We continue this series with a conversation at Latticework 2018, hosted by MOI Global and held at the Yale Club of NYC in September of that year. Murray Stahl discussed his philosophy and answered questions on a wide range of topics. Friend and member Shai Dardashti led the conversation.
It is with great sadness that we note the passing of Murray Stahl. We held immense respect for him as an investor whose original thinking made profound contributions to the investment community. We were honored to host him for a conversation about his investment philosophy in 2018 , and we are pleased to make that conversation available here.
In a fireside chat, Murray Stahl discussed finding value in an increasingly indexed market, cryptocurrency, and unconventional compounders. Bringing decades of investing experience, the former chairman of Horizon Kinetics offered a deeply contrarian perspective on the global economy.
He challenged conventional wisdom on passive investing, highlighting how indexation distorts the float and valuation of mega-cap equities. Beyond traditional markets, he dove into blockchain technology, arguing why Bitcoin might be the ultimate value investment in a world of negative real rates.
Whether dissecting hyperbolic discounting, mapping the potential of dormant assets like Texas Pacific Land Trust, or explaining leverage, his approach offered a masterclass in uncovering asymmetric opportunities. This conversation provided a rare glimpse into a mind that consistently looked where others did not.
What You’ll Learn
The risks of indexation and its impact on float-adjusted capitalizations
Why blockchain represents an existential threat to traditional finance
Compounders in owner-operators, spin-offs, and dormant assets
The mechanics of hyperbolic discounting and finding deep value
The economic potential of water rights in legacy landholdings
Contrarian ideas from shipbrokers to cybersecurity defense contractors
Transcript
The following transcript has been edited for space and clarity.
Shai Dardashti: It’s a real honor to introduce the next instructor at Latticework 2018. Joining us is Murray Stahl – co-founder, chairman and CEO of Horizon Kinetics, as well as chief investment officer of the company. Murray, who brings over 30 years of investing experience, is responsible for overseeing proprietary research and portfolio management decisions across the entire firm. He is also the co-portfolio manager for a number of registered investment companies, private funds, and separate institutional accounts. Additionally, Murray is the chairman and CEO of FRMO Corp. He is also a board member of the Bermuda Stock Exchange, the Minneapolis Grain Exchange, Winland Electronics, and IL&FS Securities Services Limited.
Our discussion centers on identifying compounders in a global economy. I have in front of me a Bloomberg article from May 2018, “The 130-Year-Old Bankruptcy That Created a $5 Billion Oil Giant,” with the sub-headline “Texas Pacific Land Trust has surged almost 2,200% since 2010.” Here’s a brief excerpt: “Not everyone missed the rally. In 1995, a low-profile fund named Horizon Kinetics LLC published research on the trust titled ‘How to Buy 1 Million Acres of Fine Texas Grazing Land for $20.’ The fund, whose CEO Murray Stahl declined to comment, has been in and out of the stock since the 1970s. It bought in in a big way in 2008, before the rally, and now, as of May 2018, holds 1.8 million shares worth about $1.2 billion.”
Could you comment?
Murray Stahl: Even though I declined to comment for Bloomberg, I’ll comment to you, so you’ll now get the entire story instead of only the analytical one.
To begin with, in life, you have to be lucky. In 1984, when I was a young analyst, the New York Society of Security Analysts would hold its meetings downtown. I was going to a meeting of a gold company and, for whatever reason, I was preoccupied. I got off the elevator to go to this Society. You had to turn left, but I wasn’t paying attention and turned right, walking to the end of the corridor. I came to a door that had Texas Pacific Land Trust on it. Realizing I was in the wrong place, I walked to the other end of the corridor and attended the meeting. The gold company wasn’t all that interesting, and the entire time, I was thinking about what Texas Pacific Land Trust was. When the meeting finished, I went back and knocked on that door. I went in and asked for an annual report, which I got and read. There was a woman there; it was a one-person office. The company no longer has an office in New York; it has moved to Dallas. In any event, that was the start of it.
The point of the story is the whole idea is to pick up information other people aren’t likely to pick up. I found it fascinating: this New York Stock Exchange-listed company went bankrupt in something like 1881 and had since been doing nothing with its cash flow other than buying back shares. If you like calculus, this is the stock for you because every time the company buys a share back, the next remaining share purchase is a greater portion of the remaining denominator, which is the remaining shares outstanding.
