Liberty Latin America (LILAK) Interview

I was recently interviewed about one of our holdings Liberty Latin America. Liberty delivers broadband Internet, cable, mobile, and home phone services to a variety of Latin American countries.

We also do a good dive on the broadband Internet business.

https://itunes.apple.com/us/podcast/35-liberty-latin-america/id1205082419?i=1000421186116&mt=2

Disclosure: Long Liberty Latin America (LILAK)

Liberty Braves-BATRK

Last week I spoke to the Intelligent Investing podcast where I talked about Liberty Braves. Liberty Braves is a John Malone controlled entity that owns the Atlanta Braves MLB team and The Battery entertainment area near the Braves new stadium, Sun Trust Park.

https://itunes.apple.com/us/podcast/the-intelligent-investing-podcast/id1205082419?mt=2

https://www.stitcher.com/podcast/the-intelligent-investing-podcast

Disclosure: We previously owned Liberty Braves but we sold it this year when I found new opportunities.

Interview-Liberty SiriusXM

I recently was interviewed by Eric Schleien on the Intelligent Investing Podcast about one of the positions we own Liberty SiriusXM. LSXMK is one of our bigger positions and is part of the John Malone complex.

Hope you enjoy the interview!

https://itunes.apple.com/us/podcast/the-intelligent-investing-podcast/id1205082419?mt=2#episodeGuid=intelligentinvesting.podbean.com%2Fliberty-siriusxm-group-anthony-morley-24b00f90dd1700f333f1ee8f1a4eedd1

Interesting Articles From the Week

It has been far too long since I have posted anything! The end and beginning of the year is rather hectic in this business so I have done far less reading and researching than normal. But here are some interesting things that I came across recently.

National Western Stock Show Citizen of the West John Malone

We have investments in some of Malone's companies and I find him to be one the most savvy businessmen in the world. But also a very high quality person!

http://www.denverpost.com/2017/01/08/national-western-stock-show-citizen-of-the-west-john-malone/

Peter Thiel Explains Himself

He's a Trump supporter from Silicon Valley. And before the election was nearly the only supporter from that area.

https://www.nytimes.com/2017/01/11/fashion/peter-thiel-donald-trump-silicon-valley-technology-gawker.html?action=click&contentCollection=Fashion%20%26%20Style&module=RelatedCoverage&region=EndOfArticle&pgtype=article

Apple Sets Its Sights on Hollywood With Plans for Original Content

This makes sense to me. It is a big market and would hopefully give them a profit center away from the iPhone.

http://www.wsj.com/articles/apple-sets-its-sights-on-hollywood-with-plans-for-original-content-1484217007

Warren Buffett Predicted Fall of Eddie Lampert and Sears

Retailing is tough...

http://www.businessinsider.com/warren-buffett-predicted-fall-of-eddie-lampert-sears-in-2005-2016-12

Hank Paulson Interview at Stanford Business School

Very good interview. In particular I enjoyed the part about him and his wife and how they have grown together in life. (39:43)

https://www.youtube.com/watch?v=gTGybnPatQk&t=22s

Have a great weekend!

An Elephant For Berkshire, or Rather a Deere

Warren Buffett took his Elephant Gun out once last year with the purchase of Precision Castparts and there might be an opportunity to do so again soon with one of the worlds most iconic brands, John Deere. Deere & Company (DE) is absolutely the type of business that Buffett would consider for Berkshire Hathaway. It has few competitors and is easily the best business in its industry. In the United States, farmers by far prefer John Deere green to the other competitors AGCO and CNH Global (1).

Having this wonderful brand allows Deere to not just sell more tractors and equipment, but to sell them at a higher price. This is evident when you compare the average gross margins over the last 5 years. 

• Deere = 25%
• AGCO=21%
• CNH = 18%

If this isn't the kind of moat Buffett is looking for then I don't know what is.

Since Deere sells most of its products to commodity producers it is a cyclical business. But, farmers and construction companies can only wait so long to replace their equipment. This causes Deere to have lumpy earnings but Buffett historically has had no problem with this if he is getting a great business. Deere is no doubt in one of those lumpy periods right now as revenues and earnings are down around 30% since 2013 when grain prices were much higher. 

Deere helps many of its customers finance their equipment. Since 2010 Deere has seen its loan portfolio grow from $17.6 billion to $24 billion. In 2002 its loan portfolio was just $9 billion. Because of its stronger financial position, there is an argument to be made that Deere would benefit from being part of Berkshire Hathaway. 

