Idea Brunch with Arham Khan of Mecca Partners
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Arham Khan!
Arham is currently the Managing Partner of Mecca Partners, a boutique long/short equity research firm that is also launching a concentrated long/short fund. Before launching Mecca Partners in February 2022, Arham was a commercial real estate analyst at East West Bank. He also spent time publishing research for GeoInvesting. One of his writing pieces caught the attention of a family office in Canada; after a few conference calls, the family office hired Arham and Mecca Partners was born.
Arham, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Mecca Partners?
Thank you for having me it is my pleasure.
In my final year of undergrad, I was a student analyst and had the opportunity to manage $500,000 of the endowment with a team. We had a lot of success; we bought IBM, Nvidia, and I individually added Alteryx and Square in 2017 – 2018. IBM did modestly well; the other 3 did somewhere between 500% and 3000%. Buying the stocks involved composing reports and submitting quantitative research and financial models to a Board, which included the founder of the program, founder and CIO of Jackson Square Partners Jeff Van Harte, a 20-billion-dollar mutual fund in San Francisco.
Through that endowment program, I was able to receive some tremendous invitations.
We had the opportunity to visit Jackson Square Partners and the New York Stock Exchange (thanks to Mr. Van Harte and the Managing Director and incredible Professor, Michael Milligan); both trips birthed a desire to build something of a cornerstone in Finance.
I started Mecca Partners in hopes of building a reputable hedge fund and a cornerstone for research and academia. If you take the time to see my research, you will find the work refreshing and insightful. It does not look quite like the other research out there, especially the latest, most complex, mature, and rigorous material.
One more incredible invitation through the program was a biannual microcap conference called LD Micro. I know how microcaps can carry a stigma, but consider, I was 21 years old, meeting dozens of management teams face to face (today, the number is in the hundreds).
As part of your research, you “meet with hundreds of issuers and management teams each year.” What is your process before the meetings to get the most out of them? What specific questions do you like asking management? And can you tell us some stories from your years of meeting management teams?
The most important question for me is how much of the company is owned by management (and if this is substantial for the individuals). We can stop there if it is not satisfactory.
Other than this, I go into every single meeting almost always with a blank slate. I will meet the company again if management is able to catch my attention, which is not obnoxiously hard to do, but they are up against hundreds of peers.
I invest in a small percentage of companies I meet, but I almost always know after the first meeting if I am (1) interested or (2) not interested but will extract every ounce of information for research and academic purposes. So, even then, I may meet them again.
(1) If I am interested, we have our next meeting and I have hundreds of pages of information ready, with about 20 pages of research material, and of that 20 pages there are missing blanks I want executives to help me fill out. I also have other fill in the blank questions (not literally fill out the blanks but help me understand what I am missing) which I pose to executives but already know the answer, trying to either understand if they are trustworthy (if I am cynical, which I always am) or if I am thinking about things the right way or not.
(2) If I am not interested, I forget about it but retain my information. I saw a company tout AI about 2 years before ChatGPT happened. I had no interest in this company, but I invested in it thinking there will be a tide that lifts all boats. It has happened twice now, appreciating the stock 300%. I got in and out the first time (this was Verses AI). Additionally, there are companies with unique insights that I am just better off knowing. I had a pretty solid understanding of what was happening and what was going to happen from 2019 through 2022 because I was routinely meeting with pharmaceuticals and doctors.
Consider how powerful this is for all future research, I can pull from experts in any field and begin understanding complex ideas, industries, economic phenomena, financial instruments, medicine, socioeconomics of other countries of a company’s host nation, and more. I have even spent time with asset managers who already run companies I want to emulate. I get to sit with BDC loan portfolios of mature, steady businesses across the United States and understand what the economy may look like at given points in time.
I also want to mention – since we are talking about my volume of meetings – my good friend Scott Arnold who passed away last year. He sat me with companies all the time; he was the second person to ever give me a meeting and I went on to meet dozens of his clients. In the beginning, I had no idea what I was doing. I was hoping to do this fun stuff for a few decades with him.
