Updates & Detours.

Wow, it has been 3 months since I last posted on here. Time really does fly. I am finding it progressively difficult to find new ideas and I am currently toying with other ways to still bring value to the value community. Anyway see below for my latest ramblings. 

Detour to Africa: So I was back in my native country of Ghana for most of the past 6 weeks. Did not do much investing related activity but looked briefly at an insurer, Enterprise Group (GSE: EGL), which was completing a rights issue when I was in Ghana. I also had the opportunity to have a conversation with one of the company’s largest shareholders. A takeaway from the conversation and a brief look at EGL’s financials was that the Buffett-esque structure of “holding company anchored by an insurer”, can  be applicable in a higher inflation developing market, such as Ghana. In July 2007 the Ghanaian cedi was re-denominated 10000 to 1 after decades of high inflation. EGL traded at roughly GH₵ 0.20 per share at the time and the USD to Cedi exchange rate was 1 to 1 following the re-donomination. Fast forward roughly 11 years and the most recent close price of EGL was  GH₵ 4.79 and the USD to Cedi exchange rate is 1 to 4.43. Some quick math will show that  is roughly 17% compounded annually in US dollar terms, not bad at all. As a related side note, I was just reading the 2017 Exor Annual Shareholder Letter , which has a good discussion of holding companies and is replete with references to Seneca & Charlie Munger, John Elkann is truly a man after my heart. Another thing I noticed from being in Ghana was how pervasive the US platform monopolies were in Ghana. Whatsapp, Uber, & AirBnB are quite popular in Ghana. Pundits who speak of declining American dominance are clearly not looking in the right places. These three companies have basically established a tax on a developing nation’s future growth in communication, transportation, and housing with very little physical presence on the ground. Is that neo-colonisation or is it providing individuals in a developing country an infrastructure to monetize their land and labour? Maybe a bit of both.  Don’t worry, I am not about to start deviating into conversations about the global world order and what’s fair and what’s not. Picking stocks is hard enough.

Detour into a Constellation: Constellation Software, the TSE listed acquirer of vertical market software companies, that is. So as I mentioned in an earlier post I held a position in Redknee Solutions. I have this bad habit of finding a stock, getting excited about a few factors, taking a position, which then compels me to begin my deep dive research. That must stop. Anyway, as I was conducting my primary research I read all of Mark Leonard’s President’s Letters in chronological order to hopefully gain a better understanding of VMS companies. I noticed just how much of a better business it was which led me to abandon my Redknee (now Optiva) position. It is a turnaround that I now classify in the too hard pile. I am also more comfortable with the decentralized playbook of Constellation, which is a believer in small teams. Redknee’s turnaround, which is being led by ESW Capital has a more centralized approach in that ESW companies like Versata are being used to outsource processes such as application development. It could all work out brilliantly but I do not think I have the ability to handicap the situation. I really like Constellation but even if I adjust for the intangibles (a serial software acquirer whose portfolio companies grow their earnings is not accounted for properly by conventional accounting principles) it seems to trade at close to 40x adjusted earnings which is abit frothy to me for an initial position.

Imvescor/MTY Deal: Of the 66.25% of the shareholders who voted, 92.73% voted for the deal. A complete landslide that took me by surprise. I attended the vote in person and my feeling was the Imvescor management were  somewhat somber in their view of a turnaround story coming to an abrupt end but glad they played their fiduciary role to a tee. Afterall, Glass Lewis and ISS both urged shareholders to vote for the amalgamation, a view I clearly disagreed with. I did see what looked like a few representatives of the acquirer, MTY, in the back of the room who showed palpable excitement when the results were announced. This contrast was a physical manifestation of the huge gap that exist between agents/fiduciaries and owner-operators that I’ve never fully appreciated even though I thought I did. Anyway, I sold all my shares before the 80/20 share/cash deal closed because although I have a lot of respect for what Stanley Ma has been able to build I have not liked MTY’s average to poor same store sales performance over the past 5 years in an expanding economy, which means the acquisition machine has got to keep going to justify valuation. Acquisition growth + organic growth (see Constellation software) is much more potent combination than acquisition growth alone.

Current positions: As I sold Redknee and Imvescor and have not been able to redeploy that capital I currently own Urbana (probably not for much longer), Google, Fiat Chrysler and lots of cash. Please, if you see any hard to find unicorns (not the ones found in Silicon Valley) but the ones that are simple great businesses, with great owner/operator management teams, at great prices feel free to let me know. I will be in Toronto from the 24-26th April for Fairfax/Constellation meetings and side events. Give me a shout if you read this blog and are in town too.

Fiat Chrysler / Sergio’s Last Hurray?


Note: Fiat Chrysler has run up quite a bit since the new year (up 30%). I was buying over the course of Sept to Dec last year so my average cost is significantly below the current price. Anyway, I think there might still be a little bit of runway on this one but not as much as before.

“I’ve always had this incredible sense of urgency, I’ve always had this desire not to let things fester and to really seize the moment, because it’s serendipity.”

Sergio Marchionne

Preface: To get you excited for the drabness that might or might not follow, I’ll let Eminem maybe start things off in what I think is a contender for best ad of the past decade. I present to you “Imported from Detroit.” American Exceptionalism FTW!!



Simply put, Fiat Chrysler (FCA) is run by a potential outsider CEO in Sergio Marchionne whose 5 year business plan has the business potentially earning an adjusted net profit between €4.7-€5.5B in FY2018. A conservative 7x earnings and current market cap of €29.5B suggest a 12 month price increase of between 12% to 31%.

Business Overview


FCA designs, manufactures, and sells mass market vehicles in 4 regional segments (NAFTA, LATAM, APAC, EMEA) mainly under the brands Fiat, Alfa Romeo,, Dodge, Ram, Jeep, Chrysler. Its luxury segment includes Maserati and it also owns a components business, (Magneti Marelli, Comau, & Teksid). It previously owned Ferrari that was spun out January 2016.


Brief History


Fiat was founded in 1899 in Italy and Chrysler founded in 1925 in America. In 1998 Daimler Benz paid $36B for Chrysler only to offload an 80% stake for $7B in 2007 to Cerberus Capital. During this period Fiat was experiencing somewhat of a renaissance under Sergio Marchionne who had become CEO in 2004. The 2 companies fates become intertwined in the depths of the global financial crisis. In January 2009, a Chrysler on its last legs signed a strategic alliance with Fiat which might have essentially given Fiat 35% of Chrysler for nothing. In a fight with holdout creditors Chrysler was forced to apply for Chapter 11 bankruptcy and emerged in June 2009 from a 42 day bankruptcy process with the UAW pension fund (68%), Fiat (20%) , and the US & Canadian governments as principal owners (balance), in addition to loans from the US government. In 2011 Chrysler recorded a quarterly profit and paid off the government loan. The current Fiat Chrysler company was formed in 2014 when Fiat acquired the 41.5% it didn’t own to make Chrysler a wholly owned subsidiary. The deal cost Fiat approx. $5B and the assumption of $5.5B in pension liabilities.

Industry Overview

The automotive industry is cyclical with high capital expenditure requirements. About 90 million units are sold annually, about 17M of which are sold in the USA. The largest players are Toyota & Volkswagen who sell about 10M units worldwide, with Fiat Chrysler coming comes in at number 7 selling approximately 4.7M units. Dealers and retail customers usually finance purchases of vehicles from manufacturers. The industry has gone through cycles of restructuring and the US manufacturers of today are not the same as they were pre financial crisis, with lighter balance sheets. That being said, the cyclical/high capex dynamic still remains and they deserve the low multiples the market gives them now.

