that can —and likely are being— prepped for ICE use. Per the Q1 2025 earnings call, GEO also has 7000 beds that were currently unutilized by ICE at their Delaney Hall and Northlake facilities; they “working with the New Mexico Corrections Department to depopulate our company-owned 1,200-bed Lea County facility by the end of the year” for which they are currently marketing for Federal re-purposing in 2H2025; GEO also has/had “2 state correctional facilities totaling approximately 3,600 combined beds” which they were initially going to sell, but now appears they are only going to sell the 2,400-bed Lawton Correctional, so (3600-2400=) 1,200 additional convertible beds; (there was also discussion of 3,000 beds at a facility contracted to the USMS, but it was in context of beds that ICE could possibly use, so not sure if this was supposed to be considered part of that so I disregard it). This totals to 9,400 beds that GEO can make available fill ICE’s 65,750-bed gap.

One odd comment from the earnings call was that CEO Donahue saying “As we have previously articulated, we estimate that the utilization of our available idle and underutilized beds could generate between $500 million and $600 million in annualized revenues with margins consistent with our Secure Services owned facilities, which average 25% to 30%.” Yet, the 10Q only mentions $255MM. I assume that this additional revenue is when accounting for use of “underutilized” beds we just inventoried? Then, activating those idle plus underutilized beds would put GEO’s mktcap/sh at $33-35 and ICE will still need 48,897 more beds to meet their OBBB goal that I’m sure GEO would love to find ways to contract.

Risks: The total supplemental ICE funds are planned to be doled out over the course of the next four years and a lot can change in that time, primarily the political composition of Congress. Future Congresses have the authority to amend, rescind, or reallocate unspent funds otherwise apportioned to ICE via the OBBB as these funds are not explicitly protected by any language in the bill that would prohibit rescission of these funds so far as I could find when processing the bill through an LLM; the OBBB itself is full of rescissions as a word search of the full text can show (see https://www.congress.gov/bill/119th-congress/house-bill/1/text).

I look at owning GEO as significantly de-risking from the normal business cycle (which saw significant uncertainty during Trump’s first term (eg. China trade war) and looks set to do so as well during his second), but what you get instead is direct exposure to rather contentious political risk. I think it’s an interesting form of diversification, but I’d also like management to really make hay while the sun is shining here.

The next earnings call in August will be interesting.

1

I had also previously assumed that the company also benefited from its business drivers being rather un-correlated (or anti-correlated) to the rest of the general economy and business cycle, but a basic analysis of their revenues and cashflows from operations (vs my general market proxies: BRK, JNJ, and PG) had mixed results. Based on this, the most I’d say is that GEO’s correlation to the general economy is just “pretty low.”

The S&P Global index construction methodology buckets $1bn-$6.7bn as “smallcap” and $6.7bn-$18bn as “midcap” (see https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-us-indices.pdf). With the recent small additions of some newer positions, along with my medium-sized positions in FNV and MKTX, my portfolio holdings’ weighted average marketcap just crosses the smallcap threshold to a $6.9bn weighted average. Thus, I will compare my performance vs the smallcap indexes as well as against the S&P 400 midcap index (and, of course, vs the broad market index):

(https://www.google.com/finance/quote/SP600:INDEXSP?hl=en&window=YTD&comparison=INDEXRUSSELL%3ARUT%2CNYSEARCA%3AVB%2CINDEXSP%3ASP400TR%2CINDEXNYSEGIS%3AFTW5000)

So far we look to be doing well vs the similarly-marketcap’ed indexes, while behind the broad market by 5pps. (Note that my portfolio is currently 17% cash and money market funds, so the performance would have been slightly higher at around 11.75% YTD if that money was invested evenly over the existing equity investments for the period. 1 Regardless, the actual outcome here is still fine to me.)

Commentary

So far for this year, weak price action breadth across the market and a lack of volatility (which has also led to cheap options contracts) has led me to tentatively start cutting small loser positions (such as in-the-red, goldilocks-macro-aligned positions that have not been successfully executing on their business or the thesis that I originally bought them for), while also adding to certain event-based investments via call options.

That is, the floorboards of the current market levels are looking just a bit creaky, so I figure now is a good time to cut some dead weight, while also adding cheap (and low overall cost-basis) exposure to investments whose underlying theses are less likely to loose steam in the event of a slight market correction. In a way, trying to shift more from market/systemic risk exposure, not to cash or other forms of ‘safety’, but more towards specific/idiosyncratic risk. I think the article here describes this POV pretty well: https://realinvestmentadvice.com/bad-breadth-keeps-getting-worse/. (I wonder how the earnings ‘breadth’ looks (eg. what percent of S&P 500 constituents have had positive EPS growth in their most recent quarter compared to the same time last year)).

(https://www.barchart.com/stocks/quotes/$MMFI/technical-chart?plot=BAR&volume=0&data=DO&density=YTD&pricesOn=1&asPctChange=0&logscale=0&startDate=2024-01-01&indicators=MACD(12,26,9)&sym=$MMFI&grid=1&height=500&studyheight=100; https://www.barchart.com/stocks/quotes/$MMTH/technical-chart?plot=BAR&volume=0&data=DO&density=M&pricesOn=1&asPctChange=0&logscale=0&sym=$MMTH&grid=1&height=500&studyheight=100)

.

Much has been said about the Mag7’s outsized effect on overall stock market returns as of late. I’ve written about it myself in the past here and here. It continues to be written about elsewhere, though I’ve not much more to add at this point as not much has changed with this trend so far as I can tell. I will simply add some more recent writings that touch on the topic here for any interested readers: https://capitalistexploits.at/a-giant-sucking-sound/; https://columnalerts.cmail19.com/t/d-e-eiuulx-jutdtltktj-r/; https://archive.ph/ff87V; https://horizonkinetics.com/app/uploads/Horizon-Kinetics-Q1-2024-Commentary.pdf (see “Today’s Technology Sector Risk”).

.

Despite the out-performance of the SPX and Mag7 vs my more modest basket of holdings, I can’t convince myself to start accumulating a position in these more popular stocks (especially at their present valuations). One of the main reasons I’m still quite comfortable with the portfolio despite the current under-performance vs the broad market index is that it aligns much better with the way I think about diversification, while still allowing for growth in the long-run to come from ideas that I think are a bit more under-followed by the market; I am reminded of the line from Kanye West’s “Ghost Town”: “Years ahead, but way behind”; I like to think my portfolio is ‘years ahead, but way behind (for now).’ (Don’t look up the line that directly precedes that one).

“Here is how it works. When $1 is invested in the S&P 500 index, $0.35 flows directly into the top 10 stocks. The remaining $0.65 is divided between the remaining 490 stocks. Investors who benchmark [to] their index risk failing unless 35% of the portfolio is invested in those 10 stocks. With the market capitalization weighting of the largest companies nearing a record, taking on a 35% stake in those companies increases the portfolio’s risk profile significantly more than many investors think. […] The reality is that even if you buy an index, you will still underperform it over time. Over the last 30 years, the S&P 500 Index has risen by 1987% versus the ETF’s gain of 1916%. The difference is due to the ETF’s operating fees, which the index does not have.” ~~~ https://realinvestmentadvice.com/benchmarking-your-portfolio-may-have-more-risk-than-you-think/

.

Here is roughly how I view my portfolio’s current macro and value/demand-driver diversification:

(https://intelligencequarterly.com/ahead-of-the-herd/the-thinking-mans-quad-system/; I then apply this idea in a manner similar to Ray Dalio’s concept of the “All-Weather” portfolio (see https://ofdollarsanddata.com/ray-dalio-all-weather-portfolio/))

“Instead of using correlation as a measure of dependence between positions, [Ray] Dalio focuses on the underlying drivers that are expected to affect those positions. Drivers are the cause; correlations are the consequence. In order to ensure a diversified portfolio, it is necessary to select assets that have different drivers. By determining the future drivers that are likely to impact each market, a forward-looking approach, Dalio can more accurately assess which positions are likely to move in the same direction or inversely—for example, anticipate when gold and bonds are likely to move in the same direction and when they are likely to move in opposite directions. In contrast, making decisions based on correlation, which is backward looking, can lead to faulty decisions in forming portfolios. Dalio constructs portfolios so that the different positions have different drivers rather than simply being uncorrelated.” ~~~ Jack Schwager, “Hedge Fund Market Wizards”

(For more info on how I’m calculating these charts, see the footnote here). 2

If I apply similar reasoning to the top 50 stocks in the S&P 500 (as of July 4 2024), I think a reasonably-arrived-at distribution ends up looking much less well-rounded than my own portfolio (noting that the large Bitcoin exposure in my own portfolio is based on a much smaller cost basis than what the total value has grown to today)…

Top 5 holdings

Aside from the 17% of the portfolio that is still sitting in cash and money market funds, the top five equity positions (including their current approximate portfolio weightings and YTD returns) are…

BSM (Black Stone Minerals) and other O&G royalties: (15% of portfolio; +4% YTD average weighted)

Not much has changed here since my previous annual portfolio review.