The first person is also worth mentioning: Chris Lahiji, founder of LD Micro, who opened so many doors for me in the business. My meetings with his issuers are in the hundreds, with 30 more this very week!
I’ll give you a few interesting stories from all my meetings. First, the kind of people I look for. Then, I’ll give you a few funny ones.
I am extremely appreciative of my meetings with Newtek (NASDAQ: NEWT — $324 million), a bank that used to be a BDC (business development company). Barry has a great grasp of the current economy based on how his credit portfolio constituents are performing. This is why I meet with hundreds of companies; my information is always the best, not because I am the best but because (1) I try to establish what the facts are from within an endless supply of conjecture and (2) I have a good reputability meter (it also helps to have esquire extraordinaire, my friend Todd Feinstein of Feinstein Law, as Partner).
Another great, insightful meeting for me was Silvercrest Asset Management (NASDAQ: SAMG — $180 million). This is a 30-billion-dollar wealth management firm traded publicly with over 96% client retention spanning decades. The management team is long tenured (decades), and the company is a world-class organization. For me, it was a great opportunity to meet with people I want to emulate.
Had a CEO say “I am 61, but I feel 40,” within one year of an IPO (about $1 billion in size). He was an employee of the company, turned owner. The company was Alteryx; it had 90% margin and did over 600% soon after. CEO retired a billionaire. Dean was very nice to me, I was 21; but I wish he would invest in Mecca Partners now (what’s good Dean).
Envela Corp (NYSE: ELA — $207 million) was a failing business taken over – mostly open market shares – by a new CEO who turned a profit every quarter afterward. When I met the company many years later, it was at a rare roadshow event; this company was not active in investor relations. The CEO is hard to get to, except for me. One of my favorite meetings and CEOs. He owns 70% of the business and is not worried about investor outreach. Although this can be a double-edged sword, it works for Envela. This is one of the most interesting equity securities out there. A lengthier, very worthy blurb below.
a. This is a $130 million business that operates two segments: luxury ‘re-commerce’ retail (70% or $100 million+ revenue) and hardware waste disposition and recycling (30%, higher margin, stronger potential growth). It is a fascinating equity and I credit myself for qualifying and quantifying the obscurities; the operations reflect the precious metals market, the aftermarket (which may be recession-proof), and relevant environmental and social mores. There are no perfect competitors; I point to page 3 and page 10 of the report where I delineate the qualitative and quantitative conclusions characterizing operations and future stock price. Envela’s CEO owns 70% of the company; soon after he was appointed in 2016, Envela was named one of 10 retailers most likely to default and face bankruptcy within 12 months by S&P Global Market Intelligence. Instead, the company produced profit in every single quarter. This stock outperformed 499/500 companies in the S&P 500 index during the volatile 1H2022.
I am a fan of Nexgel (NASDAQ: NXGL — $21 million), a company with a nice skin product for brittle skin (hospital based use). I am a bigger fan of the CEO coming out of retirement (funded by his music executive career in gangster rap) just to run the show. Our conversations are 50% business and 50% 1990s hip hop.
I have a hard time NOT having success when investing in companies with obnoxious amounts of inside ownership. Steve Mihaylo owns 70% of Crexendo (NASDAQ: CXDO — $179 million). John Loftus owns 70% of Envela. Moishe Gubin and Michael Blisko own 70% of Strawberry Fields REIT (NYSE: STRW — $151 million). Steve Mihaylo actually funded my business school, and I was introduced to him and his team by Maj Soueidan – another one of your Idea Brunch guests – a few years later.
Had a CEO tell me he enjoys going number one out in the open, specifically outside his house, which is why he bought that house
Had that same CEO’s CFO, who is also a Pakistani like myself, offer me a chance to marry any lady my age from his family. This company effectively delisted without any operations shortly after. I did appreciate the guys though.
Unfortunately, saw how “shook” (hip hop reference) CEO of Voyager Digital was before the house came crashing down, quickly and swiftly. One of my mistakes. Crypto trading platform, irresponsibly run. That is the other thing, when crypto was hot in 2020 – 2021, there were tons of new companies making noise in various fields. Almost all of them had an air of kookiness about them. Except for TeraWulf’s CEO, who was pretty buttoned up.
