Rivera Holdings First Acquisition And How You Can Invest

Rivera Holdings First Acquisition And How You Can Invest

You may have noticed I've gone silent in the last month plus.  I haven't posted much on Twitter of Facebook, and haven't released a new post on the blog since September 29th.  This silence is for a great reason though...

Behind the scenes I've worked on setting up the legal structure of Rivera Holdings, figured out who can and can't invest which I'll talk more about in the coming days, and found two companies to become its first acquisition.

I sent through snail mail and email an activist style letter to a public company stating I was looking to buy them for $20 million, or a 30% premium to its then market value.  I've still not heard from them at this point.  And they will remain a target down the road to acquire because for now I've switched gears and found another business to buy that's even better.

The second company I found by accident as I was readying a Letter of Intent to send to the first company above.

Ever since I found them I've done a ton of due diligence on the company and its industry, talked in person with the current owner five times so far, The Seller and Rivera Holdings have agreed to a Letter of Intent on an $8 million purchase for the business, and Rivera Holdings is prequalified for the full $8 million amount in a loan to cover the purchase price.

Below I detail the business target more, detail the loan, and tell how you can invest in Rivera Holdings to become part of this deal.

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Rivera Holdings is now officially and legally open for business.

Rivera Holdings has signed a letter of intent and agreed to an $8 million purchase price with a business owner looking to sell.

Rivera Holdings is prequalified for the full $8 million purchase price through debt financing – minus closing costs and what I have to bring to the table.

And Rivera Holdings is now seeking equity investors to finish closing the deal and begin building wealth for us all.

Below I’ll run these developments down one by one and explain how you can make money.

Rivera Holdings is now set up as a Delaware LLC and is ready for business.

Rivera Holdings has agreed to an $8 million acquisition and both us as buyers and the sellers have agreed to a Letter of Intent on terms.  This letter also gives us exclusive rights to work on acquiring the business for 60 days from when it was signed by both parties.

Both I and the Sellers agree the deal can be extended as long as we as buyers are showing movement towards getting the deal done.

The one problem with the Letter of Intent is it keeps me from stating exactly which business it is and which industry the company is in.  But below I still tell you some great things about the business Rivera Holdings is acquiring.

If you’re willing to sign the NDA further below the current owner of the business agrees I can then share what the business is, what industry it’s in, and our – Rivera Holdings – specific plans for the business upon closing of acquisition.

For now, let’s get to some things about this great business I can share.

  • It’s growing.

It’s on track to produce a little less than $1 million in revenue this year.  And since the current owner took over in 2014 it’s increased revenues from $500,000 per year to current level in less than three full years later.

  • It’s profitable.

On that almost $1 million in revenue it’s on track to produce an approximate $605,000 in net profit this year.  In other words, its net profit margin is on track for an incredible 60% this year.

  • There is huge room to cut expenses immediately

After meeting with the owner several times so far and doing my own due diligence I've found $115,000 worth of expenses that will get cut immediately without hurting sales or profitability.

This would drop to profitability margins and metrics and increase the net profit margin by 16%.  Or an increase from the $605,000 projected for full year 2016 to $720,000.  This is counting no further cuts we're likely to find after taking over operations.

  • It’s got valuable property and equipment on its balance sheet.

As I said above the purchase price for the entire business – land, equipment, operations, etc. – is $8 million.  The total value of just the land and equipment by recent appraisal and equipment purchases is $8 to $9 million.

In essence, this means we’re buying the land and equipment and getting a valuable 60% + net profit and excess cash producing business for free.

  • We’re buying the business at a huge discount to its true value.

As stated above, just the land and equipment is valued between $8 and $9 million.  I value current operations between $6 million and $7 million.

This means we’re buying a profitable business, operations, and valuable land and equipment that are worth $15 to $16 million for only $8 million.

  • There is massive room for sales/profit expansion at little cost to the business.

A part of current business operations are being expanded and will increase revenues by ~$100,000 to $200,000 per year once completed.  Expansion is slated to finish within the next 60 days, or around when I can take over the company depending on closing.

Further expansions to this line of business can and will be done within five years.  And prices can raise within the businesses main line of operations 26.7% in this time frame as well.  This is talked about more below.

Another part of business operations are being expanded as we speak, will begin generating revenue within next two weeks, and will increase this business sections revenue by 33% to 38%.  Or from $96,000 per year to $144,000 to $156,000 per year.

And on top of this, according to the most recent appraisal of the business and property done in August 2016

“The REMOVED has a FAR (Floor Area Ratio) of 25% indicating the area that could be improved/used for more sales opportunities is 38,600 sq feet.”

The above means ~25% of current business property - total property acreage is just under 3.5 acres - isn’t being properly used by the owner.

By utilizing this square footage better it means we could produce an extra $386,000 to $772,000 on $10 to $20 per square foot estimates on commercial lease rates.

Adding all the improvement numbers above together would add another $630,000 to $1,128,00 to revenues.  Most of which would drop to profitability – operating and net margins and cash flow – due to low costs to add these new sales opportunities.

Adding and expanding the above business lines would increase sales from ~$930,000 projected for full year 2016 to between $1,560,000 and $2,058,000 million.

Assuming the same net profit margin of 60% and the cost cut mentioned above we would earn $1,051,000 to $1,349,800 in net profit in 2017 and 2018.  Or increases in net profit of 42.4% and 55.1% respectively within two years of our take over.

At these levels I would value operations at $10.5 and $13.5 million by themselves.  Plus the ~$8 million in property and equipment would take us to $18.5 and $21.5 million for the entire business in one to two years time.

All for an original purchase price of $8 million for the entire business.

  • Plus there’s hidden pricing power within the business.

Local and regional businesses selling similar products and services have 26.7% higher prices than current business.  And we as new owners will be able to raise prices slowly over several years to reach competitive levels.

One price rise of 8.3% on the company’s major product in the first year will increase monthly revenue by ~$6,000 per month, or $~$72,000 per year.  Again, almost all this will drop to profitability.

In the second year, we’d look to raise prices another 4% and in the third year by another 4%.  Doing this would further increase revenue on the company’s major product another ~$ 6,000 per month or $72,000 over the two-year period in revenue and profitability.