The farming industry has been going through dramatic changes in recent years seeing larger and more sophisticated equipment. Many of the functions such as planting, driving a grain cart, and harvesting are now automated. It is very possible that 10 years from now a person is not required to physically operate the equipment. Because Deere has much higher margins and profits than it's competitors it will be able to allocate more money to developing these technologies, thereby increasing the massive moat it already has.

John Deere Self-Driving Equipment (CBS Special)

Normally I prefer using owner earnings to figure out the earning power for the business but for Deere that is rather difficult. Deere finances a lot of their customers equipment themselves. This causes much of Deere's cash from operations to flow into these leases. For Deere I actually consider earnings per share (EPS) to be a good proxy for the company's earning power. Below is a graph showing Deere's EPS from 1998-2015.

Berkshire recently purchased Precision Castparts, an aerospace parts supplier, for $32 billion. PCP was making about $1.6 billion at the time of the purchase. This means Buffett paid 20 times earnings or accepted a 5% earnings yield on this investment. PCP is nearly certain to have higher earnings in the future as it is a fantastic business and I think this stretched the limits of how high Buffett is willing to pay up for a great business.

The idea to purchase Precision Castparts for Berkshire came from one of the new investment managers, Todd Combs. Todd first bought PCP for his Berkshire investment portfolio in the 3rd quarter of 2012. Just before the 4th of July in 2015 Mark Donegan, the PCP CEO, stopped by Berkshire to meet with Todd and at the end of the meeting Buffett stopped in to chat. He was very impressed by Donegan and asked Todd Combs to see if the board of PCP would be receptive to an offer from Berkshire. Buffett has committed to never doing a hostile takeover so this is very important. The board was receptive, Berkshire made their $235 per share offer, and they accepted the offer.

In interviews Buffett makes it seem like he didn't really follow the company that closely but I would say that is extremely unlikely. Though he allows Todd and Ted to make their own investment decisions I'm sure he keeps up with the businesses they own as that is his favorite hobby! Once Buffett realized how good Donegan was as a manager I think it was an easy decision for him to make an offer.

Todd and Ted

(2)

Berkshire currently owns a $1.9 billion position in Deere. Todd and Ted manage $9 billion for the company so this would make it a 21% position for one of these managers. I think it very possible that a situation similar to Precision CastParts could happen if Deere's board of directors is open to an offer. If they are not it is a non-starter and Buffett won't pursue a deal any further.

Because of Deere's cyclicality I don't believe Buffett would pay the high premium he did for PCP. But I think it is reasonable that he would accept a 7% earnings yield vs 5% for Precision Castparts. With earnings of $5.77 in 2015 this means Buffett would be willing to pay around $82 ($26 Billion) to purchase the whole business. Right now that is where the stock is trading so it is unlikely that there is a deal to be made as the board would want a premium to the stock price. If the price were to decline to $70 or less I think it is very possible for the wheels to get turning on Berkshire making an offer.

Berkshire Hathaway currently has about $43 billion in cash on it's balance sheet. $23 billion of that can be used for a deal as Buffett has said he will never go below $20 billion. With a market cap of $26 billion, Deere is the right size for Berkshire to be able to handle comfortably with a small debt issuance or waiting a few more months for cash to pour into Omaha.

Right now there is probably not a deal to be made for Berkshire purchasing Deere, but it is getting close! In summary:

1. Deere is a great business with a strong moat and is almost certain to be making more money in 10 years.
2. If the Deere board is open to it, Berkshire might make an offer.
3. I don't believe an offer would be for much more than $82 so the stock probably has to trade down to around $70 for a period of time before one would be made.

John Deere S690

(3)

Disclosure: No position in Deere

1. http://www.machinefinder.com/ww/en-US/articles/john-deere-dominates-brand-loyalty-among-midwest-farming-base-2192

2. http://www.cnbc.com/2014/10/14/warren-buffetts-stock-pickers-are-crushing-it.html
3. https://www.deere.com/en_US/products/equipment/grain_harvesting/combines/s_series/s690/s690.page

Berkshire Hathaway Investment Analysis

Right now I am not finding a lot of very interesting, or cheap, investment ideas. Most companies are valued pretty fairly, or appear over-priced to me. But one big exception is Berkshire Hathaway. It has so many high quality businesses with great long-term prospects that it should really be priced higher than it is. I have talked about this with my clients, as it is currently the largest position in our investment portfolios. Below is what I wrote them about Berkshire in 2014, but the numbers have been updated for 2015.