Fiat Chrysler’s 5 Year Plan.

In May 2014 FCA announced a 5 year to sell 7M cars in 2018, have €132B euros in revenue, €4.7-€5.5B in adjusted net profit and approximately €0.5-€1B in net industrial debt. The repositioning was to leave Jeep as the marquee brand, have Chrysler be more competitive in North America, focus on higher margin truck/suv lines like Ram and revamp Alfa Romeo in the premium segment and Maserati in the ultra luxury segment. The plan was updated in January 2016 to revise the FY2018 revenue target to €136B Euros, adjusted net profit of €4.7-5.5B, an even have a net cash position of €4-€5B euros. EBIT Margins from the original plan have been increased for North America (6-7 to 9%), and EMEA (2-3% to 4%). Admittedly though, the Brazilian market has continued to face weaknesses and EBIT margin estimates have dropped from 10 to 7% for that region. Since the plan was announced Ferrari has been IPO’d and spun off and the ring-fencing behind FCA’s US’ cash has been removed allowing for a unified global financing platform.

Jeep: The cornerstone of this plan has been the revamping of the Jeep Brand which has enormous brand equity all over the globe, especially in China. In 2009 only 338k Jeeps were sold worldwide, the 2015 number was 1.2M units and Jeep is now selling 1.5 units a year. The original plan of 1.9M units by 2018 was revised to 2M units. This is supposed to be led by mostly APAC performance, which Fiat expects to increase from 100k in 2015 to 500k in 2018.

Sergio Marchionne: Potential Outsider CEO chained to a terrible business?


Born in Italy, Marchionne’s family moved to Canada when he was 13. He subsequently finished a degree in philosophy from the University of Toronto and then one in commerce and an MBA from the University of Windsor. As if that was not enough he also obtained a law degree from Osgoode Hall Law School during this time. Sergio is also a CPA. So you have an individual with a background in law, accounting, business & philosophy. He then had solid careers at Deloitte, Lawson Mardon (packaging), Glenex Industries (biotech & plasma videos), Acklands (industrial supply), Alusuisse (aluminium & chemicals), & SGS (certification & inspection services) before landing the CEO role at Fiat CEO in 2004, their 5th CEO in 4 years. Sergio changed the leadership structure from the strong one man decision maker model, vestiges of the Agnelli dynasty to finding young, engaged leaders buried underneath heaps of bureaucracy throughout the organization. He followed this by setting BHAGs (Big Hairy Audacious Goals) then giving his team the autonomy to reach them. For instance, he set a €2B 2007 net profit target for 2007 for a barely profitable Fiat when he arrived. This is similar to the ambitious 5 year plan at FCA. When Sergio took over Fiat in 2004, it had a market value of about €5B. They have since spun off CNH Industrial and Ferrari, which both have market values of approx €17B and €18B respectively. Add that to FCA’s €29B market cap for a total of €64B. 13 years, 13 bagger, partnering with Marchionne, not bad. Marchionne plans to retire at FCA’s annual meeting in April 2019. He will be sorely missed but plans to stay on as Ferrari CEO until 2021. He has only been able to achieve this feat with the full support of the Agnelli family as the cornerstone shareholder. John Elkann, the chosen heir of Gianni Agnelli, handpicked Marchionne as CEO after being thrust into leadership of the Agnelli fortune in 2004 at the tender age of 28. Elkann, who was elected to the Fiat board at the age of 21, has an interesting story himself but a story for another day.



The 5 year plan has FY2018 adjusted net profit for FCA at between €4.7 to €5.5B. Marchionne is on record reiterating these numbers as late as Q42017. With prior execution and visibility only 1 year away it is not as dangerous going with these number as say in 2014. They might not hit the 7M vehicle target but fleet mix is being focused even more on the higher margin Jeep & Ram businesses. GM trades at a P/E of 9.5 and Ford at a P/E of 12. Say you give FCAU a more modest P/E of 7 due to its smaller scale, it still implies a market value anywhere between €33B and €39B, 12% to 31% above current prices.

Another view: When rumors circulated last year that China’s Great Wall was interested in Fiat Chrysler, specifically Jeep, the rumored price for Jeep alone was €23B euros. The components business does about €10B of revenues and €500M of EBIT, most of which is Magneti Marelli. Marelli is rumored to be spun off for €5B in 2018. According to the 5 year plan FCA will end 2018 with €5B Net Cash position and has a pension liability of €10B. Maserati does €400M in EBIT and could command as much as €8B as a standalone luxury business but let’s just use €5B to be conservative. Doing the math (23+5+5+5-10) leaves us roughly in line with current market cap of €28B. In other words you can own the Dodge, Ram, Fiat, Alfa Romeo, and all the other minor brands for free. The RAM brand alone is expected to sell around 600k units in 2018. Trucks, especially those produced in North America, are generally high margin, and average pre tax income is rumored to be €4000 per truck. At 600k trucks that’s €2.4B in pre tax income. At a conservative 5x EBIT, the North American RAM unit, which we are buying for free, is worth at least €12B and would imply prices 40% higher than current. The Alpha Romeo Giulia was named Motor Trend’s 2018 Car of the Year. From a standing start of practically no units sold in North America, it sold 12k units in 2017. The Fiat brand is expected the sell 1.5M units WW in 2018 and Dodge 600k units. All of that for free!!!

What could go wrong?

Cyclicality: The business is cyclical and North America SAAR anywhere near the results we saw in the global financial crisis (10M) makes most car company business models unsustainable. With average car fleet age close to 12 years and replacement rates from the natural disasters of 2017 it is improbable but not impossible that car sales drop dramatically in 2018. In addition, the car companies are going into 2018 in much better condition than they entered 2008, as can be seen by Fiat Chrysler possibly entering next year in a net cash position as opposed to being saddled with debt.

Self Driving Cars: There is this view that self driving cars are imminent. I do not believe anything substantial can happen on this front in the next 5 bto 10 years. We may be 95% to 99% of the way there as far as technology goes but the nature of driving is that only 100% is acceptable, or at least 99.999999%. Another short of this leaves room for serious road accidents. The potential for serious liability cases will also be a deterrent for full blown automation. It is one thing to have product recalls and the isolated client lawsuit but a whole different ball game when blame is put on the automation and hence the manufacturer.

2018 target not met: This would not be the end of the world as FCA is on track to earn €3B in for FY2017. If they can at least repeat this figure in 2018, it implies a forward P/E of 9.8.



Although I’m not buying in at these prices, I’m holding at them (which is slightly illogical when you think about it, and I call myself an intelligent investor!). I’m leaning towards FCA hitting the higher end of their targets, with plans just announced to invest an additional $1B in US operations. I’ll become uncomfortable around €40B-€45B of market of market value.



Sergio Marchionne on 60 minutes , Bloomberg Q&A , NY Times profile , HBR Fiat Case Study , Jeep sale speculation , 5 Year Business Plan Update , FCA Investor Relations , A couple links from 2009 restructuring process , Thesis’ by Mohnish Pabrai, Scott Miller , Adam Wyden , & the Oracle from Omaha blog , Marchionne/Chrysler HBR Case , Reiteration of 2018 Targets & Magnetti Marelli Spinoff , Bill Vlasic’s Once Upon A Car , 2018 $1B Investment Plans

Taking Stock

So tis’ that time of the year again. You know, the time of the year when we take stock (get it? Taking Stock? As in STOCKS? Nevermind) and make promises on resolutions we vow to not keep.

On a personal level getting over some not too ideal roadblocks this year has probably made me more resilient (but isn’t the goal to become Antifragile). On a train this year, a woman described to me her winning fight with cancer and how she in many ways feels stronger after the episode. She became Antifragile. One must allow for spontaneity in life to meet people like this.