Using the amounts talked about in the previous section this would increase revenue to $1,632,000 to $2,130,000 million and produce net profits of $1,091,200 to $1,393,000 million in the first year.

In the second year revenues would rise to $1,668,000 to $2,166,000 million and produce net profits of $1,115,800 to $1,414,600.

And in the third year revenues would rise to $1,704,000 to $2,202,000 million and produce net profits of $1,163,200 to $1,465,000 million.

This is with no further cost reductions, further price increases, further marketing – all of which are planned – or adding any other sales opportunities than the ones mentioned above.

At the end of 2019, the end of the above projections, I would value the company’s operations between $11.6 and $14.7 million.

After three years the property and equipment should be worth $10 to $15 million after better utilizing the property and equipment and through land appreciation value.

Adding this value to the value of operations would make the company worth between $21.6 and $29.7 million.  In other words, our original $8 million investment will earn us conservative returns between 39.3% and 54.8% each year for three years. Or a cumulative – non-compounded – return after three years of between 117.9% and 164.4%.

At the end of three years we should own a business worth between $21.6 and $29.7 million all for an original $8 million purchase price, with few added costs over the three-year period, little in the way of major new expenses, and still opportunities to grow the company’s operations and profitability further.

And these are ultra conservative estimates because I hate projecting numbers forward like this but have to for business planning purposes.

Barring a major hurricane in the area that would hamper growth, there is no reason the business and land shouldn’t be worth at least $30 million within five years and at least $50 million within 10 years.

All the while producing a ton of excess cash we can use to further enhance this business and buy other businesses.  And of course, compound the value of the business and Rivera Holdings private shares for the long-term.

But this isn’t all…  The next six things protect our investment even further.

  • The revenue model for the business is long-term renewing contracts.

Customers are only allowed to sign yearlong recurring contracts for the company’s main operations.  And commercial leasing opportunities are also on long-term – year plus – contracts.

  • There’s huge demand for this business in my area.

This business is a 15-minute drive from my house and there’s massive demand for this company’s products in this area.  Demand is only growing too as more people move to the Tampa area and more people in the area buy houses.

  • The business has a government/regulatory moat protecting us from competition.

There is little competition for this business within a 30-minute drive of where the business is.  And due to heavy government/regulatory issues within this companies industry, local and federal governments are likely to never let another type of this business be built or started in this area.

  • Even in the event of a major hurricane destroying the entire business current insurance coverage covers everything…

And when I say everything I mean everything; the full value of all property, improvements, equipment, and even revenue protection for a 12 to 24 month period as we rebuild.

  • The business requires regular expensive maintenance/upkeep/upgrades.

But all major equipment, maintenance, and necessary expenses and upgrades were completed within the last two years.  And most of this equipment has 20 to 40 year expected life cycles.

While the business requires regular upkeep and maintenance, the current owner states there are no major planned expenses or upgrades for the next 10 years.  While the two businesses that do compete with us in the area - the only competitors within a 30-minute drive in any direction - both have major multimillion projects planned within the next two years.

  • We have a huge margin of safety not only in valuation we are buying at but also in a worst case scenario analysis.

In a worst case scenario analysis assuming a drop in sales of 30% - which is what sales dropped in the last recession – combined with an increase in expenses of 25% - which there’s no precedent for – and the company still produces net income of $197,000 for the full year 2016.

While this huge cut in sales and increase in expenses combine to drop net profits by 65% the company is still profitable in this dire situation.

This worst case scenario analysis also assumes not adding or doing any of the positive things mentioned above: no new ancillary sales opportunities, no upgrading of companies main sales operations, no cost cuts, no price rises, etc.

With this gigantic margin of safety there is almost no way to lose money owning this business over the long-term.

The Short and Medium Term Plan

I’ve already found the $8 million to buy the business – more on this below – so why am I reaching out to you?

  1. Because I want you involved in building the company by becoming an early equity holder with super voting rights at a heavily discounted rate while we grow and build Rivera Holdings into a billion dollar plus company.
  2. I’m accomplishing this by raising equity in the parent company of target acquisition Rivera Holdings.

At this point, Rivera Holdings is prequalified for the full $8 million purchase price. The loan will be for $6.8 million and I have to bring $1.5 million to the table including fees, closing costs, and me as the owner having “20% skin in the game on the transaction.”

Having said this I'm selling a 50% equity stake in Rivera Holdings at a $24 million valuation to raise another $12 million as part of this transaction for several reasons.

  1. To allow you and a few others who have helped me along the way to buy equity in Rivera Holdings at a heavily discounted rate to pay you back for your kindness, wisdom, and friendship. Early investors will also have super voting rights.  This means nothing until the company goes public, but early investors in Rivera Holdings private shares will have super voting powers shares upon the company going public.  Depending on how this is structured down the road – likely five to ten years down the road – Rivera Holdings private shares will have 2 to 10 times the voting power of Rivera Holdings public shares after IPO.  Super-voting shares are always more valuable than regular shares so this is another way early investors in Rivera Holdings will have an advantage over later investors.
  2. To help you earn safe returns on your investment capital to compound value well into the future. The end goal being building Rivera Holdings into a billion dollar plus company in time.
  3. Unless a great business falls into our laps at a cheap price I plan to never do another equity sale until we IPO Rivera Holdings.  This means you won’t be diluted except in an extremely rare circumstance that’s favorable for us all.
  4. To ensure a huge margin of safety. As a long-term oriented value investor I hate debt in most cases and I plan to use some of the proceeds of the equity sale to pay off in full, or most of, the $6.8 million loan immediately.
  5. Under current plans paying off debt in full or partly would leave $3.7 to $6 million left in cash on Rivera Holdings balance sheet compared to $0 to $2.3 million in debt. And Rivera Holdings would own a subsidiary worth $15 to $16 million immediately upon acquisition.  Even though it would show up as $8 million in book value on the balance sheet.
    1. Rivera Holdings balance sheet after acquisition would look something like this: Assets - cash, subsidiary value, etc - worth between $11.7 and $14 million at book value.  Again, remember accounting rules don’t care that we value the business a lot higher than the IRS does.  With $0 to $2.3 million in liabilities meaning shareholders equity would be between $9.4 and $14 million.
  6. At this point, I would look to get a $5 to $10 million line of credit at the acquired business - subsidiary - in case of emergencies or necessary upgrades to further increase our margin of safety.
  7. With the remaining $3.7 to $6 million at Rivera Holdings I plan to send $1 to $2 million to the bank underneath this acquisition to take advantage of business opportunities as they arise, enter into new sales opportunities mentioned above, for advertising and marketing, and for emergencies/repairs of property and equipment as they arise. With current level of expenditures this money should last more than five years.  And this doesn’t include any profits or cash produced by the acquisition in those five years.
  8. The remaining $2 to $4 million will be left at Rivera Holdings and I’m going to invest this money in safe, undervalued, profitable public company stocks as I’ve done over the past five years producing returns of 31.1% on average – not compounded – each year over the last five. Better returns than Buffett produced in the first five years of his career.
  9. I’d continue working this process to compound our value for the long-term.

