Shorting The Oracle of (Boston) Omaha?

Boston Omaha Corp., an investment vehicle into billboards and insurance, is up 100%+ in price from its IPO in June 2017.   Following the stock's stratospheric rise, managers Adam K Peterson, and Alex Buffett Rozek have been profiled in the WSJ, Barron's, and elsewhere.   One of the reasons for Boston Omaha's publicity and rise in price is that Rozek is the grandnephew of none other than Warren Buffett.

Retail investors have piled into Boston Omaha's stock, despite (Warren) Buffett having nothing to do with the firm.  According to some, Buffett's family connection to Alex Rozek has significantly distorted the price of the company.  Following the recent WSJ article publicly connecting Boston Omaha to Warren Buffett, the stock surged double digits.

SumZero sat down with Ephraim Fields, Partner at Echo Lake Capital, to discuss his recent short on the stock.  Prior to founding Echo Lake, Ephraim was a partner at Clarus Capital and a VP at CS First Boston.  Ephraim holds an MBA from the Wharton School and a BA from Washington University in St. Louis.

Luke Schiefelbein, SumZero: What about Boston Omaha initially caught your eye as a value investor?  What catalyzed your entrance into the position?  

Ephraim Fields, Echo Lake Capital:  We first became aware of BOMN when we noticed it was trading at a 52 week high.  We thought it was an interesting company but felt the stock was overvalued trading at well over 2x book value, especially since much of its book value was made up of cash.  We thought about shorting it at that point but decided not to because we felt the risk/reward scenario wasn’t good enough.  Then in late December the Wall Street Journal did a favorable story about the company which propelled the stock price meaningfully higher.  The day the article was published the stock went up 15% on fairly high volume.  We found it interesting that the article said positive things about the company and its two co-founders but the article didn’t even mention the stock’s valuation.  Nevertheless, the stock price reacted favorably to the article and we used the run up as an opportunity to begin shorting the stock which was then trading in the $30s and at 3x book value.  

Although the stock has fallen significantly since we first went short, we remain short the stock.  We think BOMN is still overvalued and believe the stock price will decline even more as a result of the recently announced $50 million equity offering and $200 million mixed shelf, and as investors become more aware of the stock’s overvaluation.

Schiefelbein: What is the market missing?  How much of the stock’s recent rise in price do you ascribe to the loose tie to Warren Buffett?

Fields: BOMN went public at $13 per share in June of last year.  It priced at the midpoint of IPO range which indicates to us there was not overwhelming demand for the offering. After not doing much for a while, the stock eventually started to trade up and then went up significantly, eventually hitting $35 per share after the Wall Street Journal article.  However, even though the stock price has gone up significantly since the IPO, we don’t think the underlying value of the company has increased a corresponding amount.  Importantly, BOMN’s management has invested some, but not all of its cash and much of the money BOMN has invested has only recently been invested.  So, even if we assume the invested capital has appreciated significantly (which it may or may not have), we still think the stock is overvalued.

We believe a great deal of the stock price’s rise is attributable to the loose ties to Warren Buffett, although we should make clear that, to their credit, BOMN’s  management is very upfront that Warren is not directly involved with their company.  However, BOMN is an illiquid, micro cap stock with a lot of retail investors so it doesn’t take much to move the stock price.  Furthermore, the stock can move on perception which is often very different than reality.  We bet there are still a lot of people who own the stock because of the “Buffett” association.      

Schiefelbein: What valuation metrics should investors be paying attention to as your thesis matures?  Why is revenue growing so quickly? What would catalyze a correction in the stock’s price?

Fields: BOMN is a losing money both on an operating income and net income basis, so it is impossible to value the stock using those traditional metrics.  Looking at the company’s revenue can be another way to value the stock but that is a bit complicated since BOMN has done many acquisitions that have obfuscated the company’s real growth.  For example, according the income statement for the nine month period ended September 30, 2017, BOMN’s revenue increased 145% from $2.6 million to $6.2 million, which appears impressive.  However, a closer examination of the financials reveals that all of that growth was derived from acquisitions.  If one looks at the Pro Forma revenue (which is pro forma for all acquisitions) revenue during that same nine month period actually decreased 6.6% from $7.4 million to $6.9 million.   

Anyway, if you want to value BOMN on a multiple of revenue, we estimate it trades at 20x  revenue, which we believe is excessive for this kind of company.  We’ve also analyzed the stock on a multiple of its Invested Capital but perhaps the easiest way to value the stock is by using a multiple of book value.  As of September 30, 2017, BOMN’s book value (including goodwill and intangibles) was $10.42 per share, which implies a current value for the stock at over 2x book value which we think is high especially considering where other comparable companies trade.  Many cash rich companies trade at approximately 1x book value and even Berkshire Hathaway (a company with significant competitive advantages that is run by two of perhaps the greatest investors ever) only trades at 1.6x book value, so we wonder why BOMN should trade at such a premium.  

Schiefelbein: What do you think about the Company’s recently announced equity offering? Why did they file it with the SEC on a Friday at 5pm?

