Sunday Finds + 3 Thoughts From Last Week
Brookfield Asset Management + Cloudflare
Welcome to Chit Chat Money’s Sunday Finds + 3 Thoughts From Last Week. In this newsletter you will find three topics I thought about last week, links to shows we’ve recently released, and links to some interesting articles, podcasts, and tweets. Check out the archive here.
1. Be careful of the dangling carrot.
Whenever reading an investor presentation or company prepared materials, I think of this image:
Maybe it’s the cynic in me, but I constantly see the “carrot” being dangled in front of investors to keep them bullish on a stock. Devious executives want negligent investors to keep following whatever bullish remarks they give, propping the stock up and allowing them to fund lucrative stock-based compensation packages for themselves and their employees. At least, that’s how I see it when looking at how some companies present their financials.
It almost always goes like this:
Core business: stalling out
small subsidiary/acquisition: growing quickly
Executives: “Don’t worry about that mediocre core business that’s 90% of our profits! Take a look at this shiny object growing 100% year-over-year we bought at 10x sales!”
Investors: Stay around because “new growth drivers will materialize in the next few years”
I am very afraid of being caught up as the horse trying to reach the carrot. That is why I think it is best to always start with SEC filings (10Q/K) when researching a business, because it is a lot tougher for a management team to make things look better than they actually are.
Inverting the situation, you rarely see executives of a high quality, moaty business trying to hype up the stock in an IR presentation. The business speaks for itself.
2. The stock-based compensation disease
We are doing Pinterest as a “Not So Deep Dive: Revisited” next week. Researching the show, I read the Q1 10-Q and came across this subsequent event:
On April 13, 2022, we granted 24,701,239 RSUs and RSAs with an aggregate grant-date fair value of $566.9 million, which we expect to recognize as share-based compensation expense over a weighted-average period of 3.8 years.
Pinterest has 663.48 million shares outstanding. If/when these dilutive securities get converted into stock, it will dilute existing shareholders by 3.7%. At the current share price of around $20, that is worth $494 million, or right around the estimate in the 10-Q.
There are 3,430 employees at Pinterest. Taking my current value for this recent dilutive securities grant and dividing it by employee count, each employee at Pinterest is getting $144k worth of stock options, on average, just from this one grant (I’m sure the loot isn’t divided evenly though).
However, let’s say you bought shares close to the top when Pinterest was trading at $85 a share. On your cost basis, these dilutive securities (if exercised) are worth $2.1 billion. This equates to $612k per employee. All this for a company that seems to be getting circles run around it by Instagram, YouTube, and Tik-Tok.
Pinterest has a boatload of cash on its balance sheet. Can we stop this SBC madness and just pay people in cash? It is incredibly frustrating to see executives continue to destroy shareholder value this way.
(feel free to correct my math if I got anything wrong here).
3. Initial thoughts on the Swedish Match proposed deal
I’m going to keep from the heavy numbers here because frankly I don’t want to and it is late. Our portfolio company Swedish Match just announced they are planning to accept a buyout offer from Phillip Morris International at 106 SEK (Swedish Krona) a share. This is a 30%+ premium to the recent share price, which seems to be the reason Swedish Match management wants to take the deal. The deal is at around $17.5 billion USD (enterprise value) and 25x TTM OCF.
For context, Swedish Match is the owner of the Zyn nicotine pouch brand, one of the hottest and most lucrative CPG products in the world (I think it could be the 21st century Marlboro).
I believe this buyout offer is a steal for PMI, and that Swedish Match is worth $25 billion today under its umbrella, if not more. Here’s why:
Zyn volumes still show no signs of slowing down in the U.S. (35% growth in Q1) and have a potentially large runway ahead.
They just passed a “moat test” in the form of huge price cuts by competitors like On!. Zyn's market share has been stable while competitors have tried to sell pouches at a third of the cost.
Once the market rationalizes, they can slowly raise prices with incredible incremental margins (operating margins already at 50%).
European, U.K, Australian, and other international markets are untapped. PMI’s distribution network + the Zyn product/brand could end up being quite lucrative. PMI’s IR presentation (hopefully this isn’t a carrot!) claims the international nicotine pouch market is set to grow at a 30% - 40% CAGR over the next five years.
I believe there was a great chance Swedish Match could have generated $3 billion+ in annual OCF five to seven years from now on its own, which is why we own the stock. Under PMI, if all goes well, that number could reach $5 billion a year sometime within the next 10 years. And this would be with tens of millions of new nicotine-addicted customers that will likely be around for more than just 10 years (and not dying of cancer from your products too, btw, if you care about that stuff).
Accepting the buyout won’t be a loss per se, but I am disappointed we are getting a compounder cut off at the knees. And that tax hit won’t be fun either. Swedish Match management, if you’re somehow reading this, please wise up and renegotiate for a higher price on this deal. Or don’t do it at all.
See you next week,
Brett
***Our fund, Arch Capital, may own securities discussed in this newsletter. Check our holdings page and read our full disclosure to learn more.***
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Catch up on Our Shows From Last Week
3 Good Reads
The Benefits of Zooming Out - Rational Reflections
I can understand why traders would follow all of this on a daily basis. After all, they are playing a different game and hoping to profit from just this sort of short-term market gyration. But for long-term investors, it makes no sense, and not just because it is a waste of time. By exposing ourselves to this noise, we increase the likelihood of making terrible emotionally driven mistakes.
Is There a Housing Shortage or Not? - Construction Physics
A shortage of vacancies also helps explain why simple eyeballing of building rates and population growth rates doesn’t seem to reveal much of a problem - since there’s only a small fraction of homes on the market at any given time, a small percentage point change in total housing units vacant can make a big difference.
What Did Medieval Peasants Know? - the Atlantic
People also tend to bring plenty of modern biases to the table, even when they’re not seeking expedience. This is particularly important when trying to discuss medieval work, Janega said. The clear delineations that people assume between work and personal life just aren’t particularly tidy for peasants doing agrarian labor. “They’re thinking of these people as having, like, a 9-to-5 job, like you’re a contracted employee with a salary and you get vacation days,” she told me. “The thing about having a day off is like, well, the cows ain't gonna milk themselves.” So while people are correct that European peasants celebrated many more communal holidays than modern Americans, in many cases, that just meant they weren’t expected to do a particular set of tasks for their lord. Minding the animals, crops, and themselves never really stopped. Their vacations weren’t exactly a long weekend in Miami—after all, they didn’t really have weekends.
1 Good Listen
Tracy Alloway - Understanding Financial Crisis (Infinite Loops)
Show Notes:
Financial crisis hindsight
Being obsessed with risk and systemic stability
Historical parallels to the crisis of ‘08
Macro vs. micro bullshitting
Why people refuse to say “I don't know”
Victorian chicken bubble
Tales of forensic accounting
NFTs being used to launder money?
NFTs’ path to success
Insights from collapse of previous civilizations
Understanding the Human OS
Fair Wages for Robots
Praise for Citi’s Matt King and Credit Suisse’s Zoltan Pozsar
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