That’s the story of how it started. Since I’m a long-term investor, I never lost sight of it.
Dardashti: You’ve written extensively about owner-operators, dormant assets, and spin-offs as fertile hunting grounds. Would you say these traits are especially pronounced in particular countries?
Stahl: I wouldn’t say so. I would say the United States has the deepest and richest stock market, so you’ll find more of them in this country. Canada and Japan have very deep and rich stock markets, and you’ll find examples of those there. Now, different nations have different industry concentrations. For obvious reasons, Canada might have more of natural resources, and you’re more likely to find a dormant asset in Canada than in Japan. Generally speaking, those things present themselves, less so now than in the past, but they do present themselves from time to time.
Dardashti: Are there any geographies outside of North America that you currently believe to be uniquely compelling landscapes for identifying compounders?
Stahl: Very few, frankly. I would say Israel is one because of the growth of technology there. In theory, I’d also say Singapore because of its great government, but you don’t have a particularly large opportunity set. Oddly enough, I’d add Japan because it has some highly intriguing owner-operator companies which can be said to go against the trend of what the major industrial companies do. The opportunities are around but less so today than in the past.
I should say one thing because I don’t want to fly under false colors: if you concentrate on dormant assets, spin-offs, or owner-operators, you understand that indexation affects everything. It is an issue people have to contend with. Let’s take the idea of an owner-operator because it’s the simplest of the three to understand. What’s an owner-operator? A company where, for good or ill, the management get to be the management because they own more equity than anyone else and essentially vote themselves in.
I’ll use Amazon, a highly successful owner-operator, as an example to illustrate the impact of indexation. We all know this company. We understand the business – it’s not that complex to understand. It’s one of the major enterprises in the world, and most people think it’s going to grow even more. I don’t know more about Amazon than the average human being – many people know far more about Amazon than I’ll ever be able to know. The only thing I will say is that to me, in my unenlightened knowledge of the company, it looks like a very expensive stock. As a matter of fact, on its formalistic number, it’s one of the more expensive stocks I’ve ever seen in my career. Nevertheless, it’s been a great stock, but I don’t presume to know more about Amazon than anyone else. More importantly, I don’t presume that because people pay what I would regard as an excessive valuation, they’re over-exuberant, euphoric, stupid, or not mindful of risk.
Amazon is in the S&P 500, where its weight is roughly 3.25%. How does the S&P decide that Amazon is going to be a 3.25% weight? The float of the company in relation to the other 499 companies in the index will determine its proportional weight. What’s the float of Amazon? You look at the shares outstanding, which, crudely speaking, are 500 million. You multiply by price, which gives you the market capitalization. You need to subtract the shares owned by management – for our purposes, let’s say Jeff Bezos owns 15%. This means 85% of the shares are presumed to be in the float, which determines the market capitalization float-adjusted and, therefore, the weight of Amazon.
The problem with that is I’m not entirely sure it is fair to say 85% of Amazon’s shares are in the float. What does float mean? Whether I owned Amazon as an active investor or didn’t, I could, in theory, buy or sell it as it’s available in the marketplace. But an index fund will only sell it in the unique circumstance when index funds have outflows, but index funds do not have outflows. Index funds only have inflows. On a typical day — of course there are days when there are outflows, but as a generalization, index funds get inflows — index funds are buying. How is it then correct to say that 85% of shares are available in the marketplace at any given day when it should be patently obvious they aren’t? That’s a big problem. As a matter of fact, if you want to call the float those shares which are not available, you could make a good case for saying the float is, in fact, shrinking.
In theory, the active managers might sell the shares, but maybe Amazon is their favorite stock. The index will buy or pay whatever price the managers are willing to sell it. The index is price-indifferent. In the world of marketplaces, you might have people who are over-exuberant, not mindful of risk, or taking things to extremes. They all have different judgmental qualities. We never have a situation where an investor will buy whatever the price is. What if the price were one million times earnings? Somebody would still come into the marketplace, go in the index, and still buy.
The point is there are so many indexes right now (I think over 7,000 in America alone) that way too many companies are swept into one index or another, and things are subject to that valuation dynamic. I don’t know when it’s going to end, but when it does, it probably won’t be a pretty picture. I have no insight into whether we are in the ninth inning or the eighth inning or going into extra innings. It’s something people need to be mindful of because it’s a risk.