Fields: On February 2, 2018 BOMN filed a $50 million at the money equity offering and a $200 million mixed shelf offering.  We were not surprised by the offering and think it is a very wise move by management.  Companies should attempt to buyback their stock when it is undervalued and sell their stock when it is overvalued.  So if we were on BOMN’s Board of Directors, we’d be advocating selling stock too!!  Remember the saying, “Buy low, sell high.”

Some people have expressed concern about BOMN’s decision to file the offerings with the SEC on a Friday at 5 pm.  In general we think it is suboptimal for a company to make any SEC filing late on Friday since many investors may not see filings that are made at that time.  These “Friday Night” filings can often harm management’s credibility and reflect a lack of transparency.  But to answer your question specifically, we don’t know why BOMN made the SEC filing at 5pm on a Friday…that is question BOMN’s management is better suited to answer.

Schiefelbein: What are the biggest risks associated with your thesis? What could go the most wrong?

Fields: Shorting stocks of any kind, especially a microcap stock like BOMN is always risky.  BOMN is a relatively illiquid name so good news (or news that is perceived to be good such as the Wall Street Journal article) could be bad for our short position.  Also, the stock price can move significantly based on very little trading volume.  The stock price may also go up if the overall market goes up.  Finally, investors must be aware that stocks can remain mispriced for extended periods of time and sometimes it takes a while for the market to value a stock at a reasonable price.  So while we think BOMN is overvalued, it may take a while for the overall market to come to same conclusion. 

Anyone short BOMN must also realize that since the stock has fallen dramatically in the past few weeks, some of the selling pressure may have abated and some investors who shorted the stock in the $30s may now be covering at a very nice profit.  In addition, if the company can demonstrate that its assets are worth significantly more than book value and invested capital, that would be bullish for the stock.  Finally, if BOMN is able to successfully sell $50 million of equity into the market at current levels that may not be good for our short position.

Schiefelbein: How much of the shareholder base do you think is made up of retail investors?  What does this skew signify?

Fields: Looking at the holders list on Bloomberg, it appears that a very large portion of BOMN’s stock is held by retail investors.  Seeing how the stock jumped after the Wall Street Journal article seems to confirm our belief.  When we first started looking at BOMN, we were surprised it didn’t have more institutional ownership considering its recent IPO.  Maybe that signifies institutional investors didn’t find the stock attractively priced.  In analyzing a stock we always assess its investor base, how “smart” we think the investors are and what will motivate existing (or potentially new) investors to buy or sell stock.  We often find retail investors to be less knowledgeable about a stock than are institutional investors and this is because, in general, retail investors do not have the skill set or the free time necessary to accurately analyze a stock as well as professional institutional investors can.  Remember when you’re buying or selling a stock, the party on the other side of the trade has the exact opposite opinion of the stock that you do.  Therefore, we prefer trades when we think the party on the other side is less skilled and less knowledgeable about the stock than we are.  

Schiefelbein: Where else do you see value in the market today?  Where else does your fund focus?

Fields: We are free cash flow and value-oriented stock pickers who focus on U.S. equities.  We think the overall global and domestic economies are doing well which is good for stocks, but we are amazed and concerned that the markets do not seem worried about any geopolitical or other risks which could clearly have a negative impact on the markets.

We try to invest in stocks whose returns are uncorrelated with the overall market.  One way we accomplish this is by investing in stocks we believe are misunderstood by the market as opposed to investing in stocks simply because of their valuation.  “Value with a catalyst” is our motto.  While we seek stocks that are mispriced, we don’t invest in them just because of their valuation.   We also insist there be a catalyst that will lead to a change in the valuation since we know markets can remain inefficient (and stocks mispriced) for extended periods of time.  

We also focus on small and micro-cap stocks since they tend to be most inefficiently priced and thus offer the best risk/reward scenarios.  Furthermore, we feel we have more of a competitive advantage looking at these smaller companies because we can more easily access management as part of our due diligence and because these names are often less “picked over” by other sophisticated investors.  Finally, we invest only in industries we feel we understand well and avoid industries where we don’t feel we have an edge such as high tech and commodities.

Another stock that reflects our investment thesis and that we like very much is Jason Industries (ticker JASN).  We’ve done very well on our investment and still think the stock is undervalued even though it has doubled in the past six months.   The company has an equity market cap of $60 million and will generate well over $10 million of free cash flow, which implies a highly attractive 6x multiple.  The stock was largely given up on by the investment community because after IPOing at $10 in 2013 the stock did not perform well and currently trades in the $2 range.  The company also has a fair amount of debt and operates in a variety of industrial sectors.  We were attracted to the stock because (i) most investors had given up on the company; (ii) the new management team has done of a good job improving the company’s operations and profitability; (iii) JASN’s $50 million convertible preferred obligation is likely worth significantly less than it appears since the conversion feature is so out of the money; (iv) while the company is levered, it has no near term maturities and it is deleveraging nicely; (v) JASN generates a tremendous amount of free cash flow and will benefit from the newly enacted tax law changes.   

Another stock we’ve recently been buying more of is One Group Hospitality (ticker STKS) which is best known for owning the STK restaurant chain.  After years of underperformance, the company has transformed into a less capital intensive and more profitable business by owning fewer properties (and instead utilizing more licensing and management deals) and by reducing corporate overhead.  Same store sales have been remarkably strong and with a recently changed management team and a cleaned up its balance sheet we think the company’s future is very bright.