Over a one to five-year period the plan is to continue to grow the acquisition and build as much value as possible, pay off debt, invest the stock market funds at Rivera Holdings, continue to produce a ton of excess cash flow at the subsidiary acquisition, and compound value of all investments and assets owned.

I wouldn’t look to do another full acquisition within the first two years after the first acquisition closes unless something ultra cheap and attractive falls into our laps.

The plan within the next five to ten years is to either take Rivera Holdings public through an IPO or to buy enough of a public company to do a reverse merger onto the stock market.

There are two ways you can make money owning shares in Rivera Holdings over the long-term:

  1. The first is holding Rivera Holdings private shares while they compound value over the next five to ten years until the company goes public and your shares become worth a lot more.
  2. The second is holding your Rivera Holdings private shares for a few years and then reselling them to Rivera Holdings after they’ve appreciated in value and/or you’ve earned your initial investment back plus a return you’re comfortable with.

Conclusion

This is a fantastic opportunity for us all to buy a massively undervalued business for half of its true worth.

This is a fantastic opportunity to buy into a 60%+ net profit margin business that already produces a ton of excess cash we can use to buy other valuable assets that also has huge room for growth in sales and profitability.

This is a fantastic opportunity to buy into a business that has a gigantic government/regulatory moat built around it.

This is a fantastic opportunity to buy into a business with a huge margin of safety and huge protections around it that give us an even bigger margin of safety.

This is a fantastic opportunity to buy into a business that will grow in value between 39.3% and 54.8% each year for the next three years.  Or produce a cumulative – non-compounded – return after three years of between 117.9% and 164.4% over three years.

This is a fantastic opportunity to get in at the early stages towards building a billion dollar plus company.

Below is a chart illustrating this.  At a 20% rate of return - far below the 31.1% I've produced each year for the last five years not compounded - and with no new capital contributions, it will take us only 22 years to compound a capital base of $20 million into more than $1 billion.

cagr-calculation

And I want you to become part of this fantastic opportunity for long-term wealth creation and appreciation as we build something great.

If you’re interested in learning more about the great business we’re acquiring please sign and return to the below email address the short two page NDA to receive more information about the target acquisition.

Or if you already want to invest in Rivera Holdings please contact me at either 605-390-3157 or JasonRivera@valueinvestingjourney.com

Sincerely yours,

Jason M. Rivera

Chairman, CEO, and Founder of Rivera Holdings

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NDA below here.

By signing the below agreement The Seller of acquisition target has agreed to let me tell potential Rivera Holdings investors more information about the target acquisition.  This includes what the business is, what industry it operates in, more specifics about its operations, and our – Rivera Holdings – plans after acquisition of target business closes.

For convenience the NDA can also be downloaded and printed off by clicking the following link.

rivera-holdings-nda

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THIS AGREEMENT is made and entered into as Nov 7, 2016 (“Effective Date”), remains effective until the close of acquisition and/or Rivera Holdings and The Sellers agree to not do sale, by and between Rivera Holdings, (“the Disclosing Party”) and _____________________________ Your Name In Space, (“the Recipient”) (collectively, “the Parties”).

Purpose for Disclosure (“Business Purpose”):  The purpose of this agreement is to protect both The Seller, Rivera Holdings, and yourself (potential investor) from breaching any legal, competitive, or fiduciary agreements made between the parties prior to acquisition of target company.

The Parties hereby agree as follows:

  1. For purposes of this Agreement, "Confidential Information" shall mean any and all non-public information, including, without limitation, technical, developmental, marketing, sales, operating, performance, cost, know-how, business plans, business methods, and process information, disclosed to the Recipient.  For convenience, the Disclosing Party may, but is not required to, mark written Confidential Information with the legend "Confidential" or an equivalent designation.
  2. All Confidential Information disclosed to the Recipient will be used solely for the Business Purpose and for no other purpose whatsoever. The Recipient agrees to keep the Disclosing Party’s Confidential Information confidential and to protect the confidentiality of such Confidential Information with the same degree of care with which it protects the confidentiality of its own confidential information, but in no event with less than a reasonable degree of care. Recipient may disclose Confidential Information only to its employees, agents, consultants and contractors on a need-to-know basis, and only if such employees, agents, consultants and contractors have executed appropriate written agreements with Recipient sufficient to enable Recipient to enforce all the provisions of this Agreement. Recipient shall not make any copies of Disclosing Party’s Confidential Information except as needed for the Business Purpose. At the request of Disclosing Party, Recipient shall return to Disclosing Party all Confidential Information of Disclosing Party (including any copies thereof) or certify the destruction thereof.
  3. All right title and interest in and to the Confidential Information shall remain with Disclosing Party or its licensors. Nothing in this Agreement is intended to grant any rights to Recipient under any patents, copyrights, trademarks, or trade secrets of Disclosing Party. ALL CONFIDENTIAL INFORMATION IS PROVIDED "AS IS". THE DISCLOSING PARTY MAKES NO WARRANTIES, EXPRESS, IMPLIED OR OTHERWISE, REGARDING NON-INFRINGEMENT OF THIRD PARTY RIGHTS OR ITS ACCURACY, COMPLETENESS OR PERFORMANCE.
  4. The obligations and limitations set forth herein regarding Confidential Information shall not apply to information which is: (a) at any time in the public domain, other than by a breach on the part of the Recipient; or (b) at any time rightfully received from a third party which had the right to and transmits it to the Recipient without any obligation of confidentiality.
  5. In the event that the Recipient shall breach this Agreement, or in the event that a breach appears to be imminent, the Disclosing Party shall be entitled to all legal and equitable remedies afforded it by law, and in addition may recover all reasonable costs and attorneys' fees incurred in seeking such remedies.  If the Confidential Information is sought by any third party, including by way of subpoena or other court process, the Recipient shall inform the Disclosing Party of the request in sufficient time to permit the Disclosing Party to object to and, if necessary, seek court intervention to prevent the disclosure.
  6. The validity, construction and enforceability of this Agreement shall be governed in all respects by the law of the Delaware. This Agreement may not be amended except in writing signed by a duly authorized representative of the respective Parties. This Agreement shall control in the event of a conflict with any other agreement between the Parties with respect to the subject matter hereof.