Dardashti: A Barron’s publication in November 2017 has you describing Bitcoin as the ultimate value investment, which qualifies as a compounder. Could you elaborate on your current thoughts about Bitcoin and any other perspectives?
Stahl: Let’s put it this way – Bitcoin is the ultimate contrarian investment. It might be a failure, by the way, and the majority of people think so. I’m not one of them, but then I might be completely wrong, and I’m willing to acknowledge that. The only thing I would tell you is I’m willing to be exposed as being wrong. Anyway, let me give you two reasons why I think I’m right.
The first and less important reason is the situation with your normal bond investment. Let’s say I brought your typical 10-year Treasury bond yielding 2.87% or something like that. After I pay my federal taxes and adjust for the inflation rate, I clearly have a negative rate of return. I might buy a bond with a more robust coupon. Let’s say I bought 100 bonds, and they yielded 4% or even 5%. Even if I were the greatest credit analyst in the world, I’d be wrong x percent of the time. If I were wrong, say, 20% of the time and lost 20% on my investment every time I was wrong, take 400 basis points off my return. Then I have to pay some taxes. Where am I? The simple fact of the matter is pretty self-evident: in the world of fixed income – and there’s a lot of fixed income in the world – it’s a negative real rate of return. With a cryptocurrency like Bitcoin, it’s not a negative real rate of return because it’s fixed issuance. That’s its first virtue. It’s not going to replace the US dollar. It’s just going to be an alternative, or parallel, currency.
The second and more important thing has to do with the standard computer systems in finance. There are just too many attack topologies to keep the system safe, so whether the corporations of the world like it or not, they will have to move to cryptocurrency and something called blockchain. It doesn’t have to be Bitcoin, but it’s coming, and it’s coming really fast. Also, cryptocurrencies have improved a lot and are much more understanding of what they do. There are now futures available. The blockchain systems are more robust. More companies are interested in them, and one day, we are going to get effective regulation and have custody. Institutional grade custody is maybe the last pathway we need for success, and I believe we’ll get it within a year, and we’ll see cryptocurrency become a legitimate asset class. When that happens, it will be worth a lot more. Of course, I could be wrong, and time will tell.
The following are excerpts of the Q&A session with Murray Stahl:
Q: I just read a book you wrote, How They Did It, which is about great investors. You talk in there about the concept of leverage as an asset class, which is under-represented in people’s thinking. I’m curious to hear your thoughts on the usefulness of leverage.
A: Leverage as a generalization is used to excess; it is a dirty word, but there’s a concept in finance called the Miller-Modigliani capital structure and variance theorem. It says the enterprise value of a corporation is invariant to the changes in capital structure, meaning that if you’ve got a business with $1,000 of debt and $1,000 of equity, it’s worth $2,000 and would still be worth $2,000 if you had $1,500 of debt and $500 of equity, or even if you had $1,900 of debt and $100 of equity. Let’s make believe a company has $1,950 of debt and $50 of market capitalization equity. If it could pay off the debt even in relatively small increments – $20 a year, for example – if it’s still kept at $2,000 enterprise value, the equity will go from $50 to $70 and so on. As you pay down debt, you would save the interest expense, which in itself would build the cash flow.
The idea behind it was that if you could find a bunch of leveraged companies capable of handling the leverage, you could make an extraordinary rate of return. I even started the strategy to do that, and I think it did reasonably well. The only problem was I managed to talk just two people into doing it, so it never raised a lot of money.
Q: There’s leverage, and there’s leverage. Currently, you’ve got MLPs and publicly traded BDCs. All of them seem to trade well below their NAV and to be highly levered. You write this great piece every week called Bits and Pieces, and you highlight a few of these. Could you share your thoughts on discount to NAV now and if there are any particularly compelling ideas you think we should take a look at?
A: I used to call this the equity yield curve, something whose value is discounted at an extremely high rate. I read a book by George Gilder, who came up with a much better phrase, so I’m going to steal it: hyperbolic discounting. It means that whatever the then asset value is, the market discounts it. If you have an asset value of x, you’re not realizing it today; you’re going to realize it at some indeterminate point in the future. Because you don’t know when that point will come and because the value of the assets might be questionable as well, you get a discount at a higher rate.