On a philosophical level the idea of time wealth has become seared deep in me. I first came across this idea on the Tim Ferriss podcast with guest, Rolf Potts. So basically we all come into this world with an immense resource, time wealth. Some lives are unfortunately cut short but generally speaking you have considerable time wealth and you are free to do with it whatever you please but many of us end up getting on the hedonic treadmill and trade this time wealth for money wealth in order to obtain things we do not need. I’ve always known this but cannot say I actually embodied it. It is a continuous process but I am definitely better than I was on this front. Also do not worry, I understand the irony of writing this on a blog about making money wealth in the stock market.

Now to the blog & portfolio. Writing this blog has been fulfilling because it has enabled me to meet some very interesting people over the past few months. I thank some of them here. Another thing I’ve noticed is you only truly get to understand a stock after you’ve purchased it and live with it, both in your mind and your brokerage account. All else is smoke & mirrors.

Facebook has been the most contentious stock in my portfolio. After buying it I’ve been able to delve deeper into their business model. It looks like both the greatest business model ever created and a net negative to society.After speaking to a portfolio manager who has kids, unlike me, he said there is almost no price at which Facebook makes sense to him due to the some of the negative psychological effects, especially on children (time wasting, depressions, suicides due to online bullying, ad targeting that is too specific and coercive, etc). After watching former Facebook exec Chamath Palihapitiya speak at Stanford, this Guardian story, Bret Weinstein on Joe Rogan (very interesting the places you can build your investing mosaic) and the very weak rebuttal from Facebook here I officially pulled the sell button on my Facebook stock. Mind you, I still think the path to a 5 year double from these prices is still very possible but not all money is good money. There are times when businesses that are net negatives to society still do extremely well (eg. tobacco companies) but a question to ask is, is the value proposition to the user obvious? It’s easy to see how useful Google Search & Maps is to the user. For Facebook, it’s hard to see what use Facebook or Instagram has to the user although it is proving to be very useful to advertisers (who are users in some way). Now, Whatsapp is extremely useful but what happens when Facebook tries to monetize it? Also it’s no fun having to constantly debate your conscience. A more interesting question though is where should one draw the line on ethics? I had no issues doing well owning Alimentation Couche-Tard a few years ago but as a convenience store chain how much of their bottom line comes from cigarettes and lottery ticket traffic? Something to think about and maybe some hypocrisy on my end.

Also sold Cymbria, the story here is less due to an assault on my conscience (ok, maybe that is too excessive) like Facebook but more of an oversight, noticed after reassessing my thesis and sharing the idea with a portfolio manager. I am even more confident and positive about the unique culture at Edgepoint since I wrote the report but I think I made a mistake on 2 main issues, how much I think they earn and not knowing enough about the relationship between Edgepoint Wealth Management and Edgepoint Investment Group. On the latter point, Edgepoint Wealth pays a fee to Edgepoint Investment Group (owned by the 4 principals Krembil, Farmer, MacDonald, Bousada). Although I doubt any funny business is going on here I just do not have any way to discern how much of the value in Edgepoint Wealth is taken at this level before the rest gets to the bottomline. My revenue number in my Cymbria post for Edgepoint Wealth was $230M but after pulling up the financial statements from the four funds and adding up the fees I get a number closer to $100M. Some of the discrepancy could be explained by the reasoning that the Series I and O fund fees do not get charged right to the fund and that the average assets are higher than the time period of the funds’ financial statements (June 2016-June 2017). Ok, so to the $100M we know for sure if I add $10M (1% of approx $1B in Series I & O for fees) and another $10M for the higher average assets ($13.5B vs $12.5B), you get a revenue number closer to $120M. Using 40% net margins and a 20x multiple that would imply a value for Cymbria’s stake in Edgepoint (20.7%) to be worth approx $200M (not that different from the recently released revaluation of Edgepoint). Add this $200M to Q3 2017 net assets of $792M (ex Deloitte’s Edgepoint valuation) and 23.47M shares outstanding, you get a per share value of $42.26. Cymbria last traded at $52.50, a 24% premium to my new intrinsic value per share. I also got uncomfortable with owning part of an asset manager at whatever point in the cycle we find ourselves. Lesson here, I should always start with what is knowable (the fees in the funds’ financial statements, and then infer from there, not the other way around). Will keep monitoring this one since I think the operators are truly doing things the right way. Apologies if the explanation is a little convoluted, I am just assuming the older post has been read.

Entering 2018 I am long Fiat Chrysler (15%), Imvescor (15%), Google (10%), Urbana (10%), Redknee Solutions (10%), and 35% in cash. Fiat Chrysler and Redknee writeups still to come. These are not recommendations and I could sell out of my positions at any time if things change. To the very small audience that hails from a very wide range of countries (from here in Canada all the way to Indonesia), I thank you. Onwards to 2018 and growth of both ourselves and our portfolios.

Deal or No Deal

Update: So, as I was about to publish the post below, ADW Capital dropped this bombshell of a press release. I left my post as it was in order to allow you to compare my rationale to his. To be radically honest, I think his press release is definitely better. You can jump straight to his or keep reading mine 🙂 Enjoy, and please feel free to reach out to me if you have any questions.

For more background, please read my previous Imvescor post here.

Timeline: So, on October 27th Imvescor sent out a press release to say they had received a preliminary non-binding indication of interest from a 3rd party rumored to be Cara. Stock went up 11% from 3.6 to 4. Apparently MTY then quickly reacted and sent a letter to Imvescor’s board expressing interest which eventually culminated in Dec 12th deal for MTY to acquire Imvescor for $4.10 in cash and stock.

Deal Terms: Imvescor shareholders will receive approximately $50 million in cash (20%) and the remainder in common shares of MTY (80%). $0.8259 in cash per share and 0.0626 MTY shares for each Imvescor share held representing a total consideration of approximately $248 million and a premium of 13.3% to Imvescor’s volume weighted average price on October 26, 2017.

Q417 and FY17 Earnings Release: Yesterday (December 19th), Imvescor reported Q4 and FY17 numbers with SRS up 4.9% in Q4. That now makes 10 straight quarters of SRS growth. For FY17 SRS is up 3.4% vs 1.4% in FY16. Ben & Florentine’s SRS was up a whooping 10.6%. For Q417 16 franchisees participated in the restaurant rejuvenation program (RRP), to make that 34 for year and 67 in total now, with the goal being 100. System sales were up 12.1% in the quarter mainly from the Ben & Florentine purchase but up 6.9% on normalized basis. Q417 operating EBITDA was up 26.7%, 15.1% on a normalized basis for FY17. Despite the increase in Operating EBITDA, results from operating activities and net earnings for Q417 decreased 22.8% and 33.7%, respectively, as a result of an additional investment in the RRP of $0.8 million, reorganization costs of $0.5 million and $0.4 million for the re-measurement of the contingent consideration related to the Ben & Florentine acquisition. For fiscal 2017, results from operating activities decreased 4.3% while net earnings increased 0.3% on a normalized basis over fiscal 2016.

Is the deal fair: In my opinion MTY needs Imvescor more than Imvescor needs MTY. To be fair there are obviously many benefits of the operating leverage implicit in the larger plaform but MTY is more exposed to mall food courts which have been having a hard time and has experienced either flat or declining SRS sales in recent years vs Imvescor’s 10 straight quarters of positive SRS. On the call announcing the deal both managements guided to $5M in synergies which I believe might possibly be on the lowside. Question is, how do I come to synergies of $10M vs $5M announced:

-For FY17 Imvescor recorded $2M in professional fees. According to its AIF audit and tax preparation fees are closer to $0.3M. Subtract $0.3M from $2M to get an estimate of $1.7M savings in professional fees.

