Idea Brunch with Frank Taber of Seeking Value

Finding value in unusual places

Welcome to Sunday’s Idea Brunch, your weekly interview series with underfollowed investors and emerging managers. We are very excited to interview Frank Taber!

Frank is an Australia-based private investor and author of Seeking Value, a newsletter on micro-caps, compounders, deep value, and special situations. Frank runs a concentrated portfolio focused on small illiquid companies.

Frank, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and your passion for small illiquid securities?

Thanks for asking me to do this Edwin, I’m a big fan of Sunday’s Idea Brunch so it’s an honor to be the investor responding today.

My background is actually in education. Writing and investing started as more of a hobby for me, although it really is an obsession at this point. I completed a major in business studies at a university here in Australia as part of my bachelor's degree, which is what really sparked my interest and helped me develop some of the basic accounting knowledge and general business understanding. From there I went down the Warren Buffett rabbit hole and spent years reading every bit of value investing literature that I could find. Some of the key readings that really stood out and shaped my investing philosophy are Warren Buffett’s shareholder letters (particularly the early partnership letters), Joel Greenblatt’s ‘How to be a Stock Market Genius,’ and Nick Sleep’s Nomad partnership letters. All of which I highly recommend!

As you might infer from that collection of reading, that is really where I’ve developed a passion for the more obscure, small, and illiquid companies. Some people might not think of Warren Buffett as a small-cap, special situations guy, but during the Buffett Partnership days through the 50s and 60s, he was a much different investor than the ‘great business at a fair price’ Warren that we know today. Buffett has mentioned that he believes he could return 50% annually with a small sum of money. I have no doubt that to do so he would return to a deep value, special situation approach with highly illiquid securities around the globe. The problem for Warren is that it’s only possible with a small sum of money. Luckily, or maybe unluckily for me, I don’t manage a huge portfolio.

As a retail investor, I really believe the biggest advantage you have is to focus on micro-caps that have very little or no coverage. If you are looking for inefficiencies in the market you best be looking at the places no one is looking. That includes looking at the small companies in markets all around the world. Of my 8-stock portfolio, I have exposure to Australia, the UK, China, and New Zealand. Most of which are small and illiquid companies that institutional investors really can’t access. I don’t exclusively invest in micro/small-caps as I do believe inefficiencies exist in larger companies as well. It is just less frequent and hard to come by in my experience. Small illiquid companies make up 80%+ of my portfolio and I’d prefer to keep it that way.

What do you look for when evaluating small & illiquid companies? What are some of the common characteristics your come across?

I categorize my investments into two core categories, ‘compounders’ & ‘special situations’. What I am looking for in a company varies depending on the category or type of investment. In an ideal world, it would be a 50/50 split in the portfolio, but I just take the best opportunities I can find and am not overly concerned if the portfolio is 100% into either category.

I’ll start with the compounders first. These are positions I am looking to hold for 10+ years and am very reluctant to sell unless something fundamental about the business changes. I am looking for a business with sustainable competitive advantages. The key word there is ‘sustainable.’ Most investors are pretty quick to identify some type of competitive advantage in almost any business, but for a long-term hold it really needs to be a competitive advantage or moat that won’t erode over time. Another key aspect of the compounder position is a high-quality management team, preferably with an owner-operator that has a meaningful stake in the business and a reasonable incentive structure. Quality management is very subjective, but when looking at a founder that has the majority of their net worth invested alongside shareholders, I can be much more comfortable holding over a long period. If the insiders are buying shares privately or even buying back stock, I become even more comfortable. The last and probably the most important aspect of management is their ability to allocate capital and grow per-share value over a period of time. Some of this can be seen quantitatively within the financials, however, I more so want to see consistent and honest commentary, both historically and currently, around capital allocation from the CEO or management themselves. That should be backed by returns on capital and per-share intrinsic value growth. Considering I am holding for the long-term it is important the cash flows are reliable and predictable with a long runway for growth. Once I know the business is a high-quality business, I also want to ensure it is undervalued. A wonderful business at a wonderful price.

The special situations I am looking for might not be the standard Joel Greenblatt defined situations, although sometimes they are. The category can also include event-driven situations, asset plays, and deep-value, maybe going as far as a stock trading below liquidation value. These positions usually have a much shorter time horizon. For tax purposes (in Australia) I try to ensure it is a minimum hold of 12 months, so typically I’m looking at a 1-5 year holding period for these positions. Within this category, quality becomes less important overall. Of course, I prefer these to be great businesses as well but more importantly, I want them to be trading at a significant discount to intrinsic value. I do however still look for great capital allocators with high insider ownership. Usually, these companies are not something that would show up in a stock screener. There needs to be some type of underlying earnings power or asset that is hidden within the financials. After all, it is cheap for a reason. For a stock to be inefficiently priced the market needs to be missing something. I am looking for something the market is missing or overlooking. These types of investments usually have a significantly higher IRR than the compounders however they also come with more risk and uncertainty. These types of ‘special situation’ investments are not what I would recommend to most investors. There is a much higher probability of being wrong. I do however think the best investment returns can come from these situations. Every now and then you may come across a blend between ‘compounder’ and ‘special situation’, it may start as a deep value, turnaround story and become a long-term compounder. That’s the swing big scenario.

You have a very concentrated portfolio. How do you think about and get comfortable with concentration?