Berkshire Hathaway (BRK-B)

It should be of no big surprise that Berkshire would end up in the portfolio at some point. Warren Buffett, with help from Charlie Munger, has the best long-term track record of anyone in the investment business. Berkshire has grown book value at 19.2% compounded over the last 51 years, or a total of 798,981%. To put this in different terms, Warren Buffett and his BPL partnership bought their first shares in Berkshire for $7.50. Those same shares are now worth $210,530.

Obviously Berkshire has had a fantastic past, but what we care about is the future. The businesses are best described in Warren Buffett’s annual letter to shareholders, which can be found at www.BerkshireHathaway.com. I think that the 2014 letter was his best by far, as he talked about the history of Berkshire and what him and Charlie think the future holds. I will give a brief description of the businesses below.

The Insurance business is what has fueled Berkshire’s massive growth over the years. It is represented by Berkshire Hathaway Reinsurance, GEICO, Gen Re, and Berkshire Hathaway Primary Insurance Group (a collection of insurance business). If these insurance businesses generate more premiums than claims in a given year then they essentially are able to hold large amounts of money for free. This is called float, of which Berkshire has about $88 billion. Berkshire then invests as much of this money as it can, in common stocks or wholly owned businesses. In 2015 the Insurance group contributed about $1.8 billion in underwriting profit or about 7% of earnings for Berkshire. This does not count the earnings from the float which are much more.

The next largest business is the Burlington Northern Railroad which contributes about 22% of my estimate of Berkshire’s owner earnings (profits) in 2015. The BNSF operates one of the largest rail networks in North America, mostly in the western United States. Since it was purchased in 2010 by Berkshire it has seen its earnings grow dramatically from about $2.2 billion to $4.9 billion last year. This will be an extremely important asset for Berkshire for many years.

Berkshire Hathaway Energy is one of the biggest energy companies in the United States. BHE is an owner of power companies in Oregon, Utah, Nevada, and Iowa. This is a business that provides about 10% returns to Berkshire that is almost guaranteed to be around many years in the future. Charlie Munger believes that BHE will become the largest power company in the US in a few years. The energy business contributed earnings of $2.2 billion or 9% of earnings.

The last part of Berkshire is a large collection of businesses that sells everything from cowboy boots, to chocolate, Dilly Bars, and industrial parts. Most of these companies enjoy strong positions in their markets and have bright prospects for the future.

Berkshire is a very unique company to value because of its large common stock portfolio, $112 billion at year end. What is unique is that all of these companies are essentially minority interests in businesses that Berkshire owns. But, the only “earnings” from these businesses that show up on Berkshire’s financial statements are the dividends that are paid. Thus, Berkshire has a large amount of what Buffett calls “look-through earnings”, essentially all of Berkshire’s portion of the earnings that aren’t paid as dividends. Some of the companies that Berkshire owns in it's common stock portfolio are Wells Fargo, American Express, US Bancorp, IBM, John Deere, IBM, and Coca-Cola.

To figure out the look-through earnings for Berkshire’s investments I calculated the owner earnings attributable to Berkshire for each company it owns stock in. Then subtracted out the dividends paid to Berkshire. After these calculations I found that Berkshire has about $5.7 billion of earnings that are not reflected on its financial statements.

In 2015 Berkshire generated $32.7 billion in cash and had to spend about $9.2 billion in capital to maintain its various businesses. If we add in the “look- through earnings” Berkshire made about $29.3 billion or $11.87 per B share. In 2009 this figure was about $6.15 and in 2004 $3.65, meaning that Berkshire has been doubling earnings about every 5 or 6 years.

In addition, Warren Buffett has said that he will not allow Berkshire to have less than $20 billion in cash. Berkshire currently has $61 billion. $22 Billion of which will be used to purchase Precision Cast Parts. This leaves us with $19 billion in excess cash that will be invested at some point, providing future streams of earnings. I will break this down into easier per share numbers below.

Class B Per Share figures for 2015:

Owner earnings= $11.87

Excess cash     = $7.78

Current price    = $140

We will subtract the cash from the stock price because that money will generate future investment returns for us. We do not know when this will be, but we can all but guarantee that it will happen because of who is running the company.

Effective Price=$132.22

Effective Initial Rate of Return= $11.87/$132.22 = 9.0%

If we owned Berkshire as our own private business, we would be buying a business that has recently doubled earnings each of the past 5 years that is managed by the investor with the best long term track record. If earnings continue to grow, a highly likely proposition, then intrinsic value will likely grow at a similar rate. In a world where not very much looks interesting, I believe this represents a great investment.