I noted that there appears to be a significant shift in global sentiment and narratives regarding energy and climate change policies with skepticism growing about their effectiveness, particularly influenced by changing government actions. The reversal of governments to coal (https://www.reuters.com/markets/commodities/energy-crisis-fuels-coal-comeback-germany-2022-12-16/), wood (https://www.dw.com/en/eu-weighs-up-future-of-wood-burning-as-renewable-energy-source/a-64985113), and fossil fuels, accompanied by subsidies (https://www.reuters.com/business/environment/global-fossil-fuel-subsidies-rise-despite-calls-phase-out-2023-11-23/), has already increased gasoline consumption. The failure of certain climate change policies is resulting in an “unexpected” increase in demand for coal, oil, and especially natural gas. It seems likely that governments and businesses, no longer able to hide the inadequacy of green policies, will turn to fossil fuels like natural gas as a more viable option, leading to a surge in demand beyond current forecasts. Investments in oil and gas may become more attractive as the narrative shifts away from strict adherence to ESG ideals.

In a recent interview with Daniel Yergin, author of the famous book on the history of the oil industry, “The Prize”, he predicts that…

“The demand for natural gas will continue to grow until the 2040s, partly to replace coal in electricity generation. Oil and gas have different trajectories. But there is another thing to mention: It is only recently that Western governments have woken up to the fact that there is a problem with the supply chains of metals for green technologies. Now the alarm bell has gone off.” ~~~ https://www.nzz.ch/english/energy-guru-daniel-yergin-im-sick-of-the-discussion-about-energy-transition-ld.1821620

Also earlier in that same interview the question is asked “What is the difference between the current energy transition and previous ones?” to which the response is…

“Well, there is one fundamental difference. All of them were energy additions. Oil overtook coal as the world’s number one energy source in the 1960s. But coal hasn’t disappeared. Last year, the world used more coal than ever before, three times as much as in the 1960s. Now we are trying to go from one system to another in a really short time without paying a lot of attention to the amount of resources and minerals that would be required. […] The aim is to shift supply chains away from China. However, this will be difficult because it is not only about mining, but also about China's dominance in the processing of metals and minerals. What’s more, the process from discovery to production in mining can take up to 20 years. I think that there has been an underestimation of the supply chain challenges that are apparent in the energy transition. […] I think the world is becoming more fragile because of the breakdown of globalization. It’s almost time to be nostalgic, because that era of globalization is now over. And all trends and signs indicate that it’s going to get more challenging.”

Aside from the deglobalization / supply chain issues (which will create other long-term inflationary knock-on effects), what I think is left (just barely) unsaid here is that the current push from fossil fuels to green/renewable energy technologies is the first energy transition that is 1] artificially imposed (vs being pursued by organic market forces seeking a better energy efficiency product), is 2] going from a more efficient energy source to less efficient ones, and 3] attempting to remove, by force, the use of the incumbent (and more efficient) energy source, rather than allowing natural competitive forces to result in the phasing out of the older source (which one would expect to happen if the newer source were actually superior).

“If one studies the history of energy, its production and consumption, new technologies with superior energy efficiency always displace old technologies with inferior energy efficiency. As the pundits argued, if wind and solar were ideal forms of energy with superior energy efficiencies, we would be forced to leave behind our oil and gas investments and embrace renewables, as renewables would ultimately displace all hydrocarbon-related energy production. […] Despite being heralded as the future, wind and solar have terrible EROIs [energy return on investment, which measures how much input energy is required to generate a unit of usable power output]. Compared with coal or natural gas, sunlight and wind are not energy-dense. Compare the energy from a gas stove with a stiff breeze or a sunny afternoon; they are different orders of magnitude. Since renewable energy density is so low, their size must be enormous to generate the same output. […] Large size means copious raw materials, which consume enormous energy. As a result, the energy required to generate output is very high, and the EROI is low. […] We concluded that between 50 and 70% of the fall in wind and solar energy’s LCOE [levelized cost of electricity for a generator over its lifetime] was attributable directly to lower capital and energy costs. […] A decade of abundant energy and loose liquidity helped mask renewables’ poor efficiency. That is now over.” ~~~ https://www.gorozen.com/commentaries/3q2023

(https://ourworldindata.org/land-use-per-energy-source; https://energy.glex.no/feature-stories/area-and-material-consumption)

From “The Bitcoin Miner’s Almanac”…

“Strong stable and predictable nuclear energy has an incredibly high capacity factor [how much energy a generator actually produces relative to it’s actual nameplate capacity], ranging in the 80s and 90s. This means a nuclear energy facility with a nameplate capacity of 1 GW of enegry, or 1000 MW, is consistently producing power in the 800 to 900 MW range over a given period. Compare that to a wind farm with the same 1 GW installed capacity. You can expect to consistently operate at a capacity factor between 20% to 40%, producing 200 to 400 MW of energy over a given period. These capacity factors suggest that to produce the same amount of energy from a wind farm as a nuclear plant in a given year, you would have to triple or quadruple the size of your wind farm. […] And I haven’t even mentioned the immense utilization of hydrocarbons to manufacture, deliver, and install those electrical generators —and the geopolitical risks tied to lithium and cobalt production.” ~~~ Robert Warren

In any case, just because something is a good business, that doesn’t mean it’s a good buy right now. I’ll just note that these positions were initially bought during the brief dip in the markets in September of 2021 and I’ve not added much to them since. Rather, they have grown naturally to their existing weightings in part due to elevated energy price levels since that time (as well as due to certain changes in corporate structure and index inclusions).

GBTC + WELX + IBIT: (13% of portfolio; +45% YTD weighted average)

Not much has changed here from the end of 2023 in regards to how I think about the investment.

For anyone curious about my current thoughts on the crypto miner, WELX, given their long-standing holdings of Mt.Gox crypto bankruptcy claims that are apparently now set to be paid out, see the brief substack note/thread I posted here (TLDR: I think the price has gotten ahead of value for the time being, even if their at-cost claims are about to get marked-(up)-to-market):

For my general thoughts on Bitcoin, one can read the older post here:

FNV, Franco Nevada Corp.: (6% of portfolio; 24% YTD)

********** UPDATE 20240719:

I did not include this when I originally made this post because my portfolio is only weighted 3% in FNV stock, but if I were to factor in the underlying economic interest via call options which I initially bought alongside my equity position, then the total exposure rises to 6%; I figure accounting for total economic exposure is a more transparent method when listing off “top portfolio positions”.

Since the time I originally wrote on this situation in the beginning of 2024, FNV stock has gone up 24% from $105/sh to $131/sh, right about where I had initially valued the business. However, this rise was primarily due to the rise in gold prices (20%) and the FNV/gold sh/oz ratio of how many shares an oz of gold could get you is still the same as when I wrote this post, at 18x.

Rate cuts, expected later this year, could further boost gold prices and FNV’s stock in kind (https://seekingalpha.com/news/4124828-gold-settles-at-all-time-highs-citi-sees-potential-for-continued-gains-to-3000).

Adjusting my original Cobre-reopening-contingent price target to account for this year’s rise in gold prices would put it at a target of $156/sh (=135x1.20) —assuming gold prices remain the same.