-$4.8M in executive leadership & board salaries were recorded at Imvescor in FY17. CEO is probably on his way out, CFO has already announced she is leaving in January. COO, Legal Counsel should be gone too. Only 1 individual from the IRG board is getting nominated to the MTY board if the deal goes through. MTY is known to completely slash the leadership deck of the acquired after acquisition so I think it is fair to share they could be at least $3M in savings over here.

-Roughly 400K in corporate rent expense will be gone. The 2 headquarters are only a 7 minute drive away from each other and it is most likely the Imvescor HQ will be gone.

-So, $1.7M + $3M + $0.4M, we are now already at roughly the $5M figure announced as the synergies in the deal. The combination of MTY and IRG will create a multi-brand industry leader with a portfolio of over 5,700 stores under 75 brands and approximately $2.9 billion in system sales. Surely it should not be difficult to find another $5M of top and bottom line synergies (only 1.7% of system sales) from additional leverage of shared services, grouping of purchasing, renegotiation of leases, borrowing from MTY’s stronger knowledge of the retail channel. In addition there is $10M of compensation expense allocated to the franchising segment that is not broken down. Who knows how much of that is duplicative in a combined firm?

-Bringing it all together you get actual FY17 operating EBITDA of $19.5M plus $10M of synergies at a 10x multiple for EV of $295M less $11M in net debt. So $284M of equity value over 61.6M fully diluted shares gives $4.61 per share which implies the possibility of an improved offer from MTY or other possible bidders. Shares closed December 20th at $4.23, above the deal price of $4.10 due most likely to MTY closing Dec 20th at $54.81 compared to the deal reference price of $52.26. The market might possibly be pricing in the fact that this is no the last we’ve seen of this deal.

-Playing around with the numbers abit, if Imvescor can truly earn the $23.3M of operating EBITDA in FY2018 I estimate, with $10M in synergies, 10x multiple, Debt paydown from operating cash flows, approximately 61.6 fully diluted shares, it is entirely possible to get at least $5.40 per share a year down the line.

Will the deal happen: So on the day the deal was announced Adam Wyden (ADW Capital) acquired another 2% of Imvescor, with his total now up to 14.01%. In the press release ADW Capital announced its view “that this price grossly undervalues Imvescor and a higher price can be obtained by continuing as a going concern or through a superior or enhanced offer.” In an interview with Quebec media outlet La Presse Wyden has been on record as saying Imvescor was worth $6.60. On the other end of the spectrum Imvescor’s management has locked in 18% of the shareholder base in support and voting agreements led by Eric Shahinian of Camac Partners who holds 8.4% of the stock. Mawer Investment Management owns close to 18% of Imvescor in several of its mandates and I believe they will cast the deciding vote at the special meeting in February 2018. Mind you, Imvescor, a stock that used to find it difficult to trade 50,000 shares daily has traded almost 12M shares since Dec 12 so maybe the shareholder base has changed significantly.

Conclusion: Humility is in order, it is entirely possible management is right and I am wrong. Maybe the benefits of partnering with MTY in this increasingly competitive space outweigh cutting short the path of momentum Imvescor is on. On the flipside the individual (Wyden) who knows Imvescor much better than me and has followed the story since 2011 has even higher estimates than me ($6.60 per share). To be fair critics might say he is just talking his book but this was not what I came away with from my conversation with him. Anyway, the information circular for the deal comes out in January so maybe more colour will be provided. This experience has shown me it is much better to partner with individuals who own a lot of stock and have complete skin in the game. A final question to ask is this, if Stanley Ma, who is a great owner/operator, was CEO and principal shareholder of Imvescor instead of MTY, will he accept this deal?

Imvescor Restaurant Group (TSE: IRG)

“Oh man, I love this business, I have the luckiest career of anyone that I can imagine. I have two kids, and I constantly tell them that what you’ve got to do is find the things in life that you’re passionate about and do it. I’ve been lucky enough to find something that I’m passionate about – because it’s people. It’s different. It’s not cookie-cutter. It’s competitive, and I like that competitive aspect. It’s always going to be new.”

Frank Hennessey, CEO Imvescor Restaurant Group (RestoBiz Interview)

Investment Highlights:

-3-year strategic plan (announced April 2015) has led to turnaround and 9 straight quarters of SRS sales growth, with 4.9% SRS growth in the most recent quarter.

-Sale of Commensal manufacturing operations on Dec 1 2017 for $4.2M now means Invescor is a purely asset light franchisor.

-CEO Frank Hennessey is an expert operator and Adam Wyden of ADW Capital is a young highly motivated cornerstone shareholder.

-An almost debt free balance sheet provides opportunity to relever and create platform for acquisitions or become the acquisition target.

-The business can earn north of 23M in operating EBITDA in FY 2018 with the turnaround complete and business at an inflection point.

Brief company history: Founder Bernard Imbeault acquired Pizza Delight in 1969 and slowly built it into a recognized brand in Atlantic Canada over many decades followed by the acquisition of Mike’s in 2004. A successful IPO in 2004 led to a few years in an income fund structure (2004-2009). Newly public with ambitious plans, further fundraising led to the purchase of Scores and Baton Rouge with Imbeault stepping away from day to day duties in 2007. In 2011, high debt levels and a tepid economic recovery led to a liquidity event and recapitalization led mostly by Fairfax ($15M equity and $10M in debt). In 2013, Fairfax exited their investment. Continued weakness in system sales and the recapitalization led to the board considering strategic alternatives which eventually led to the hiring of Frank Hennessey as CEO in September 2014.

Business description: Imvescor is an asset light franchisor in Eastern Canada, primarily Quebec & New Brunswick. Its brands include Pizza Delight, Toujour Mike’s, Scores, Baton Rouge and the recently acquired Ben & Florentine. As of Q3 2017, the company had 255 franchised and 7 company owned restaurants.

Business Model: Company makes money by charging an initial franchise fee of 30 to 60k and an ongoing royalty of 3 to 6% of gross sales. It also licenses products under its brands to be sold by 3rd parties. It has the No.1 pasta sauce in Quebec which is priced 70% higher than other pasta sauces and roughly 20 skus in marketplace.

The Turnaround: When Frank Hennessey was appointed as CEO system sales of $410 million in 2010 had fallen to $377M in 2014. Finance and administration was immediately moved from Moncton to Montreal. Subsequently key hires included Tania Clarke (formerly of Keurig) as CFO, Vincent Dugas (formerly of Sysco) for acquisitions and Robert Longtin (formerly of Boston Pizza) for business development. In April 2015 Imvescor announced its strategic plan to transform its brands over the next 3 years with fiscal 2018 goals of 14-18% revenue growth, SRS of 3-5%, 10 net new restaurants & $20M+ of EBITDA. To do this management sought to simplify and standardize service & training, purchasing, G&A Optimization & communication. In addition, they sought to revitalize the menu, food culture, marketing and introduce a $5.5M Restaurant Rejuvenation Plan (RRP). The objective was to increase SRS, franchise profitability, leverage shared services, and improve shareholder returns. So far 51 restaurants have been renovated with a goal of over 100 by FY 2018. Franchisees have invested $15.6M thus far, with IRG investing $2M alongside. Some results include a 22% reduction in SKUs, 42% reduction in vendors, 67 renegotiated leases, & $10M saved for franchises. This had led to the 9 straight quarters of SRS growth, Q4 2017 (reported on Dec 19th) will make it 10.