One of your most notable ideas was going long Wingstop (NASDAQ: WING) back in April 2017, which has since risen over 1,000%. What initially attracted you to Wingstop and why did it do so well? Is it still a good investment today?
This is a great story. When I was 9, my family moved to Saudi Arabia; I stayed for 5 years. There, I got a scholarship to attend Webb Schools, a boarding school back home in California. My junior year, my friend and I delivered some food and charged people in the dorms. It worked okay, but the next year, the school decided on “meatless Mondays.” Demand skyrocketed and I decided Wingstop was the obvious and economic choice for us high school kids.
Over 95% of sales were one item: chicken. It made my job very simple. Kids were paying 100% premium a piece! Price today is even higher, so safe to say wings were the right choice.
Fast forward to college, I am just dipping into the finance world. Wingstop (NASDAQ: WING — $7.18 billion) was the second stock I wrote on, after Adobe. The reason it is a good investment today is the same reason it was a good investment then.
Most people will run away from the valuation (that is the benefit of being early). But let me provide a different, overlooked perspective. How do you value perpetuity? The entire menu is almost exclusively one item. The return on capital, thanks to the early and innovative focus on take-out dining, is very high on a per square foot bases. And, franchisees are addicted; franchisees are not just opening one store, they open multiple.
Arham, what are some of the first things you do when researching a potential investment? What does that first hour of research look like for you? Do you do anything that few others do?
I end my research if inside ownership is low. If it will not make key personnel wealthy, it will not make me money (or, I am happy to miss out).
I read 10-Ks and 10-Qs, and I read them all. I go back many years. One of my favorites to tell young people to look at is an Adobe 10-K from around 2013 – 2016. The cloud thesis is alive and well today (many still use a desktop phone at the office . . .). I do not read much else until later. Here, I am searching for fundamentals and at least one catalyst (which I should quantify in a model). Fundamentals to me mean (or important fundamentals for me): revenue retention, gross margin, future cash flow, and some semblance of a flywheel (definitely if it is a growth thesis). I also like a boring value stock, but I particularly care when – and this goes for growth too – I can calculate or qualify perpetuity. I want things that last forever, and produce forever, and (over) achieve forever. In my opinion, winners continue winning. Professor Milligan said this once: you would not bench Jordan if he has 40 points in the 3rd quarter. He was right, because you certainly do not move on from Tom Brady after 6 championships (he got 7).
a. Note: why Adobe 10ks in 2016? Cloud transformation, subscription model, piracy issue taken care of, no more $700 dollar CDs per head, a must have product for certain institutions. It was my first real analysis/research, extremely beneficial. The thesis produced almost 500% return; then, I used the same cloud migration thesis for Altigen (ATGN) and Crexendo (CXDO), which did 189% and 248%, respectively.
One of the reasons I stick to filings more than others’ research is I try to establish facts. This way, I can see singles and doubles and I do not rely on swinging for the fences, especially when singles and doubles keep coming and I am not striking out. All of my winners returning several times over were modeled for modest, prolonged success, call it around 15-35% a year. I try in particular to establish a price floor, especially when buyout offers give me one, and especially because I have great success with illiquid securities. I am investing in these companies for many years, so I am always at the table. I would like to give you a controversial side note for “establishing facts,” because society does not allow us to do it often.
a. I bring up the following example because it mirrors how I approach investing — cynically assess universal assumptions, establish facts and not-facts, and use common sense. Consider the parable: if your LDL cholesterol is “high,” your doctor will rush to prescribe statins; yet, well-established literature found people with high LDL live longer. This is a huge thorn in “scientists” backside and so it has been kept under the rug as something with not enough data to conclude (almost understandable, as a doctor must not provide care with higher – what they perceive as –margin of error). There are missing pieces here, and much so-called science – which is supposed to be fact based – has entered a realm of conjecture. Try getting an advanced lipid panel done, which may actually show you relevant data, but see how it may be difficult to obtain for no reason. Try presenting this information to “scientists” and see their visceral reaction when “science-ing” – that is, challenging until facts are established – insults their religion (I am being purposely offensive). Consider, also, an absolute, undeniable fact (related to this LDL example of mine): the minimum threshold for carbohydrates in the human diet is zero (but we are told animal fat/cholesterol is the culprit of heart disease).