IN WITNESS WHEREOF, the Parties have executed this Agreement as of the date first above written.

___________________________________________________

Your Signature

___________________________________________________

Your Printed Name

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Remember to sign and return the above NDA to JasonRivera@valueinvestingjourney.com to receive more information about the target acquisition.

On Float The 60 Page Book Released

On Float The 60 Page Book Released

Over the last seven months I've detailed investment float a lot here.  All the nuances, and both the positives and negatives of float.

The hope being we'll have a huge advantage over other investors by knowing the immense power float holds.  How to evaluate it.  And how it affects a company's value among many other things.

Over the last seven months, seven parts, 12,000 words, and 60 pages of content I explain all the following in detail.

  • What float is.
  • Why it's important.
  • How companies can use float as positive leverage.
  • How Buffett got so rich using float.
  • How to find float on a balance sheet.
  • How to evaluate float.
  • How float affects a company and its margins.
  • Maybe the most important thing why float affects a company and its margins.
  • How float affects a company's value.
  • And answered the question is float ever bad?

I released the last part of the On Float series on the blog last week so why am I writing this post?

Because I've compiled all the information above and put the content into a 60 page PDF book that's releasing free today.

And by free I mean free.

You don't have to pay me a cent.  Don't have to pass this along on Twitter or Facebook.  And don't even have to give me your email address to gain access to this book.

All you have to do to download this book is click on the link below.  That's it.

On Float The 60 Page Book

Feel free to share this with anyone you'd like and as many people as you'd like.  No restrictions and no hassles.

The only things changed from the blog posts to the transition into book were I deleted some redundancy from the blog posts and changed/fixed some formatting issues that popped up in the transition.

All other content to my knowledge is the same.

I hope you enjoy and learn as much from this information as I have.

Conclusion and Further Recommended Reading – On Float Part 7

Conclusion and Further Recommended Reading - On Float Part 7

This post is the last one in the On Float series started way back on February 2nd 2016.  Yes that date is correct.  I posted the first article in this series Charlie Munger On Deferred Tax Liabilities and Intrinsic Value - On Float Part 1 seven months ago.

If I've done my job well in the seven parts, more than 12,000 words, and 60 pages of content including this post we all should know the following now.

  • What float is.
  • Why it's important.
  • How companies can use float as positive leverage.
  • How Buffett got so rich using float.
  • How to find float on a balance sheet.
  • How to evaluate float.
  • How float affects a company and its margins.
  • Maybe the most important thing why float affects a company and its margins.
  • How float affects a company's value.
  • And answered the question is float ever bad?

But as with any great thing in life and investing there's always more to learn and improve on.  Knowing this I've included the things I've learned the bulk about investment float from below.

Also make sure to read the comments sections of any of the following as well as there is usually great commentary there on the specifics of float.

All the following are in no particular order.  Have been added to the Recommended Reading and Viewing page.  And are designated as MUST READS!!! on the Recommended Reading and Viewing page.

My posts about float.

I specifically want to thank Warren Buffett, Charlie Munger, Professor Sanjay Bakshi, and The Brooklyn Investor for sharing their knowledge on float.  Without their knowledge none of my posts would have happened.

Reading the above things and taking notes where necessary will help you further understand the nuances of float.

But if you really want to continue learning about float make sure to read company filings, take notes, analyze the company fully, analyze its float, and value the company.

Doing this over and over - like with almost everything in value investing - not only ingrains these concepts in your thought processes.  But the more you do it the more nuances you'll spot.  And the more intimate knowledge you'll have of investment float and its immense power.

If I've done my job well over the last 60 pages we should now have a huge advantage over other investors who either don't know what investment float is.  Don't know how to value and evaluate it.  Or won't take the time to learn how to do these things.

But as always there's always more to learn and improve on so on to the next one...

Please leave any comments, questions, or concerns you have about float in the comments section below.

***

Remember if you want access to my exclusive notes and preliminary analysis you need to subscribe for free to Value Investing Journey.  And this isn't all you'll get when you subscribe either.

You also gain access to three gifts.  And a 50% discount on a year-long Press On Research subscription.  Where my exclusive stock picks are evaluated and have crushed the market over the last four years.

Is Float Ever Bad? On Float Part 6

Is Float Ever Bad? On Float Part 6

The goal of this blog is to help us all improve as investors and thinkers so we're a little wiser every day.  The hope being that our knowledge will compound over time so we'll have huge advantages over other investors in the future.

The aim of today's post is to continue this process by talking about a topic few investors know about.  And even fewer understand.

Most people overlook float when evaluating companies because they either don't know what it is.  Don't know the power it can have within a business.  Or don't know how to evaluate it.

This won't be an issue here.

Press On Research subscribers already know this as I talk a lot about float in many of the issues I've written.  But I want to begin talking about it more here because float is one of the most powerful and least understood concepts of business analysis.

Today's post is a continuation of the earlier posts:

Today we're going to answer the question "Is Float Ever Bad?

Is Float Ever Bad?

I'm a guy who likes to live by the above quote.  If I can make things simpler I always do.  Not only does this make things easier to understand but it also can save a ton of time.

When analyzing investments and dealing with complex topics like investment float this isn't always possible.