Panama’s new President, Jose Raul Mulino, was elected in May and was sworn into office on July 1. Unlike other candidates, Mulino has been seen as less adversarial to the Cobre project and his election has been interpreted as a positive sign towards the possible reopening of the mine (https://www.reuters.com/markets/commodities/first-quantum-seek-dialogue-with-new-administration-panama-over-cobre-panama-2024-05-06/; https://archive.ph/JZBMY). Both the Panama government and First Quantum have strong economic incentives to come to the negotiating table here and I think some kind of settlement will be negotiated within, say, 12 months or before the end of 2025.

My original thesis on FNV can be found here:

**********

FRMO, FRMO Corp.: (5% of portfolio; +16% YTD)

In a similar vein to WELX, I think that FRMO is rather fairly valued at this point —if not slightly overvalued. I continue to hold on to this stock, but have sold off small bits of portfolio basis points from the position to average into other holdings like the RENN Fund and others when I think the market discounts to fair value in those other names are more attractive (and where value-realization ‘durations’ and general demand driver exposure are similar).

Here is my basic model for valuing FRMO:

You can use either the market price for SLGD to determine what FRMO’s 4.955% stake in HK LLC (which is reverse merging into SLGD) is worth or use can use the method that I outlined in my previous post on the reverse merger here:

The HK revenue stream value, I determined based on working backwards from a simple DCF model using the known historical fees that FRMO has gotten from this stream and the apparent fact that HK revenues have grown very little over time (see my SLGD post for more details on how I come to this conclusion); I then just round that figure up to $20MM from around $19MM.

(Ignore the margin of safety and stock price stuff in the graphic here as that’s just an artifact of my inputting the nominal book value of the stream).

RCG, The RENN Fund: (4.5% of portfolio; +3.6% YTD)

Really nothing much new to report here since my 2023 review. I think of this as a VC fund curated by Murray Stahl and I expect the performance to either do nothing until I finally capitulate and sell it off or for HK to figure out something to close the discount and get their NAV above the $25MM threshold to start earning fees on the fund and/or for one or more of their private investments to take off and become one of those ‘20 year over-night success stories.’ Management it well-aligned with shareholders and you’re getting exposure to several of Stahl’s private equity ideas that you would not be getting exposure to elsewhere across the HK complex.

You can see my initial investment thesis (with some minor updates) here:

APG, APi Group: (4% of portfolio; +12% YTD)

See https://lemoncakesinvesting.substack.com/i/139945007/api-group-apg-of-portfolio-gainloss.

.

One final note: I sold off my OTCM position to fund some smaller positions that I think have better upside prospects for now. Basically, I think it’s a good business, but I think current prices are already very fair, so the odds and upsides here just seem to recommend using that capital to fund other investments. I think this article sufficiently covers how I also generally thought about selling this position for the time being: https://seekingalpha.com/article/4698794-otc-markets-group-stock-wrong-price-for-fine-business-hold-for-now.

Some notable new nano positions

I have a habit of collecting up small positions in stocks that I think are interesting even when I think they are already either fairly valued or have upside catalysts that are pretty unlikely. In this case, in a similar manner to my interest in gold royalty FNV, we have some “contingency-investments” coming in as various small additions…

CRMZ, CreditRiskMonitor.com (1% of portfolio; -9% YTD)

I have only a small position at the moment and the price has been coming down recently. My current assumption is that it is due to market anticipation of lower rates incoming and expectations for lower inflation and economic volatility going forward (see https://archive.is/RBj4h). Even if I agreed with Mr.Market on these expectations, I’d note that such a time —one where the future economic environment appears to be, and the price action is reflecting, an environment presenting structural headwinds to CRMZ’s business dynamics— would be a good one for accumulating shares of this owner-operated, no-debt, anti-market-correlated business to hold for the longterm.

I can’t seem to find very many anti-correlated businesses that I like, so I’m always interested in owning bits of those kinds of things when I do find them. I’m currently twiddling my thumbs for a lower price right now, since dollar cost averaging in tiny amounts can be a pain for OTC-traded stocks given the transaction fees that come with it.

ITEX (1% of portfolio; +25% YTD)

This is a rather well covered microcap, so IDK that there’s much I’d add to that information; I had been writing something as a draft, but haven’t gotten around to finishing it. In any case, you can get a good read on the company at various points in time up to more recent years in the writeups here: https://www.valueinvestorsclub.com/search/ITEX

Along a similar theme to CRMZ, ITEX is an asset-light, shareholder-aligned/incentivized company that benefits from times of economic stress, acting as a network for member users to liquidate/move excess inventory or capacity without having to resort to heavy discounts, but rather allowing a barter of value for value between member businesses. For example a restaurant experiencing a drop in table reservations during a recession could exchange the value of those reservations for a local member company’s printing services of equivalent (ITEX-dollar) value that the restaurant can use for advertising themselves. Unlike post-2020 CRMZ, ITEX has also long paid a dividend which could come in handy in times of economic stress for dollar-cost-averaging into opportunities that would undoubtably be available in such a scenario. One thing to note, though, is that unlike CRMZ, the business is a bit of a melting iceberg (with revenues declining at around a 7% CAGR since their peak in 2010). Such an asset can still be valuable, but it means one should be doubly careful about the price paid for any shares —especially considering how illiquid the stock is.

My position here is small at the moment as the stock is very illiquid and volumes started picking up the day after I started DCA’ing into the stock, but I’d be open to put a few more portfolio percentage points into the name at the right prices.

.

1

Let’s look at the portfolio as having just two stocks that we could have put out money towards: Lemon Cakes ETF (LC) and Cash.

Our total return for the year so far could be calculated like this:

where…

(I had to copy images of the LaTex as Substack’s built-in interpreter seems unable to render it when it’s in the footnotes section, IDK why; and if anyone knows how to get \newline to work in Substack’s LaTex, do let me know.)

We can get the return of the Lemon Cakes ETF as…

Our cash allocation to Cash is 17% and whether we say the cash return was 0% or 2.3% (accounting for the 4.6% interest rate), so the return on the Lemon Cakes ETF still comes out to around 11.75%.

2

I have a Google Spreadsheets sheet that contains columns for Ticker, % of portfolio, demand drivers, and macro quads.

The “demand drivers” column contains semicolon-delimited lists of short descriptions of the general value and demand drivers that I think best describe what drives the business for that ticker that are still general enough to apply to more than just that specific company. The “macro quads” column contains semicolon-delimited lists of the primary (and tertiary, if applicable) macroeconomic quads that I think would act as meaningful tailwinds for a given ticker. The macroeconomic quads I use to determine the labels to apply for each ticker is shown below:

(From an old article by Nicholas Glinsman of Malmgren-Glinsman Partners (see https://intelligencequarterly.com/ahead-of-the-herd/the-thinking-mans-quad-system/); I then apply this idea in a manner similar to Ray Dalio’s concept of the “All-Weather” portfolio (see https://ofdollarsanddata.com/ray-dalio-all-weather-portfolio/))

Now to determine the various exposures to different demand drivers of the total portfolio, I do this. In a separate sheet, I use a set of formulas to first list all of the portfolio weights for each ticker and the list of demand drivers for that ticker. Then I have formulas to break up each individual ticker’s list of demand drivers and uniformly distribute the ticker’s total portfolio weights, so a row of stock weighting and value/demand drivers cells for, say, Wheaton Precious Metals, that looks like…

3% | Gold prices; Gold GOE prod. volumes; geopol tensions

Will end up as multiple rows that look like…

1% | GOLD PRICES
1% | GOLD GOE PROD.
1% | GEOPOL TENSIONS

I then use all of these final pairs of distributed portfolio weightings and associated drivers to create a pivot table that aggregates everything across all of the companies by the value/demand driver labels and displays the sum portfolio weighting associated with that label.

When doing this exercise for the set of the 50 highest-weighted S&P 500 stocks, I am getting the list of top 50 positions with company name, ticker, and index weighting data, having an LLM (Anthropic’s Claude 3.5 Sonnet) generate the macro quads and generalized demand drivers lists for me, and spot-checking the outputs to check that they make actual sense —so there is the possibility of some bias there on my part, but I think the outputs were reasonable and anyone can do a similar exercise to this on their own and adjust things however they think is most accurate.

(As a spot-check, I gave the LLM my own list of portfolio holdings and had it come up with the individual and aggregate macro exposures on its own and it came up with a roughly similar distribution to the one I came up with. So at the very least, it does not appear that I am too biased in my estimation of my portfolio’s macro diversification vs the S&P 500 on a relative basis.)

