Truly one of the best things I have ever read about my style of investing, @LazyBeavers
interviewInterview with Twitter @TheLazyBeavers
July 2022
Introduction
Well thank you. I'm afraid you flattered me a bit with that introduction. I certainly don't aim for those levels of return -- doing so would be quite reckless, in fact. But what�s Buffett say? It's not necessary to do extraordinary things to get extraordinary results. In all seriousness, I think it's important to recognize that 14 years is actually a pretty short track record, and I started from a small capital base, so there's little evidence to suggest a 40% IRR is repeatable or scalable.
Background
So I got my start investing in college about 20 years back. I really knew nothing about finance but did know a bit about the railroad industry from prior work and hobbies. I purchased shares in a small US railroad Genesee & Wyoming, they have long since been acquired, back when it was probably about a $100M microcap. They were consolidating shortline and regional freight railroads across the US at a time when the large Class Is were looking to spin off many such routes. And this is an industry where there truly were great synergies to be had following a roll-up strategy, particularly in operational efficiency by clustering these acquisitions into various regions. Anyway, I sold several years later for a sizeable return from what I'm sure was more luck than skill, but it did seed some capital to do this full-time since 2008. It also, fortunately, gave me an appreciation of the return potential in microcaps.
Investment Approach
My general investment philosophy comes from a realization years ago, somewhat depressing at first, that there are millions of people out there smarter, better educated, more narrowly focused, and frankly more ambitious than me. And while it's great to learn from such people, it's not so great to compete with them, so I gravitate toward less competitive assets that are easy for a layperson to understand and then I try to apply an unusually long time horizon.
While I would say I'm fairly industry agnostic, I am limited to a pretty small circle of competence. I'm not smart enough to identify the next medical breakthrough, or assess the risks in a financial services company, or to know if and when some junior miner is going to strike gold. Likewise, I'm not able to forecast when a cash-burning enterprise will make their final capital raise and reach profitability, and have no interest in trying to understand complicated cap tables and financial instruments. So I do tend to gravitate toward tangible consumer products and other simple business strategies with straightforward financials. As Buffett says, it's usually far more profitable to stick with the easy and obvious than it is to resolve the difficult.
I suppose the best way to describe what I look for is small public companies that shouldn't be public. Their P&L is usually too small to really justify the expense of being public. They're largely owned by founders or current management so they have very illiquid securities. Their capitalization is too small to attract institutional interest. Most importantly, even if they could raise equity capital, they have no need or interest in doing so because they are sustainably cash-flow positive and self-funding their growth. And, as a result of all these aforementioned factors, you probably won't find them with top tier IR firms, or at investor conferences, or probably with sell-side coverage of any kind. And they're certainly not issuing quarterly guidance or any such distractions.
So one may already be quite reasonably asking themselves, what's so attractive about a subscale public company that should probably be private? Well, most of the factors I mentioned cause these companies to be quantitatively or qualitatively excluded by most potential investors. You're essentially left with the opportunity to make a pseudo private investment, with all of the liquidity constraints that entails, but with potential public market mispricing.
To step back for a minute, if you purchase a minority interest in a private business, you're probably buying from someone who knows more than you do. That may be the company itself, or a founder, or an exiting seed investor. And you're likely paying at least fair value for the privilege. Not to mention that most individual investors lack access to the best dealflow so they�re disadvantaged before they even begin.
With illiquid public securities, everyone has generally the same access and you may be able to buy one, two, three, even five percent of a business at a price well below that which you could purchase the entire firm. As an example, just a couple years ago I acquired nearly 5% of a public US microcap for about $500K. Market cap at the time was around $10M. I can promise you the company wouldn't issue shares at 10 million. I can promise you the management that owns nearly half the company wouldn't sell a single share at 10 million. In fact not a single share was sold until the price went up about 15x the next year. And while the stock is still rather illiquid, it now often trades 100 times the dollar volume it did a couple years ago.
So why was that opportunity available? Well, I'm just a small retail investor and it took me years to purchase that position, and many months my buys were 80% or more of the stock's trading volume. The investment was really only suitable for those who were small and patient and had a long time horizon to be partnered with that business until a potential liquidity event. That being said, these opportunities probably don't come around very often. Of course if someone's minimum position size is 8-figures then they probably don't come around much at all. But, if someone can have a meaningful position at 6-figures? Well then the opportunity set becomes larger.
Look, I'm in my late 30s, I've been doing this since college, and I've seen less than a dozen similar opportunities that were truly actionable for me. It shouldn�t surprise you to hear my circle of competence is sadly quite small, to the point I don't even look in most industries and geographies. There are surely hundreds of similar opportunities in other regions that I�ve missed, and that�s fine. It's probably always a good idea to stick within one's circle, but I would suggest there's perhaps even less room for error dealing with concentrated illiquid positions. I've had a couple lessons learned the hard way there and would be happy to get into that at some point.
Failures
There's one in particular I bought back in 2012, 2013, a small Canadian home security company, Avante Logixx. They're still public actually and going through quite a disruptive management change. In full disclosure I haven�t owned the firm for several years ago now.
The founder had built up a high-end security business in wealthy neighborhoods of Toronto. They had the best technology, best service, and highly recurring revenue. But they were burning significant cash on technology projects competing against the likes of Honeywell and really risking insolvency. So in steps a private equity guy as co-CEO with a promise of financial discipline. Most importantly, they pitched an enticing roll-up strategy of adjacent security services, a strategy I had some prior success with and perhaps had been blinded to the execution risks.
So, expenses were cut to reach profitability, but then core business stagnated, and then the acquisitions were slow to come, and when they did they were small and produced little synergy. Of course the roll-up strategy was dependent on a liquid public currency. Issue shares at 12x EBITDA to purchase subscale private businesses for 5x EBITDA. These roll-ups of fragmented industries often sound great in theory. But when they go wrong they can go really wrong because you lose the ability to raise cheap capital and the multiple arbitrage they're dependent on.
Now I don't want to get into all that went wrong with the business strategy. In fact there was no spectacular blow-up, but the value accretion just never materialized. If you look at the long-term stock chart you could even wonder how this was such a failure for me. Well it was opportunity cost, both mentally and monetarily. That was prior to a reverse split and I was sitting on maybe 2.5 million shares of a stock that was trading maybe 30 thousand a day? So when I lost confidence in 2016 and wanted out, it was a long painful exit. I actually had to wait over a year until an activist, and actually the company's next CEO, bought a large stake in the open market.
Of course this is a problem with illiquid positions. I sometimes own 100 times or more of the average daily trading volume in a security. It's not easy to get in, and it's not easy to get out prematurely. So applying the strategy to just any asymmetric risk/reward opportunity is foolish. There was little risk that Avante would blowup -- it was a profitable, high recurring revenue business. That minimal downside risk really drove my overconfidence. But I was outside my circle of competence investing with an industry and people I didn't know, with a business strategy dependent on the financial engineering of a roll-up. The likelihood that this would be an investment I could hold for 5, 10, 15 years and see through to an ultimate liquidity event just wasn't there, so sizing it as such was really an act of embarrassing hubris on my part.
cont..