There’s a company in Canada called Dundee Corporation, whose market capitalization is more or less C$80 million. This used to be an investment management company called Goodman Asset Management. The head of the company, who is a really astute investor, became ill. He had sold his business and thought there was going to be a lot of inflation. He put the bulk of the assets into every inflation beneficiary you can think of – gold, oil, cattle, land, all of them. You know what happened to inflation beneficiaries in the last five years – they didn’t do well. He got to a point where he couldn’t run the company anymore and turned it over to his son, who shortly thereafter got hit by a streetcar and is in really bad condition. The company got turned over to another son, who had a stroke while riding a bicycle, I think. He was also injured falling off a bicycle although I believe he’s recovered somewhat.
In any event, the stock trades at about C$1.40 (I may be off by a few pennies). The net asset value as per the company’s financial statements is 10, so that’s a hefty discount. It’s a composite of private investments and public investments, so let’s say roughly 60-odd percent of the investments are private and 30-odd percent are public. While it’s unlikely to be the case, let’s assume for the purposes of discussion that all the private investments were worthless, you’d still have a net asset value in the high threes. The public assets are worth whatever they’re trading at. You understand why these things happen now. It’s too small to be in an index, so it’s not covered that way. Unfortunately or fortunately, depending on your point of view, that’s what you need to do if your desire is to unearth value.
Staying with Canada, another example is a closed-end fund called Urbana. It has an assortment of securities in there, both private and public, say, crudely, 60% public and 40% private. It trades at maybe 37% discount to net asset value. One of the investments is a big piece of the Bombay Stock Exchange in India. I think it also owns shares of Bank of America and CBOE. Some of them are large capitalization, liquid companies. In any event, you can see the same thing – the market is valuing the private assets at almost nothing, and they are worth something.
The people who ran the predecessor company happen to own a fairly extensive amount of land in Quebec. When they started Urbana about 14 years ago or thereabouts, they took this land of no value and put it in a closed-end fund. To this day, if you look at the statement of assets, it’s not recorded as having a valuation, but some people believe there’s gold in the property. There are what I would call significant gold mining companies exploring the property, and maybe there is something there. The worst that could happen is there’s nothing. The land is probably worth something, but what if there is gold there? All of a sudden, it becomes a different investment.
You’re not going to find Urbana in any index. Unfortunately or fortunately, as the case may be, that’s where you have to go because of the rise of indexation. It means a lot of things have a reasonably robust valuation, partially because of low interest rates, partially because of the buying pressure of indexation, and partially because people know so much more. There’s so much more information and so much more efficiently pricing, but most people are now willing to go to that extreme, and there you have it.
Q: My question is regarding Bitcoin and cryptocurrency, how competitive it will be. The MIT Technology Review recently wrote an article which said “Let’s kill bitcoin.” What it referenced was the possibility of the Fed coming out with a digital currency, FedCoin, and that there’s nothing to stop Facebook from coming up with a coin, FaceCoin or individual companies issuing a plethora of additional digital coins. The question isn’t if it can be replicated, but what can give us confidence that Bitcoin would prevail in a world where you have multiple competitors?
A: To begin with, I’m not telling you Bitcoin will prevail. I don’t know if it will. By the way, the article wasn’t entitled “Let’s Kill Bitcoin”; it was “Let’s Destroy Bitcoin.” The premise was that the Federal Reserve needs to destroy cryptocurrency, which I disagree with. Neither the Fed nor any other central bank can destroy cryptocurrency, in my opinion, and I’ll tell you why.
First, I can understand why a central bank might be troubled by the idea of a cryptocurrency. The Fed, like the other central banks, reserves to itself the power of issuance and sets the price of money, which is the interest rate. The most important price in the economy is the interest rate because it determines the value of all assets and provides a backdrop for economic growth or lack thereof if central banks make the rate too high.
The second thing is that central banks, as we all know, engineer a certain amount of inflation because the public debt burden, which in most industrial economies is quite considerable, needs to be managed. This is achieved through a certain engineered inflation rate. If central banks were to cede that function to a cryptocurrency, you can understand how problematic it would be and why they wouldn’t like it.