Lump this post in the basket of other ‘interesting stock, but I wouldn’t buy right now’ posts I’ve written. I’m basically only writing this to possibly help any other fellow investors in the HK complex of funds or sister companies to avoid a possible stinker here —or to get feedback from y’all on why I’m wrong about this and should actually be buying at these levels (as the spread is nominally quite large). This post also could be thought of as containing a general framework to think about the stock as prices fluctuate —and possibly provide a more attractive opportunity— ahead of the (expected) end of April 2024 merger completion date.

Keep in mind that I wouldn’t say that the current price of $0.86 is necessarily my own price target (IDK that I fully have one at the moment). More so I’m just looking at what the market is saying and going “Does that make sense? Is that justified? What would one have to believe to price the stock like that?” and playing around with some numbers to try to see what kind of reasonable assumptions lead to that current price. I'm doing that and, after playing with the numbers and POVs a bit, going “Hmm, maybe Mr.Market(-for-SLGD-stock) 1 has a point here.” There are not-unreasonable POVs from which I think the current market-implied price for HKAM makes sense as I will try to show.

(Source: here)

*I should note that I own a significant position in FRMO which owns a 4.95% stake in HK LLC, so even though I’m saying that I wouldn’t buy SLGD (soon to be HK) or that it’s not very undervalued at the moment, I’d still benefit to some degree if SLGD popped after the merger.

**When I show spreadsheets here, blue text means that it is a figure that I’m deriving myself / is based on formulas in the sheet, while black text is usually hard-coded values (eg. based on data directly copied from another source). Cells are are colored pink denote values that should be noted as key assumptions that are being used in the sheet.

*** When we look at financial statements from FRMO that include results of HK LLC, note that there is going to be some oddness because as mentioned in the FRMO 2023 annual letter: “Horizon Kinetics is on a calendar fiscal year and FRMO is on a May fiscal year, so that the March 31, 2023 financial statements for Horizon Kinetics were the latest available at the time that the FRMO financial statements were prepared.”

Contents

• Background info

  • The merger

  • Why they did it

• Calculation of Final Consideration

• Theoretical “IPO” value of SLGD/HK

  • HKAM

  • HK NAV

• Price implied expectations (PIE) for HK’s value, post-merger

  • % of AUM

  • Perpetual growth model

• Epilogue

Background info

The relevant entities:

• Scott’s Liquid Gold (SLGD): SLGD is a public microcap that trades on the OTC Markets. I don’t really know much about the company. I’m currently going on the assumption that the market price they had before their announcement of the reverse merger with HK was basically fair value. In any case, given their relative pre-merger size vs HK, I don’t think that too much of an analysis of the business is needed to understand the value of the overall deal we’re going to cover.

  • Regardless, here is a quick history of the company: Incorporated in 1954, SLGD initially focused on its namesake Scott's Liquid Gold household cleaning products and, over time, expanded into household and personal care products. Starting around 2022, the company started making significant divestments of various product lines leaving them with only the Kids N Pets and Messy Pet product lines by the start of 2023. In December 2023, SLGD announced that it had agreed to a (reverse) merger with HK LLC with Horizon Kinetics being the surviving entity. 2

• Horizon Kinetics (HK): HK is an asset management company founded in 1994 by Murray Stahl, Steven Bregman, Peter Doyle, Tom Ewing, and John Meditz.

  • In more recent news, you may know Stalh and HK for their involvement in converting the 100-bagger stock Texas Pacific Land Corp, TPL, (of which they’ve been long-time investors in and now own around 20% of) 3 from a trust to a C-corp and later getting sued by the rest of the company’s BoD (whom are much less invested and aligned with shareholders, I might add) for opposing the dilution of existing shareholders for the purpose of providing ‘deal currency’ for unprecedented M&A adventures by the rest of company management 4.

  • For more information see their SEC Form ADV 5 and other disclusures here: https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=902164; https://adviserinfo.sec.gov/firm/summary/106096; (here is some info on their subsidiary KBD Securities (which I assume stands for ‘Kinetics Broker Dealer’) that also mentioned in the merger agreement) https://brokercheck.finra.org/firm/summary/104110

• FRMO Corp. (FRMO): FRMO is a public (asset holding) company founded by Stahl around 2001 in which he and co-founder Steve Bregman each own 16% of the common shares and take no other form of compensation. While not directly part of the transaction, they have a 4.95% equity stake and 4.199% revenue participation interest (read as: “royalty”) in HK. I’ve owned the stock for a good while and they are relevant to this discussion because, through their equity stake (which prompted them to start including summarized financials of HK in their annual reports starting in 2020) and revenue interest (from which we can derive a rough sense of what HK’s total revenues might be), we can derive some historical financial data for HK in this situation where we would otherwise have no public source from which to make educated estimates of HK’s fundamentals.

  • For more information about FRMO, I’ve written more on the company it in the past here

    and here

    (note that the latter article was the first post I ever wrote so the writing is a lot looser and rambles even more than in my more recent stuff; this was written at a time when I had to make zero considerations for the idea that anyone might actually read anything here; I’d encourage readers to view the About section of this substack).

The merger

For the full details on the deal, see the SLGD 8K filing here: https://www.sec.gov/Archives/edgar/data/88000/000095017023072802/0000950170-23-072802-index.htm

Like I mentioned, in late December 2023, SLGD announced that it had agreed to a (reverse) merger with HK LLC with HK being the surviving entity.

(Congratulations to those who apparently sniffed value in the air when the big divestments started rolling around June 2023, https://www.google.com/finance/quote/SLGD:OTCMKTS?sa=X&ved=2ahUKEwiA0KK03qeFAxU7M0QIHaZfAegQ3ecFegQIKRAf)

The SLGD board of directors will be expanded from 4 to 7 members, with HK selecting 6 of those directors (as 3 of the original 4 will be made to resign and HK will select the 3 who replace them in addition to choosing the new 3 to make up the final 7 (“Section 1.06 Directors and Officers” of the 8K)). After the merger “[t]he Company currently expects its legacy shareholder ownership to be between 2% and 4% of the pro forma combined company. However, the exact percentage may be different and will reflect the number of Merger Shares calculated in accordance with the Merger Agreement based on Horizon Kinetics’ financial position at closing.” Meanwhile, HK members will be receiving the substantial majority of the combined company’s shares (between 96% and 98%) in exchange for their ownership interests in Horizon Kinetics. The 8K does not say who will be Chairman or CEO, but in all likelihood it’s going to be Stahl and/or Bregman.

According to Stahl, the deal is expected to close around April 30, 2024.

“I’m expecting, but don’t hold me to it, this deal to close sometime around the end of April. Let’s say, with fortune, April 30th.” ~~~ Murray Stahl, FRMO FY2024Q2 conference call (https://www.frmocorp.com/_content/letters/2024_Q2_FRMO_Transcript.pdf)

(Pictured above: HK moving from the private market into the emptied out husk of SLGD; source: https://todropscience.tumblr.com/post/109995319497/just-a-hermit-crab-pagurus-prideaux-slowly)

Why they did it

As a bit of foreshadowing to my ambivalent/dour opinion on the spread —and apparent “opportunity” therein— between the current stock price and the post-merger “IPO” target price, note that this merger is not being done with any explicit eye to value creation or HK being able to capture some kind of profitable opportunity by having the company be public, but rather to provide some exit liquidity for some of their long-time owners.

“Why did we decide to do it? There are two kinds of shareholders at Horizon Kinetics. There are ones who are active in the business—you’re talking to one right now. I’m not going anywhere, I’m not selling any shares. As far as I know, I’m in good health, and I like what I’m doing. I’m going to keep doing it. So, everything is fine. I’m not looking for any liquidity. I don’t need any liquidity, thank goodness. But there are people who own shares that are not active in the business. They were just investors in the beginning, and they got to a certain age, and they may have some need of liquidity, so it’s not fair to keep them locked up. So, there are two options. Option number one is, we could have bought their shares, in which case, we would have a negotiated price. We’re the insiders, and we’re giving them a price, which from their point of view may or may not be fair. You can see that might be problematic. It might even be a conflict of interest if we were to quote a price. The other possibility is, the market will determine a price. If they want to sell, they can sell. If they don’t want to sell, they don’t have to sell. Maybe they even want to buy more. We’re going to see what happens.” ~~~ HK founder Murray Stahl, https://www.frmocorp.com/_content/letters/2024_Q2_FRMO_Transcript.pdf

Calculation of Final Consideration

A key point in estimating the per share value of SLGD/HK post-merger is being able to guess as to what the post-merger shares outstanding (S/O) are going to be. We can do this because the calculation for the number of new shares that will be issued in the merger is provided in the merger agreement 6.