If Berkshire doubles earnings again in 6 years it will be making around $22 per share. If we get that same initial return of 9% that we are getting now that would value the company at around $244 giving us a 12.3% average return. Because of the high quality of the businesses and its managers I believe Berkshire deserves a higher price in relation to it's earnings than 9%. If that happens we would get even better returns.

Fortunately, it is not just me that thinks Berkshire is cheap! Warren has said that he will only buyback stock when it is "significantly undervalued" and for Berkshire he will buyback stock at 1.2 times book value. Currently 1.2 times book value per B share is $125.89 and very recently the stock price was trading close to that. We are a bit about above that now at $140 or 1.33 times book value. When the stock is trading close to where Warren thinks its cheap, it probably is. 

This is not to be taken as investment advice, but is for informational purposes only. I am not making a recommendation to purchase shares in Berkshire Hathaway. Please do your own research.

Daktronics-DAKT

My History With DAKT

Daktronics is one of the first public companies that I really started paying attention to. It is one of the largest and probably the most well known public company in South Dakota. I went to college for my first two years in Brookings at South Dakota State University, where Daktronics is based. That is where I met one of my heroes in life, John Sondey. John was an economics teacher whose true passion was investments. Fortunately, as a Freshman in college I met him and he noticed my interest in the stock market. Then he allowed me to take his investing class that was normally reserved for seniors. This was really the beginning of my formal education in investing. During the class he let us invest $12,000 of his own money in 6 different stocks. At the end of the semester if we made money, we gave half of the proceeds to the local food shelf. The other half of the proceeds were distributed to the students in the class! After the last class of the semester that money was promptly reinvested in the local downtown establishments.

Since Daktronics was based in the same town, and had so many connections to the University, it was often a topic of conversation in class.

Company History

Drs. Aelred Kurtenbach and Duane Sander founded Daktronics in 1968 while they were professors of electrical engineering at South Dakota State University. The company has always maintained a close relationship with the University which has been able to provide it with highly trained engineering talent and other full and part-time employees.

The companies first product was a voting system display that was sold to the Utah Legislature in 1970. In 1971 it expanded the business into scoreboards and in 1973 into commercial displays. The company continued to innovate and in the 1980's successfully sold scoreboards for the 1980 Olympic Winter Games, college athletic facilities, and its first major league facility. In the 1990's the company successfully implemented LED technology into it's video boards and expanded into further product lines. In 2002 the company had its initial public offering and was the world market share leader in LED video displays with over 26.5%. Their market share has since grown to 29%(1). The New York Times had a great feature on the company in 2014.

The company has a large percentage of insider ownership and it seems that it is mostly controlled by the founder Aelred Kurtenbach and insiders. Reece Kurtenbach, Aelred's son, is the current Chairman of the Board and CEO of the company. Jim Morgan, the CEO from 2001-2013, owns a sizable stake in the company and is on the board of Directors.

Ownership % Shares Value Dr. Aelred Kurtenbach 5.2% 2,277,392  $   20,769,815 Reece Kurtenbach 1.0% 417,223  $     3,805,074 Jim Morgan 3.4% 1,490,456  $   13,592,959 DAKT 401k Plan 5.7% 2,495,664  $   22,760,456 15.3% Shares Out    43,762,596 Share Price  $           9.12

Business and Segments

Daktronics reports its' figures in 5 different business segments: Commercial, Live Events, High School Park and Recreation, Transportation, and International. Below is a brief analysis of each.

Commercial

You might find these display systems at gas stations, restaurants, casinos, amusement parks, or even in Times Square and the Las Vegas Strip. These displays are typically used to inform customers of events or prices. This business represents about 27% of Sales for Daktronics. It's Gross Margin is also 27%. This part of the business has been seeing larger and more customized displays being built in recent years. I suspect it is likely that this trend continues in the future as displays get better and more dynamic. This business has produced consistent profits overtime, with the only anomaly being in 2009.

Live Events

These are the largest and most dynamic of Daktronics video display systems. You will see these in most of the large stadiums in the United States. Some examples include Sports Authority Field at Mile High (Denver Broncos), Levi's Stadium (San Francisco 49ers), and Target Field (Minnesota Twins). New stadiums are building larger video boards than ever and it seems that this trend will only continue. The expected lifetime of this equipment is 8-12 years so once installed their is a natural replacement cycle provided Daktronics can win the job again.