Going forward:

The major legwork is behind Imvescor and I expect the effects of the RRP to keep paying dividends going forward. In addition, at least 50 more stores are still to be renovated.

Capital Allocation: Imvescor closed a deal at the end of Feb 2017 to acquire the Ben & Florentine breakfast/lunch concept, founded in 2008, for $25M ($17.7M upfront and $7.3 earn outs). This acquisition included 40 locations and $35M of system sales with opportunities for sharing services due to Imvescor’s Quebec entrenchment. In Q2 2017 (Imvescor’s Fiscal year starts in November so Q2 is Feb to April) Ben & Florentine contributed $2.8M of revenue and $600K of EBITDA. Annualizing this number shows Imvescor acquired Ben & Florentine for approximately 10x EBITDA. This acquisition has some real potential. It gives Imvescor more access to the growing breakfast segment and as at Q3 2017 they have already added 6 more locations.

Frank Hennessey has stated that for acquisitions he has 3 things he looks for: First, the target must be a franchise or franchisable. Second, the target should be of a size that enables Imvescor to gain operating leverage on their G&A or be a concept which has strong and immediate growth potential and third, Imvescor must always act responsibly as it relates to valuation. He has also stated a desire to acquire in Ontario but wants to see how the introduction of the $14 minimum wage plays out. Hennessey’s ability as an operator is undeniable but he does not have a Stanley Ma-like record of acquisitions, so some execution risk exists. Some estimates peg the full service restaurant segment at $25B of sales in Canada. Conversations I’ve had with analysts suggests there are at least 100 potential acquisition candidates floating around Canada. In the U.S. you can find many private equity sponsors and large players scooping up concepts in a competitive environment. In Canada, you basically have MTY and Cara in a duopoly as far as acquisitions go. Imvescor is uniquely positioned to become a 3rd player in this highly fragmented field. It is also ¼ of the size of the other players so smaller deals will move the dial more.

Invert, Always Invert: If Imvescor does not go on an acquisition spree, there is always a chance they become the acquired. Say they earn 23M of operating EBITDA in FY 2018, add to that roughly $10M in corporate G&A and expenses allocated to the franchise segment that can be eliminated by an acquirer. Apply a 10x multiple to $33M in operating EBITDA and you get $330M in EV. Debt will probably be minimal or nonexistent by then so it is all equity. That’s 30% above current prices. Stanley Ma will probably not pay up as he is quite disciplined in the multiples he is willing to pay but one can always hope. Cara is more likely to pay if you consider what they paid for St Hubert.

Key Players:

Frank Hennessey (President & CEO): Ex Darden, Cara, Harvey’s exec who has developed a reputation as a turnaround artist. Turned around Bento Sushi (2010-2014). Over his tenure sales grew by 50% and EBITDA by 150% in less than 3 years. Is using a similar playbook at Imvescor. I have read a few earnings calls transcripts and he seems to focus on the long term. For example, he does not give short term guidance. He understands the business inside out. He stresses the core tenets of price, quality, value & ambience as the keys to success in this industry. The only major negative is that he owns almost no stock but stock options instead.

Adam Wyden: Columbia Business School MBA and son of Oregon Senator Ron Wyden, Adam Wyden started a hedge fund (ADW Capital) in his parent’s basement in 2011 and has had an impressive CAGR of 31% net so far. He has been involved in Imvescor for years with some purchases going as far back as 2011. In August 2016, along with Camac Partners, ADW Capital sought the sale of Imvescor by writing this letter to the Board. No sale happened. Fast forward to November 2017 and Wyden has increased his stake now to 12% of Imvescor. Now, why would an individual who encouraged a sale increase their stake to 12% of a not too liquid stock? In a phone call I managed to organize with Wyden, without giving too much away he reiterated many of his views from his Value Investor Insight interview in March 2017 (belief in the turnaround, potential for further acquisition, 2018 EBITDA estimate, etc). My view is that in Wyden, fellow shareholders have a highly motivated partner who also understands the name inside out and is not afraid to engage with management if focus were to be lost.


Assumptions & Inputs:

-MTY trades at 12.8x EV/EBITDA and Cara Operations at 10.9x, using an average of these 2 I will apply a multiple of 12x to Imvescor FY2018E Operating EBITDA.

-As at the last quarterly report (Q3 2017 ended July 30 2017), net debt was $15.2M. Assuming the $4.2M from the Commensal sale will be used to pay down debt, Net Debt will be reduced to approx. $11M. With debt to EBITDA below 1 Imvescor can pay off the remaining balance by end of FY2018 barring any acquisitions.

-The increase in revenue from FY 2014 to FY2015 is due to the fact that Imvescor temporarily assumed responsibility for the manufacture of some Trattoria di Mikes products as the manufacturer was in bankruptcy proceedings. The drop from FY2015 to FY2016 is due to the ending of this arrangement and the listing of Commensal as discontinued operations

-Higher franchise revenue in FY2018 due to a full year of contribution from Ben & Florentine vs 8 months in FY2017. In addition, there should be north of 50 Ben & Florentine’s vs the 40 at acquisition and continued strong SRS sales closer to the 4.9% recorded in Q3 2017.

-Corporate Expenses as a % of revenue returning to FY16 levels in FY18 (15%) due to the fact Ben & Florentine will be fully integrated and shared services can be leveraged.

-0.3M DSUs, 1.78M options @ $2.27, 60.5M shares outstanding. Dec 5th, 2017 closing price of $4.08 for fully diluted shares outstanding of 61.6M.

-Dividend yield: 2.2%

-Operating EBITDA: EBITDA + RRP – Discontinued Operations + Acquisitions costs – Change in Onerous Contract Provisions + Reorganization Costs + Shareholder Proposal Costs.

-There are some reservations about focusing on operating EBITDA as a metric but in a business model that is this asset light issues are less egregious.


Ontario Minimum Wage: With the introduction of the $14 minimum wage on Jan 1 2018 in Ontario it is difficult to estimate the impact it will have on the restaurant industry. Franchisers like Imvescor are less exposed than the actual restaurant owners but the environment might lead to franchisees becoming unwilling to invest in current restaurants and obtain more franchises. Imvescor is further protected with its locations being concentrated in Quebec where the minimum wage is $11.25.

Quality Assurance & Health Concerns: In this industry, brand equity can suffer greatly if a customer falls seriously ill due to a bad meal. 2 years after Chipotle’s E-coli issues the company has still not recovered. This is always a concern. Shareholders can take some solace in the fact that Frank Hennessey earned his chops in supply chain and quality assurance at Cara.

Low insider ownership: Insiders own almost no shares and only have exposure through options which is less than desirable. As of the most recent AIF directors and executive officers were listed as owning 139,000 common shares which is less than 0.25% of shares outstanding. On the flipside, this becomes an advantage as individuals like Wyden are capable of instituting change if management does not deliver on the potential of the company.

Recommendation: In conclusion, I believe Imvescor is a buy at these prices. The turnaround is almost complete and the seeds planted will keep bearing dividends in the years to come. There is also potential in the M&A space, whether as an acquirer or an acquirer. Finally, management is strong operationally and you have the possibility of change being effected if they do not deliver.

Note: Imvescor reports on Dec 19th and conference call is on the 20th. I think it would be a very interesting listen. Tune in.

Links: Frank Hennessey interviews in Les Affaires & Resto Biz , Adam Wyden Value Investor Insight Interview , Imvescor Investor Relations , Imvescor Earnings Call Transcripts , Sell Side Research from GMP and Acumen Capital. ADW Q12017 Letter to Investors, Cara Investor Relations , & MTY Investor Relations


Preface: In this market one finds it hard to find great businesses at great prices or even fair businesses at great prices but every now and then you spot what appears to be a great business at a fair price. I believe Cymbria fits this bill. Allow me to explain why.