(https://www.sec.gov/Archives/edgar/data/88000/000095017023072802/slgd-ex2_1.htm)

The number of shares to be created in the merger are such that, based on the calculation of the HK’s total “value”, the value per share for the newly created shares will (theoretically) be $1.25. (Of course, the market appears to think that the value of HK should be calculated differently to how the merger agreement is planning to do it and is the main subject of this post, which I will get to in a bit).

(Theoretical stock price = Value/Share ==> Final Consideration # of shares = Value / Target price).

Theoretical “IPO” value of SLGD/HK

The value of HK for the Final Consideration of the merger is based on two components: HK’s NAV (net assets owned by HK on their balance sheet) and the value of HK’s “operating business”, which is the asset management business. (Starting from this point, when I’m referring to HK’s operating asset management business, I’ll be using HKAM for short).

HKAM

The value of HKAM, per the merger doc, will be calculated thusly: “Under the Merger Agreement, the value of the Horizon Kinetics operating business is (i) stipulated to be $200 million if and only if Horizon Kinetics’ regulatory assets under management (“AUM”) are between $6 billion and $8 billion, and (ii) otherwise is calculated by multiplying AUM by a factor of 0.03.” We can get a good idea of what HK’s current AUM might be right now using their recent SEC Form ADV Firm Brochure, published March 28, 2024 (https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=902164), which states: “As of December 31. 2023, client assets managed by HKAM totaled approximately $6,503 million [ie. $6.5 billion]; discretionary assets totaled $6,297 million and non-discretionary assets totaled $207 million.”

This 3%-of-AUM heuristic is something I’ve seen before when it comes to valuing asset management businesses and has been mentioned by Stahl in previous FRMO conference calls 7, so it shouldn’t be a surprise to see HK determining HKAM’s value in this way.

That was in December of 2023, we’re about 1/4 into 2024 now and maybe there’s been some change. One thing to note is that we can kinda guess with high confidence the overall makeup of HK’s AUM using their public 13F/D disclosures 8. From this, we can see that the main drivers of HK’s AUM is going to be the performance of TPL and GBTC (and to a lesser extent, WPM, CACI, ICE, and FNV), both of which are up year-to-date and thus we can be confident the AUM is still above $6bn (though probably less than $8bn) resulting in a value attribution of around $200MM ($6.5bn*0.03=$195MM) to HKAM by the method of the merger doc (well actually, anything between $6bn and $8bn AUM results in HKAM getting pinned to exactly $200MM by the agreement rules, but in this case the difference in tiny).

(https://fintel.io/i/horizon-kinetics-asset-management; HKAM’s public investments were composed of 44% TPL and 11% GBTC as of December 31, 2023; YTD, TPL is up by around 10% and GBTC by 60% for a total YTD percentage point contribution of (0.44*0.10)+(0.11*0.60)=11pps (which is actually nearly identical to the YTD return of HKAM’s headline Kinetics Paradigm Fund 9, which can give one a sense of how much these two investments drive returns for HK overall); we would have needed around 2x that return YTD in order to get $6.5bn up past $8bn)

HK NAV

********** UPDATE 20240807: Scott’s Liquid Gold is now officially Horizon Kinetics Holding Corporation (HKHC) ($SLGDD) with the merger and 1-for-20 reverse split officially completed on Aug 1 2024. The associated 8K filing (https://www.sec.gov/Archives/edgar/data/88000/000095017024092922/0000950170-24-092922-index.htm) also includes a breakdown of consolidated financials for HK LLC.

As of March 31, 2024, total equity was $252,598,000 (they report their estimated NAV at the end of the filing as a slightly lesser $249,606,000, which I assume has something to do with excluding intangibles and goodwill, though I’m not sure). The total consolidated equity of the combined business as of March 31, 2024 (which includes Kinetics Common and Kinetics Holdings) was $296,078,000 (see “UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION”). You can find the breakdown of the investments in the footnotes of the filing. (Be sure to check the associated date for the breakdown values as there are duplicate footnotes because the filing includes numbers for annual 2022 and 2023 results as well as first-three-months of 2024 results, so make sure you’re looking at the right time period).

The largest contributor to HK’s assets is their “investments in proprietary funds”

While they never describe what these various funds do within the document itself, you can find a bit more information on them in an old post on FRMO I made a while back —as they have many of these LP investments in common. See the section link here (try not to scroll in your browser for a few seconds once you get transferred by the link, so the web browser can jump to the right section within the post).

For some info on the Horizon Kinetics Equity Opportunities Fund (which FRMO does not own a stake in), you can see the attached docs on this old 2018 letter from Santa Monica Partners’ Lawrence Goldstein: https://irp.cdn-website.com/cfd0d660/files/uploaded/ltp-2018-q1.pdf

As for the value of the new company after the 1-for-20, while the dollar price has changed, I maintain that the price seems to imply a level of expected future growth for HKAM that seems unfounded given their historical performance as I described in later sections of this existing post.

**********

********** UPDATE 20240504: So the merger proxy was recently published (https://www.sec.gov/Archives/edgar/data/88000/000095017024052083/0000950170-24-052083-index.htm, see “UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION”) and we’re able to see the total NAV of HK, factoring in the contribution of HK’s merged “Member Corporations” less the equity of SLGD, at around $243,669,000 —a good bit below my initial estimate of ~$300MM, even before I considered the possible additional contribution of the member corporations. **********

********** UPDATE 20240406:

Actually, there’s an easier and more current way to get HK’s approximate NAV.

FRMO owns a 4.95% stake in HK LLC. FRMO records their ownership stake on their balance sheet as the proportionate book value of HK LLC.

“But right now, I think the pro-rata ownership is something like either 4.93% or 4.95%. If you take that FRMO balance sheet figure of, let's call it, $14.5 million to make it easy, and you divide it by .0495, just to approximate, that's $292 million. That would be the Horizon Kinetics balance book value, if you wanted to make that calculation. HK doesn’t have $292 million in cash and hard assets, since there's some goodwill there, but it’s got a lot. I'm not disclosing the number we have right now, but as I said, there's not a lot of goodwill there, especially not for an investment management company.” ~~~ Murray Stahl (note this these particular numbers are from Jan 2023)

As of FRMO’s most recent quarterly report, which contains numbers as of Nov 30, 2023, that calculation gives an HK LLC book value of ($15,079,831/0.0495=)$304,643,050.51; not too far off from the low end of the merger doc Final Consideration example table, only requiring a ((325000000/304643050.51)−1=)~7% increase from that level get to the very lowest example number (which is about the same as the return on HK’s headline Kinetics Paradigm Fund since that time to today), so $325MM seems like a reasonable base NAV estimate for HK LLC.

Also note that this does not take into account the NAV that could be included by the consolidation of HK LLC’s “member corporations” in the merger’s pre-closing restructuring (something pointed out to me by the author of https://fundamentalfinanceplaybook.com/):

“The Company shall enter into a merger agreement or agreements with one or more of its members that are corporations for U.S. federal and applicable state and local Income Tax purposes, including one or more of Horizon Common, Kinetics Common and Kinetics Holdings (collectively, the “Member Corporations”), pursuant to which the Member Corporations participating in such merger transaction shall be merged with and into the Company, with the Company being the surviving corporation of such mergers and the shareholders of such Member Corporations receiving membership interests in the Company in exchange for their shares of stock in such Member Corporations.” ~~~ https://www.sec.gov/Archives/edgar/data/88000/000095017023072802/slgd-ex2_1.htm

I played around with this idea a bit and just added to the base HK LLC NAV estimate the share counts (adjusted for the recent 1-to-3 split) of TPL “Amount of Securities Beneficially Owned” from Horizon Common Inc, Kinetics Advisers LLC, and Kinetics Asset Management LLC based on Form 4 filings by HKAM and HK LLC, plus all of Winland Holdings CEO Matt Houk’s (an HK employee) 14% ownership stake in the company, as well as *assuming* a similar stake in CMSC as FRMO (I recall as a 1% stake). This only gives an 8% increase in NAV from $325MM to around $350MM, but there is a lot of unknowns once one starts looking into this (eg. how much of HK Hard Assets I and II are collectively owned by these sister companies that are not counted in the direct beneficial ownership amounts, etc), so there’s quite a bit up in the air on this; I’m just trying to form a base of what’s *known* here.