The other side of it is that there are so many attack surfaces and attack topologies that the amount of successful hacking is unbelievable, and it’s only getting worse. You might have read about the Bank of Bangladesh getting hacked. I think it recovered about $20 million of the money stolen, but the miscreants got away with $90-odd million. That’s not the complete story, however. Yes, the Bank of Bangladesh got hacked, but what got hacked was its account at the New York Federal Reserve. They can hack the New York Fed for $90-odd million. What if they hacked it for $90-odd billion? What if they hacked a commercial bank for $90-odd billion? What would happen? Who would make that good?
You can see it’s an extremely serious problem, so the idea of a centralized counterparty versus a distributed ledger (blockchain) is dangerous. You might say, “Okay, I like the idea of blockchain, a distributed ledger. Why don’t we just have the United States government or the Federal Reserve come up with the crypto dollar, and we’ll have another blockchain?” Can’t do it. Technically, they can, but to no end. It wouldn’t do any good, because if the number of units isn’t fixed, a distributed ledger has nothing to reconcile against.
Let’s take today’s environment. Say we had a crypto dollar. Now, money is created by banks, and when they give me a loan, they’re not reaching into their vault and checking out dollars for me. They are creating money, so it’s going to be this external money creation outside the blockchain. What are you going to reconcile against? How are you going to know that your tally is accurate? The authentication problem is there. The reason gold became money is that it allowed something to be authenticated because governments, when they had control of money, would historically cheat. That’s why we went to a gold standard. Then governments promised to be good, at least in the sense that they wouldn’t illegally counterfeit. They would just legally print up whatever money they thought was appropriate for that environment.
Nevertheless, we have counterfeiting today. North Korea, for example, has something called Bureau 39. It has mastered the photoengraving process and prints up currency and other things. This is why many governments would like to eliminate cash – you can’t guarantee the authenticity of it. Now somebody, perhaps a state actor, has hacked the New York Federal Reserve, and there are plenty of other cases like that as well. You’ll have to go to fixed issuance, which means they’re not competitors.
That article, “Let’s Destroy Bitcoin,” means let’s attack the system and overwhelm it. Given the amount of knowledge you need to attack a distributed system, to figure out where all the servers are located around the world, I don’t think it’s within the power of even the most aggressive government to disrupt the way it is right now. You might be able to disrupt sections of it, but they would get back online pretty fast. There are many things one can do to defend against such an attack. It’s likely that any government is going to challenge it. As a matter of fact, the trend of regulation in America (Arizona, Georgia, Wyoming) suggests you will soon be able to pay your state taxes in cryptocurrency. The Intercontinental Exchange is moving to physical futures, and we already have futures contracts on CBOE and CME. Bank of America recently filed a patent on institutional-grade cryptocurrency custody, and on and on it goes.
It’s moving extremely rapidly. With all its imperfections and deficiencies, it is the most contrarian investment on the planet at the moment because everybody hates it.
Q: Given the work you’ve done on crypto and blockchain, are there certain industries you’re trying to avoid because you think they will get buggy-whipped or negatively impacted?
A: The two most obvious sectors endangered by the evolution of cryptocurrency are technology and finance. In the S&P, the technology sector is about 26%, and the financial sector is roughly 14%, so around 40% combined. You could clearly see if one can, via currency, bypass a trusted counterparty. Right now, when you’re buying a house, you put money in escrow and the bank is holding it. In the world of smart contracts, maybe you don’t need a bank to hold it. Maybe you don’t need title insurance. Maybe you don’t need a bank to pass your money through. Maybe you can buy or sell securities on a peer-to-peer basis. You don’t need a brokerage intermediary. If you don’t need all these institutions, they don’t need to buy all the fancy computer equipment either, and that’s the danger in technology. It’s quite a threat if it materializes, and I think it will.
Q: You sit on the board of the Bermuda Stock Exchange, right? How do you see that as a long-term threat or a long-term opportunity to a particular stock exchange?
A: Let’s put it this way – you’ll be hearing news about it in the not-too-distant future. But you see, there are only so many licenses in the world. It’s not a question of technology. In order for crypto to flourish, it needs to have a properly regulated environment. I would say Bermuda has extraordinarily good governance. The government of Bermuda is moving to create a crypto-friendly good government business environment, like the Canton of Zug in Switzerland has done, which is why they call it Crypto Valley. That gives you an idea of what the Bermuda Stock Exchange may or may not have to do with it.