Company history: Cymbria is an investment company incorporated in 2008 by 4 Trimark alumni (Tye Bousada, Geoff MacDonald, Patrick Farmer and Robert Krembil) who became disgruntled with the sales driven, asset gathering nature of the Canadian fund management space. Cymbria was created by the IPO of Class A shares and the private placement of Class J shares in 2008 for gross proceeds of $234M.The proceeds went into the holding company structure which consisted of $509,585 for a 20.7% stake in the new investment manager created, Edgepoint Wealth Management, and the balance to manage an active portfolio of global securities. Edgepoint Investment Group is the manager of Cymbria.

Business description: The holding company is simple: a portfolio of mostly public companies and the 20.7% stake in Edgepoint. The group of four (Bousada, Farmer, Krembil, MacDonald) own 100% of the voting common shares of Cymbria and 68.1% of Edgepoint Wealth Management. Cymbria shareholders own 20.7% of Edgepoint Wealth and Edgepoint Wealth’s employees own 11.2% of their firm. Furthermore, Robert Krembil entities (Krembil Foundation and Chiefswood Holdings) control 12.6% of the Class J Shares and the industrialist Robert Schad controls another 12.2% of the Class J Shares. Edgepoint Investment Group charges Cymbria a MER (management expense ratio) of 1% for the Class A shares and 0.5% for Class J shares.

Business model: At the Cymbria level, value comes from growth of the portfolio of securities and increases in the valuation of Edgepoint Wealth. Edgepoint Wealth operates mainly in the competitive Canadian retail ($13.5B AUM) and institutional ($3B AUM) spaces through four funds (Edgepoint Canadian, Edgepoint Canadian Growth & Income, Edgepoint Global and Edgepoint Global Growth and Income). Retails funds can be purchased in either Front End (FE), Low Load (LL) and Fee Based/Advisory Fee Formats. Interestingly enough, the firm does not offer any Back End (BE) funds. With BE funds the standard arrangement is that the mutual fund manager pays the financial advisor a fee upfront (usually 5%) while the manager charges the client this fee on early redemption over a declining schedule (usually seven years). LL funds have both lower upfront fees (usually 3%) and shorter schedules (usually three years). On an annual basis, Edgepoint Wealth Management charges retail clients a Management Expense Ratio (MER) which ranges from as low as 0.8% with the fee-based option, to as high as 2.42% with one of its LL options. Institutional fees are usually lower and negotiated by mandate. Out of these fees Edgepoint Wealth expenses are the annual trailer fees to the advisor, transfer agency, custody, fund accounting, filing fees, legal, audit, general and administrative, and other costs.

Canadian AUM Space: As of September 2017, Canadian mutual fund assets stood at $1.43T of which $1.2T was in equity and balanced funds. Another approximately 1T sits in segregated and pooled pension assets. In a sense this is Edgepoint’s addressable market but a large section of these assets are sticky and sit with the big banks. A retail client whose mortgage, chequing and savings, and insurance is at a big bank is very difficult to recruit back into the non-bank space. Not impossible but difficult. A more realistic addressable market are Edgepoint’s non-bank competitors. The most recent AUM reported of the major public non-bank competitors (IGM, CI, Fiera, AGF) adds up to $424B. Round that up to include much smaller shops and one can say Edgepoint is playing in a $500B pool. As imprecise as these figures probably are it is better to be roughly right than precisely wrong.

Investment Rationale


Strong Performance: Over its four portfolios Edgepoint Wealth Management has outperformed its benchmark since inception (November 2008 to September 30th 2017 CAGR) by adhering to its discipline process of buying companies with strong competitive positions, strong managements, strong barriers to entry, and long term growth prospects at discounts to intrinsic value. Their highest conviction ideas are added to the public equities section of Cymbria’s portfolio. At the Cymbria Level NAV has grown by 311% (Nov 08 to Q2 2017).

Culture/Skin in the Game: The company seems to have a strong culture at the employee level, advisor level, client level. Up until this point, the company has done no advertising and marketing, released no fancy merchandise, sponsored no major events and even uses black and white printing to save costs. Retail clients tend to pull money out at the worst time and Edgepoint has taken moves to curtail this. It has a $15,000 minimum and every financial advisor they develop a relationship with has to sit with a relationship manager who ensures the advisor is aligned with the firm. By December 2016, employees of Edgepoint had over $160m of their own money invested in their funds. They also own 11.2% of Edgepoint Wealth Management as mentioned earlier. As of the last count, all 62 employees listed on the Edgepoint website are listed as partners and this level of commitment clearly shows. Employee turnover is extremely low, outside the founding partners, of the 14 new hires I counted in their 2008 annual report, 12 are still with the firm. Edgepoint’s non-bank competitors have 4x as many employees. Even if you factor in the fact that some back-office administration is handled by CIBC Mellon as opposed to non-bank competitors like Mackenzie and CI where these activities happen in-house, the productivity per employee is impressive. The future effect of culture is hard to quantify and often poorly underwritten in public markets.

Threat of ETFs is overblown in Canada: Canadian ETF assets are now over $135B. Total Canadian AUM is probably closer to $3T so ETFs are roughly 4.5% of the market. Over time ETF market share will only increase and many active fund managers will be badly affected. To the contrary, fund managers that provide value to their clients after fees will remain valuable, maybe even more so with less active competition. Also, ETF inflows have increased in a rising market. In the next major downturn where there is forced selling of ETFs, prepared active managers will benefit greatly from the indiscriminate selling.

Disagreement with Deloitte on Edgepoint Valuation: The company works in consultation with Deloitte as the 3rd party in helping value Edgepoint. The accounting profession is conservative by nature, and rightly so, but I believe Cymbria’s stake in Edgepoint is worth considerably more than the $151M it is valued at as of Q2 2017, and will explain why in the valuation section below. Deloitte’s assumptions ranges are:

Annual market growth 4%–8% ($14.4M)–$14.6M

Annual gross sales $700M–$1.9B ($14.0M)–$12.9M

Redemption rate 8%–14% $21.7M–($22.1M)

Discount rate 10%–13% $25.4M–($7.8M)

Terminal value 7x–11x ($6.9M)–$18.0M


I am of the view that Edgepoint is likely to hit or exceed the high end of the ranges for annual market growth, annual gross sales and terminal value.



Assets (ex Edgepoint stake): The value of Cymbria assets less its stake in Edgepoint is $816M as of Q2 2017. This consists mainly of cash $75M and public equities of $731M. The top holdings are listed below.



As of October 31st, 2017, Class A NAVPS was reported at $43.46 compared to $39.46 in Q2 2017. Adjusting for this 10.14% increase leads to an estimated increase of assets from $816M to $898M.


Edgepoint: As no public financials are available for Edgepoint Wealth Management one must infer from other publicly available data.



The 2 public companies used as comparables are the Mackenzie segment of IGM Financial and the Asset Management segment from CI pulled out of their 2016 Annual Reports.

Rev as % of Average AUM: 1.7%. Should be at least as high or slightly higher than CI considering the fact that Edgepoint does not offer any low margin fixed income funds, but CI does.

Commissions as % of Revenue: 7.35%. To be conservative I chose the average of CI & Mackenzie numbers and applied it to Edgepoint. I suspect it might be even lower as Edgepoint does not offer BE funds, which have the highest commission.

Trailers as % of Revenue: Again, average selected, 31.2%.