Understanding the good things about investment float is definitely one of those things you can make only so simple.  The concept is simple to understand but the there are a ton of different nuances to understand which leads to complexity.  You can likely tell since it's taken me 51 pages thus far in the five earlier posts to explain the good things about investment float.

Luckily the answer to the titled question is a simple one.  And also involves simple and easy to understand concepts as well.

Yes, certain investment float is bad.  And no, not all float is equal.

The heuristic or mental model I use when evaluating float is that if the company isn't profitable - or near profitability - its float is useless.  And can even be a negative burden for a company.

Why?

Remember, float are liabilities that can become positive leverage if used well by management and the company is profitable.  But always remember leverage can go both ways as well.

If a company isn't profitable and hasn't produced profits in several years float turns into negative leverage.  This is because in the long run float are liabilities the company will have to pay at some point.

The longer a company goes without earning profits the longer it will take a company to pay its liabilities because it's not earning enough money.  This also makes it harder to fund operations and grow in a healthy way without taking on a ton of debt or even more liabilities.

Let's go through a quick example to show this.

Let's say we have two insurance companies.  Company A has an average combined ratio of 90% over the last five years and Company B has an average combined ratio of 110% over the last five years.

Not only does this mean Company A's profits are 20 percentage points better on average than Company B.  But it also likely means that Company B has continued racking up liabilities it can't afford to pay when due or when a catastrophe strikes.

This is because Company B hasn't earned a profit on average over the last five years.  And of course all else remaining equal a company earning 20 percentage points better profit's on average is the higher quality company.

The same general rule goes for non insurance companies as well.  If they aren't, haven't been, and show no signs of becoming profitable float should be viewed as negative leverage for a company.

I use the following rules when evaluating all companies float...

  • To view float as a giant positive for any company I like to see consistent profitability in the last five years.  And/or seven of the last 10 years.
  • If a company has off and on profitability I view float as neutral.
  • And if the company is consistently unprofitable I view float as a huge negative for the company.

I consider profitability of operating margin, ROIC, ROCE, and FCF/Sales.  The company doesn't have to produce huge excess profitability in each category.  I look for consistency and trend of profits more than anything when evaluating float.

This idea is a lot simpler to understand than the concept of what float is and makes it potentially great for companies and investors.

One last thing to remember when evaluating float is that whether the company has positive or negative acting float doesn't matter if the company doesn't allocate capital well.  And the management doesn't know what float is or how to use it.

To evaluate these potentials see the previous five posts on this topic.

Summary

If I've explained everything well enough in the series so far we should understand -

  • What float is.
  • Why it's important.
  • How companies can use float as positive leverage.
  • How Buffett got so rich using float.
  • How to find float on a balance sheet.
  • How to evaluate float.
  • How float affects a company and its margins.
  • Maybe the most important thing why float affects a company and its margins.
  • How float affects a company's value.
  • And answered the question is float ever bad?

In the next and final seventh chapter of this series I'll share the best resources I've learned from about float with you.

Knowing what we know now we should have a gigantic advantage over other investors who either don't know about float.  Or aren't willing to put in the time to learn what it is and what it can do for a company and investment.

If you have any questions, concerns, or comments on float up to this point please let me know in the comments section below.

***

Remember if you want access to my exclusive notes and preliminary analysis you need to subscribe for free to Value Investing Journey.  And this isn't all you'll get when you subscribe either.

You also gain access to three gifts.  And a 50% discount on a year-long Press On Research subscription.  Where my exclusive stock picks are evaluated and have crushed the market over the last four years.

Alert: Corning To Buy Company I’ve Recommended

Alert: Corning To Buy Company I've Recommended

Note: I just sent versions of the following message to both Value Investing Journey and Press On Research subscribers.

Thanks for being a loyal email subscriber.

While working at the investment newsletter from September 2014 to February 2015 I recommended three companies to subscribers.

I wrote in my 2014 and 2015 Value Investing Journey and Press On Research Portfolio Reviews that while I couldn't reveal the research or the names of those companies.  I may write new research reports about them at some point in Press On Research.

While doing research on them to write-up in Press On Research one of them ended up agreeing to a buyout offer from Corning (GLW).

Alliance Fiber Optic (AFOP) agreed to the buyout price of $18.50 per share.  A 22% premium to what I recommended the company at.

I can't release the full analysis article I wrote but in short my thesis on the company was that it was undervalued by 22% to 65%.  That it had some minor competitive advantages.  That there was a huge $140 billion trend in the companies industry that could explode its shares.  And it crushed bigger competitors in terms of profitability.

Just to name a few margins that were spectacular it produced a 19.3% FCF/Sales Margin.  Had an ROIC of 34%.  And had an unlevered return on net tangible equity of over 100%.  The only time I've found a company whose margin was above 100%.  And this means it's one of the best run businesses on the planet.

And this still wasn't all...

Insiders owned 14% of its shares.  It paid a 1.2% dividend.  And planned to buy back 6% of shares outstanding.

I loved this company.  And its profitable operations were some of the best I've come across when evaluating companies over most of the last decade.  Especially considering it was only a $250 million company.

The buyout price of $18.50 per share in cash from Corning is a low-ball offer though.

AFOP is worth between $20 and $25 per share with no growth expected.  And like I said above there's a huge $140 billion trend in the companies industry that could explode its growth and share price further.

At this point I'm not sure if shareholders will fight or not but lawsuits have been filed by at least two different law firms saying AFOP insiders breached their fiduciary responsibility to shareholders by not seeking a higher price.

I agree the price AFOP agreed to is low.  But it's not egregious so I'm not sure if these lawsuits will continue or if shareholders will get any money at some point.

Either way the subscribers of the investment newsletter I worked for will gain ~22% in 14 months owning this great company.

If you'd like to see my other exclusive company recommendations where my picks have crushed the market over the last four years you need to subscribe to Press On Research.

And remember as Value Investing Journey subscribers you get a 50% discount on a one year subscription.  Full year price for you as a subscriber is only $49 instead of $97.  And newsletters similar to mine sell for several thousand dollars at prominent investment newsletter companies.