Q: I was fascinated by FRMO. Is that an owner-operator company? It’s very hard to figure out what’s in there and how it’s valued, so I’d be interested in any thoughts you have on the matter.
A: To begin with, I’m the chairman of FRMO Corporation, and I own, at least at market value, about $28 million worth of stock. I got a little irrationally exuberant, but I haven’t traded it, and I still hold it. This makes me an owner, and I operate.
The idea behind creating it was that it’s a tax-inefficient structure in Horizon Kinetics. We get a lot of cash flow, and much of it goes to the government. The idea was to do our personal investing in the corporation and get the corporate rate, which now has been lowered, and it’s much more tax-efficient to do it there. A certain amount of our crypto investing is being done there. In general, anything we consider intriguing and contrarian, we do in FRMO.
There are three or four assets. We are in hard assets and in crypto. FRMO gets a certain amount of investment management revenue because it owns a piece of Horizon Kinetics. And that’s its purpose. Some years ago, we did a very small stock offering, but not because we needed the money. When you look at the financial statement, you’ll see FRMO is a cash-rich company without any debt. We just wanted to see if we could do it, so we raised a small amount of money, a few million dollars, just to see if it was possible. The whole idea is to stay liquid because I believe the indexation phenomenon will not end well, and we’ll need a liquid pool of assets one day. At that time, most clients will be loath to invest money. You might have some exceptions, but those will be the exceptions that prove the rule, so we need to have a liquid pool of investments we can count on. That’s the liquid pool, and we keep building it.
Q: I remember you had mentioned something about this idea of synthetic bonds that you create, and I think it was related to options. I’d love to hear an update on that idea.
A: The idea was that the bond coupon doesn’t give you anything. Let’s assume I found a credit-worthy bond. I get a coupon of X, and I pay my taxes. What I have left doesn’t even cover inflation. Why not take whatever is left after taxes and buy an option on something that we think has investment merit? The worst that happens is we lose a coupon. We still have the principal. The best that happens is we have an extremely high rate of return because of the inherent gearing of the option. We do that from time to time. It’s a pretty capital-intensive thing to do because you have put a lot of money up in the bond, and the principal value is continually being eroded in inflation. I wouldn’t put a heck of a lot of money into it, but we do it now and then.
Q: Following up on the FRMO question, could you comment on Winland? What is it, what are you doing?
A: Winland Electronics is a company FRMO bought an interest in. It makes information devices. If you need to know what the temperature is within a certain range in a basement or refrigerator – if you were storing drugs, for example, and the temperature is really important – you can use a monitoring device made by Winland. You would think a lot of companies make these, but they don’t because it’s not a high-margin operation. There are many interesting things you can do with the business. It’s hard to grow it because there’s limited demand for monitoring devices. A typical monitoring device doesn’t cost a lot of money, but the company does have strong cash flow and cash on the balance sheet.
We’ve been using the cash to buy credit liens. When a company goes bankrupt, instead of buying the bond, let’s say some merchant is owed a small amount of money. We would buy that lien, which ranks very highly in the bankruptcy. No institutional investor wants to deal with these things because we are talking about tiny amounts of money. I think it’s highly appropriate for Winland. Some of these credit liens measure in hundreds of thousands of dollars even though the bankruptcy might be in billions. Sometimes, for technical reasons, the bankruptcy workout funds want this thing to be eliminated for legal reasons. They might buy it at par just to get this out of there and make the legality less complicated.
We were able to buy credit liens in the Mt. Gox bankruptcy. Mt. Gox, you might recall, was the big hack some years ago. At the time, it led to a big crash in the value of Bitcoin. The company filed bankruptcy and socialized the losses, so even though not every account was hacked, the idea was to act as if all of them were. However, the bankruptcy courts are slow in the United States, and they’re even slower in Japan. As they were going through the motions, the Bitcoin that remained appreciated greatly in value. The issue at law became, at least in Japan, whether you are entitled to the market value of your account on the day of the hack or to your pro rata interest in the market value as it remains. Happily for us, the court ruled the latter.
I can’t say we knew a lot about Japanese bankruptcy law. It’s one of those things where it was valued as if that is not a conceivable outcome. By the way, another thing is you get statutory interest on the corpus in Japan, so even if they had valued the former, you would have got the corporate interest. It seemed like a reasonable investment. I can’t say we were able to buy a lot of it and create a fund to do this, but we ended up doing it in the enterprise a bit.