**********

How can we come up with a reasonable value for HK’s NAV? Well, as I mentioned, the other public Stahl vehicle FRMO Corp has a material equity stake in HK LLC and has been providing summarized financials for the company in their annual reports since 2020 10. I’ve summarized those reported numbers here:

Note that these numbers are reported for the period ending March 31 of that year from the previous year. A lot has happened since March 2023, so how can we guess HK’s current NAV? Well, the Final Consideration Calculation in the merger doc provides a range of possible NAV amounts as an example for what the Final Consideration share count might be. Let’s look at the low end of the range:

I don’t think they provided this particular range in their example just by random chance, especially given that the HKAM value (according to the valuation method of the merger docs) used in this example table is based on realistic estimates of HK’s AUM, and subsequent “value”, that we do have recent data for. How much would HK’s NAV of $192MM in March 2023 need to rise by April of 2024, this year, in order to get up to at least that low end of the range? That would be an increase of ($325MM/$192MM - 1 =) 70% from March 2023, no small feat. However, Stahl and HK have been one of the earliest institutional investors in the Bitcoin space, starting mining operations and buying their first shares of GBTC in around 2015, and that gives these NAV estimates (that are greatly above the March 2023 NAV) an air of plausibility given how Bitcoin has done since that time to today.

At the time of my writing this (April 3, 2024), TPL is up by 3% from March 31, 2023 and GBTC is up 258%. Iff we assume that HK’s private balance sheet was basically the same as it’s public investments at the time (I’m guessing that a lot of their assets are investments in their own HKAM’s own products as well as some private/yet-to-be public assets Stahl has discussed in the past), we could use the HKAM public ownership filings or FRMO’s own reported % of TPL on their books to guess at what ballpark amounts of GBTC HK would need to have been holding in order to get near +70% in April 2024 from March 2023 on just the strength of these two investments.

(FRMO FY2023 annual report, https://www.frmocorp.com/_content/10k/FRMO_Annual_Report_2023.pdf; For those unfamiliar with FRMO, “Investment A” is TPL and “Investment B” is GBTC; if you don’t believe me see “Questioner 8” here: https://www.frmocorp.com/_content/letters/2021_Q3_FRMO_Transcript.pdf)

I set up the problem like this:

(0.03*X)+(2.58*Y)= 0.70, X = 0.466, solve for Y ==> Y = 27%.

That’s quite a bit of GBTC, but not an amount that FRMO has not held, itself, at past points in its history, so it’s not impossible to think that HK would have made that kind of allocation for themselves during the crypto winter or in any case been comfortable holding that level of BTC exposure at the time.

(https://www.frmocorp.com/_content/10q/FRMO_Corp_Q3_2021.pdf)

I think that assuming a BTC/GBTC allocation materially beyond that is a lot less believable (and certainly has no precedent that I’ve seen).

Assuming that the Final Consideration Calculation table’s NAV range was not completely chosen at random, my takeaway here is that HK’s current NAV is likely on the very lowest end of the provided range. So, let’s pin it at that lowest $325MM value as a reasonable, yet conservative, estimate.

(Of course this is ultimately speculation and we will see HK’s true balance sheet and asset makeup once the merger is completed, but I think this estimate is not based on anything too crazy).

.

Combining our educated guess as to HK’s NAV with HKAM’s theoretical value according to the merger agreement’s method of valuation, we get a combined value of $525MM.

Using this estimate for what the HK NAV and HKAM valuation will be determined to be at the time of the Final Consideration, we can then use the Final Consideration calculation to determine the number of shares that will be created; we divide the total estimated HK company value by 1.25. “Final Consideration shall be the quotient obtained by dividing Total Company Value by 1.25; provided, however, that the maximum Final Consideration under the Agreement shall be 637,000,000 shares of Parent Common Stock.”

$525MM/1.25 = 420,000,000 shares

Combine this with the existing 13,006,162 S/O of SLGD (per their most recent 10K, https://www.sec.gov/Archives/edgar/data/88000/000095017024036394/0000950170-24-036394-index.htm) and we can get a total expected number of shares, post-merger, as well as a total company value when adding the expected/theoretical HK total value to the value of SLGD’s existing line of business (I do this by simply taking the SLGD marketcap pre-merger-announcement and assuming that that is fair value for the stock). Take that combined SLGD+HK company value and divide it by the post-merger expected S/O and we can see what the final share price should be; $1.22/sh.

However, what we see in reality is that the collective mind of the market (or the market for these particular microcap OTC SLGD shares, to be more exact) is valuing SLGD existing shares at a much lower price than that ($0.86/sh). The question then is: Is this huge discount to the targeted “IPO” price actually a reasonable evaluation of HK’s “value” or is this price being overly pessimistic and thus creating an opportunity to capture a hefty spread when the deal concludes?

Price implied expectations (PIE) for HK’s value, post-merger

“It is not enough to think about difficult problems one way. You need to think about them forwards and backward. Inversion often forces you to uncover hidden beliefs about the problem you are trying to solve. “Indeed,” says Munger, “many problems can’t be solved forward.” ~~~ “Inversion and The Power of Avoiding Stupidity”, https://fs.blog/inversion/

Now, I’ve mentioned a bit about how great I think Stahl is as an investment thinker, how I’ve been a longtime investor in other companies he runs, and have just shown what a significant spread that SLGD shares are trading at relative to the targeted reverse merger “IPO” price. So why am I mostly indifferent on the stock (aside from the fact that I already have significant exposure to Stahl’s investing ideas through material positions in other Stahl/HK vehicles)? Why do I think that the current price and spread may actually be justified?

We can see the price implied expectation (PIE) value that the market is assigning to HK LLC by taking the current existing share price multiplied by the expected post-merger S/O and netting out the value of SLGD’s existing business (again, assuming that the marketcap pre-merger-announcement was fairly valuing that business). We can also the subtract the estimated value of HK’s NAV to get just the market’s price-implied-expectation value of HKAM ($42.2MM or contributing $0.10/sh to SLGD). In the table below, I’ve also provided some ratios of HKAM’s implied value vs “known” financials such as HK’s most recently reported AUM, revenues, and earnings (the latter two as summarized in FRMO’s annual reports, which here report HK’s numbers as they existed in March 31, 2023).

The question then is: Is this valuation of HKAM justified? What are some reasonable lenses through which one would have to be looking at HKAM in order to assign this value that is at such disagreement with the way that the merger agreement would like to think of its value?

% of AUM

Note that HKAM’s fees on their investment products range from just 0.85% AUM for their ETFs to 1.25% on their mutual funds (see “Fees and Compensation”, https://files.adviserinfo.sec.gov/IAPD/Content/Common/crd_iapd_Brochure.aspx?BRCHR_VRSN_ID=902164). At an assumed average realized fee of 1% of AUM across their products, valuing HKAM at 3% of AUM is the same as valuing it at 3x revenue.

From the table, we see that the price implied value of HKAM vs our known AUM figure is 0.65% of AUM, not 3% as is planned to be used in the merger Final Consideration calculation for HKAM’s value. Is 0.65% an unreasonably low rate at which to capitalize the business against their AUM?