Thank you for being a subscriber

Jason Rivera

Value Investing Journey

Press On Research

Author of How To Value Invest

***

To find out all the great companies I've recommended you need to subscribe to Press On Research.

And if you're a Value Investing Journey subscriber remember you also get a 50% discount on a one year Press On Research subscription.

Similar newsletters to Press On Research sell for several thousand dollars at a big newsletter company.

If you have further questions about Press On Research please go to the link in this sentence or email me at jasonrivera@valueinvestingjourney.com.

Buffett’s Alpha Notes – The Power of Float – On Float Part 3

Buffett's Alpha Notes - The Power of Float - On Float Part 3

The goal of this blog is to help us all improve as investors and thinkers so we're a little wiser every day.  The hope being that our knowledge will continue to compound over time so we'll have huge advantages over other investors in the future.

The aim of today's post is to continue this process by talking about a topic few investors know about.  And even fewer understand.

Most people overlook float when evaluating companies because they either don't know what it is.  Don't know the power it can have within a business.  Or don't know how to evaluate it.

This won't be an issue here.

Press On Research subscribers already know this as I talk a lot about float in many of the issues I've written.  But I want to begin talking about it more here because float is one of the most powerful and least understood concepts of business analysis.

Today's post is a continuation of the earlier posts: Charlie Munger On Deferred Tax liabilities and Intrinsic Value - On Float Part 1. And What is Float? On Float Part 2.

Today I'm going to illustrate how powerful float is over time.

Buffett's Alpha Notes - The Power Of Float

My notes aren't in the quoted areas unless in parenthesis.  Bolded emphasis is mine throughout.

“Further, we estimate that Buffett’s leverage is about 1.6-to-1 on average. Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks.”

“We show that Buffett’s performance can be largely explained by exposures to value, low-risk, and quality factors.”

“Looking at all U.S. stocks from 1926 to 2011 that have been traded for more than 30 years, we find that Berkshire Hathaway has the highest Sharpe ratio among all. Similarly, Buffett has a higher Sharpe ratio than all U.S. mutual funds that have been around for more than 30 years.

Sharpe ratio is a measure for calculating risk adjusted returns. I don’t use this metric but It’s talked about a lot in the Buffett’s Alpha PDF so you need to understand what it is to understand the context of the article even if you never use it.

Alpha is another metric I don't use... It's a measure of risk adjusted performance.  It's the return in excess an investor/business generates when compared to an index.

For example if your stock picks have returned 20% every year over the last ten years while a comparable index has returned 10% every year for those ten years you've generated an alpha of ten percentage points every year.

“So how large is this Sharpe ratio that has made Buffett one of the richest people in the world? We find that the Sharpe ratio of Berkshire Hathaway is 0.76 over the period 1976-2011. While nearly double the Sharpe ratio of the overall stock market, this is lower than many investors imagine.

Adjusting for the market exposure, Buffett’s information ratio is even lower, 0.66. This Sharpe ratio reflects high average returns, but also significant risk and periods of losses and significant drawdowns.

If his Sharpe ratio is very good but not super-human, then how did Buffett become among the richest in the world?”

“The answer is that Buffett has boosted his returns by using leverage (FLOAT) and that he has stuck to a good strategy for a very long time period, surviving rough periods where others might have been forced into a fire sale or a career shift. We estimate that Buffett applies a leverage of about 1.6-to-1, boosting both his risk and excess return in that proportion.”

Thus, his many accomplishments include having the conviction, wherewithal, and skill to operate with leverage and significant risk over a number of decades.”

If you read the article linked below ignore the academic talk of beta, efficient markets, and other academic terms that have little to no relevance in value investing.

“Buffett’s genius thus appears to be at least partly in recognizing early on, implicitly or explicitly, that these factors work, applying leverage without ever having to fire sale, and sticking to his principles. Perhaps this is what he means by his modest comment:”

Ben Graham taught me 45 years ago that in investing it is not necessary to do extraordinary things to get extraordinary resultsWarren Buffett, Berkshire Hathaway Inc., Annual Report, 1994.

“However, it cannot be emphasized enough that explaining Buffett’s performance with the benefit of hindsight does not diminish his outstanding accomplishment. He decided to invest based on these principles half a century ago. He found a way to apply leverage. (FLOAT) Finally, he managed to stick to his principles and continue operating at high risk even after experiencing some ups and downs that have caused many other investors to rethink and retreat from their original strategies.”

I disagree with the high risk mentioned in this entire article.

The academic version of risk is a lot different from what we as value investors think of risk.  Most of the “excessive risk” mentioned throughout the article is attributed to volatility.  Which isn’t risk in what we do.

Why then does Buffett rely heavily on private companies as well, including insurance and reinsurance businesses? One reason might be that this structure provides a steady source of financing, allowing him to leverage his stock selection ability. Indeed, we find that 36% of Buffett’s liabilities consist of insurance float with an average cost below the T-Bill rate.” (FLOAT)

In summary, we find that Buffett has developed a unique access to leverage that he has invested in safe, high-quality, cheap stocks and that these key characteristics can largely explain his impressive performance.

Buffett’s large returns come both from his high Sharpe ratio and his ability to leverage his performance to achieve large returns at higher risk. Buffett uses leverage (FLOAT) to magnify returns, but how much leverage does he use? Further, what are Buffett’s sources of leverage, their terms, and costs? To answer these questions, we study Berkshire Hathaway’s balance sheet, which can be summarized as follows:

We would like to compute the leverage using market values (which we indicate with the superscript MV in our notation), but for some variables we only observe book values (indicated with superscript BV) so we proceed as follows.

The above means the estimated 1.6 to 1 leverage the paper states Berkshire gets from its float is a low estimate.  This is because they had to use book values as estimates for the wholly owned Berkshire subsidiaries.

These book values don’t represent any growth in value of the subsidiaries only the original purchase price in most cases.  And knowing what kind of companies Buffett buys these companies have gained a ton of value over time meaning more leverage according to the papers logic.

The magnitude of Buffett’s leverage can partly explain how he outperforms the market, but only partly. If one applies 1.6-to-1 leverage to the market, that would magnify the market’s average excess return to be about 10%, still falling far short of Berkshire’s 19% average excess return.