Q: Considering your involvement in trade claims, do you have any perspective on where we are in the cycle? Do you see an uptick in volume or a constant?
A: We don’t see any measurable uptick, at least from our perspective, but then again, we’re looking at the lowest end of the spectrum, things that are tiny. I don’t know if we’re going to see a big up from our way of looking at it. When the cycle gets bad enough, I’m sure there’ll be big trade claims. The institutionals will be there, and we won’t be in a position to compete well against them. They will know a lot more about it, and they have lawyers and attorneys. I suspect we won’t do very well. I think we’re going to stay in our niche. We’ve seen no economic data that points to a deterioration in the economy by looking at that information.
Q: I would like to pick your brain on TPL. Given the transformation of the trust in 2017 with the water business, how do you see it in five or ten years?
A: Let’s say you went to Google Earth and looked at Midland County, Texas, which is a relatively developed area of the state in terms of hydrocarbons. You can see how much water is used for fracking, the rights of way people require (easements), and filtration. Then you look at the Delaware base, where TPL is, and it’s largely empty. If you were to imagine it had the same density, how much money could be made? Even though TPL has oil royalties, let’s make believe it doesn’t. It also has real estate that I believe has some commercial value, but let’s ignore that as well. This leaves us with easements and water. It’s hard to distinguish between the two because sometimes, you’re bringing water from another property, and you have to get an easement across their property. In any event, there are 880,000 acres of land with no hydrocarbon on it but with water and good strategic positioning.
Let’s say the average acre could get $10,000 a year in easements. In easement, what’s called land damage fee, you normally get $5,000 for the right to walk across someone’s property. Let’s imagine you have two easements, $5,000 each a year, and it’s 200,000 acres. That’s a lot of money. That’s not $5,000 a year recurring; it’s a one-time $5,000 for five years, and then you get another, but then there’s the water. Large oil companies say, “We will need well over one billion barrels of water a year for fracking.” The going rate for a barrel of water is roughly $1. There are only two big land masses there – TPL Property and University of Texas – so I suspect most of the water would have to come from those two sources. Do the arithmetic – that is recurring, and it’s a big number. Besides, I’m leaving out the oil, so you can get an idea of what it could be theoretically.
Q: I’ve attended luncheons you’ve hosted in New York, and you also have a webinar periodically. Could you tell people how they might learn more and engage further?
A: You can call our office – there’s always a number provided on the website. You can also get on our mailing list. We do quarterly lunches you can attend. You don’t have to buy anything. They say there’s no such thing as a free lunch, but there is. You can listen to me for free, and there’s a dial-in or a recording if you don’t want to attend. There’s a lot of material on our website. We do have webinars from time to time, and sometimes I do engagements like this one. I think we’re reasonably accessible. I answer all questions even if they have nothing to do with investing. Not that I know that much about investing, but I don’t know that much about the other things either, so you’re not losing anything.
Q: You spoke at Best Ideas 2018. Do you have any new thoughts or comments on what you talked about?
A: To be perfectly honest with you, I don’t remember what my best ideas were, but I can tell you right now about four stocks I like. I’m leaving Dundee out because it’s so illiquid. Aside from Texas Pacific Land Trust, there is a company called Civeo, which was spun off from Oil States Petroleum several years ago. It has lodgings in natural resource areas, hotels or motels, if you like, for workers so they can be reasonably comfortable at the end of a working day. In all these remote areas, the projects with the declining natural resources, mostly oil, collapsed and so did revenue. Crudely speaking, it lost 90% of its revenue. Could it get worse? Probably not, but it’s not good. The best you could probably say is that maybe things are ever so slightly better than a bottom, and it’s a maybe. In any event, the company is cash flow-positive. There’s a certain amount of debt on the balance sheet, and I believe it can service the debt.
This is an example of what I said before about leverage. It’s not that leveraged by the Miller-Modigliani capital structure and variance theorem. There are only two possibilities: either it’s getting better or it’s not. If it gets better, it’ll get more revenue, the cost won’t go up, earnings will be a lot higher, and it will be a great stock. If it doesn’t get better or it doesn’t get materially better, gradually, it will pay down the debt and the equity will be worth more. It will be a reasonable investment, not an extraordinary one. That’s, in brief, the story here.