Not only are they building large video boards for replays, but stadiums are adding many smaller banner type boards for advertising and other purposes. For example, the group that owns the Denver Broncos stadium expects a 2 to 3 year payback from advertising revenue on the banner displays they recently installed in their stadium. With such strong returns it is not wonder that other stadiums have been purchasing these boards as another source of revenue. 

This business sometimes has lumpier sales just because of the timing of large stadium projects. It currently represents 38% of Sales for Daktronics. It does have lower Gross Margins than the Commercial business though, coming in at 18% in 2015.

High School Parks and Recreation

Daktronics is one of the leaders in providing scoreboards for high school athletic and theater activities. This was one of the first businesses that the company entered and has had rather stable sales overtime. Like in the other segments, schools are seeing value in higher end scoreboards for advertising. They are also being adopted as message centers for students, faculty, and community members. This segment represented 11% of Sales and maintained healthy 32% Gross Margins in 2015.

Transportation

The Transportation business builds signs for roadways, airports, parking structures, and various other applications. I see their signs all of the time on my way to and from the Minneapolis-St. Paul Airport. Historically this has been one of the higher margin businesses for Daktronics. Their Gross Margins have generally been around 30%. This is the smallest business unit though with just $48 Million or 8% of company Sales. I believe the company has a good future in the business as the world adopts more intelligent transportation systems and improved communication systems for travelers. Unfortunately, this segment has more competitors than some of the others so it's growth might be mitigated.

International

The company includes all business sales internationally in one unit so it is hard to get true clarity on the mix of products. The company says that commercial video systems, digital billboards, and transportation systems are their main products. The large US style Live Events scoreboards have not caught on in the rest of the world yet. Particularly with Soccer stadiums in Europe and South America. FIFA seems to be concerned about crowds becoming agitated over replays, and not having undue influence on the referees. I suspect this will change as stadiums try to improve the fan experience. I know in the US the use of the large billboards is much appreciated by the fans, but time will tell. The company has been growing very nicely internationally, increasing Sales from $51 Million in 2008 to $102 Million in 2015. 

Competitive Advantage

I believe that Daktronics has a pretty good competitive advantage. It is certainly not a great one like Visa has but it isn't a terrible one like Airlines historically have been. I would say it is somewhere just above average. The market had about $2.1 Billion in Sales in 2014 and Daktronics has a 29% market share with the closest competitor having just 9% of the market. They operate in a very niche industry that requires rather specific engineering expertise and I think this would be difficult to replicate in a short amount of time. Also, the margins are pretty good but not super high. Thus, I don't see a good reason for another company to pour hundreds of millions of dollars in plant and equipment to try and compete. 

Valuation

And now the most important piece of the puzzle. Over the last 10 years Daktronics has experienced rather lumpy financial results. Despite this, Sales have grown from $230 Million to $615 Million or 10.3% compounded. Owner Earnings Per Share meanwhile have not grown at quite that rate, only about 6% compounded.

Cumulatively, over the last 10 years I estimate that Daktronics made $6.10 and paid $3.05 of that out in a dividend. In 2015 I think Owner Earnings Per Share were around 63 cents (different from the the graph) as their were some abnormal working capital changes.

In the last 5 years the company has decided to pay most of their free cash out in a dividend. While this is not necessarily a bad thing, I tend to prefer a company that can reinvest in its own business. Daktronics has built new plants and added production lines in recent years, but has had the fortunate "problem" of having extra cash around.

I am glad that the company has not repurchased stock. Because, for the most part over the last 10 years the stock was not significantly undervalued. I do question whether they could have made an acquisition that would have helped the company. Maybe a supplier or one of their competitors. I cannot criticize this point to hard though as I do not have a good idea of what that acquisition might be.

In the future I expect Daktronics to continue to grow Owner Earnings Per Share at about 5-8% rate compounded, though this will be lumpy. I also expect the company to continue to pay out most of it's excess cash in a dividend as that seems to be the desire of the founders and management that are on the board of directors.

I believe Daktronics Intrinsic Value is around $7 per share so I would like to purchase it at a good discount to that. Currently shares trade at $8.86. Not excessively higher than my estimate of Intrinsic Value but not at a price that I find interesting. If the stock prices comes down a ways below $7 there is a good chance I would be purchasing shares in Daktronics.

Happy Holidays!

1. Daktronics Q2 2015 Investor Presentation Page 5
2. 10 Year Daktronics Financial Results