Berkshire’s more anomalous cost of leverage, however, is due to its insurance float. Collecting insurance premia up front and later paying a diversified set of claims is like taking a “loan.”

Table 3 shows that the estimated average annual cost of Berkshire’s insurance float is only 2.2%, more than 3 percentage points below the average T-bill rate.

 Hence, Buffett’s low-cost insurance and reinsurance business have given him a significant advantage in terms of unique access to cheap, term leverage. We estimate that 36% of Berkshire’s liabilities consist of insurance float on average.

Based on the balance sheet data, Berkshire also appears to finance part of its capital expenditure using tax deductions for accelerated depreciation of property, plant and equipment as provided for under the IRS rules. E.g., Berkshire reports $28 Billion of such deferred tax liabilities in 2011 (page 49 of the Annual Report). FLOAT

Berkshire Hathaway’s overall stock return is far above returns of both the private and public portfolios. This is because Berkshire is not just a weighted average of the public and private components. It is also leveraged, which magnifies returns.

While Buffett is known as the ultimate value investor, we find that his focus on safe quality stocks may in fact be at least as important to his performance. Our statistical finding is consistent with Buffett’s own words:

I could give you other personal examples of “bargain-purchase” folly but I'm sure you get the picture: It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price. – Warren Buffett, Berkshire Hathaway Inc., Annual Report, 1989.

Given that we can attribute Buffett’s performance to leverage and his focus on safe, high-quality, value stocks, it is natural to consider how well we can do by implementing these investment themes in a systematic way.

In essence, we find that the secret to Buffett’s success is his preference for cheap, safe, high-quality stocks combined with his consistent use of leverage to magnify returns while surviving the inevitable large absolute and relative drawdowns this entails.

Indeed, we find that stocks with the characteristics favored by Buffett have done well in general, that Buffett applies about 1.6-to-1 leverage financed partly using insurance float with a low financing rate, and that leveraging safe stocks can largely explain Buffett’s performance.

This is the power of float illustrated over a long time period.

The above means his excess returns are attributed only to smart use of float and buying cheap great businesses over a long period.

This is why we must understand what it is and how to use it to our advantage to become better investors.

If you want to read the full 45 page PDF that includes the math, examples, and references download the paper Buffett’s Alpha here.

Most of Buffett's and Berkshire's float comes from insurance companies.  But float can be found at any company.  And next up I'll show you how by analyzing a company's balance sheet to find float.

***

Remember if you want access to my exclusive notes, preliminary analysis, and access to all posts as they come out you need to subscribe for free to Value Investing Journey.  And this isn't all you'll get when you subscribe either.

You also gain access to three gifts.  And a 50% discount on a year-long Press On Research subscription.  Where my exclusive stock picks are evaluated and have crushed the market over the last four years.

What Is Float? On Float Part 2

What Is Float? On Float Part 2

The goal of this blog is to help us all improve as investors and thinkers so we're a little wiser every day.  The hope being that our knowledge will continue to compound over time so we'll have huge advantages over other investors in the future.

The aim of today's post is to continue this process by talking about a topic few investors know about.  And even fewer understand.

Most people overlook float when evaluating companies because they either don't know what it is.  Don't know the power it can have within a business.  Or don't know how to evaluate it.

This won't be an issue here.

Press On Research subscribers already know this as I talk a lot about float in many of the issues I've written.  But I want to begin talking about it more here because float is one of the most powerful and least understood concepts of business analysis.

Today's post is a continuation of the earlier post Charlie Munger On Deferred Tax liabilities and Intrinsic Value - On Float Part 1.  And we're going to answer the question today, what is float?

But before we get to that next is an excerpt from the July 2015 Press On Research issue where I talk about float extensively.

The Biggest Investment Secret In The World

How Warren Buffett Got So Rich And How You Can Too

Warren Buffett’s admired around the world for his philanthropy as he’s going to donate 99% of his $70 billion plus net worth to charity when he dies.

He can donate so much money because of how great an investor he is.  But almost no one knows how Warren Buffett made his fortune.

Yes, most investors know about his investments in Coke (KO), Johnson & Johnson (JNJ), and Wells Fargo (WFC).  But this isn’t how he built his fortune.

Investor’s who’ve studied Buffet know he built his partnership, and then Berkshire Hathaway, buying small companies.

But this still isn’t the true secret to Warren Buffett’s success.

Today I’m going to tell you how he grew $100,000 into more than $70 billion.  And tell you how we can start doing the same.

But before we explain the exact companies Buffett built his fortune on.  We need to talk about why Press On Research concentrates on small caps.

A University of Kansas student asked Buffett about this in 2005:

“Question: According to a business week report published in 1999, you were quoted as saying: “It's a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”…would you say the same thing today?”

Here’s Buffett’s answer emphasis is mine:

“Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today's environment because information is easier to access."

Yes, I’ve said this before many times.  But it’s an important concept to understand.

Small ultra safe investments that produce a ton of cash.  Have little to no debt.  Pay dividends and buy back shares.  And are cheap are my favorite investments.

These kinds of businesses are what Value Investing Journey and Press On Research is all about.

Today’s recommendation has no debt.  Owns more cash and cash equivalents than its entire market cap.  And just its net cash and cash equivalents make up 77% of its market cap.

This doesn’t count any of its property, plant, and equipment, future premiums earned, or cost-free float.  And this company is undervalued by 29% to 70%.

But this still isn’t all…  It’s also much more profitable than competition.

Today’s pick isn’t just a great company with all the above traits.  It’s also in Buffett’s favorite industry to invest.

Investing In Insurance

Most people won’t research insurance companies.  I wouldn’t early in my investing journey.  And many professional analysts stay away too.

This is because insurance companies are hard to understand at first.  Have new and confusing terminology to learn.  And normal profit metrics don’t matter much for them.

But if you learn how to evaluate them not only will you learn they’re easy to evaluate once you know what you’re doing.  But you can use the same repeatable process on every insurance company.  And Buffett has continued to buy into insurance – his favorite industry – constantly over the decades.  And it’s why he’s so successful.

In reality insurance companies are easy to understand.

Insurance companies take money – premiums, the insurance version of revenue – as payment for insuring things like businesses, equipment, health, life, etc.