Then there’s a British company called Clarksons PLC, which is a ship broker. If you look on its website, there’s a really neat diagram. It has an index of rates for all kinds of shipping. In the last few years, shipping rates are roughly 67% down, maybe even more. Anyway, as a broker, it’s ad valorem pricing, like a real estate broker. In other words, you get a commission based on the value of the charter. If the charter rates rise, you’ll be getting a constant percentage of a greater amount of revenue, and the costs stay the same. I think it’s going to happen in the next couple of years because there are a lot of vessels that burn high sulfur fuel. This will become illegal at the end of 2019, and most vessels are too expensive to retrofit. It’s reasonable to suspect the supply of ships is going to contract. All things being equal, assuming the mandate is the same, it should raise the charter rates, and this should be an intriguing investment.
Last but not least, there is a company I’m always hesitant to talk about because it’s a little more expensive than I would normally buy, but I bought some at lower prices. It’s called CACI. It’s a defense contractor, but not your typical defense contractor. It’s one of the several they call beltway bandits in Washington. These companies do computer work, really top security and hush-hush work, things like intelligence gathering and cybersecurity. It has been awarded some extraordinarily large contracts relative to the size of the company. They would be good contracts if Boeing won them, and CACI is a $4 billion market cap company. If you read the DARPA annual statement, where defense dollars are going to go is into this sort of thing because an adversary interfering with your data or your ability to interfere with the adversary’s data is the difference between victory and defeat on the battlefield. Intelligence information processing is the key to the modern battlefield. There are only a handful of companies that do it, and I would regard them as the best.
Q: As a final question, any books you’ve read recently that you recommend?
A: I read George Gilder’s new book, Life After Google. I’m reading another book of his called Knowledge and Power. He makes some really intriguing points, and all his books are rich in creative thought. One of the points he makes is that you think about Google as a structure. You search for something and get an answer in fractions of a second. In order for this to happen, there’s a lot of data running along the telecommunication infrastructure, but Google doesn’t pay for it, you do. When you look up something on Google and you get an ad, it’s data-rich, meaning it has a lot of bits, a lot of information. You’re getting an ad you don’t want, and you’re paying for its service to its clients. It’s a highly unusual business circumstance.
I dare say he makes the case it’s a business circumstance that won’t endure. He doesn’t say this in the book although he does make a brief reference to it. One of the things that will happen in the future is that searches will be done through cryptocurrency. Your data is going to belong to you. Let’s say you’re interested in aircraft, and this fact might be on the blockchain. Someone can see that this human being is interested in aircraft. They won’t know it’s you. You might be a good candidate to fly in a plane, rent a private plane, perhaps buy one, or take pilot’s lessons. They will have to pay you for the right to penetrate your cyberspace. In other words, every single person on the planet is going to have a monetizable asset, their data, and sole control of it. That’s coming, and it’s a major disruption to the typical business model. There is a cryptocurrency called CAT, I believe. There are others, and it’s all in the initial stages. I don’t know which one will get it right, but one of them will.
The larger point in the books is the idea of information in general, as I see it. We live in a society where information is available to everybody. With one of these iPhones, we can get the kind of information we used to get out of the New York Public Library – it’s incredible! Therefore, the hierarchical structure of society will change in ways that are hard to imagine because historically, relatively few people were well-educated and in possession of information. Society was pyramidal, was hierarchical. A few people knew how to run tings. Everyone else, historically, was illiterate or not very knowledgeable. Now, a lot of people are incredibly knowledgeable, maybe even more knowledgeable than the policymakers themselves.
Let me conclude with an example. Say something happened with water in California (which happens all the time), and you need to do something. You consult mayors of cities and the governor of California, even the president of the United States. Whether you like him or not, we can all agree a hydrologist he is not. You’ll have to go to experts. The hierarchical structure of society will devolve in a way that to make policy, all sorts of people will be consulted and will play a major role in policymaking, which has never happened before in history. Therefore, the power at the top of a hierarchy is going to decline, and the power of the bottom of the hierarchy is going to rise, which is a good thing for democracy. We’ve never experienced that before. It’s a pretty good development for society, and I think George Gilder does too, as his ideas suggest.
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