Non-Commission Expenses as % of Revenue: 10% as a percentage of revenues is applied. This is where you would find general & administrative costs, and sales & marketing. Here, Edgepoint should be best in class due to employee productivity and lack of advertising and marketing expenses. In the startup years they chose a transfer agency cost per account as opposed to % of AUM. As the business got bigger, they benefited from economies of scale. In 2015, Custodians switched from Citibank to CIBC Mellon but similar agreements are probably in effect.

P/E Multiple Applied: At the end of 2009 Edgepoint AUM was $450M and now stands at $16.5B. That’s a CAGR of approximately 60% per year! It is reasonable to assume AUM can grow at 15% per year. for the next five to ten years from a combination of inflows and performance. With staff productivity and the scalability of the investment management business it is difficult to see employee count more than doubling over the next five to ten years. The firm ended 2009 with 21 full time employees and now has 62, so 3 times more employees but 36 times more AUM. 20x earnings is a reasonable multiple to pay for that can double assets in the next five years with very little incremental expense.

*Firm only post current AUM on website thus September 2016 could not be located but June 2016 located on Way Back Machine.

Liabilities: Total of $43M with the majority ($39M) being a deferred income tax liability.

Share Count: 100 common stock held by Edgepoint Investment Group, these are the only voting shares. As of August 8th, 2017, Cymbria had 14,409,374 Class A shares, which are non-redeemable and traded on the TSX, and 8,214,987 non-redeemable Class J shares, which are also non-redeemable that can be exchanged for an equivalent value of Class A shares on the last business day of each week. As of Q2 2017 the per share value for Class A shares was 39.46 and 43.50 for Class J, which equates to an exchange ratio of 1 to 1.102382 (J to A). This means if all J shares were to be exchanged for A immediately, there would be an additional 9,056,054 Class A shares. Finally, there are 13025 DSUs. Add all this up and you get 23,478,553 Class A equivalent shares.

Putting it all together:


In August 2017, CI announced an agreement to acquire Sentry’s $19.1B of assets for $780M, that comes to a purchase price of approximately 4% of AUM. IGM has $150B of AUM and is trading at $11B (7.3% of assets) and CI Financial had 121B of AUM (pre-Sentry deal closure on Oct 2nd) and is trading at $8B (6.6% of AUM). The weakest player, AGF, with $35B of assets is trading at 665M (1.9% of AUM), and has been shedding assets for many years. Valuing Edgepoint at approximately $1.7B is 10% of its $16.5B AUM which is very clearly on the high end and implies putting a lot of faith in the product and the management.



Competitive Landscape: The big Canadian banks have been particularly adept at acquiring and integrating asset managers and dealers. These banks may solely or partially offer their related proprietary investment funds, which could have an adverse effect on independents such as Edgepoint.

Timing: Being almost 9 years removed from the last market bottom we are statistically closer to the next bottom than during the Cymbria IPO. This might not prove to be the ideal time to own a portfolio of securities and a stake in an asset manager. However, this risk is mitigated to an extent by the fact that the portfolio in concern is actively picked by managers with a proven track record and might be cheaper than the market at large.

ETFs/Fee Pressures: CRM2 regulations came into effect in 2016, which require greater disclosure of fees to clients. This might prove to be a tailwind for ETFs, which sometimes have fees as low as single digit basis points. Asset managers as a whole will always perform worse than the index after fees but there will always be pockets of managers who will outperform over the long term. Can they be identified ex ante? I believe so. Here is one of best examples of this by none other than Warren Buffett. A large part of my investment thesis is that the bad performers are the most affected in the long term but maybe even stellar performers like Edgepoint will have to charge drastically lower fees. In that scenario, the thesis falls apart.

Recommendation: So, all of that for a mere 7.1% upside. Cymbria is still a BUY in this environment. It presents an opportunity to own what seems to be a hard to duplicate culture in the retail mutual fund space and a proven process and results at a slight discount to intrinsic value. Great business, fair price!


Some Links:


Cymbria’s Investor Relations, CETFA ETF data, CI Acquires Sentry, Benefits Canada article and PDF, IGM Financial 2016 Annual Report, CI Financial 2016 Annual Report, IFIC Industry Overview September 2017, Latest AUM figures for CI, IGM, Fiera, & AGF.


Note: This post has many similarities to my “100 Years” Google post. Some sections are even repeated verbatim. That’s because the more and more I looked into Google, the more I realized Facebook is the Ying to Google’s Yang. Why have one when you can have both.


The story: Imagine creating a product where the user of the product was also the product (to a 3rd party) but never thought of himself/herself as such. This user then constantly provided the most intimate details of their lives as content for free and then gives you the privilege to bundle their personality up and sell to the 3rd party (an advertiser). Essentially, cost of good solds at no cost. Creating this all from the starting point of your dorm room. Then waking up one day to realise that your company might have played a not-so-small role in electing a leader who is the living breathing antonym of all your liberal ideals, leading you to one day do some deep self-reflection and wonder where it all went wrong in a post on the network you created. You can’t make this stuff up.


                             Facebook post by Mark Zuckerberg on Sept 30th 2017


All that being said, Mark Zuckerberg is a great CEO. He is only 33 and seems to sincerely want the world to be a better place. See his Harvard commencement speech and  US 2020 presidential campaign  tour but as the saying goes, “The road to hell is paved with good intentions.” Only time will tell.

Now on to brass tacks.

Theme: As Marc Andressen put it, “Software is eating the world.” The firms most likely to benefit from this are technology platform companies. Ben Thompson put it best in his brilliant post “Aggregation Theory.” The theory breaks down how suppliers are being modularized by technology platform companies, the new distributors, who then take a disproportionate share of the spoils. For example, Airbnb modularizes the rooms in an apartment building which then disrupts the previous supplier (hotels).

Thesis: Facebook has a stellar management team and a strong moat through its network effect. Its messenger platforms (FB Messenger/Whatsapp) are yet to be monetized. Facebook ad buys might not be underindexed in Europe and the company will benefit from improving standard of living in emerging market economies. Human beings are social creatures thus social data might be more valuable than other forms of data to advertisers. In addition Facebook has a walled garden with information that is currently inaccessible to the biggest data beast of them all, Google. It is also possible the stock is underbought by many institutions due to the sometimes negative connotation attached to FANG stocks.

The business: Facebook sells ads programmatically worldwide mainly through its platforms Facebook and Instagram. It owns 2 other messaging platforms with over a billion users, Facebook Messenger and Whatsapp, that are yet to be monetized. Its virtual reality efforts are housed under Oculus. Finally, Facebook has a small payments/fees business is approximately 3% of revenues.

Market Size: Global advertising is an approximately $600B market with online being approx 38% of this at $228B. At $33B LTM Revenue, Facebook is just 6% of global advertising and 14.4% of online advertising. After reading this post on the total addressable market (TAM) of search it is possible to imagine long term market size being grossly underestimated. Take the following thought experiment: if a brand, say Louis Vuitton, has to close a prime retail location (in, for example, London or Manhattan) because more and more retail is migrating online, how much of its former rent will LVMH pay for a “prime location” on Google Search or one of Facebook’s many platforms (Whatsapp, Instagram, Messenger, Facebook)? See it this way and the TAM of search becomes more unbounded.