In a recent podcast with William Green, Joel Greenblatt said that he doesn’t find an 8-stock portfolio ‘concentrated.’ I agree. Greenblatt discussed the importance of being concentrated when making his 40% annual return over 20 years. I personally have a ~45% weighted position in an Australian accounting firm and I am completely fine with that. 

An old Buffett analogy is that no one thinks a local business owner is taking a significant risk when the majority of their net worth is concentrated in just one business. Yet when investing, people will say a 5-8 stock portfolio is high risk. I really don’t think that’s the case. Higher risk relative to a 30+ stock portfolio? Of course. But if done well, it’s not high risk on an absolute basis. If you are looking to preserve capital and be defensive, then diversification is the route you should take. But if you are looking to outperform the market by a large margin then concentration is a necessity in my opinion. 

My thoughts on diversification might be controversial to some, so I will caveat it by saying that you can make money in a lot of different ways. Some great investors have outperformed over long periods with a diversified portfolio. It is a lot safer and probably how 99% of people should invest. I may also become more diversified as I become older and more focused on capital preservation.

You have a very unique portfolio – ranging from an Australian accounting firm to an English funeral company. How are you able to come up with off-the-beaten-path ideas in an industry with so much groupthink?

The positions in my portfolio and fairly geographically diverse. This again ties back to my perspective that to find inefficiencies in the market you need to be willing to invest almost anywhere in the world. For example, it would seem that China is more likely to be inefficiently priced in comparison to the US. Perhaps it is rightfully cheap, but it’s worth exploring. As are markets like Japan, the UK, and Australia. Within the US or any market for that matter, there are always certain industries or single companies that the market has priced incorrectly, but they are hard to find. It becomes much easier to find a great idea when you broaden your horizon and explore global markets. As a retail investor, I want to take advantage of as many competitive edges I have over the well-capitalized, large intuitions with a team of analysts. What better edge is there for retail investors than looking at small illiquid companies in global markets that institutions aren’t willing to or cannot invest in?

When it comes to groupthink, I think it’s impossible to avoid entirely. The so-called ‘off-the-beaten-path’ ideas in themselves are a type of groupthink. Within my network of investors, the large majority are searching for these obscure small-cap companies. Although our group is certainly much smaller and contrarian in comparison to the broader market. But in reality, a lot of my ideas come from a network of investors with a similar approach to investing. For the most part, though I ignore market news and pay very little attention to the macro environment unless it is crucial to a company I am researching, in which case it’s usually a pass. I also have a curated Twitter feed of investors that tend to focus on business fundamentals. But that in itself creates somewhat of an echo chamber so you always need to be careful. Put simply though, the most interesting ideas to me are always in different markets around the world and are usually perceived as a boring business by the average investors. I own an Australian accounting firm, a UK funeral services company, a New Zealand media business, a regional US bank, and an Australian family law business — all of which have market caps of less than $500 million.

What are some interesting ideas on your radar now?

One position that I own is NZME (ASX: NZM — AUD$256 million), a legacy New Zealand media company. They have a few different business operations including a real estate listing business ‘One Roof’ that is somewhat similar to a Zillow for the American readers. But One Roof only contributes ~5% of total revenues and in my mind can be thought of as a zero, but possible free upside. The main businesses consist of two segments ‘audio & publishing.’ The audio segment is a traditional radio advertising model with some shift towards digital into podcasts. That audio segment is ~30% of revenues and again not a core part of the thesis. The main segment, and the segment of interest, is Publishing.  The appeal here is the shift from print to digital. The print model is a declining business that has led to and probably deserves a low multiple. It was a low-margin, somewhat capital-intensive business. The digital model, a subscription model, is a much higher margin and capital-light business model growing at impressive rates. NZME has recently announced deals with both Google & Facebook that will contribute a reasonable amount of EBITDA with zero CapEx — adding to the already expanding margins as the digital business takes over the print business.

NZME media reaches ~70% of the New Zealand population, which makes a shift towards a digital platform much more accessible with a low customer acquisition cost. Taking management’s lower end of the guidance at $67m in EBITDA for FY22, NZME is trading at ~5x EV/EBITDA. If we look at similar media comps that have transitioned towards a digital model, they trade typically between 10-12x EBITDA (much worse businesses than NZME in my opinion), whilst the New York Times trades >20x EBITDA. I would expect some multiple expansion as the market realizes this is no longer a dying newspaper business. In a nutshell, at the price I paid earlier in the year I am looking at a 10% dividend yield and a FCF yield of ~20%. That FCF is expected to grow ~50% YoY. Going into the investment, I could conservatively see 100% upside whilst a more bullish scenario could be >200%. But a lot has to go right for that scenario to play out. Some of that has now been priced in over the past couple of months but I am still a happy shareholder waiting to see how this plays out. The company has committed to 30-50% of FCF to be paid out as a dividend, so even if we don’t get a multiple re-rate and FCF doesn’t continue to grow, shareholders still receive a reasonable dividend yield that could justify an investment alone. This investment fits into my ‘special situation’ bucket (even though it’s not a traditional special situation), and it has a 1-5 year time horizon depending on how things progress. NZME may be slightly less appealing at the current price of ~$1.40 per share in comparison to the $1.20 I paid earlier this year. But for now, I am still a happy shareholder.

A company in my portfolio that is actually cheaper than when I invested is Dignity (London: DTY — GBP258 million).