I don’t really know. I’ll say this: There are several problems with simply taking a 3%-of-AUM heuristic and applying it to every asset manager we come across. You can read more about this issue here: https://mercercapital.com/riavaluationinsights/practice-management/valuation-of-asset-management-firms/; https://mercercapital.com/riavaluationinsights/practice-management/asset-manager-valuation-and-rules-of-thumb/; https://www.linkedin.com/pulse/evolution-rule-based-valuation-metrics-why-still-dont-brooks

We can play around with different %s-of-AUM valuations here:

(Note that, while even just at 1%-of-AUM we can still get great returns iff HK’s NAV is valued above 1.2x, I’d just note that people I’ve talked to who contacted HK about what that NAV is —while not being given a specific value— have been told that the majority of those assets are “liquid” assets, which I take to mean “public”, which I’d guess mostly mirror their portfolio investments and are mostly TPL (via another private HK LP, HK Hard Assets and Hard Assets II which I won’t get into) as well as GBTC and BTC owned on HK’s own account, in addition to smaller holdings like MIH/MIAX, HM Tech, CMSC, and Diamond Standard. In fact, I’d bet a lot of HK’s NAV are investments in their own produtcs. In any case, given that these assets would be —on the whole— nothing specific to HK and able to be bought on the market by anyone, I think the conservative approach of sticking with a 1x multiple on NAV is not overly harsh. Others may disagree, but we really have zero information on this element, so not much to really speak on here, IMO.)

Ultimately, the value of a business is much more closely tied to its earnings, the growth prospects thereof, and discount rate(s) against which ones weighs those earnings, rather than any multiple on revenues that bakes in such assumptions (in addition to assumptions on profit margins) in a way that is not made explicit, yet nonetheless exists under the surface.

Given all of the information available on HKAM’s underlying financials from SLGD’s public filings on the merger (that being no information at all), at this point I’d think there wasn’t much else to go on for valuing the business and —in the absence of any other information— would just go with the 3% rule of thumb that HK seems to think was a fine valuation method to use in the merger agreement.

However, remember that FRMO has annual reports going back to 2009, a revenue interest in HK as well as an equity stake that —as we’ve seen in prior sections— has given them reason to report summarized financial results for HK alongside their own annual results, since 2020. We can use these clues to derive some earnings and longterm growth information about HK that we wouldn’t otherwise have any insight into.

Perpetual growth model

OK, yes, HK is kinda “trapped” in TPL (https://www.morningstar.com/funds/fund-shop-bets-ranch-one-stock); it’s an capex-light 100-bagger and there are worse stocks one could be concentrated and stuck in. Yes, Stahl is the main brain of the whole operation, is legally a senior citizen now, and presents a notable key-man risk; I’d assuage those worried about this by directing them to the article here (https://www.mutualfundobserver.com/2023/08/the-unfortunate-manager-the-ill-timed-bus-and-you/). Yes, HK is “IPO’ing” on the much less liquid OTC Markets 11. In any case, the valuation multiples that the market price is implying just seem way too cheap at first glance, but I guess the response then is, “Compared to what, exactly?”...

.

“The cost of a thing is the amount of what I will call life which is required to be exchanged for it, immediately or in the long run.” ~~~ Henry David Thoreau, “Walden”

“The concept of opportunity cost is overlooked. In the real world, your opportunity costs are what you want to base your decisions on. […] In life, if opportunity A is better than B, and you have only one opportunity, you do A. There’s no one-size-fits-all.” ~~~ Charlie Munger, https://25iq.com/2015/11/21/why-and-how-do-munger-and-buffett-discount-the-future-cash-flows-at-the-30-year-u-s-treasury-rate/; https://www.valueinvestingworld.com/2014/05/charlie-munger-on-opportunity-costs.html

Investors in the HKAM business are effectively buying a stake in HKAM’s stock portfolio + asset management business that derives its fees from that portfolio. IMO, the stock portfolio’s expected returns represent a reasonable opportunity cost or benchmark return that the asset management business can be compared against. Using this as the discount rate to value HKAM as a business grounds it to tangible, observable returns which I think better reflects economic reality and opportunity cost for their particular business vs an abstract cost of capital estimate that we might have to use if the business were not as simple as HKAM’s is.

Here is the breakdown of HKAM’s investment portfolio as disclosed in their public 13F/D filings:

Around 42% of that energy exposure is solely from HKAM’s investment in TPL and all of that crypto exposure is from the GBTC Bitcoin ETF. I believe that, overall, the returns of TPL (and to a somewhat lesser extent, GBTC) are what ultimately drive HK’s AUM (and thus management revenues and earnings). IMO (and maybe I’m missing something) this is a bit obvious, but we can kinda check this by looking at how correlated this kind of investment portfolio’s total returns are to just TPL’s returns using the Kinetics Paradigm Fund (ticker: WWNPX) as a proxy.

(https://kineticsfunds.com/funds/paradigm-fund/)

Here is WWNPX vs a custom portfolio of 45% TPL, 5% GBTC, and 50% of plain SPY, without re-balancing, compared over the past 3 years:

(https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=3SKyD2LTfXslN3akezztoW)

We see that one could get similar —in fact, better— results from just a fund of HK’s top two individual investments vs their headline mutual fund and that those results have really been mostly driven by TPL over the backtest period (results are similar for a 5yr period).

When I look at HKAM’s investments that ultimately drive their AUM (and thus revenues and earnings), I see the opportunity cost as being a self-bought “mini-ETF” of just TPL and GBTC in a similar relative weighting to HKAM’s overall investment portfolio. That is, just taking the capital that one would have used to invest in stock of HKAM and just going direct by using that money to buy the underlying top two, highly concentrated positions of the asset manager that drive their returns. (Doing this would certainly give you much more liquidity than investing in SLGD shares in the OTC market). What would the return be of such a self-made “ETF”?

(Note that I keep using 5% here as the GBTC initial weighting only because that was the weighting that HKAM had for in the Paradigm Fund in 2021, https://www.nasdaq.com/articles/$7-billion-investment-firm-horizon-kinetics-grows-bitcoin-exposure-2021-07-28. I think it’s a good median point between the 1% they started with and the 15% they have now.)

Something to note is that, in addition to being very large (especially for TPL), these allocations have not changed much since around 2019Q1 for TPL (when HK won their proxy battle to have the Texas Pacific Land Trust converted into a C-corp) and 2021 for GBTC 12. Furthermore, HKAM does not —by and large— take a very active approach to investing, but rather they are highly concentrated and tend to prefer to hold things for a very long time as can be evidenced by WWNPX’s tiny turnover ratio (less than 1%, https://kineticsfunds.com/funds/paradigm-fund/), their Kinetics Fund’s stated investment philosophy (https://kineticsfunds.com/our-approach/investment-philosophy/), and the number of times the phrase “long-term”, “long-view”, etc come up in the 2024 interview with Murray Stahl here (https://horizonkinetics.com/app/uploads/VII_Worth-The-Time_Stahl_Feb-2024.pdf). The name of their firm itself, Horizon Kinetics, was based on the idea of putting their energies (kinetics) into long time horizon endeavors 13. Also, if you read any of the writings, interviews, etc from Stahl or HK, you’d get the strong sense that they don’t intend to sell their TPL or Bitcoin 14 positions any time soon.

My point is that, at the highest level 15, it’s not that hard replicate and maintain the underlying investment fortunes of HKAM on one’s own. They’re not trading a “diversified” portfolio in and out of dozens of long and short special situations every quarter or using technical analysis and high-powered computers to trade in and out of thousands of stock every day/week. All you’d need to to is track 2 things every quarter to manually keep your “mini ETF” on track with HKAM’s main drivers: Their portfolio % of TPL and of GBTC (and you can do so using this: https://whalewisdom.com/filer/horizon-asset-management-inc-ny). Also recall that my backtest of TPL/GBTC/SPY did not do any re-balancing and beat WWNPX in that 3yr time period (and similarly if you change the period to a 5yr one). So, this POV is practical as well.

All this to say, when I think about the opportunity cost of buying HKAM, the business, I don’t think one would be unreasonable for comparing it to simply buying a self-constructed 90%/10%-TPL/GBTC “mini-ETF”. Of course, when we look at the long-term returns of such an “ETF”, we’ve seen that would imply an opportunity cost or discount rate of around 27%. Could this really be something that the market is applying to HKAM’s valuation?

.