Competitive Advantage/Moat: Facebook and its umbrella properties have created the largest network effect mankind has ever seen. Some numbers. Facebook has 2B monthly active users (MAUs) and 1.3B daily active users (DAUs). Whatsapp has over 1B DAUs. Facebook Messenger has 1.2B MAUs. Instagram has 800M MAUs. It has now become much more difficult for a social network to achieve massive scale. Edge cases exists where a niche is created (see Tinder or Twitter) but Facebook size social networks will become increasingly difficult to create. To deepen the moat Facebook continually adds new features to drive engagement. In addition, in the old days when your competitor created a revolutionary product the lead time one needed to catch up might be months or years (product development, testing, manufacturing at scale etc). Now it takes Facebook just weeks or months to copy the features of would be incumbents.

Average Revenue Per User: In Q2 ‘17, across all its platforms Facebook earned $18.93 per user in US & Canada, $6.19 per User in Europe, $2.12 per user in Asia Pacific, $1.47 in Rest of World, and averaged $4.65 per user Worldwide. Looking at these numbers two observations come to mind that might indicate the room FB has to grow. Firstly, US & Canada revenue per user is 3.05x that of European but North America GDP Per Capita GDP is only 1.6x European per Capita GDP. This indicate Europe is possibly under indexed for Facebook Ad spend. The other comparison is between US & Canada ARPU  and Asia Pacific & Rest of World, $18.63 vs $2.12 & $1.47 respectively. As the poorer regions of the world become wealthier, it is entirely possible that brands reach their customers most efficiently through Facebook. Facebook is a play on a richer world 5, 10, 20 years from now, without the heavy capital expenditures that greenfield projects usually entail. Additionally, from comparing my personal user experience on Facebook to that which I had on Instagram, one gets an intuitive feel that Instagram is under-monetized. The delicate balance management has to maintain is to load ads but not interfere with user experience.

Whatsapp/FB Messenger: In times past, the West has led in technology and China has been accused of producing knockoffs but this is not the case when it comes to messaging. One only needs to look at China’s WeChat to see the potential of Whatsapp/ FB Messenger. In addition to messaging, WeChat can be used to shop online, pay for physical goods, share large files, exchange money. Although Facebook has not been clear on how it is going to monetize its messaging services, on the most recent earnings call Zuckerberg’s comment was “I want to see us move a little more quickly” when ask about monetizing Whatsapp. At the F8 Developer conference held in April 2017 the company stated that their roadmap was to focus on video now, messenger in 3 to 5 years, followed by virtual reality and augmented reality over the longer term. The chart below from the Economist shows the potential of Whatsapp/FB Messenger. It might be absolute domination like WeChat might have due to services like Venmo that already exist but the potential is there.

the economist


Zuckerberg the Monopolist: Zuckerberg is only 33 and has been a great owner/operator thus far with a long runway ahead of him and with monopolist tendencies to boot. He has sought to crush competitors at every opportunity. Instagram Stories as a rebuttal to Snapchat. Facebook Live as a rebuttal to Periscope. He has completed acquisitions at every opportunity in order to protect the network effect at all costs (e.g. Instagram and Whatsapp), There was even a rumored failed bid for Snapchat. In addition, Facebook barely shares its economics with its ecosystem as opposed to Google that shares ad revenue with Youtubers and with websites via its Adsense network. Recent announcements to focus on more content initiatives might hurt margins but will probably be best for the ecosystem.

World Class Supporting Cast: This includes the fantastic COO Sheryl Sandberg, the very underrated Jan Koum of WhatsApp (who managed to sell a 55 employee business for $19B), Marc Andreessen of the venture capital firm Andressen Horowitz, Peter Thiel (Zero to One is a must read), Reed Hastings of Netflix, statesman Erskine Bowles and you have an all star top brass.


It is important to keep things simple when it comes to valuation. My approach is to look out 5 years, estimate what the company is going to earn and what it might be worth then and what its future might look from that point on. So, in the last 12 months Facebook earned $13.2B, with a market cap of $516B and $35B of cash on the balance sheet, one is paying roughly $481B and 36x earnings for the whole business. EPS has grown at a CAGR of 62% over the past 5 years and is expecting to grow at a CAGR of 28% over the next 5 years by some street estimates which I will use for simplicity’s sake. I think these estimates might end up looking conservative. Management has started making investments in content that might put pressure on gross margins but a lot of operating leverage will appear from increasing ad load outside the US & Canada and bringing more users online in the developing world. As supply decreases (by not bombarding consumers with ads), demand (programmatic ad buys) will increase which will probably result in higher ad prices. So in 5 years time Facebook might be earning around $45B. Throw on a conservation 20x to these earnings due to a more mature growth profile after 5 years and the business is worth $900B sometime in 2022. So it’s entirely possible that you could compound your money at 13% annually over the next 5 years with Facebook. I have excluded effects of dilution for simplicity, as market value gets larger, an increasingly smaller portion of aggregate value will be used to compensate employees. As of last count they were 2.7M options at a weighted price of $7.38 and 100M RSU at a weighted price of $100, with 2.9B shares outstanding at the last count this is less than 5% of the share count and won’t make or break the valuation case. As Broyhill Asset management points out here, in a market that has a dividend yield of 2%, real earnings growth of 1.5%, inflation of 1.5%, expected P/E increase change of 0% as P/Es already elevated, although not impossible, it is difficult to imagine the S&P 500 gaining more than 5% annually going forward. In that context a 13%, again not fact but estimate, by Facebook is decent.


Technological Disruption: The world of bits (tech companies) will always be more prone to change than the world of atoms and immutable laws of physics (railroads, utilities, etc.).

Consumer Revolt: Although hard to estimate, they have been times in the past where consumers revolted against advertising which is in some ways exploitative. If this happens do users move to another platform? Alternatively, Facebook could move to a subscriber model if/when that happens.

Antitrust: In a world of slow growth, higher inequality and more winner take all scenarios there is the chance of a backlash against tech companies having a larger share of the spoils. See Google’s $2.7B settlement with the EU as an example. A situation could occur where a company like Facebook could have it profits taxed at a much higher rate than currently persists.

Amazon: If Facebook is a tool to capture people’s attention and subsequently advertise to them but more and more retail product is going through Amazon which has its own advertising program (Amazon Affiliates), it is entirely possible that a Facebook ad might not have the same value in 10 years as Amazon becomes more pervasive.

Recession: Advertising is cyclical to some extent. In a scenario where there is a recession in the next 5 years, Facebook business and multiple might get really affected.

Conclusions/Standing on the shoulders of giants/the institutional imperative.

It does not hurt that investment managers much smarter than me, like Pat Dorsey at Dorsey Asset Management and Shad Rowe at Greenbrier Partners, have Facebook as their top holding, but on the other hand, the stock has been either completely ignored or taken up as a small holding in the institutional world (ex ETF). From anecdotal conversations with a few analysts at some big shops that I’ve spoken to, the train of thought goes something like this, “We are a value shop, no way I’m convincing my PM to buy FB at close to 40x earnings.” or “We have avoided FANGs this far in the bull market, the optics of owning one now is hard to sell to clients. It either shows we were wrong all along or we do not believe in our process.” This evidence is purely anecdotal but it is possible there are reasons for not owning the stock that have nothing to do with FB and its actual merits. It will be great to be able to buy Coca-Cola at a single digit multiple and to have it grow at double digits like Buffett did in the late ‘80s, but there is some good research about acquiring companies with long runways and high growth at high multiples and still ending up ahead due to the power of compounding, see this great paper by LindsellTrain.

With all credit due to:

Ben Thompson’s blog, Greenhaven Q2 ‘17 Letter, Alex Moazed’’s Modern Monopolies, Facebook’s Investor Relations, Stevenoop’s TAM post, Horizon Kinetic’s Q2 ‘17 letter, John Lanchester’s amazing review of 3 books, World Bank Per Capita GDP Data.