A Deeply Humbling Business That Involves Extreme Discipline and Trust

This article by MOI Global instructor John Lewis is excerpted from a letter of Osmium Partners, based in Greenbrae, California.

Investing is a deeply humbling business that involves extreme discipline and trust. To this end we take maximizing shareholder value very seriously. It is our strong belief that to be a successful investment every business needs to have a massively engaged owner both outside and inside the board room. For our portfolio holdings we are the massively engaged owner outside the board room. For those that are successful allocators of capital, have faster than industry growth rates and better than industry profit margins, while we watch carefully, we don’t have much to say except well done.

From studies we have found that about 4% of publicly traded businesses create meaningful shareholder value above the indices. Our core focus is targeting the outstanding 4%, and not looking for fights/problems. For businesses that are off track to deliver meaningful returns to shareholders over a reasonable period of time, we take the NFL policy: Not For Long.

We believe the best action in most cases is to push for a sale of the business. The benefit is typically twofold: 1) a liquidity premium for change of control that is typically 40%+/- and 2) a competitive auction process whereby if a security is substantially mispriced the premium can be substantial. Two cases: ZIPR +130% premium to market and INTX +120% premium to market. Since 2002, well over 20 of our businesses have been acquired by mainly strategic buyers and we have appointed over 13 directors to public company boards.

We remain confident that many of our businesses are in the early phases of public market value creation as many have been investing heavily over the last few years. Most trade at a sharp discount to our estimate of private market value. We are also finding numerous low quality businesses that have unattractive results and exceptionally high valuations to short.

One key point to emphasize: Many of our companies have extraordinarily high incremental EBITDA margins with incremental revenue growth. Specifically, RST has guided to 65% of incremental revenue converting to operating cash flow, FC 45-50% of incremental revenue growth converting to cash flow growth, Spark is targeting margins in the 20-25% range. These companies are poised to drive very significant operating cash flow growth per share. They are all fairly meaningful businesses: Spark will spend $150 million a year in online member acquisition (guidance) with significant profit margins, RST is investing $140 million a year between R&D and Sales and Marketing or $6.00 per share, FC is generating $155 million in gross profit a year. These resources are being reinvested in very intelligent ways to really grow the businesses in high margin digital subscriptions in the coming years.

The old adage is that the stock market is a market of stocks. Some are quite expensive and risky and conversely there are pockets that trade at less than 30-40% of fair value. We do not want to tip our hand, but we are still finding what we consider extremely attractive reinvestments in the market. We are having a strong month in April (although two positions report at the end of April).

I read somewhere that in the U.S. there are always 100 million people looking to 1) lose weight 2) date and 3) find a new job. Essentially these are evergreen markets that frequently have high margins and large long term customer bases seeking solutions which Weight Watchers ($1.2 billion), Match ($17 billion), and LinkedIn ($27 billion acquisition by MSFT) have capitalized upon and become largely the household brands of choice.

We believe other long term journeys with the customer include Franklin Covey, Rosetta Stone (2-3K hours to learn a language and K-12 95% annual renewal rate in literacy), Travelzoo (the average subscriber stays 7.5 years), and Spark which taps into the evergreen market of 100 million people just in the U.S. looking to date (plus 29 other countries). Nearly all of our businesses have long term relationships with the end customer. We seek businesses that deliver a “value surplus” to their customers where they give more value than they get to create end of time customers vs. end of quarter customers.

Members, log in below to access the restricted content.

Not a member?

Thank you for your interest.  Please note that MOI Global is closed to new members at this time. If you would like to join the waiting list, complete the following form:

First name:

Last name:

Email address:

City / state / country:

Company:

How did you hear about MOI Global? Select Member referral Staff This website Media / Internet Other

If referral, please provide member's name:

Which of the following applies most closely to you? Select Investment Firm - Head Investment Firm - Analyst or PM Institutional Allocator - Firm C-Level Executive Institutional Allocator - Firm Employee Family Office - Head or Co-Owner Family Office - Employee Non-Investment Firm - C-Level Executive Non-Investment Firm - Employee Other

How do you hope to add value to the community?

Leave this field empty if you're human:

Certain factual and statistical (both historical and projected) industry and market data and other information contained herein was obtained by Osmium Partners from independent, third-party sources that it deems to be reliable. However, Osmium Partners has not independently verified any of such data or other information, or the reasonableness of the assumptions upon which such data and other information was based, and there can be no assurance as to the accuracy of such data and other information. Further, many of the statements and assertions contained herein reflect the belief of Osmium Partners, which belief may be based in whole or in part on such data and other information. The analyses provided may include certain statements, assumptions, estimates and projections prepared with respect to, among other things, the historical and anticipated operating performance of the companies. Such statements, assumptions, estimates, and projections reflect various assumptions by Osmium Partners concerning anticipated results that are inherently subject to significant economic, competitive, and other uncertainties and contingencies and have included solely for illustrative purposes. No representations, express or implied, are made as to the accuracy or completeness of such statements, assumptions, estimates or projections or with respect to any materials herein. Actual results may vary materially from the estimates and projected results contained herein. Past Osmium performance is not indicative of future results. Osmium takes concentrated positions. Osmium Partners disclaims any obligation to update this letter. A portion of the Partnership’s assets may from time to time be invested in securities that have limited liquidity. The Partnership’s investment strategy is to make concentrated investments in what it views as its best ideas. The Offering Memorandum and Limited Partnership Agreement offers a comprehensive overview of the risk factors involved in investing with Osmium Partners. The information contained herein is provided for informational purposes only. This is not an offer to sell, or a solicitation to buy, limited partnership interests in Osmium. An investment in Osmium is not suitable for all investors. Graphs/charts are provided for illustrative purposes only and should not be relied on to form an investment decision. Stocks mentioned in the newsletter do not constitute a recommendation to buy or sell the individual securities.