For reference, I’ll replicate again the HK financials summarized from the FRMO annual reports and include some additional information:

Let’s look at the perpetual growth model for the terminal value of a business (https://corporatefinanceinstitute.com/resources/financial-modeling/dcf-terminal-value-formula/):

TV = (FCFn * (1+g)) / (WACC - g) ==> g = ((TV/FCFn)*Rd - 1)/(1 + (TV/FCFn))

… and let’s let TV/FCFn be translated to P/E assuming that HKAM, being an asset management business, is extremely capex/asset-light and is free of debt (given that their largest investment is a royalty company and by how FRMO is run, I don’t think these are unreasonable assumptions).

Since we have HKAM’s most recent actual earnings from the summarized financials in the FRMO annual report and we know the market’s price implied expectation for HKAM’s value, then we can get the price-implied-expectation for the P/E multiple and HKAM perpetual growth rate that the market is baking into SLGD share prices.

Recall our working opportunity cost we are using for the discount rate against HKAM’s business is 27%, which from our table here would imply a perpetual growth rate of something like 0%. Is a 0% growth rate for HKAM’s earnings realistic?

.

Like I’ve mentioned, FRMO has had a revenue royalty/participation interest in HK since at least 2010 (the oldest annual report on their website where I can find it mentioned), this participation rate has always been a fixed 4.199% (at least since 2013), and their footnotes have (almost) always included a description of how much of their total revenues were from that HK revenue interest. Since we know the revenue participation rate is fixed, have a 10yr+ record of FRMO’s own revenues, as well as breakdowns of the portion of those revenues that come from the participation interest, we can work backwards to derive HKAM’s revenues going back those same 10+ years. Eg. if FRMO’s annual report shows total fee income is X and disclaims that Y% of fees were from the HK revenue interest, then we can derive HKAM’s total revenues (at the time of FRMO’s end of fiscal year) as (X*(Y/100))/0.04199. Here is a snippet of that data:

(The base revenue data up to 2019 is just copied from the blog post on FRMO here (https://fundamentalfinanceplaybook.com/2020/02/22/embedded-optionality-frmo-case-study/). For the early years where no breakdown was provided, I just use the low end of the range of known portions of stream-based fees. Below I’ve removed the annual report footnote comments to compress the table so I can screenshot the whole thing.)

(Notice that these derived revenue figures roughly line up with the available official summarized revenue figures in the FRMO annual reports, except for 2021. This is due to the fact that HK’s fiscal year is not the same as FRMO’s and GAAP adjustments are made to the official reported numbers summarized in the FRMO reports 16. Given that the numbers here are smoother while still generally matching up with the official FRMO HK summary financials, I’m inclined to take these as being closer to the cash accounting version of HK’s revenues.)

Notice that in these whole 10+ years, HKAM’s apparent revenue growth has been a whopping 0.01%. Given this no-growth status, we can also use the year-weighted average of HKAM’s revenue of $58,422,320.65 to make some estimates about normalized earnings.

One way to estimate HKAM’s normalized earnings from that long-term revenue figure is by taking the average of the officially reported expenses and subtracting that from the normalized revenue estimate ($16,072,169.25). The other way is to take the average net margin ($10,658,172.46); I actually like this way better as it more closely lines up with the actual numbers (aside from 2021 which, as I mentioned, I think is misleading due to GAAP estimates) and the average net margin figure produced is pretty close to the average non-bank financial services’s 15.44% net margin, according to Prof. Damodaran’s NYU dataset for Jan 2024 (https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html).

.

TV = (FCFn * (1+g)) / (WACC - g) ==> g = ((TV/FCFn)*Rd - 1)/(1 + (TV/FCFn))

So, iff one accepts the idea that the opportunity cost of investing in HKAM is a mini-ETF of 90%/10%-TPL/GBTC (which has a long-term return record of ~27%), then according to the perpetual growth model (using the most recent HK earnings number and the market’s price implied value of HKAM) this would imply an earnings growth of 0% and we’ve just seen that there seems to actually be a case for why one might think that should be expected.

Thus, IMO, the market is not crazy to price SLGD at such a big spread below the merger’s Final Consideration target “IPO” price and the current discount is not quite the slam dunk that fellow Stahl-stans may think it (or I might wish it) to be.

Epilogue

OK, suppose all of that is just wrong.

Let’s play around with the perpetual growth model to see what kinds of earnings multiples would be implied by some alternative growth rates.

TV = (FCFn * (1+g)) / (Rd - g) ==> TV/FCFn = (1 + g)/(Rd - g)

…again, we can let TV/FCFn = P/E for the asset management biz.

(Here I use the normalized long-term earnings estimate based on average known net margins (which is only slightly lower than the actual March 2023 numbers))

What kind of discount and growth rates, Rd, and g look right to you? You can use this table to estimate the upside based on your preferred multiple (and assuming the very low end of HK’s example NAV as presented in the Final Consideration calculation example in the merger doc (which, again, I think is a reasonable and not overly-conservative guess)).

(Here I’ve circumscribed the approximate multiples that line up with a 27% opportunity cost discount rate and 0% long-term earnings growth)

.

We can also look at HKAM as a zero-growth annuity. This seems like a justified POV given the apparent generally range-bound revenues at HKAM over the past 20yrs. From the FY2024Q2 FRMO earnings call:

“Horizon Kinetics has a pretty big dividend payout ratio. FRMO doesn’t pay a dividend, but Horizon Kinetics pays, I think, a pretty robust dividend. We receive that dividend, so whatever’s left over after the dividend gets put back in retained earnings”.

Of course, this assumes a static NAV for HK (eg. as opposed to earnings getting reinvested by Stahl and Bregman into their own balance sheet, as someone very observant has pointed out to me 17). Also, it’s possible that HK sees renewed growth as they shift from mutual funds to “actively managed” ETFs.

TBH, I wouldn’t be surprised if SLGD ultimately just ends up trading based just on the dividend yield. I mean, that could be the play here: Invest in SLGD (or whatever HK is going to change the ticker name to) to get directional exposure to HKAM’s underlying investment portfolio (and likely very similar NAV composition and probably invested in their own funds) in addition to receiving a dividend from the fees that HKAM collects from managing that portfolio for clients. From this POV, anyone who is a retail investor in any of HK’s funds that basically just trade like “TPL/GBTC mini-ETFs” may as well just swap that position for SLGD shares at this current price point (which I think I’ve made the case as representing a fair value).

“[A]bout ten years ago I had this theory —one of the few theories that actually proved to work out— though there was no way to implement it in investing. […] And I thought, well, the private equity companies, they have to put some money in the deal. But then they're getting the incentive fee, on top of everything else. So, let's say they put money in Deal A. If Deal A is successful, then by definition they have to do better than the clients, because they will make the same return the clients make on the deal, but they will also then get the performance fees, which the clients will pay. So, I thought to myself, if I want to be in private equity, I'm much better off buying the publicly traded private equity companies than I am buying into private equity directly or through a private equity fund.” ~~~ Murray Stahl

(Of course there are differences between PE and HK’s asset management business such as the fact that they are investing mainly in public equities, largely do not charge performance/incentive fees on top of their regular management fees, and generally aren’t going to be imposing multi-year lockup periods on clients 18, but the core principle of benefiting from both the investment performance and fee income by owning shares in the management company itself still applies).

.

Hopefully this analysis has been useful for anyone looking at the situation. Writing this all out took a lot longer than I thought it would; this is all just from a single spreadsheet that’s pretty compact and expanding it out into a linear narrative as required by this format was a lot more work than I thought it would be. If anyone catches anything odd or misguided, I’d be happy to be shown where I’m making any major errors in reasoning here.

.

4

The issue is done and dusted at this point, but for more information on that saga, you can see the articles here

Special Situation Investing

TPL's governance battle (TPL)

Welcome to Special Situation Investing Episode 69. For reference, this episode was published on 18 March, 2023, a time which has proved volatile for most stocks to include, Texas Pacific Land, the subject of today’s episode. TPL’s recent decline struck us as worthy of another episode because we’ve been so bullish on the company in the past and because t…

Listen now

3 years ago · 9 likes · 9 comments · Six Bravo

and here

Special Situation Investing

Portfolio Update (TPL, NRP, PBT, GTX)

Welcome to Episode 120 of Special Situation Investing…

Listen now

2 years ago · 28 likes · 18 comments · Six Bravo

as well and peruse the popular blog dedicated to following the company here.