The insurance company doesn’t have to pay you a dime of the money it earns over the years until there’s some kind of damage or theft of whatever’s insured.

When this happens they pay the agreed upon insurance rate out to the policyholder.

While the company continues to earn money – premiums again - it invests some of it so it can pay back your policy in the future.  And also make a profit in excess of the amount earned, invested, and paid out.

If the company writes its policies and invests well over time it will earn underwriting profits.  And grow the assets it can use to write more policies and invest more money.

If it doesn’t, the company will go out of business when a major disaster strikes.

Think of insurance companies like investment management companies.  But instead of only earning management fees.  Insurance companies earn premiums on top of investment earnings.

These effects can double profits over time…  If management is great at what they do.

The insurance business while easy to understand is one of the hardest businesses to be great at.

Other than being a low-cost operator like GEICO.  Owned by Berkshire Hathaway.  There are no competitive advantages in this industry.  And it also experiences wild swings of huge profitability than massive losses.

But if the company writes policies and invests money well over a long period they can grow to great sizes at almost no extra costs.  The only new costs may be to hire more staff.

Insurance companies also hold the greatest secret in the investment world…  Float.  This is how Buffett built his fortune.  And how we’ll start to build ours.

But before we get to this we need to know why float is so important.

Brief Berkshire Hathaway History

Buffett began buying Berkshire Hathaway stock in 1962 when it was still a textile manufacturer.  And when he still ran his investment partnership.

He bought Berkshire stock because it was cheap compared to the assets it had.  Even though the company was losing money.

He continued to pour millions of dollars into Berkshire to keep up with foreign and non union competition.  But none of this worked.

In time Buffett realized he was never going to make a profit again in the textile industry.  So whatever excess funds Berkshire did produce he started buying other companies.

The first insurance company Berkshire Hathaway bought was National Indemnity Company in 1967.

Since then Berkshire’s float has grown from $39 million in 1970 to $77 billion in 2013.

Float compounds like interest does if you use and invest it well.  But not only does float compound, if you use it right it also compounds the value of the company that owns the float.

Since 1967 when Berkshire bought National Indemnity, Berkshire’s stock price has risen from $20.50 a share to today’s price of $210,500.  Or a total gain of 10,268%.

This is the power of insurance companies when operated well.  And today’s recommendation is an insurance company that operates the right way too.

But before we get to that I need to explain how float makes this possible.

The Biggest Investment Secret Revealed

‘Float is money that doesn’t belong to us, but that we temporarily hold.”  Warren Buffett

Float is things like prepaid expenses.  Billings in excess of expected earnings.  Deferred taxes.  Accounts payable.  Unearned premiums.   And other liabilities that don’t require interest payments.
But they are the farthest thing from liabilities.

MY UPDATED NOTE HERE... I'LL TALK ABOUT THIS MORE IN DEPTH IN A LATER POST AND DETAIL WHAT I MEANT TO SAY AND DIDN'T EXPLAIN WELL ENOUGH HERE.

Instead of paying this money out now like normal liabilities.  Companies can use these “liabilities” to fund current operations.

Float is positive leverage instead of negative leverage like debt and interest payments.
Think of float as the opposite of paying interest on a loan.  Instead of paying the bank for the cash you’ve borrowed.  The bank pays you interest to use the money you loaned.  And you can use this money to invest.
Using cost-free float to fund operations can improve margins by up to a few percentage points.

MY NOTE HERE: I'LL EXPLAIN THIS BETTER IN A FUTURE POST TOO.
The best way to explain why float is so important is with the following quote:

“Leaving the question of price aside, the best business to own is one that over an extended period can employ large amounts of free – other peoples money – in highly productive assets so that return on owners capital becomes exceptional.”  Professor Sanjay Bakshi adding to something Warren Buffett said about great businesses.
I said in last month’s issue: “When a company’s float/operating assets ratio is above 100% it means the company is operating with “free” or cost-free money.”

But this isn’t true with insurance companies.

For an insurance company to operate on a cost-free basis it has to produce underwriting profits for a sustained period.

I look for underwriting profits of at least five years straight to consider its float cost-free.

And the company I’m going to tell you about today has earned an underwriting profit every one of the last 10 years.

When you come across companies that are able to do this on a consistent basis you should expect exceptional returns in the future.

This is because when a company operates its entire business on a cost-free basis it means several things. 1)  It’s a great business.  2.)  It’s an efficient business.  And 3.) float magnifies profit margins.

So what is this great company?

I go on here to detail the company I recommended - and bought for the portfolios I manage - in July to subscribers.

So What Is Float?

To summarize the above float is anything listed in the liabilities section of its balance sheet you don't pay interest on.

Interest based liabilities - NOT FLOAT - include capital leases, and short and long-term debt.

Most of the time these are the only interest based liabilities on a company's balance sheet.  Make sure by checking the off-balance sheet transactions and total obligations notes - if any - in the companies footnotes.

Examples of non interest based liabilities - FLOAT - include prepaid expenses, accounts payable, taxes payable, accrued liabilities, deferred tax liabilities, unearned premiums, etc.

These vary more but remember if the company doesn't have to pay interest on the liability it's float... Money the company has to pay later but in the mean time can use to invest in and grow the business.

Think of float as normal debt without the negative effects.

In the short to medium-term - long-term for most insurance companies - float while listed as a liability on the balance sheet should be considered an asset to the company.  Why?  Because while the company owns the float it can use these "liabilities" to invest and grow the business.

How though?

Because while the company lists the liability on its balance sheet - and still owns the liability - it can use the float as positive leverage to grow the company or invest in other businesses.

Sometimes at a better than cost free basis as mentioned above... But we'll talk about this in a future post on float.

Next up I'll go through a company's balance sheet to separate float from non float.  And show you how to value and evaluate it.

What do you think of float at this point?  Do I need to explain anything better?  Let me know in the comments below.

***

Remember if you want access to my exclusive notes and preliminary analysis you need to subscribe for free to Value Investing Journey.  And this isn't all you'll get when you subscribe either.

You also gain access to three gifts.  And a 50% discount on a year-long Press On Research subscription.  Where my exclusive stock picks are evaluated and have crushed the market over the last four years.