b. Back to investing. . . what are some facts I established (you do not have to agree but I will put the less controversial ones first)? You will notice many of these are highly microeconomic and specific. This is because macroeconomically, the market will go up or it will go down, nobody knows and most top-down analysts are consistently wrong, because they do not establish facts. I believe facts are established from the ground up. Any established macroeconomic fact already exists in economic textbooks, it is the aggregate supply and demand curves, these are all we can manipulate from the top-down (policy, etc.), in my opinion (and then we have to be right about ensuing events and externalities).
i. Between 2020-21, Envela Corporation, a precious metals reseller, had great tailwind from metals’ prices. My thesis heavily relied on the assumption Q3 2020 revenue would sustain in Q4 despite no authority to forecast spot prices (no one can, it is a guess). This sustenance is extremely important because the stock was so illiquid and we were trying to establish a price floor given the illiquid circumstances. On page 3 of this report, we I look to establish comparable companies (this is a company with no comp, as previously delineated in the “blurb” for Envela. Yet, we look to establish US Auto parts and consignment providers are comparables. On page 5, we establish these comparables’ performance as proxy for Envela; because only we do this, we believe we know something the market does not. Further, on page 10, we get a little more quantitative in this comparable approach. Page 3, the least fancy, is the key.
ii. The price floor for a multinational small business roll up of elderly hospice/nursing agencies – according to Mecca Partners – is approximately 10-12x EBITDA, anything below may be a buying opportunity. This is what I found after researching Nova Leap Health Corp (NVLPF), one of my favorite, simple businesses and a great CEO, Chris Dobbin.
iii. Re-cycled plastic and bioengineered plastic can never and will never retain the characteristics of virgin plastic/resin. It is not possible. Chris asked me to present at LD Micro in a panel this week, one of the fun introductory questions is: CEO for a day, which company? My answer is Amcor (AMCR) because they bought Berry Global (formerly BERY). I have to look this up every time because the number is so obnoxious, but Berry Global was spending $700 million every year for sustainability CAPEX. Almost everything they sell is plastic!! And a lot of it is for food and beverage packaging!!
iv. We believe synesthetic marketplaces of buyers and sellers (like Square and Fiverr which are buy theses, and others like Upwork and IZM which we know about) witness a “rich get richer” phenomenon during growth and maturity of the platforms. Larger buyers begin to drive more transaction volume and therefore revenue. See slides 9 and 10 on this presentation for a powerful illustration.
c. Autonomous vehicles and this world of futuristic artificial intelligence robot cities may never happen, and it will not happen for decades, it may not happen in centuries. A few months ago, a gunman walked through New York City (densely populated as hell with more cameras than anywhere) openly toting a machine gun and killed several people inside a commercial office building (does anything in the world have more value than NYC commercial real estate)! Give me a break. In less crass words, there are practical hurdles; society cannot see fully autonomous vehicles door to door unless ALL vehicles are autonomous and achieve minimized error. I do not care what you think is a good threshold of minimal error, the minimum threshold of error when it comes to one (or two, or hundreds, or thousands, or millions) two-ton vehicle(s) carrying humans are 60 miles per hour speeds on pavement and declines is absolutely ZERO.
d. Cloud transformation is a several decade long thesis which may continue to produce outsized returns.
e. I am always supportive of the environment, but oil has not run out and I do not quite think it ever will. Call me when it does. . . it might be Judgement Day.
Of course, I model cash flows. I spend a lot of time on my models and I can be granular as a habit. It is most important to establish which kind of model to utilize. As I mentioned with Nova Leap Health Corp, I believe only a PE multiple can work and is most prudent.
This really covers it. Just a few bullets of to-dos (inside ownership, thesis, catalyst, establish facts, model properly) with lots of bullets of not-to-dos.
What are some interesting ideas on your radar now?
I have two ideas I’m very excited to share that I have researched for years: